Monitors and Freeriders in Commercial and Corporate Settings

The usefulness of private arrangements and legal rules for the maintenance and promotion of social and economic relationships depends, in great part, on their effective enforcement. Enforcement, however, is not possible unless violations are first detected. It therefore seems critical to consider the ability and motivation of legal actors to monitor each other's behavior.1 The level of monitoring in a simple two-party transaction is likely to be efficient. The monitor will continue to expend effort as long as his cost of doing so is less than his expected benefit. But when there are many potential monitors with overlapping interests, the optimal level may prove more elusive. An individual seeking to reduce his own monitoring costs may attempt to rely on the efforts of others; such "freeriding," 2 if widespread, will lead to undermonitoring. Overlapping interests can also lead to duplicative efforts on the part of potential monitors. From an economic perspective, both undermonitoring and overmonitoring are undesirable.' This Article considers the possibility that legal relationships and rules relieve monitoring difficulties, including the freeriding problem, and thereby promote joint enterprises. In particular, it examines the role that monitoring plays in commercial and corporate settings. Part I considers the role of security interests in determining creditor priorities in bank-