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'Legal and Economic Entities as Transferable Bundles of Contracts'

Detail Summary
Date 29 March 2010
Time 11:45 - 13:15

'Legal and Economic Entities as Transferable Bundles of Contracts'


This paper develops a theory of the firm in which legal entities play an important role. In contrast to the existing theory of the firm literature that focuses on ownership of assets, we focus on contracts as the key sources of value. We explain why entrepreneurs may want to structure the firm's contracts so that they may be freely transferred to a new owner, but only if all the contracts in the firm are transferred together. This bundled assignability gives entrepreneurs liquidity while protecting counterparties (employees, suppliers, customers, etc) from opportunistic transfers that will reduce the value of the performance they've been promised. Bundled assignability balances these competing interests, and in doing so, gives the entrepreneur the incentive to make non-contractible investments that increase the complementarity of the contracts in the bundle. Legal entities assist in this process in two ways. First, since transfers of equity interests in a legal entity will generally not be considered assignments of the firm's (non-assignable) contracts, legal entities reduce the contracting costs of creating bundled assignability. Second, legal entities create asset partitioning. When an entrepreneur holds multiple businesses under common control, asset partitioning can affect the entrepreneur's incentives to keep the businesses together or separate them efficiently. An appreciation of these roles of legal entities not only refines our theories of the firm, but provides guidance in shaping legal doctrine concerning the effects of various types of control transactions on a firm's contractual rights and obligations.

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