April 19, 2005
Fiduciary Law & Entrepreneurship
Posted by Gordon Smith

On Monday I presented a lecture on the topic of "Fiduciary Law & Entrepreneurship." Here is the introduction:

In a series of articles beginning in 1997, economists Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny (“LLSV”) created a sensation among legal academics by proposing that “countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets.” As if that were not enough, LLSV then took their speculations a step further. Relying on evidence that robust capital markets contribute to economic growth, LLSV concluded that legal protections for minority investors are linked to economic development.

Subsequently dubbed the “law matters” thesis, the link between legal protections for minority investors and economic development has remained enticing to legal scholars, despite withering attacks on LLSV’s methodology. While LLSV approach legal issues with breathtaking naiveté, my purpose today is not to attack their methodology, but to examine their logic and to theorize about possible links between fiduciary law and entrepreneurship. In other words, I ask the question: does fiduciary law matter to entrepreneurship?

The role of fiduciary law in the LLSV story is unclear. Indeed, they do not mention the word “fiduciary” at all, at least in their initial articles on law and finance. Nevertheless, I think there is widespread agreement among legal academics that legal protections for minority investors must include fiduciary duties. My lecture was the first step in an attempt to describe the role, if any, played by fiduciary law in economic development.

I am a skeptic on many grounds, but two stand out. First, the connection that LLSV hypothesize entails an assumption that common law systems offer minority investors more protections than civil law systems offer. Subsequent work by other economists has explored various possible reasons that this might be true. Among those is the notion that common law courts are more adaptable than civil law courts. Although this is the stereotype, I have my doubts based on many conversations with civil lawyers. I am currently working on another project in which I hope to explore that issue more systematically.

Second, even if common law courts can be shown to be more flexible than civil law courts, there remains the important issue of whether common law judges will use that flexibility to protect minority stockholders. Why LLSV assume that courts will act in this way is unclear. Moreover, if you have studied Delaware corporate law at all, you probably recognize that the assumption of a minority-leaning judiciary is highly suspect.

I could say a lot more, but I plan to write something about this, so I will save the rest for the paper.

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