A TEAM PRODUCTION
THEORY OF
CORPORATE LAW
Margaret Blair
& Lynn Stout 1999
PRINCIPAL-AGENT MODEL
 Explanation of public corporation ownership
 Shareholders (principal) own corporation and hire officers (agents)
 Goal of corporation is to increase shareholder wealth
 Corporation law is used to reduce “agency costs” and maintain
faithfulness of directors/officers (agents) to the principals
 E. Fama, Agency Problems and the Theor y of the Firm (1980)
 Advocated the separation of ‘management’ and ‘risk bearing’ roles
 Used insights provided by Alchian and Demsetz ( 1972) to establish
agent and principal roles
PRODUCTION, INFORMATION COSTS,
AND ECONOMIC ORGANIZATION
 Published in 1972 in AER
 Armen A. Alchian (University of California, Los Angeles)
 Harold Demsetz (University of California, Los Angeles)
 What makes a team?
 The use of several resource types
 The product does not equal a sum of individual contributions
 Not all resources used by the team belong to one person
 Think about two people lifting a 100lb box
 Does each person lift 50lbs?
 Does one lift 75lb and the other 25lb?
PRODUCTION, INFORMATION COSTS,
AND ECONOMIC ORGANIZATION
 Shirking: A problem with the a team
 Fixed by using a “Monitor”
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Residual claimant
Observe input behavior
Central party common to all contracts
Ability to alter team membership
Ability to sell these rights (ownership)
 When does a team become a firm?
 When it is possible to increase production through a team
 When it is economical to estimate marginal productivity via
observation
A TEAM PRODUCTION THEORY OF
CORPORATE LAW
 Blair and Stout (1999) refute application of Principal - Agent
Model and corollary that corporations ’ primary goal is to
maximize shareholder wealth
 Model applies to firms in general, but provides no special insights
into public corporations
 Team Production Approach
 Where a productive activity requires the combined investment and
coordinated effort of two or more individuals or groups
 Issues occur in form of ex ante (agreement) shirking and ex post
(agreement) opportunism
A TEAM PRODUCTION THEORY OF
CORPORATE LAW
 Issues occurring under Team Production Approach
circumvented by corporate law as a “Mediating Hierarchy”
 Formation of Public Corporation provides a hierarchy existing
outside original production team
 All team members “agree to give up control rights over the output
from the enterprise and over their firm-specific inputs” (i.e. to a BoD)
 No single team member is a “principal” having right of control
 Solves three primary issues with Team Production Approach:
 Convoluted information-gathering and decision-making
 Shirking and opportunism via principal-agent contracts
 Disputes between team members regarding allocation of duties and
rewards
A TEAM PRODUCTION THEORY OF
CORPORATE LAW
 A public corporation is not simply a “bundle of assets” under
common ownership, but rather a complex collection of
agreements between team members working together for
mutual gain: “A nexus of firm -specific investments.”
 Control over assets and outputs are mutually given up in order
to reduce shirking and rent -hoarding via implementation of an
internal mediating hierarchy
A TEAM PRODUCTION THEORY OF
CORPORATE LAW
KEEPING DIRECTORS FAITHFUL
 Influences of Corporate Law and Culture
 Directors motived to do well if they want to maintain their positions
 Directors also motivated by desire to maintain reputations
 Corporate law limits ability of directors to serve their own interests
 Directors unable to appropriate corporate assets beyond established
compensation
 Assumption exists that if directors cannot serve their own interests, they
will serve the interests of their firm (Is this a valid assumption?)
 Corporate culture motivates directors to serve as fair trustees of firm
 Serves role of benevolent/trusted mediator implied in all contract theory
MEDIATING HIERARCHY THEORY
 May only be a “second -best” solution to relegation of asset
and firm output control
 Given certain constrains, a board of directors may offer substantial
reduction in inefficiencies and rent loss
 Mediating Hierarchy Theory expands on legal view of
corporation as a “nexus of contracts” (explicit and implicit)
 Highlights importance of team production dynamics within public
firms
 Establishes tools to understand political nature of a corporation
 Explains role of BoD in determining firm focus on
employees/shareholders