Making a Difference: The Contractual Contributions of Easterbrook and Fischel, 59 University of Chicago Law Review 1391 1992), reprinted in 35 Corporate Practice Commentator 65 (1993)
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George Stigler reportedly once toasted Milton Friedman by saying: "Milton, if you hadn't been born, it wouldn't have made any difference." This multi-edged compliment might have implied that even if Friedman had not been born, the market place of ideas would have supplied his analysis. Judge Frank Easterbrook and Professor Daniel Fischel do not have the same faith in the market place of ideas for corporate law. Their view instead is that academics (and regulators) "are rewarded for novel rather than accurate beliefs".

Academics face weaker motivations than market participants because they don't suffer if they lobby for inefficient rules. Given these weakened incentives, the publication of The Economic Structure of Corporate Law is an especially noteworthy accomplishment. Easterbrook and Fischel have made a difference in our understanding of corporate law. By illuminating the economic structure of corporate decisions, their book provides a powerful guide to legislatures and particularly to courts crafting corporate rules.

For readers who are put off by lavish praise I recommend skipping to the next paragraph. This may be the best book ever written about corporate law. The authors write clearly and creatively. Few corporate scholars today use the verb forms "crank up" or "fork over". Theirs is a style that has not been worn down by excessive law review editing.

At several points, the book stimulates readers by posing perverse conundrums. For example, in exploring the contours of the business judgment rule Easterbrook and Fischel ask: why the same judges who decide whether engineers have designed the compressors on jet engines properly, whether the farmer delivered pomegranates conforming to the industry's specifications, and whether the prison system adversely affects the mental states of prisoners cannot decide whether a manager negligently failed to sack a subordinate who made improvident loans. Instead of asking why so many businesses incorporate in Delaware, Easterbrook and Fischel ask why so few incorporate there. These conundrums propel the reader to find out if the authors really have an answer. It is fun to read.

It is also a book that needs to be read, even if you've already studied a number of Easterbrook and Fischel's well-known articles. The book is not merely a compilation. I can verify their claim in the preface that "sections have been written from scratch, and all portions of the book (including those based on articles) have been substantially revised and updated". The book--much more than the individual articles--integrates, for example, how the disciplining effects of debt, or shareholders' ability to diversify, affects the choice of optimal corporate rules.

The book also includes an excellent introduction to the technique of analyzing abnormal stock returns to measure how the market values particular corporate events. The book surveys the results of these "event" studies to measure the impact of a host of takeover maneuvers. This emphasis on empiricism is an admirable part of the authors' conviction that the choice of optimal rules will often turn on the relative size of competing effects. For example, in analyzing mandatory disclosure rules in securities law, Easterbrook and Fischel refreshingly admit that "we are left, for the moment at least, with arguments rather than proof". The book thus avoids a common complaint about law efficiency analysis, because it does more than present a priori theories. Indeed, the authors stress at the outset: "The best structure cannot be derived from theory; it must be developed by experience".

More importantly, the book displays how the authors' views on corporate law have evolved to a more detailed and balanced approach. Their strong-form belief that legislatures pass efficient statutes is now tempered by their acknowledgment that managerial "opportunism and the receptivity of state legislators to campaign contributions" can lead to inefficient legislation. Their strong-form belief that target managers should have an immutable duty to remain passive in the face of tender offers is now tempered by their acknowledgment that shareholders, at least at the time of the initial incorporation, should be allowed contractually to give their managers the ability to resist. In short, the book is even more reasoned and reasonable than the original articles. State legislatures sometimes pass inefficient laws; mandatory duties to disclose certain types of information may be efficient. The book is not a simple-minded paean to either the status quo or freedom of contract, even though the book argues that the contractual status of corporate law is by and large optimal. By openly discussing exceptions to their general thesis, they more fully reveal the strength of and the limits to their argument.

Even with the substantially new and evolving materials in Easterbrook and Fischel's work, this is a difficult review to write. The individual articles that form the starting point of several chapters have given rise to an enormous literature and several independent debates. It is difficult to add to a slate that is far from blank. This review will focus on two overarching claims of the book: (1) the normative claim that efficient corporate law will usually be the set of hypothetical default terms that firms would contract for, and (2) the causal claim that competition among the states will generally drive corporate rules toward efficiency. In particular, I will argue that, while the hypothetical contract standard provides an important normative benchmark, it does not insure efficiency. The hypothetical contract is inconsistent with some of their examples of efficient default choice, and is an underspecified standard for legislative and judicial action. Instead of directly assessing the efficiency of the contractual equilibria induced by alternative default rules, the authors continue to run the efficiency race without a full stable of horses.

This review also suggests that the economic structure of contracting places important limits on the ability of legislatures to compete for corporate charters. The very barriers to private contracting also disempower state legislatures from providing superior contracts. Common law courts are the only institution that could possibly fill gaps better than the firms themselves. But the primacy of the common law in the competition for corporate charters is largely divorced from the "race to the top" as a causal mechanism that insures efficiency. Thus, the causal mechanism for the provision of efficient gap-fillers remains a topic for further research.

For those that expect a roadmap, Section I addresses the authors' claims of the supremacy of default rules based on hypothetical contract provisions. Section II considers the usefulness of alternative default rules in two key areas of corporate law. Section III addresses the authors' causal claim concerning the incentives and behavior of state legislatures.


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