How Disagreement Remade Corporate Law
From their early days as Law School students, Frank H. Easterbrook and Daniel R. Fischel were ensconced in the Chicago way. Together they built a bedrock for understanding corporate law.
Senior Lecturer Frank H. Easterbrook, a judge on the US Court of Appeals for the Seventh Circuit, and Daniel R. Fischel, a former dean of the Law School and the Lee and Brena Freeman Professor Emeritus of Law and Business, think there is something very special about disagreement. Even when those disagreements include an alleged knock by the chairman of the US Securities and Exchange Commission or academic workshops so intense that, decades later, the participants still recall a scholarly paper being tossed into the air in exasperation.
Critique, they say, revs the engines of intellect.
“Challenge without debate is not productive,” Easterbrook said one day last spring, as he and Fischel were discussing their ideas about corporate law at a symposium celebrating a book they wrote three decades earlier. Easterbrook knows: he and Fischel, who graduated from the Law School four years apart in the 1970s and later became faculty colleagues, have been revving engines—to great effect—for decades. In 1991, they published The Economic Structure of Corporate Law (ESCL), a book that spurred a generation’s worth of argument and changed the way scholars and practitioners understand and teach corporate law. In it, they put forth a theory rooted in the Law School’s signature study of law and economics: the rules of corporate law, they argued, emulate the contractual provisions that parties would reach if they could bargain at zero cost and enforce their agreements perfectly.
That theory comprised a set of ideas they had been developing for years—ideas that had been hotly debated in Chicago Law workshops throughout the 1980s and that, even while raising a certain amount of scholarly ire, laid the basis upon which corporations can be understood.
The book offers a framework for understanding corporate law by looking at data and behaviors because, as Easterbrook puts it, the best way to learn the law applicable to specialized endeavors is to study general rules and to seek to understand what features of existing law are optimal.
“Even Easterbrook and Fischel’s most vocal critics engage on the terms established in The Economic Structure of Corporate Law,” said Professor Anthony J. Casey, ’02, the faculty director of the Law School’s Center of Law and Finance and faculty advisor of the student-led University of Chicago Business Law Review (UChiBLR), which jointly sponsored a March 2022 symposium celebrating the book. “They might disagree with the explanatory power of Easterbrook and Fischel’s approach, but a starting point to most academic questions on corporate law is the contract question. Scholars either explain how their analysis fits into the contract approach, or they explain what limits on contracting push them outside of that approach.”
The influence of The Economic Structure of Corporate Law is one reason UChiBLR, which launched in 2021, chose Easterbrook and Fischel as the focus of its first conference. The papers presented at the event revealed in myriad ways just how relevant Easterbrook and Fischel’s ideas remain. One presenter, for example, proposed that the single-purpose paradigm Easterbrook and Fischel defend in the context of large corporations might also produce desirable outcomes for nonprofits. Others proposed reforms to allow a corporation’s shareholders to vote on securities class actions, defending their idea with insights proposed in ESCL that such reforms would “preserve the benefits of the class action system while curtailing its cost.”
Another reason UChiBLR focused on ESCL is this: the story of the Easterbrook-Fischel collaboration—and the Law School culture in which their ideas developed—is also a story about how ideas are made. It’s a story of how they begin, how they evolve, and how sometimes their full import isn’t felt until years later.
The Chicago School
Douglas G. Baird, the Harry A. Bigelow Distinguished Service Professor of Law, still remembers watching as the ideas that power The Economic Structure of Corporate Law came to life.
It was the early 1980s, and Easterbrook and Fischel were presenting much of their work at Law School workshops that for decades had been the proving ground for new ideas in law and economics. Faculty from the University of Chicago and elsewhere would try out their latest papers at these sessions, often spurring fierce debate. Baird remembers Easterbrook and Fischel workshopping one on managerial passivity—“The Proper Role of a Target’s Management in Responding to a Tender Offer”—in the fall of 1980.
“There was a lot of criticism,” Baird said—and it was “a great privilege” to see.
“One of the reasons I came to Chicago was exactly to see the kind of intellectual energy and excitement that you really felt in the early 1980s when these pieces were coming off the typewriter every couple weeks or so,” he said.
It was an energy suffused with Chicago influence: Easterbrook, ’73, and Fischel, ’77, each learned law and economics as students at the Law School, where they studied under pioneers like Richard A. Posner, William M. Landes, and Ronald H. Coase. When they met in the late 1970s, Fischel was clerking for the Supreme Court of the United States, and Easterbrook was newly promoted to Deputy US Solicitor General.
As Fischel describes it, he made two decisions in his career that really mattered. The first was to go to the University of Chicago, which completely changed his life in terms of the interests he developed. When he later went off to Washington, DC, to clerk for US Supreme Court Justice Potter Stewart, Richard A. Posner, a Law School professor, law and economics pioneer, and future federal appellate judge, encouraged him to contact Frank Easterbrook.
Calling Easterbrook was the second decision that really mattered in Fischel’s career.
“That decision was less luck and a direct result of being advised that if I wanted to cultivate my interest in the economic analysis of law, the right person for me to call was Frank,” Fischel said. “I contacted him when he was already legend in the US Solicitor General’s office.”
Easterbrook had the business law portfolio in the Solicitor General’s office.
“Dan pointed out—just as Dick Posner had pointed out to me—that the economic analysis of law logically extends to corporations and securities,” Easterbrook said. “The dominant scholarship at the time, however, was moralizing about what corporations should do or what state law should be, rather than trying to understand what was actually going on or what participants in the corporate venture might want to go on.”
Fischel and Easterbrook had similar ideas and decided to put their heads together when they were both back in Chicago, where they served on the faculty alongside some of the law and economics giants who had influenced them as students.
Landes and Posner were already legendary when Fischel was a student and were running the law and economics workshops. Fischel attended the seminars and was privy to the discussions Landes and Posner were having with peers from across the Midway, including Gary S. Becker, George J. Stigler, and Lester G. Telser, all University of Chicago economists.
“That interdisciplinary approach had an enormous influence on me as a student,” Fischel said. “I also took an independent study with Posner and studied with him for a whole year. These teachers really changed my life and were a reason that I contacted Frank.”
Posner’s influence on Easterbrook was also significant. In fact, what are believed to be Posner’s very first words as a teacher at the Law School were uttered in Easterbrook’s first-year Torts class in the fall.
“He was recruited to teach Torts because Harry Kalven, the regular teacher of Torts, was ill. The first words out of his mouth were, ‘Torts is not my field,’” Easterbrook recounted.
“We were first-year law students, and this did not encourage confidence,” he continued. “The next thing that happened was he assigned this paper to read, ‘The Problem of Social Cost’ [by Ronald H. Coase], which did not really appear to be about law and appeared to be about economics.”
Some of the students in Easterbrook’s class had trouble with this combination. Easterbrook, on the other hand, thought Posner’s melding of law and economics was wonderful.
As a 3L, Easterbrook studied with Posner again, taking two seminars about the economic analysis of law the same quarter, one of which was based on Posner’s working draft of a book that later became The Economic Analysis of Law. As Easterbrook described the class, Posner tried to show students that economics could be used to understand just about anything.
The other seminar Easterbrook took was offered by Coase—a future economics Nobel laureate—and was based on the idea that to understand the proper intersection of economics and law, one had to do things like look at the articles of incorporation. This was an early opportunity to appreciate the value of dissent: Posner and Coase were not afraid to critique one another.
“It was absolutely fascinating to see these two attacking each other’s ideas, although their ideas of what economics was and what you could learn from it were very similar,” Easterbrook said. “The fundamental difference was that Coase thought that economics was about economic markets whereas Posner thought that economics is about all of life.”
Fischel was also greatly influenced by Coase. When Fischel was director of the law and economics program at the Law School early in his career, the two often talked about the need to understand institutional detail to make intelligent generalizations about various legal doctrines. Coase taught him that there was a need to study actual contracts and not just have models about contracts.
“Frank and I dedicated our book to Coase, in part, on an idea in Coase’s 1937 paper on the firm where he wrote that the firm and contracts were basically substitutes for each other based on various institutional arrangements and transaction costs,” Fischel said. “This basic model is what motivated much of what Frank and I did together and a lot of what we did separately.”
Other teachers at the Law School, including Edmund Kitch, ’64, who taught at the Law School between 1965 and 1982, greatly influenced both men when they were law students. Fischel learned the prospecting theory of the patent system from Kitch and took at least three other classes from him, including an intellectual property class, a regulated industry class, and an antitrust class.
“[Kitch] was really a brilliant theorist with incredible economic intuition and was very supportive as well of me while I was a student,” Fischel said.
Added Easterbrook: “I share Dan’s praise for Ed Kitch, who was just a brilliant man . . . He wrote one of the most profound papers in the history of patent law, and then never touched the subject again.”
An Intellectual Family Tree
While Easterbrook and Fischel learned how to think about the intersection of law and economics from legal giants including Posner, Coase, Landes, and Kitch, and economists like Becker, Stigler, and Telser, they said being ensconced in the Chicago school was teaching them to think critically about the conventional wisdom about corporations.
Both were taught from The Modern Corporation and Private Property by Adolf Berle and Gardiner Means. The book was a major source of study for students learning about corporate law. It was an iconic book then, is still sold today, and was first published in 1932.
As Easterbrook and Fischel describe it, the book gave them examples of what not to do when studying corporate law.
“In some sense, [the book] played a huge role in my career because it was accepted wisdom when Frank and I were students,” Fischel said. “[The book] talked about how there was something defective in publicly held corporations because of the separation of ownership and control.”
Berle and Means thought this separation was negative, as opposed to recognizing reasons for that evolutionary form in terms of specialization of function, access to capital markets, and being able to attract investment for large-scale ventures from people who had capital but not the managerial expertise.
“These concepts may not today sound like very sophisticated insights, but when Frank and I were students, these ideas were completely unknown in the economic literature,” Fischel said.
Easterbrook agrees with Fischel but looks at the book in another way. He recognized that Berle and Means’s ideas were controversial among both legal scholars and economists and that the book had started debates that would later help define his work with Fischel.
“Berle and Means . . . [concluded] there was no effective check on management and that law did not provide an effective check on management,” Easterbrook said. “And, therefore, that shareholders were at the mercy of management . . . and the law had to step in.”
Easterbrook recalled how the conventional wisdom began to morph. “Some then argued that there was a great deal of concentration of ownership that provided control of many public corporations, and that with differentiated ownership, a smaller block of stock will produce effective control,” Easterbrook said. “Then others jumped in and said that differentiated ownership allowed shareholders to be exploited because if ownership of 5 or 10 percent of stock was enough for effective control, shareholders could be ground into the dust.”
“This,” Easterbrook continued, “led Ralph Winter to write his famous paper ‘State Law, Shareholder Protection, and the Theory of the Corporation,’ in 1977 and ask, ‘Why is everybody so stupid? Why are these terms not being priced?’”
A tide had started to turn about the same time Easterbrook and Fischel began collaborating. Economists at the University of Chicago were beginning to put together the database of public prices that enabled them to ask questions such as: if somebody assembled a 10 percent block of stock, would the prices of the other 90 percent of the shares go up or down?
“[The data showed] that prices went up, so the shareholders were not sheep being sheared by managers,” Easterbrook said. “There were other forces at play, which we felt was important for others to understand.”
As Easterbrook and Fischel began working together, they turned to their faculty colleagues for vigorous critique, presenting many of their ideas at workshops between 1979 and 1984. “The workshops back in those days were brutal,” Baird said. “I remember someone—who shall remain nameless—presented a paper and after about five minutes, someone questioned a fundamental assumption about the law. Another person said, ‘Well, no, the law is actually the opposite.’ After that, someone else in the audience took the paper, threw it in the air, and said, ‘Next paper, please!’”
What made the Chicago workshops unique was the cross-pollination of ideas from both economists and legal thinkers. From those workshops,
career-long debates and close friendships with colleagues resulted. Easterbrook sees these vigorous debates as part of the basic academic enterprise.
“Challenge without debate is not productive,” Easterbrook said. “We once presented a paper on [managerial] passivity. One workshop participant said he had given the paper to his friend, the chairman of the Securities and Exchange Commission. Apparently, the SEC chairman said we were wrong. The workshop participant’s one question to us was, ‘So what do you say about that?’” Easterbrook recalled.
“I don’t remember what I answered,” Easterbrook said. “What I can say today is that this form of argument by authority is not the Chicago way.”
Impact
Fischel says he does not think he would change anything about the book, even 30 years later. “I’ve raised with Frank over the years whether we should do a second edition. For various reasons, we’ve always decided either to put it off or just not do it,” Fischel said. “It is not clear how much we would have to add. We could do a sequel, update it, incorporate areas that we didn’t discuss very much in the first book, but our basic views haven’t changed.”
A sequel, according to Fischel, might just become a more current version of the same book as opposed to all the work that has been done by people who read the book, thought about it, and made their own decisions about what conclusions and inferences to draw on or criticize.
“In some sense, looking at the book as a framework is consistent with the ‘progress of knowledge,’” Fischel said. “Somebody asked if I thought our work was standard orthodoxy. I said, ‘There’s no such thing as standard orthodoxy.’ What’s important is for the people who think times have changed to follow their own instincts and go in their own direction.”
Easterbrook thinks about it a little differently. “Some people might take the book as the standard orthodoxy. There is such a thing. But I believe the book should be attacked and torn down because orthodoxy can get in the way of thinking through problems,” Easterbrook said. “We were clear in the book, and nothing in the intervening years has changed my mind.”
Easterbrook says that if one is wondering what the optimal corporate organization is and how efficient the markets are at driving things, that these are empirical questions. The answers to these questions change over time as relative costs change.
“If you ask, ‘Is this market efficient?’” there is no answer, because it’s always compared with what, right? There may be some regulatory way of doing it, and the costs and benefits of those alternatives will change over time. If people aren’t looking at those things, they’re not asking the right questions.”
Where both men agree is that their book posed a series of questions that other people can ask to either improve on what they have done or to show that the costs have changed over time. Different answers are to be expected. “That is the nature of progress and exactly the way a free exchange of ideas in academia should work,” Fischel agreed. “Everything is an open question.”
Tribute
In the inaugural issue of UChiBLR, the authors consider how Easterbrook’s and Fischel’s insights apply in different contexts. The issue pays tribute to Easterbrook’s and Fischel’s contributions and presents a range of new perspectives on their work.
“It’s impossible to overstate the impact that Easterbrook and Fischel had on the study of corporate law,” said Adriana Z. Robertson, the Donald N. Pritzker Professor of Business Law and a faculty advisor of UChiBLR. “Even decades after it was written, it’s astonishing how relevant their work continues to be to contemporary debates.”
Other scholars agree. In a coauthored foreword to UChiBLR’s inaugural issue, Hajin Kim, an assistant professor at the Law School; Joshua C. Macey, an assistant professor at the Law School and faculty advisor of the student-led journal; and Anthony J. Casey note that some of the more provocative contributions in UChiBLR’s inaugural issue probe disagreements Easterbrook and Fischel had in their earlier writings to shed light on current corporate law debates.
Other authors explore whether the growth of environmental, social, and governance investing [ESG] might change Easterbrook’s and Fischel’s views on the desirability of poison pills or how the legal system might improve upon the market in regulating corporate governance. (ESG refers to company behavior standards used by socially conscious investors to screen potential investments.)
The scholars who wrote for the inaugural issue, in fact, show that many of the ideas put forth in ESCL have clearly evolved. Authors, for example, ask whether investors want to maximize shareholder profits or pursue additional goals, and if the market for corporate control is an effective tool for disciplining corporate agents when managers and shareholders pursue goals beyond profit maximization. Others ask if shareholder profit maximization is not the exclusive or primary goal of a corporation, then who gets to decide what is?
Some concluded that the market still shapes corporate decision-making. Others examined how corporations develop by studying corporate purpose proposals and side letters to see if the assumptions that underlie the theory of the corporation as a nexus of contracts are sound.
Some of the most touching moments of the symposium occurred when participants credited Easterbrook and Fischel for sparking their interest in corporate law. Lucian Bebchuk, a Harvard professor renowned for his work in corporate governance and law and finance, described how he first started writing about corporate law because he disagreed with Easterbrook and Fischel’s approach to takeovers. Todd Henderson, ’98, the Law School’s Michael J. Marks Professor of Law, noted it was his great fortune—perhaps the greatest of his life—to learn from both Easterbrook and Fischel. Ed Rock, an expert on corporate law and corporate governance from NYU, wrote that “while . . . ECSL is rarely the last word on any corporate law issue, it often is the first word.”
Easterbrook and Fischel may not have resolved conclusively the questions they raised in ESCL. After all, the landscape is constantly evolving, and answers will change. But because of them, corporate law is arguably a field in and of itself, not just a subfield of law and economics. And because of the scholars before them, Easterbrook and Fischel were able to identify many of the questions that make corporate law a distinct field of study.
As for what Easterbrook and Fischel thought about the 30-year retrospective, they say they welcomed the criticism, though felt a bit like sitting ducks on the morning of the symposium.
“I told Mike Klausner [of Stanford] and Ed Rock after their presentation, which had compliments but was also quite critical, that I thought their ideas were terrific,” Fischel said. “Hearing their work gave me a tremendous sense of satisfaction about what our book accomplished in terms of the advances that have occurred [since we wrote it]. They improved on and expressed different points of view from what we were able to say originally.”
As Easterbook put it: “This is the University of Chicago. Comments are supposed to be critical. You don’t want praise because then you don’t have an incentive to go off and do better the next time.”