Why Learn Corporate Law? [No. 86]

Summary

This script explains the significance of studying corporate and securities law, particularly in the context of law and economics. It uses the example of McDonald's franchise agreements to illustrate how economic reasoning impacts legal decisions. The script argues that seemingly harsh provisions, like the ability to terminate franchises without cause, ultimately protect successful franchisees and the overall brand by enabling the company to remove underperformers. The broader lesson is that legal provisions often have complex economic consequences, emphasizing the importance of understanding multiple layers of reasoning in law.

Takeaways

• 📚 Studying corporate and securities law is crucial as it intersects with law and economics, revealing the complexities and power dynamics in legal frameworks.
• 🧠 Economics plays a significant role in understanding legal problems, often requiring the ability to reason through multiple steps.
• ✅ The 'guillotine provision' in franchise agreements, like those with McDonald's, may seem unfavorable but actually benefits both parties in maintaining quality and flexibility.
• 🙅‍♂️ Legislating against such provisions could inadvertently harm good franchisees by forcing McDonald's to bear higher costs for managing bad franchisees.
• 🍔 McDonald's is less likely to terminate good franchisees who contribute positively to the brand's success.
• 🚫 Making it harder for McDonald's to terminate bad franchisees increases costs, which could lead to reduced payments to all franchisees.
• 💼 The ability to terminate bad franchisees quickly protects the brand's reputation and the interests of good franchisees.
• 🏥 The quality of a single franchisee's operation can impact the entire brand, highlighting the importance of quality control.
• 📉 A bad experience at one franchise can deter customers from other locations, emphasizing the interconnectedness of brand experiences.
• 🔍 To truly understand economic activities and contractual provisions, one must analyze them through an economic lens.

Q & A

Why is corporate and securities law considered powerful in the context of law and economics?

Corporate and securities law, along with antitrust law, is where law and economics reaches its height of power because it involves applying economic concepts and methods to understand legal problems, which often require complex reasoning beyond immediate outcomes.

What does Milton Friedman suggest about the understanding of economics?

Milton Friedman suggests that understanding economics usually requires the ability to understand more than one step in reasoning, implying that it involves complex and multi-step logical processes.

What is a 'guillotine provision' in a franchise agreement?

A 'guillotine provision' is a clause in a franchise agreement that allows the franchisor, such as McDonald's, to terminate the franchisee for any reason or no reason at all.

Who benefits from the 'guillotine provision' in a franchise agreement?

The franchisor, like McDonald's, benefits from the 'guillotine provision' as it gives them the flexibility to terminate a franchisee's agreement without needing a specific cause.

Why might a law requiring cause for termination actually harm the franchisee?

A law requiring a cause for termination could make it harder for McDonald's to get rid of underperforming franchisees, increasing the costs associated with managing them. This could lead to McDonald's offering less favorable terms to all franchisees to cover these increased costs.

How does the ability to terminate bad franchisees quickly protect the McDonald's brand?

The ability to terminate bad franchisees quickly helps protect the McDonald's brand by ensuring that locations that do not meet quality standards do not tarnish the reputation of the brand, which could affect customer trust and loyalty across all locations.

What is the unintended consequence of trying to protect franchisees through legal provisions?

The unintended consequence is that instead of transferring wealth from McDonald's to franchisees, it actually transfers wealth from good franchisees to bad franchisees, potentially rewarding poor performance.

Why is it important to consider economic terms when analyzing contractual provisions?

Considering economic terms is crucial when analyzing contractual provisions because it helps to understand the underlying incentives and consequences of such provisions on different parties involved, leading to a more nuanced understanding of economic activities.

What does the speaker suggest about the importance of studying corporate and securities law for understanding economic activity?

The speaker suggests that studying corporate and securities law is essential for understanding why economic activity is organized the way it is, as it provides insights into the reasons behind contractual arrangements and the organization of economic entities.

How does the script illustrate the complexity of legal and economic interactions?

The script illustrates the complexity of legal and economic interactions by showing how a seemingly one-sided provision in a franchise agreement can have broader economic implications, affecting not only the parties directly involved but also the overall brand and market dynamics.

Outlines

00:00

📚 Understanding the Power of Corporate and Securities Law

This paragraph introduces the importance of studying corporate and securities law, despite it being perceived as boring. It highlights the significance of law and economics in understanding legal issues, emphasizing the need for reasoning beyond the immediate implications. The example of a franchise agreement between McDonald's and a small business owner is used to illustrate the complexity of legal provisions. The 'guillotine provision' in the agreement, which allows McDonald's to terminate the franchisee without cause, is discussed. The paragraph challenges the intuition that such a provision is detrimental to the franchisee by explaining the economic rationale behind it. It argues that restricting such provisions would actually harm good franchisees by forcing McDonald's to bear the costs of bad franchisees, thus reducing the overall value proposition for all franchisees. The paragraph concludes by stressing the importance of economic thinking in understanding why certain contractual provisions exist and the broader implications for economic activity.

Keywords

💡Corporate and Securities Law

Corporate and Securities Law is a branch of law that deals with the formation, operation, and dissolution of corporations, as well as the legal framework for the issuance and trading of securities. In the video, it is highlighted as an area where law and economics intersect, providing a framework for understanding the economic implications of legal decisions. The script uses the example of franchise agreements to illustrate how this law affects business operations and economic outcomes.

💡Law and Economics

Law and Economics is an interdisciplinary field that applies economic concepts and methods to understand legal problems and to assess the impact of legal rules. It is mentioned in the video as a way to analyze the effects of legal provisions on economic behavior. The video emphasizes the importance of understanding economic reasoning in multiple steps, as exemplified by the analysis of franchise termination clauses.

💡Franchise Agreement

A Franchise Agreement is a legal contract between a franchisor (like McDonald's) and a franchisee (the business owner) that grants the franchisee the right to operate a business under the franchisor's brand. The video discusses a specific clause in such agreements that allows the franchisor to terminate the agreement without cause, which is central to the economic analysis presented.

💡Guillotine Provision

A Guillotine Provision, as mentioned in the video, is a clause in a franchise agreement that allows the franchisor to terminate the agreement without cause. The video argues that while it may seem unfair to the franchisee, it actually serves an economic purpose by allowing the franchisor to quickly deal with underperforming franchises, thereby protecting the brand and the interests of good franchisees.

💡Economic Concepts

Economic Concepts are the foundational ideas and theories in economics that help explain how individuals and businesses make decisions and how markets function. The video uses economic concepts to analyze the impact of legal provisions on business practices, such as how the ability to terminate a franchise agreement affects the overall economics of franchising.

💡Milton Friedman

Milton Friedman was an American economist who emphasized the importance of economic theory in understanding market behavior. He is quoted in the video to underscore the complexity of economic reasoning, which requires understanding the implications of decisions across multiple steps, as seen in the analysis of franchise agreements.

💡Franchisor

A Franchisor is the entity that grants the right to operate a business under its brand, in this case, McDonald's. The video discusses how the franchisor's ability to terminate a franchise agreement without cause can have economic benefits for the franchisor and, paradoxically, for the good franchisees by maintaining brand quality.

💡Franchisee

A Franchisee is the individual or business that operates a franchise under the terms of a franchise agreement. The video explores the economic implications for franchisees when faced with the possibility of termination by the franchisor, highlighting the importance of understanding the economic dynamics at play in such legal arrangements.

💡Brand Quality

Brand Quality refers to the perceived value and standards associated with a brand. In the video, it is argued that the ability of McDonald's to terminate underperforming franchisees without cause helps maintain the brand's quality, which is crucial for the success of all franchise locations.

💡Economic Activity

Economic Activity encompasses all actions and behaviors related to the production, distribution, and consumption of goods and services. The video suggests that understanding the organization of economic activity, such as through the lens of corporate and securities law, is crucial for grasping why certain business practices and legal provisions exist.

💡Legal Provisions

Legal Provisions are the specific terms and conditions set forth in laws or contracts that dictate the rights and obligations of the parties involved. The video uses the example of franchise termination clauses to illustrate how legal provisions can have far-reaching economic consequences, affecting not just the immediate parties but also the broader market and brand reputation.

Highlights

Corporate and securities law is where law and economics reach their height of power, alongside antitrust law.

Law and economics employs economic concepts to understand legal problems, often requiring more than one step in reasoning.

A franchise agreement, such as between McDonald's and a franchisee, may include a provision that allows McDonald's to terminate the franchise for any or no reason.

This termination provision, known as a 'guillotine provision,' might seem harmful to franchisees but benefits both McDonald's and good franchisees.

If laws restricted such provisions, forcing McDonald's to terminate franchisees only for cause, it would actually harm good franchisees.

There are two types of franchisees: good ones that perform well and bad ones that do poorly.

McDonald's will not terminate good franchisees as they bring in profits, but it will want to terminate bad ones quickly.

Restricting McDonald's ability to terminate bad franchisees increases the cost for McDonald's to deal with underperformers.

As a result of increased costs, McDonald's would pay all franchisees less, reducing the overall quality of franchise agreements.

The wealth is unintentionally transferred from good franchisees to bad franchisees by these legal restrictions.

Bad franchisees can harm McDonald's brand by providing poor-quality food or service, affecting the reputation of all McDonald's locations.

The ability to terminate bad franchisees quickly helps protect the reputation of good franchisees.

Economic reasoning explains why McDonald's creates provisions that seem harsh but serve to protect its overall brand and good performers.

The broader takeaway: legal provisions in business agreements often reflect deeper economic strategies.

Understanding the economic foundations of legal decisions in areas like corporate and securities law provides insight into how economic activity is organized.

Transcripts

Why should you study corporate and securities law, if these seem to you to be about the

most boring subjects imaginable?

The answer to that is corporate and securities law is the area of law where, along with antitrust,

law and economics reaches the height of its powers.

Law and economics is about employing economic concepts and methods to understand legal problems.

And the thing about economics, as Milton Friedman once said, is that understanding economics

usually requires the ability to understand more than one step in reasoning.

Here's what I mean.

Suppose that in a franchise agreement between, say, McDonald's and a small business owner

for the operation of a particular McDonald's location, you find in the franchise agreement,

a provision that says the McDonald's may terminate the franchisee for any reason or no reason,

whenever it feels like.

In fact, you probably will find a provision like that.

Who benefits from that provision?

The simple answer is McDonald's does.

It looks like a terrible provision.

It's in fact called a guillotine provision.

It looks like a terrible provision from the point of view of the franchisee.

It's not.

You might imagine that if we were to pass a law saying no provisions like this, if the

franchisor, McDonald's, is going to terminate the franchisee, the small business person,

that it has to be for cause, or it has to be a 90 days notice, or there has to be a

hearing or due process, or something like that, you would think that you're benefiting

the franchisee at the benefit of McDonald's.

You'd be wrong, and here's why.

In reality, there are going to be two types of franchisees, ones who do good jobs and

ones who do bad jobs.

The ones who do good jobs McDonald's is never going to terminate, because McDonald's is

in the business of franchising restaurants, and a franchisee who sells a lot of hamburgers?

McDonald's loves that person.

They're going to bend over backwards to keep that person.

They're not going to terminate them without a decent reason.

But then there are the bad franchises.

Those are the ones McDonald's wants to terminate, and those are the ones you are making it harder

for McDonald's to terminate.

When you make it harder for McDonald's to terminate these people, however, what really

happens is that McDonald's now knows it has to deal with two classes of people, the good

franchisees and the bad franchisees, and the cost it incurs for the bad franchisees is

going up.

And for that reason, they're going to pay all franchisees less.

All franchisees as a group are going to get a worse deal because of the added costs from

the bad franchisees that McDonald's now has to deal with.

You intended to transfer wealth from McDonald's to the franchisees.

What you really did is you transferred wealth from good franchisees to bad franchisees,

and it's even worse than you know.

Because the reason that McDonald's normally terminates a franchisee is because the franchisee

is not doing a good job.

His or her restaurant isn't clean.

In that restaurant, they allow the cheeseburgers to stay too long under the heat lamps, or

they allow the shakes to melt, or whatever, but they produce food that is not up to McDonald's

quality.

When that happens, that particular location of McDonald's suffers, but so do all the other

locations of McDonald's, because it impairs the McDonald's brand.

If you go into one McDonald's and have a bad experience, you're going to be less likely

to go into other McDonald's and have bad experiences.

So, the provision in the franchise agreement that allows McDonald's to terminate bad franchisees

quickly, for any reason or no reason, whenever it feels like it, not having to litigate the

issue with the franchisees lawyers actually protects good franchisees from the bad acts

of bad franchisees.

If you want to understand the world and why people do things like this, create contractual

provisions of this kind, you've got to think it through in economic terms.

Perhaps this isn't the area of law you want to practice.

It's a big world.

There are lawyers who need to do all different kinds of things.

But if you want to understand, either in a theoretical way or for some practical purpose

or other, why economic activity gets organized the way it does, this is the type of course

that will begin to tell you the reasons for that.