LEGAL ENTITIES AS TRANSFERABLE BUNDLES OF CONTRACTS

The large, modem business corporation is frequently organized as a complex cluster of hundreds of corporate subsidiaries under the common control of a single corporate parent. Our Article provides new theory and supportive evidence to help explain this structure. We focus, in particular, on the advantages of subsidiary entities in providing the option to transfer some or all of the firm's contractual rights and obligations in the future. The theory not only sheds light on corporate subsidiaries but also illuminates a basic function of all types of legal entities, from partnerships to nonprofit corporations. We show that when, as is common, some of a firm's key assets are contractual, both the firm's owner(s) and its contractual counterparties are exposed to the risk of opportunism relating to the assignment of the contracts. The owner faces opportunistic holdup by counterparties if counterparty consent is required to assign contracts in a sale of the entire firm. The firm's counterparties, in turn, are exposed to opportunistic assignment if the owner can freely assign contracts without consent. This bilateral opportunism problem can be mitigated through bundled assignability: the owner is permitted to assign her contracts freely but only as a bundle. The components of the bundle of contracts (which constitute much of the firm itself) provide assurance of performance to counterparties. And free transferability, in turn, gives the owner liquidity without risk of holdup. Most importantly and least appreciated in the literature and the case law bundled assignability increases the owner's incentive to make valuable investments in the firm. We explain why legal entities provide the simplest, most reliable means of creating bundled assignability. Further; we support our analysis with the first empirical study of assignment clauses in commercial contracts. Firms, we show, commonly provide for bundled assignability in their contracts, and they use legal entities to define the boundaries of transferable bundles. This suggests that our theoretical model accurately captures the motivations of contracting parties in practice.