2.2.6 The firm from a legal angle

In essence a firm functions as a nexus of contracts: the firm is the contracting party that coordinates the activities of suppliers of inputs and of consumers of products and services (Kraakman, Armour et al. 2009, p. 6). Such a firm, or from a legal point of view a business corporation, has in the wording of Kraakman, Amour et al. a set of five core legal characteristics:

Large firms in general and especially firms with a stock quotation - firms this study is focused on - include those characteristics. Obviously other kinds of firms do exist (such as limited partnerships or foundations), however they do not embody all those characteristics simultaneously, nor are they the topic ofthe underlying research.

Legal personality (i) can be considered 'separate patrimony': the ability of the firm to own assets that are distinct from the property of other persons and that the firm is free to use, sell or pledge. The legal person becomes the contracting party distinct from the various individuals who own or manage the firm (Kraakman, Armour et al. 2009, p. 7) (Kraakman, Davies et al. 2004, p. 7). Although legal personality is a construction (a fiction), in reality the legal person is the bearer of duties and rights; the legal person can exercise its rights, and its duties are enforceable (Van Schilfgaarde and Winter 2009, p. 17). Limited liability (ii) implies that creditors are limited to making claims against the firm. Only claims concerning the assets of the firm are possible and not the assets of shareholders or managers in private. Together, limited liability and legal personality are regarded as a kind of default regime: the shareholder's personal assets are pledged as security to his personal creditors and the corporation's assets are reserved for its creditors (Kraakman, Armour et al. 2009, p. 9) (Kraakman, Davies et al. 2004, p. 9).

The characteristic of transferable shares (iii) implies that the shares in the firm are transferable to others. The shares are transferable by transactions on the stock exchange or transactions among limited groups of individuals. Transferable does not mean transferable shares under all circumstances (freely transferable shares): limitations or conditions are possible. Although the shares are transferable and constant shareholding changes are possible, within the firm a centralisation of management (iv) exists to coordinate the productive activity (Kraakman, Armour et al. 2009, p. 11). Part of the decision-making power is delegated to the management which has a specific board structure. This board is separated from the operational managers of the firm, consists of more than one member, has a one-tier or two-tier board structure, is distinct from the shareholders, and to a considerable extent is elected by them. The ownership of a firm can be divided into two key elements: the right to control the firm and the right to receive the firm's net earnings. In investor owned-firms (v) those elements are tied together to the investment of capital in the firm. The right to control the firm (for example the right to vote, to approve major decisions or to elect directors) and the right to receive the firm's net earnings (for example dividends) are - in general and exceptions aside - proportional to the amount of capital invested in the firm (Kraakman, Armour et al. 2009, p. 13). The more capital is invested in the firm, the larger the control rights and the more of the firm's earnings are received. The five core legal characteristics of firms discussed above are laid down in detail in (inter)national legislation and constitute corporate law. According to Kraakman corporate law has two general functions: "first, it establishes the structure ofthe corporate form as well as ancillary housekeeping rules necessary to support this structure; and, second, it attempts to control conflicts of interest among corporate constituencies (...). These conflicts all have the character of what economists refer to as 'agency problems' or 'principal-agent'problems" (Kraakman, Armour et al. 2009, p. 35).

This quote beautifully links the judicial point of view concerning a firm to the economical view. A firm has a set of five core legal characteristics that are further clarified in corporate law which has the function of controlling the conflicts of interests (i.e. agency problems). Kraakman et al. note that within a firm three principal conflicts can exist (see II in figure 2.1a). The conflict between the firm's owners (the shareholders) and the hired managers involves the first possible agency problem. The interests of the principals and agents likely do not align because the shareholders are interested in the capital return of their invested money and the managers aim for a high salary, luxury and status. The second agency problem regards the conflicts between shareholders who own the majority of controlling interests in the firm and the minority or non-controlling shareholders. The controlling shareholders have the possibility of abusing their powers against the minority shareholders. In the case of investor-owned firms (see (v) above), little money invested means few control rights to avoid abuse by controlling shareholders. The third and last major agency problem could involve conflicts between the firm itself and other contracting parties (such as employers, creditors and suppliers). A firm can behave opportunistically towards these principals: for instance misuse its powers towards employers or mislead consumers whilst knowing these principals are partly dependent on the firm (Kraakman, Armour et al. 2009, p. 35). Corporate law aims to control these three agency problems. The possibilities that exist to solve, or at least to decrease those problems are explained below and also in what manner this already is or can be laid down in (inter)national corporate law.