As I mentioned in one of my first Steemit posts, I've been trying to wrap my head around the intersection of blockchains, cryptocurrencies, smart contracts on the one hand and corporate law and governance on the other hand. Like I mentioned earlier, there's a lot of hype... er... enthusiasm about how these new technologies will change how firms are organized and governed. However, unless we're explicit about these sorts of predictions and thorough about what past scholarship says about the nature of the firm, this enthusiasm seems unfounded.
I just finished up a draft of a research paper that tries to tackle a very small piece of this issue. It's an attempt to look at potential corporate governance uses of smart contracts in their current, basic state (and as a lawyer--as opposed to a developer--understands them). Here's part of the introductory section, and I'll post more excerpts in later posts. I'd love feedback--any arguments I'm missing, anything that's unclear or inaccurate, etc.--so please tell me what you think in the comments!
As blockchains and the related concept of “smart contracts” become more widespread, commentators are beginning to the explore potential applications of these technologies to corporate governance. As is probably the norm with any new technology, the discussion can be prone to heavy doses of hype and generalities. For example, some evangelists have been promoting the concept of “decentralized autonomous organizations,” a utopian form of business organization that will (in the eyes of believers) transform the way humans organize and conduct business. (1) One early commentator posited that just as machines supplanted manual laborers during the industrial revolution, blockchains could potentially “remove management from the equation” in today’s age. (2) While blockchains and smart contracts may have great potential for use in corporate governance, much of the discussion on this topic is far removed from the realities and existing policy concerns of corporate law and governance. The coverage that has been the most helpful has been explicit about the limitations and key features of the technology, the specific parties and processes involved in corporate governance, and the incremental yet important ways that blockchains and smart contracts might improve the status quo. (3)
Rather than provide a sweeping exploration of how blockchain-based smart contracts will change the nature of the firm, this paper explores the potential impact of smart contracts on one narrow management tool: precommitment strategies. Put simply, a precommitment strategy is a way for a party to commit itself ex ante to a certain course of action, knowing that there might be impediments—self-inflicted or external—to pursuing that course of action in the future. These exist in abundance in the corporate context. Companies enter into covenants with lenders not to pledge certain assets as collateral. Companies commit to paying a dividend in the future by making public pronouncement in the present. Management teams threatened by a hostile takeover enter defensive agreements to dilute the holdings of would-be acquirers (i.e., a poison pills), giving them ex ante negotiating leverage. Precommitment strategies derive much of their value from being very costly to renege on. Thus, the effectiveness of many corporate precommitment strategies depends on whether they will actually be enforced, by courts or otherwise.
As we will see, blockchain-based smart contracts have unique features that could potentially be used as strong and effective forms of precommitment strategies by companies. A party who enters a smart contract commits itself to a course of action that is embedded in immutable computer code. Since blockchains are generally public, counterparties can examine this smart contract and have full trust that it will be performed. And enforcement of a smart contract comes not from courts but from a decentralized computer network. Smart contracts also come with significant limitations, but their distinctive features could certainly lead to new and creative precommitment strategies.
Section I begins by providing an overview of (1) how smart contracts and blockchains work and (2) what they are good for. Section II then defines precommitment strategies, explores past scholarship on precommitment strategies in corporate law, and examines three specific precommitment strategies—namely debt covenants, dividend policies, and poison pills—to see how they could be creatively deployed through a smart contract.
(1) See Matt Levine, Blockchain Company Wants to Reinvent Companies, Bloomberg View (quoting the creators of a so-called DAO as saying “The DAO…is a new breed of human organization never before attempted”).
(2) Vitalik Buterin, Bootstrapping a Decentralized Autonomous Corporation: Part I, Bitcoin Magazine.
(3) See, e.g., David Yermack, Corporate Governance and Blockchains, NBER Working Paper No. 21802.
Noah Driggs is a third-year law student at the University of Chicago Law School. His interests and work experiences include financial compliance, venture capital, other miscellaneous legal issues faced by startups, and most recently blockchains and cryptocurrencies. Feel free to reach out via Twitter or LinkedIn. Nothing posted on this blog should be construed as legal advice.
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