The Personification and Property of Legal Entities

Property rights in productive assets are commonly held by legal entities rather than individuals. Only persons can own property, and the law defines persons to include organizations such as corporations, partnerships, and trusts. This chapter addresses the related issues of the justification for firm ownership of property and the efficient division of assets among distinct legal entities. In brief, firm ownership coordinates the productive activity of self-interested individuals. Earlier scholarship by economists suggested that the allocation of control over assets reduces the inefficiencies of incomplete contracts caused by imperfect information. Thus, economic integration brings assets into common ownership to avoid or simplify contracting. These theories, however, do not distinguish between assets owned directly by an individual and assets controlled indirectly through an entity. They also do not distinguish between assets held within a single entity and assets partitioned among multiple entities within common control. More recent literature fills this gap by explaining the legal significance of the boundaries of distinct entities, whether or not they fall under the control of a single owner. The starting point for understanding firm boundaries is the observation that the person who is best situated to control the use of an asset may not be in the best position to finance its use. Berle and Means (1932) famously noted that the corporation is a vehicle for achieving such separation and that the separation raises significant and costly conflicts between owners and managers. This chapter explains how the deliberate drawing of firm boundaries can reduce these agency costs and thereby lower the cost of financing productive activity. In particular, the discussion focuses on the advantages of tailoring financing (or capital structure) to asset type. The law presents significant challenges to the goals of tailoring. Although optimal financing terms are often asset-contingent, the law favors entity-based rather than asset-based financing. In particular, the law requires considerable uniformity in the manner in which assets are financed and governed within a single entity, and the law raises obstacles to collaborative efforts across legal entities (the trade of goods, services, or capital across firm boundaries) even if they are held under common control