Corporate law and Residual Claimants

Bernard Black

Berkeley Olin Program in Law & Economics, Working Paper Series from Berkeley Olin Program in Law & Economics

Abstract: Common shareholders are not the only important residual claimants on a firm's income. Instead, other claimants, including employees, creditors, preferred shareholders, option holders, suppliers, customers, and the government (as tax collector) also often gain substatially when the firm does well, and suffer when the firm does badly. The conventional contractarian explanation for why only common shareholders vote - that they are the firm's principal residual claimants - thus fails to fit the facts. I propose a refraiming of the question - why do only common shareholders vote - as several related questions. In a world where common shareholders, employees, creditors, preferred shareholders, and others are all important residual claimants, why do common shareholders receive voting control rights, some creditors receive default-based and nonpayment-based control rights, other creditors receive only nonpayment-based control rights, preferred shareholders receive weak, situation-limited voting rights, and employees, suppliers, customers, and the government receive no formal control rights (unless they happen to also own common shares)? In answering these interrelated questions, the emphasis shifts from explaining why residual claimants receive control rights to explaining why they often do not. Why are residual interests so much more widely distributed than formal control rights? Why do employees, suppliers, customers, and the government receive no formal control rights even though they are often major residual claimants? Why do preferred shareholders receive voting rights that are almost uselessly weak? Why do trade creditors receive only nonpayment rights while banks receive stronger default rights, when standard contractarian theory - in which formal control flows from residual interest - would predict the opposite outcome? The article sketches some possible approaches to answering these questions.

Date: 1999-03-01
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