Legal and Economic Theories of Corporate Governance: Past Approaches

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Theories of the firm and theories of corporate law or corporations provide the basis for the study of corporate governance. One can say that all such theories address at least some questions that are interesting in this context. The purpose of this chapter is to provide a critique of the existing theories. A new theory will be proposed in the next chapter.

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In recent years, the rather arcane subject of corporate governance, meaning the governance of the public companies that dominate the economy, 1 has risen high on the political and legal agenda. Various reasons for this can be identified, prominent amongst them the debates, with which the governance issue has become entwined, about the virtues in relation to both social welfare and international competitiveness of different versions of capitalism and the corporation. As company lawyers are well aware, diverse opinions have emerged, with some advocating the adoption of a legal model of the company based around so-called stakeholding principles akin to those said to be found in Germany and Japan, while others seek to reinvigorate the traditional, shareholder-oriented, Anglo-American model. 2 Despite these differences, however, there is widespread agreement that shareholders have an important role to play in ensuring good governance. For some, good governance requires a restoration of shareholder supervision and control. 3 For others, including many supporters of 'stakeholding', it should not be judged purely in terms of maximising 'shareholder value' but still requires more 'committed' ownership by shareholders, if only to eradicate the danger of 'short- termism'. 4 In keeping with this, the Labour government has recently asserted the need for more active and less fickle shareholding and has for some time been toying with the idea of making voting at company general meetings compulsory for institutional investors. 5 Underlying this consensus is a shared assumption: that the shareholders of large corporations 'own' the companies concerned; 6 or in the 'nexus of contracts' or 'agency' theory of the company, in what amounts to the same thing, that the
This paper analyzes the survival of organizations in which decision agents do not bear a major share of the wealth effects of their decisions. This is what the literature on large corporations calls separation of 'ownership' and 'control.' Such separation of decision and risk bearing functions is also common to organizations like large professional partnerships, financial mutuals and nonprofits. We contend that separation of decision and risk bearing functions survives in these organizations in part because of the benefits of specialization of management and risk bearing but also because of an effective common approach to controlling the implied agency problems. In particular, the contract structures of all these organizations separate the ratification and monitoring of decisions from the initiation and implementation of the decisions.
'Corporate Governance Adrift is a challenging book ... the authors have succeeded in creating a work that is consistently fascinating and an argument that is lucid and gripping without ever compromising its intellectual weight.' - Manifest Recent corporate governance scandals have brought to the fore the inherent contradictions of a capitalism dominated by financial markets. This challenging book by Michel Aglietta and Antoine Rebérioux argues that capitalism's basic premise - that companies must be managed in the sole interest of their shareholders - is incongruent with the current environment of liquid markets, profit-hungry investors and chronic financial instability. The authors advocate rather that a company should be managed as an institution where common objectives are developed for all stakeholders, and that this democratic principle should be extended to the management of collective savings to reduce macro-financial instability. These two conditions, they contend, could make contemporary capitalism a vehicle for social progress. © The Saint-Gobain Centre for Economic Studies 2005. All rights reserved.
This paper is a survey of the literature on boards of directors, with an emphasis on research done subsequent to the Benjamin E. Hermalin and Michael S. Weisbach (2003) survey. The two questions most asked about boards are what determines their makeup and what determines their actions? These questions are fundamentally intertwined, which complicates the study of boards because makeup and actions are jointly endogenous. A focus of this survey is how the literature, theoretical as well as empirical, deals-or on occasions fails to deal-with this complication. We suggest that many studies of boards can best be interpreted as joint statements about both the director-selection process and the effect of board composition on board actions and firm performance.
The concept of shared value—which focuses on the connections between societal and economic progress—has the power to unleash the next wave of global growth. An increasing number of companies known for their hard-nosed approach to business—such as Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart—have begun to embark on important shared value initiatives. But our understanding of the potential of shared value is just beginning. There are three key ways that companies can create shared value opportunities: By reconceiving products and markets • By redefining productivity in the value chain • By enabling local cluster development • Every firm should look at decisions and opportunities through the lens of shared value. This will lead to new approaches that generate greater innovation and growth for companies—and also greater benefits for society. The capitalist system is under siege. In recent years business increasingly has been viewed as a major cause of social, environmental, and economic problems. Companies are widely perceived to be prospering at the expense of the broader community. Even worse, the more business has begun to embrace corporate responsibility, the more it has been blamed for society's failures. The legitimacy of business has fallen to levels not seen in recent history. This diminished trust in business leads political leaders to set policies that undermine competitiveness and sap economic growth. Business is caught in a vicious circle. A big part of the problem lies with companies themselves, which remain trapped in an outdated approach to value creation that has emerged over the past few decades. They continue to view value creation narrowly, optimizing short-term financial performance in a bubble while missing the most important customer needs and ignoring the broader influences that determine their longer-term success. How else could companies overlook the well-being of their customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell? How else could companies think that simply shifting activities to locations with ever lower wages was a sustainable "solution" to competitive challenges? Government and civil society have often exacerbated the problem by attempting to address social weaknesses at the expense of business. The presumed trade-offs between economic efficiency and social progress have been institutionalized in decades of policy choices.
В статье производится анализ агрегированной производственной функции, вводится аппарат, позволяющий различать движение вдоль такой функции от ее сдвигов. На основании сделанных в статье предположений делаются выводы о характере технического прогресса и технологических изменений. Существенное внимание уделяется вариантам применения концепции агрегированной производственной функции.
Property in transition (Book I, chapter 1) …The typical business unit of the 19th century was owned by individuals or small groups; was managed by them or their appointees; and was, in the main, limited in size by the personal wealth of the individuals in control. These units have been supplanted in ever greater measure by great aggregations in which tens and even hundreds of thousands of workers and property worth hundreds of millions of dollars, belonging to tens or even hundreds of thousands of individuals, are combined through the corporate mechanism into a single producing organization under unified control and management.… Such an organization of economic activity rests upon two developments, each of which has made possible an extension of the area under unified control. The factory system, the basis of the industrial revolution, brought an increasingly large number of workers directly under a single management. Then, the modern corporation, equally revolutionary in its effect, placed the wealth of innumerable individuals under the same central control. By each of these changes the power of those in control was immensely enlarged and the status of those involved, worker or property owner, was radically changed. The independent worker who entered the factory became a wage laborer surrendering the direction of his labor to his industrial master. The property owner who invests in a modern corporation so far surrenders his wealth to those in control of the corporation that he has exchanged the position of independent owner for one in which he may become merely recipient of the wages of capital.
Public companies play crucial roles in today’s world, and it has been acknowledged that ascertaining the objective of such companies is a critical issue. However, there remains great uncertainty as to what that objective should be. This article examines the two predominant theories that have been propounded as the corporate objective, namely the shareholder primacy and stakeholder theories. This is followed by an explanation of, and the case for, a new model, the entity maximisation and sustainability model. This model focuses on the company as a separate legal entity and maintains that the objective of the company is to maximise the wealth of the entity as an entity and, at the same time, to ensure that the company is sustained financially.
Economists have long been concerned with the incentive problems that arise when decision making in a firm is the province of managers who are not the firm's security holders. One outcome has been the development of “behavioral” and “managerial” theories of the firm which reject the classical model of an entrepreneur, or owner-manager, who single-mindedly operates the firm to maximize profits, in favor of theories that focus more on the motivations of a manager who controls but does not own and who has little resemblance to the classical “economic man.” Examples of this approach are Baumol (1959), Simon (1959), Cyert and March (1963), and Williamson (1964b). More recently the literature has moved toward theories that reject the classical model of the firm but assume classical forms of economic behavior on the part of agents within the firm. The firm is viewed as a set of contracts among factors of production, with each factor motivated by its self-interest. Because of its emphasis on the importance of rights in the organization established by contracts, this literature is characterized under the rubric “property rights.” Alchian and Demsetz (1972) and Jensen and Meckling (1976b) are the best examples. The antecedents of their work are in Coase (1937, 1960). The striking insight of Alchian and Demsetz (1972) and Jensen and Meckling (1976b) is in viewing the firm as a set of contracts among factors of production.
The corporate-control market The conventional approach to a merger problem takes corporations merely as decision-making units or firms within the classical market framework. This approach dictates a ban on many horizontal mergers almost by definition. The basic proposition advanced in this paper is that the control of corporations may constitute a valuable asset, that this asset exists independent of any interest in either economies of scale or monopoly profits, that an active market for corporate control exists, and that a great many mergers are probably the result of the successful workings of this special market. Basically this paper will constitute an introduction to a study of the market for corporation control. The emphasis will be placed on the antitrust implications of this market, but the analysis to follow has important implications for a variety of economic questions. Perhaps the most important implications are those for the alleged separation of ownership and control in large corporations. So long as we are unable to discern any control relationship between small shareholders and corporate management, the thrust of Berle and Means's famous phrase remains strong. But, as will be explained below, the market for corporate control gives to these shareholders both power and protection commensurate with their interest in corporate affairs. A fundamental premise underlying the market for corporate control is the existence of a high positive correlation between corporate managerial efficiency and the market price of shares of that company.
The past twenty years have seen great theoretical and empirical advances in the field of corporate finance. Whereas once the subject addressed mainly the financing of corporations--equity, debt, and valuation--today it also embraces crucial issues of governance, liquidity, risk management, relationships between banks and corporations, and the macroeconomic impact of corporations. However, this progress has left in its wake a jumbled array of concepts and models that students are often hard put to make sense of. Here, one of the world's leading economists offers a lucid, unified, and comprehensive introduction to modern corporate finance theory. Jean Tirole builds his landmark book around a single model, using an incentive or contract theory approach. Filling a major gap in the field, The Theory of Corporate Finance is an indispensable resource for graduate and advanced undergraduate students as well as researchers of corporate finance, industrial organization, political economy, development, and macroeconomics. Tirole conveys the organizing principles that structure the analysis of today's key management and public policy issues, such as the reform of corporate governance and auditing; the role of private equity, financial markets, and takeovers; the efficient determination of leverage, dividends, liquidity, and risk management; and the design of managerial incentive packages. He weaves empirical studies into the book's theoretical analysis. And he places the corporation in its broader environment, both microeconomic and macroeconomic, and examines the two-way interaction between the corporate environment and institutions. Setting a new milestone in the field, The Theory of Corporate Finance will be the authoritative text for years to come.
The paper first develops an economic analysis of the concept of shareholder value, describes its approach, and discusses some open questions. It emphasizes the relationship between pledgeable income, monitoring, and control rights using a unifying and simple framework. The paper then provides a first and preliminary analysis of the concept of the stakeholder society. It investigates whether the managerial incentives and the control structure described in the first part can be modified so as to promote the stakeholder society. It shows that the implementation of the stakeholder society strikes three rocks: dearth of pledgeable income, deadlocks in decision-making, and lack of clear mission for management. While it fares better than the stakeholder society on those three grounds, shareholder value generates biased decision-making; the paper analyzes the costs and benefits of various methods of protecting noncontrolling stakeholders: covenants, exit options, flat claims, enlarged fiduciary duty.
The objective of this article is to conduct a survey of the different corporate governance theories. In the first part, we present the micro theories by opposing the disciplinary view to the knowledge-based view. The second part deals with the macro or national systems theories. We separate the theories based on appropriation of the organizational rent from those attributing a dominant role to production. This survey highlights that the financial view of corporate governance is a very particular case and presents many limits.
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