The Law and Economics of Restrictions on Transfer of Shares: Taming Property Rights in Shares and the Silver Fox

Law is a byproduct of normative solutions, or a sort of extended phenotype. Facing the emergence of new forms of business organizations, legislators have created systems of property rights in order to ensure equilibrium not only within the corporate structure, but also among the interests and protections each corporate constituency claims for itself. One of the ways to facilitate this equilibrium is by providing default rules that restrict transfer of shares or give leeway to company members to introduce such restrictions in the operating agreements. Thus, in this paper, I look, from a bottom-up perspective, at markets, their dynamics and evolution, and compare them to evolution in nature by looking at the environment within which this evolution occurs. It has long been claimed that evolution in nature is different from institutional evolution. However, I look at law as providing tools for institutional engineering just as biology supplies the scientist with the necessary cognitive equipment to undertake her experiments based upon the artificial selection of species. The output of this comparison should be one that, normatively speaking, enables legislatures, regulators, and courts, in particular those in common-law jurisdictions, to create optimal legal solutions that are able to break engrained status quo and manifestations of socio-economic and doctrinal path-dependence, or situations of pleiotropy in the law, if necessary. Using transfer restrictions in private limited liability companies (PLLCs) as a ground for experimentation, the first section tries to unveil the legal and economic purposes of setting such restrictions. There, I present a three-level model that provides legislatures, regulators and courts with methodological tools for implementing optimal legal solutions. In addition, I expose the contractual features of the operating agreements by defining them as a ‘contract for the governance opportunity’ provided by the law. I give an overview of the most important possible restrictions within a comparative perspective. I also look at combinations of these restrictions. This is, I believe, a first in the literature. In the second section, I put forward an explanation for the effects restrictions may have on the configuration of property rights in shares, similar to the effects of the taming process on the silver fox. I not only advance a thesis of path-dependence of legal solutions, but also develop the idea of pleiotropy in law. In the third section, I inquire into the normative justification of restrictions considering the relational element prevailing in the PLLC. I conclude by disclosing my view of corporate and contractual evolution through an equivalent principle of artificial selection similar to that which took place with the selective breeding of the silver fox. My view is that legislators have the ability to shape market agents’ behavior. They can do it in a dynamic way, by providing efficient default rules that are liable to change social phenomenona of path-dependence. This implies legal engineering and experimentation at different levels. It also implies a new theory of defaults that sees default rules as commodities that can be used to achieve the best contractual solutions within an evolutionary framework.