Why the Optional Firm Resists Legal Transplantation

"The Silicon Valley attitude is: We're asking people to go on an adventure with us. If we find a treasure, everyone deserves a piece." This line opens Yifat Aran's paper "The Optional Firm," which I had the pleasure of discussing at the recent ECGI conference. It captures both what makes the paper so compelling and why its prescriptions might not simply travel across the Atlantic.

Aran's argument is elegant. Venture-backed start-ups, she shows, are webs of contingent claims, namely staged financing, convertible preferred stock, founder reverse vesting, employee options, that all derive their value from one linchpin, the common-stock residual claim. The board's central task, she shows, is not classical monitoring but retention: keeping mobile human capital committed by keeping the upside credible. Delaware's much-criticized solicitude for common stockholders is, on this account, the structural condition of a selection process that matches capital and talent to the highest-value ventures. For the US, I find this very persuasive.

My slight hesitation begins where the paper turns to Europe. The optional firm presupposes people willing to trade salary and security for a lottery ticket on a treasure hunt. That is a cultural disposition – the one the historian David Priestland calls merchant. In Merchant, Soldier, Sage, Priestland reads history as a contest between three castes. There is the merchant, with his ethos of competition, flexibility and profit, the soldier, following a strict code of honor, loyalty and discipline, and the sage, whom Priestland describes as literate, generator of ideas, guardian of expertise and long-term order. The United States since the 1980s is his paradigm of merchant dominance. Continental Europe's institutions, by contrast, grew out of soldier-sage alliances such as military and academic elites and postwar technocracies. 

How deep does this run? Alexander Sajnovits' new book traces how German corporate law "has grown, since the end of the nineteenth century, above all as a collectivist law of associations" (p. 3, my translation), setting the corporation and its purpose apart from the individual purposes of its shareholders. Delaware corporate law, he argues, rests on individualist, contractarian pillars (p. 4). Against this background, the Optional Firm appears as a legal transplant in need of a good fit, in Sajnovits’ words: without touching " the fundamental paradigms of the receiving legal order" (p. 543). In that context, Aran's proposed reorientation of fiduciary duties towards common stockholders is a paradigm-level transplant which would "fundamentally change the collective orientation" of the German corporation (p. 544). Along similar lines, Enriques, Nigro and Tröger have shown how Delaware-style contracting is in Europe often disabled via interpretive "metarules". Sajnovits explains why those metarules are so stable: They express a collectivist thought-style, a century in the making.

This makes the familiar deficit story –  Europe is a failure on capital markets because it lacks merchant virtues –  appear as capturing only a part of the broader picture. Consider what the soldier's virtues such as loyalty, commitment, and the long bond actually buy: Where employees are not one pay cheque from the exit, both sides invest in deep, firm-specific skills. This is the comparative advantage the varieties of capitalism literature ascribes to coordinated market economies: patient, cumulative, engineering-heavy innovation. Germany's “hidden champions” illustrate this – unglamorous world-market leaders built on decade-long employment relationships rather than option packages. Retention, Aran's own governance objective, is achieved through loyalty and voice rather than a call option on the residual. Along similar lines, patient, state-anchored capital displays a risk-return profile which seems to provide a better fit with the soldier/sage-culture.  

What follows for European reform? A copy-paste approach is unlikely to do the job. Legal transplants must be paradigm-compatible to work. Sajnovits’ example is Germany's reintroduction of dual-class shares: Delaware-inspired but docked onto German law without capsizing it. The EU Inc. 48-hour incorporation belongs in the same category. A soldier/sage can use his understanding of merchant culture, as Sajnovits puts it, "as a mirror that makes visible the blind spots of one's own doctrine" (p. 545). To have lasting success, Europe must use its own toolkit. Patient anchor capital through ETCI-style vehicles, mission-driven finance for deep tech, climate and defense, employee participation through profit-sharing and employee shares compatible with codetermination and the long employment bond, last not least: a rights-based data economy whose trustworthiness is itself becoming a competitive asset. Borrow selectively where paradigms permit, elsewhere, build the optional firm's functional equivalents with Europe's own grain. 

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Katja Langenbucher is a Law Professor at Goethe-University's House of Finance in Frankfurt, co-director of  the Institute for Monetary and Financial Stability, and affiliated professor at SciencesPo. She is an ECGI Research Member.

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This blog is based on a paper presented at the 5th conference on The Law and Finance of Private Equity and Venture Capital, held at Goethe University Frankfurt. The conference was convened by Bocconi University, the DFG LawFin Center at Goethe University Frankfurt, LSE Law School, the Faculty of Law of the University of Oxford, and the Institute for Law & Economics at the University of Pennsylvania, together with ECGI., Visit the event page to explore more conference-related blogs.

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