Organizational Loyalties and Models of Firms: Governance Design and Standard of Duties

EUI Working Paper LAW No. 2005/05

63 Pages Posted: 5 Nov 2005

Date Written: May 2005


This paper makes the two following claims: 1) The legal dimension of loyalty within organizations goes beyond duties. The governance design aimed at ensuring loyalty may strongly affect standards that characterize each layer of the organization. The interaction between standards of duty and the governance dimension of loyalty should, therefore, be more tailored to specific legal forms and their functional correlation with ownership and financing. 2) There is a greater divergence than has so far been acknowledged between the function of loyalty in vertically integrated firms and in networks of small firms. This difference, created by the relationship between the duty and the governance dimensions, should have repercussions on the definitions of legal standards. In particular, it should reflect the different relationships between hierarchy, monitoring, and loyalty and the choice between prohibitory, authorization-based, and compensatory rules. The analysis concentrates on the key variables that may affect the choice between vertical and horizontal monitoring to ensure compliance with loyal behavior in two polar models: hierarchical firms and networks of small firms. It reveals the importance of considering the governance design when defining duties of loyalty and related standards to evaluate party-related transactions in both cases but, at the same time, the necessity of using different interpretive categories.

Keywords: Company law, theory of the firm, liability of directors, conflict of interests, duty of loyalty

Suggested Citation

Cafaggi, Fabrizio, Organizational Loyalties and Models of Firms: Governance Design and Standard of Duties (May 2005). EUI Working Paper LAW No. 2005/05, Available at SSRN: or

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