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ISSN 1936-5349 (print)
ISSN 1936-5357 (online)

HARVARD
JOHN M. OLIN CENTER FOR LAW, ECONOMICS, AND BUSINESS

AGENCY PROBLEMS, LEGAL
STRAGEGIES AND ENFORCEMENT

John Armour, Henry Hansmann, Reinier Kraakman

Discussion Paper No. 644
7/2009

Harvard Law School
Cambridge, MA 02138

This paper can be downloaded without charge from:
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This paper is also a discussion paper of the
John M. Olin Center’s Program on Corporate Governance.

Agency Problems, Legal Strategies, and
Enforcement
John Armour
University of Oxford - Faculty of Law;
Oxford-Man Institute of Quantitative Finance;
European Corporate Governance Institute (ECGI)

Henry Hansmann
Yale Law School;
European Corporate Governance Institute (ECGI)

Reinier Kraakman
Harvard Law School;
John M. Olin Center for Law;
European Corporate Governance Institute (ECGI)
Abstract: This article is the second chapter of the second edition of "The Anatomy of Corporate Law: A Comparative and Functional Approach," by Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda and Edward Rock (Oxford University Press 2009). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. In its second edition, the book has been significantly revised and expanded.

"Agency Problems and Legal Strategies" establishes the analytical framework for the book as a whole. After further elaborating the agency problems that motivate corporate law, this chapter identifies five legal strategies that the law employs to address these problems. Describing these strategies allows us to more accurately map legal similarities and differences across jurisdictions. Some legal strategies are "regulatory" insofar as they directly constrain the actions of corporate actors: for example, a standard of behavior such as a director's duty of loyalty and care. Other legal strategies are "governance-based" insofar as they channel the distribution of power and payoffs within companies to reduce opportunism. For example, the law may accord direct decision rights to a vulnerable corporate constituency, as when it requires shareholder approval of mergers. Alternatively, the law may assign appointment rights over top managers to a vulnerable constituency, as when it accords shareholders - or in some jurisdictions, employees - the power to select corporate directors. We then consider the relationship between different enforcement mechanisms - public agencies, private actors, and gatekeeper control - and the basic legal strategies outlined. We conclude that regulatory strategies require more extensive enforcement mechanisms - in the form of courts and procedural rules - to secure compliance than do governance strategies. However, governance strategies, for efficacy, require shareholders to be relatively concentrated so as to be able to exercise their decisional rights effectively.

JEL Classifications: D23, G32, G34, G38, K22, M14

1

2 Agency Problems and Legal Strategies
© 2009 JOHN ARMOUR, HENRY HANSMANN, AND
REINIER KRAAKMAN

2.1 THREE AGENCY PROBLEMS
As we explained in the preceding Chapter, 1 corporate law performs two general functions: first, it establishes the structure of the corporate form as well as ancillary housekeeping rules necessary to support this structure; second, it attempts to control conflicts of interest among corporate constituencies, including those between corporate ‘insiders,’ such as controlling shareholders and top managers, and ‘outsiders,’ such...
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