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The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities

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The Failure of Corporate Law returns corporate law to a system in which the public has a greater say in how firms are governed. Kent Greenfield maintains that the laws controlling firms should be much more protective of the public interest and of the corporation's various stakeholders. Only when the law of corporations is evaluated as a branch of public law-as with constitutional law or environmental law-will it be clear what types of changes can be made in corporate governance to improve the common good. Greenfield proposes changes in corporate governance that would enable corporations to meet the progressive goal of creating wealth for society as a whole rather than merely for shareholders and executives.

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Editorial Reviews

William Greider

“Kent Greenfield takes us into fertile and promising territory that has been generally neglected by both politics and social reform—the corporation as a potential engine of progress. His critique is grounded in the extraordinary fallacies and failures of corporate law, and he demonstrates with remarkable clarity how a series of essential changes in the premises and obligations of the corporation can turn the nature of the beast in very positive directions.”

Joseph William Singer

“With relentless logic and impeccable evidence, Kent Greenfield presents a stunning critique of the shareholder supremacy theory of corporate law, complete with practical and progressive law reform proposals designed to get so-called public corporations back into the business of promoting the public interest. He challenges conventional wisdom to show how corporations can be managed to promote the interests of all stakeholders, including shareholders, workers, creditors, and the communities in which corporations operate, while promoting both profits and social welfare. Arguing for a broad definition of costs and benefits, this book persuasively lays out new principles for corporate law designed to serve the interests of society as a whole, while promoting both efficiency and justice.”--Joseph William Singer, Bussey Professor of Law, Harvard Law School

Gordon Smith

“Kent Greenfield has emerged as the most creative thinker in the contrarian school of progressive corporate law. At the heart of this progressive vision is the notion that corporate law matters. His version of the progressive argument that corporate law is shareholder-centric and needs to expand its borders to include employees and other nonshareholder constituencies is creative and should provoke lively debate between traditional and progressive corporate law scholars for years to come.”--Gordon Smith, University of Wisconsin Law School

William S. Laufer

“Kent Greenfield makes a compelling case for progressive corporate law reform in The Failure of Corporate Law.  Through careful deconstruction of a traditional and yet fundamentally failed body of law, Greenfield offers an impressive reconstruction that hinges on a simple but truly profound claim—corporate law is vitally important. With so many fundamental questions about the role of corporations left largely unattended, at a time of dramatic socioeconomic change that crosses all borders, Greenfield offers a rich and thoughtful prescription for some of the most important and powerful institutions of our time. The Failure of Corporate Law is an exacting and challenging contribution to the study of corporate law and corporate governance.”--William S. Laufer, author of Corporate Bodies, Guilty Minds

Ethical Corporation - Joseph Singer

"A stunning critique of the shareholder supremacy theory of corporate law, complete with practical and progressive law reform proposals designed to get so-called 'public' corporations back into the business of promoting the public interest. . . . Arguing for a broad definition of costs and benefits, Greenfield persuasively lays out new principles for corporate law designed to serve the interests of society as a whole, while promoting both efficiency and justice. . . . Simply the best and most well-reasoned progressive critique of corporate law yet written."
Law & Politics Book Review - Benedict Sheehy

“Greenfield commences with a reconsideration of the basic and generally accepted purposes and norms of law. The result is as startling as it is enlightening. . . . A seminal piece of writing that evidences dominance of a vast range of ideas, research, and critical thinking, and puts it into a coherent, well argued, accessible whole in a mere 243 pages. It merits a place alongside Berle and Means, Easterbrook and Fischel, and indeed, one can but hope that it becomes the touchstone for further corporate law reform globally.”
Ethical Corporation
A stunning critique of the shareholder supremacy theory of corporate law, complete with practical and progressive law reform proposals designed to get so-called 'public' corporations back into the business of promoting the public interest. . . . Arguing for a broad definition of costs and benefits, Greenfield persuasively lays out new principles for corporate law designed to serve the interests of society as a whole, while promoting both efficiency and justice. . . . Simply the best and most well-reasoned progressive critique of corporate law yet written.

— Joseph Singer

Law & Politics Book Review
Greenfield commences with a reconsideration of the basic and generally accepted purposes and norms of law. The result is as startling as it is enlightening. . . . A seminal piece of writing that evidences dominance of a vast range of ideas, research, and critical thinking, and puts it into a coherent, well argued, accessible whole in a mere 243 pages. It merits a place alongside Berle and Means, Easterbrook and Fischel, and indeed, one can but hope that it becomes the touchstone for further corporate law reform globally.”

— Benedict Sheehy

Harvard Law Review

"For the sympathetic reader, Professor Greenfield's book is heartening. For the unsympathetic reader, it offers a worthy target."
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Product Details

  • ISBN-13: 9780226306933
  • Publisher: University of Chicago Press
  • Publication date: 2/1/2007
  • Edition description: New Edition
  • Pages: 257
  • Product dimensions: 6.32 (w) x 9.32 (h) x 0.89 (d)

Meet the Author

Kent Greenfield is professor of law at Boston College Law School and served as a law clerk under Supreme Court Justice David H. Souter.

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Read an Excerpt

The Failure of Corporate Law


Copyright © 2006

The University of Chicago
All right reserved.

ISBN: 978-0-226-30693-3


The horrors of September 11, 2001, are still fresh in our hearts and minds, and not just for those who lost dear ones. The war in Iraq is even fresher. These are the two biggest news stories of the new millennium so far, and they are inextricably linked-at least in the sense that the horrors of September 11 made the Iraq war politically possible. Another of the big news stories of the last few years was the corporate scandals of 2002. These scandals brought about the largest bankruptcy in history, a host of criminal convictions, billions of dollars in shareholder losses, the evaporation of thousands of jobs, and the spoiling of the public's confidence in the stock markets and corporate accounting practices. While much has been written about the connection between the first two events, little has been said about their connection to the corporate scandals and to corporate law more generally. Unfortunately, there is something to say.

At first glance, it seems obtuse or heartless to talk about corporate law in connection with the attacks of September 11 and the war in Iraq. It is indeed obtuse or heartless to say that corporations or corporate law caused the events of September 11 or brought about the war. It is, however, correct to say that corporations and corporate law helped create both the context in which the tragedy of September 11 could occur and the contours of the nation's response to it. Corporate law made the tragedy of September 11 more possible, and thus made the war in Iraq more likely as well. This connection between corporate law and the attacks of September 11 is a worthy case study in the flaws of U.S. corporate governance.


Soon after the attacks, many analysts pointed fingers at slipshod airport security as one of the necessary conditions for the attacks. It may be unfair to assert that the security personnel working at the airports from which the hijacked flights departed had failed in their jobs in the strict sense of the word. The hijackers used pocket knives and box cutters to hijack the planes, neither of which was prohibited by airline regulations at the time. Having said that, it does not require a leap of logic to assert that the hijackings could have been prevented by a more attentive security staff (is it not unusual to have several passengers carrying box cutters on the same flight?) or security regulations or policies that made safety a higher priority (why did airlines not bar passengers from carrying box cutters?). So the question arises: why was security so porous that morning?

One possible answer would be that security was flawed that morning because air travelers did not want or feel they needed anything better. Airport security on September 11 was largely the responsibility of the airlines and of security firms the airlines hired. Because airline companies are for-profit corporations operating in a "free market," traditional economic theory would suggest that the market provided what the consumers desired. If travelers had truly wanted more safety, they would have demanded it and the airlines, in turn, would have given travelers what they demanded. The cost of airfares would have necessarily increased to pay for the additional security. To traditional economists, the fact that security was not any better on that day means simply that the airlines' customers were not willing to pay what it would cost to have the kind of screening that would deter the hijackings.

If this economic theory is correct, the correct public policy response to September 11 would be to trust the market. If people wanted to have better airport security, they would demand it. Air travelers willing to pay more in exchange for additional safety would provide the economic incentive for airlines to respond to travelers' desires, and airlines would start competing to provide additional safety and security.

It is striking that among all the major investigations and analyses of the hijackings, not a single one proposed that we should simply allow the market to work. Instead, the very first public policy response to the hijackings was just the opposite. Barely two months after the attacks, Congress voted to federalize the passenger screening function, taking that portion of the responsibility for airport security away from the airlines and giving it to a newly created federal agency.

Of course, anyone who travels knows that the new agency is not without its own problems-going through airport security remains a frustrating, inefficient, and occasionally infuriating task. No one has seriously suggested, however, that the security function be given back to the airlines. Few trust the economic theory that much. Even though we know the government agency has its own serious flaws, it is as if September 11 helped us realize at a fundamental level that we cannot trust airlines to provide the kind of safety we now know we need.

This is why September 11 is not only a story of how fanatic zealots committed murder on a grand and horrific scale. It is also a story of market failure, of how the market for air travel failed to provide not only what we needed but also what we would have wanted had we known how unsafe we really were. This begs the question, then, of why such a market failure occurred. Why did the airlines not provide better safety? Or more fundamentally, why did the free market not provide better safety?

To answer these questions one needs to recall that the airlines contracted out the responsibilities of staffing the security checkpoints to private, for-profit security firms. These firms bid on these contracts on the basis of cost. It is no surprise, then, that the screening firms paid their workers little more than minimum wage, which made it difficult to attract the best people. Turnover among screeners averaged over 125 percent annually, meaning that on average a new person was hired for every position more than once per year. Because of the low pay, many of the screeners had to work at some other job as well, making them exhausted and unable to concentrate effectively. Many of the contractors did not offer health insurance or paid sick days. As a result, according to the New York Times, "many screeners report[ed] to work sick and struggled to remain alert." The fixation on keeping costs low meant that training of checkpoint screeners often consisted of little more than watching a videotape and receiving about one hour of on-the-job training. A government report issued barely 18 months before September 11 warned that the screeners' low pay, poor training, and high turnover posed real risks to the safety of air travel.

Sadly, the risks were largely ignored until it was too late. Only after the tragedies of September 11 did people finally realize that the fixation on low costs was a massive error.

It is worth thinking about why screeners' wages were so low to begin with. One thing is clear, at least in hindsight: wages were not low because travelers were unwilling to pay a few dollars more for airline tickets so that the security firms could pay for good training and decent wages for screeners. In this respect, the market failure was in large part an information failure. Most people who traveled simply did not know the risks and did not know how flawed the screening was. To use myself as an example: Before September 11, 2001, I did not know that airport security was the responsibility of the airlines, and I traveled often. I assumed travel was safe. I assumed that someone-the government, really-made sure that airport security was tight. I was mistaken, as many were.

One reason why we did not know that air travel was unsafe was that the airlines themselves did not have the incentive to tell us. Because their interest was to maximize air travel, no airline had any reason to warn travelers that it was possible for teams of fanatics to use box cutters to hijack planes, fly them purposefully off course for more than an hour, and propel them like missiles into skyscrapers. Much of the information about the risks of air travel was in the hands of the airlines, and their desire to make money meant that there was no way they were going to tell us about those risks.

Moreover, even if one of the airlines had wanted to distinguish itself as the "safe" airline, it would likely have failed. The reason is that such marketing would have had little meaning to travelers. Because most travelers assumed air travel was safe, it would have been difficult to make believable claims about the distinctiveness of one airline over another, at least without panicking the traveling public. In other words, no one traveling on September 11 really knew how dangerous it was. Some of the risks were unknowable, to be sure. But the risks that were known were not known by the travelers, and the market did not provide an incentive to give travelers that knowledge.

The market failure was more than an information failure, however. Even if I had known that screeners were poorly paid and trained and that security was flawed in other ways, my options would have been extremely limited. I could not have volunteered to pay more for my air travel in exchange for more security. A travel agent would have chuckled at such a request. I could not have sought out a safer airline, since all the airlines (at least in the United States) provided basically the same apparent level of safety. Even if I had known how risky air travel really was, the market would not have provided me a way to satisfy my desire for a safer trip.

What's more, even if all travelers had wanted safer air travel, it is unlikely that the market would have provided it. The only way travelers could have expressed their preferences in the market would have been to stop buying plane tickets. Faced with the decrease in demand, it would have been much easier for the airlines to compete on the basis of price than on the basis of safety. Improvements in airport screening would essentially inure to the benefit of all airlines, and no individual airline would benefit more than any other. It would have been more cost effective for each airline to distinguish itself by offering lower prices or more convenient schedules.

Similarly, contractors providing the security for the airlines did not have good incentives to compete for their contracts on the basis of their ability to provide better security. Contractors paying their employees more to provide better safety would be putting themselves at a competitive disadvantage. Because safety improvement would be a collective good and largely unseen by the ultimate customer, the individual airlines would be uninterested in paying the contractors more so that they could pay the screeners more.

All this is to say that the market for air travel did not provide, and probably could not have provided, the level of security we needed. Even now, when air travelers are very much aware of the risks of air travel, airlines in the United States still are not competing on the basis of safety. The responsibility for security was moved into the hands of the government, and airlines are competing on the same grounds as before.

There is an additional puzzle. One wonders why shareholders of United and American and other airlines failed to demand that the airlines be more secure. In hindsight, better security would likely have been a good investment financially. After September 11, airlines suffered dramatic financial losses because of the drop in the number of passengers who were willing to travel by air. According to the Wall Street Journal, United Airlines alone was losing $20 million a day six weeks after the disaster.

There are a number of reasons why shareholders did not prevent the disasters. Quite likely, many of the airlines' shareholders simply did not know that they held airline stock. Their shares might have been held in trust, with an institution, or in a pension or mutual fund. For those shareholders who did know, it is probable that they held the same assumptions as the rest of us-that air travel was safe and that there was no need to worry that such a disaster would occur. Shareholders might also have been making a calculated judgment that greater security would not be a good financial investment, on balance. Last, and most likely, shareholders simply might not have thought about it. Shareholders of large public companies are not typically managers-the management of the firm is in the hands of the board and senior employees. Shareholders have little or no say in specific decisions that a company makes and little or no knowledge of the management issues a company faces.

But even if shareholders had known of the potential security problems and wanted to do something about it, they would not have had any more genuine options than air travelers themselves. They could have raised the issue at an annual meeting of the shareholders, but issues about safety would have likely been seen as management prerogative. The only other option for concerned shareholders would have been to sell their stock. That would have protected the shareholder from the financial risk of air disasters. But it would not have had any effect on company policy, since the company would have no way of knowing that the reason a shareholder sold her stock was to protest poor security.

So no one-travelers, shareholders, the airlines, or the screening firms-had any real ability to improve airline security by acting through the market. We had to depend on nonmarket forces, that is, government intervention, to correct the flaws in airline security that we learned about in such a horrible way. The market was powerless to provide what we all realize now we so desperately needed.


Consider again the position of a hypothetical, fully informed shareholder in United Airlines before September 11. Because this person had no real way to affect the security of air travel, even knowing it was flawed, the only economically "rational" reason to hold onto the stock was as a wager that cheap, imperfect security was a better financial investment than more expensive, less imperfect security. This would seem a crass calculation.

Corporate law adopts the fiction that shareholders make exactly this type of decision about every stock they own, regardless of whether real shareholders ever, in fact, are this informed or make such a callous calculation. Because shareholders can learn about companies from information freely available and can sell stock in a fluid securities market, it is assumed that those who hold a company's stock voluntarily accept the risk-return ratio. It is also assumed that shareholders care about only one thing-making money. Shareholder preferences are assumed to be homogeneous, and the law and market are arranged to make sure that management hews closely to this one assumed concern. If shareholders do not like it, they can sell their shares (or so the story goes). The notions that shareholders know everything important about a firm and care about only one thing are fictions, to be sure. But these fictions allow corporations to be characterized as voluntary, consensual organizations. In Easterbrook and Fischel terms, "the corporation is a voluntary adventure."

The assumption of consent does not stop with shareholders. Everyone else involved in a company-from creditors to employees, from customers to communities-is also assumed to be consenting to their involvement in a meaningful way. This is what the law-and-economics scholars mean when they say a corporation is a "nexus of contracts." No one is coerced into taking part in the firm. If the parties dislike the terms of the "contract" between themselves and the company, they can leave. Not only can shareholders sell their shares, but employees can quit, managers can find a different company to manage, suppliers can sell their goods elsewhere, creditors can sell their bonds. According to these contractarian theorists, the corporate contract does not affect anyone not a party to it. Easterbrook and Fischel make the claim explicitly: "The corporation's choice of governance mechanisms does not create any substantial third-party effects-that is, does not injure persons who are not voluntary participants in the venture." In economic terms, the claim is that the corporate contract does not create any "externalities."


Excerpted from The Failure of Corporate Law by KENT GREENFIELD Copyright © 2006 by The University of Chicago. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

Part One - Fundamental Flaws
1. September 11 and Corporate Law
2. Corporate Law as Public Law
3. Workers, Shareholders, and the Purpose of Corporations
4. Corporations and the Duty to Obey the Law
5. Democracy and the Dominance of Delaware
Part Two - Progressive Possibilities
6. New Principles, New Policies
7. Corporate Governance as a Public Policy Tool
8. Workers and Corporate Fraud
9. Irrationality and the Business Judgment Rule
Postscript: Getting Real about New Possibilities
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