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Abstract

In several recent cases, the Delaware Chancery Court has emphasized that where a conflict of interest exists between holders of a company’s common stock and holders of its preferred stock, the standard of conduct for directors requires that they strive to maximize the value of the corporation for the benefit of its common stockholders rather than for its preferred stockholders. This article interrogates this view of directors’ fiduciary duties from the perspective of incomplete contracting theory. Building on the seminal work of Sanford Grossman and Oliver Hart, incomplete contracting theory examines the critical role of corporate control rights for addressing conflicts that arise between a firm’s investors so as to maximize firm value. It therefore provides a natural starting point for examining how the control rights residing in a company’s board of directors should be used for resolving conflicts between common and preferred stockholders.

This analysis highlights the utility of a default fiduciary duty that prioritizes common stockholder welfare for maximizing the value of the corporation. In particular, such a duty helps facilitate Coasian bargaining among investors to resolve unanticipated conflicts that can arise while also minimizing the risk of bargaining failure. Critically, however, a dictate for directors to maximize stockholder welfare can operate in this fashion only to the extent it exists as a default rule that a director can opt out of when elected to represent the interests of a particular investor or group of investors, as is common among preferred stockholders. Moreover, close inspection of Delaware case law highlights how such a dynamic is consistent with Delaware’s corporate jurisprudence which has historically viewed stockholder wealth maximization as ultimately a means to maximize the value of the corporation. To ensure the continuing vitality of the corporate form, Delaware courts should, accordingly, abandon any pretense that corporate directors have an immutable duty to maximize common stockholder value and revert to their traditional focus on policing against the bargaining failures that can occur when investors use directors to address the incomplete contracting challenges that are replete in corporate finance.