Law and the Rise of the Firm

69 Pages Posted: 3 Jan 2006

See all articles by Henry Hansmann

Henry Hansmann

Yale University - Law School; European Corporate Governance Institute (ECGI)

Reinier Kraakman

Harvard Law School; European Corporate Governance Institute

Richard Squire

Fordham University School of Law; European Corporate Governance Institute (ECGI)

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Date Written: January 2006

Abstract

Organizational law empowers firms to hold assets and enter contracts as entities that are legally distinct from their owners and managers. Legal scholars and economists have commented extensively on one form of this partitioning between firms and owners: namely, the rule of limited liability that insulates firm owners from business debts. But a less-noticed form of legal partitioning, which we call "entity shielding," is both economically and historically more significant than limited liability. While limited liability shields owners' personal assets from a firm's creditors, entity shielding protects firm assets from the owners' personal creditors (and from creditors of other business ventures), thus reserving those assets for the firm's creditors. Entity shielding creates important economic benefits, including a lower cost of credit for firm owners, reduced bankruptcy administration costs, enhanced stability, and the possibility of a market in shares. But entity shielding also imposes costs by requiring specialized legal and business institutions and inviting opportunism vis-a-vis both personal and business creditors. The changing balance of these benefits and costs helps explain the evolution of legal entities across time and societies. To both illustrate and test this proposition, we describe the development of entity shielding in four historical epochs: ancient Rome, the Italian Middle Ages, England of the 17th-19th centuries, and the United States from the 19th century to the present.

Keywords: Corporations, Partnerships, Companies, History of the Firm, Entity Shielding, Limited Liability, Legal Entities, Bankruptcy

JEL Classification: D23, G32, G33, K22, L22, N23

Suggested Citation

Hansmann, Henry and Kraakman, Reinier H. and Squire, Richard C., Law and the Rise of the Firm (January 2006). ECGI - Law Working Paper No. 57/2006, Yale Law & Economics Research Paper No. 326, Available at SSRN: https://ssrn.com/abstract=873507 or http://dx.doi.org/10.2139/ssrn.873507

Henry Hansmann (Contact Author)

Yale University - Law School ( email )

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European Corporate Governance Institute (ECGI)

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Reinier H. Kraakman

Harvard Law School ( email )

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Cambridge, MA 02138
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617-496-6118 (Fax)

European Corporate Governance Institute ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Richard C. Squire

Fordham University School of Law ( email )

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New York, NY 10023
United States
212-964-1584 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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