By Laura Vialon
Corporate law has been dominated by nexus of contract and agency theory. These theories have proven effective to test corporate law’s efficiency against, but their narrow focus has led to a corporate law estranged from the actual organisation it has to support. For a long time, few have thought about advancing a different, more realistic theory, capturing the complexity of the real-life entity. Recently however, David Gindis and Eva Micheler have – with their latest joint piece published in the Journal of Corporate Law Studies – opened a new debate introducing an institutional theory for corporate law. This blog purports, a more realistic analysis of corporate law’s efficiency is not the only opportunity this offers. Furthermore, a realistic – social sciences, evidence based – theory of the business organisation enables normative advances: When we see what is and how it works, we can actually fix it.
For a long time now, microeconomic theories dominate Anglo-American corporate law and how it is taught in universities: theory of the firm, agency theory, transaction costs with Coase, Jensen & Meckling, Easterbrook & Fischel and others. The firm exists as it reduces transaction costs compared to the market; on the market contracts need to be negotiated on an individual basis, in the firm, a central agent coordinates production and less complex bilateral (implied) contracts reign. Agency theory is about minimising agency costs within the firm which arise through the separation of ownership (shareholders) and control (board of directors). The core of agency theory is that there is always a conflict of interest between these two corporate players and corporate law is the most efficient when it can minimise this conflict the best possible. This elegant model has inspired corporate lawyers to venture into the social sciences, giving them a framework to test corporate law’s efficiency against. Legally this has spurred for example director’s rising pay, independent board structures and hostile takeover legislation (see Johnston or Deakin) and in general (nexus of) contract theory à la Easterbrook & Fischel has led to a more facilitative rather than regulatory corporate law.
Despite law & economics’ success in influencing statute, there has always been critique and empirical testing has now discredited some of its premises. Years of nexus of contract and agency theory from the 1980’s on have not created the efficiency we need today – which would be rather resource efficiency, design intelligence and not profit maximisation from a sustainability perspective – nor have they lead conclusively to ‘greater financial development and firm-level performance’ (Deakin): Apparently axing corporate governance around shareholder value with the aim to reduce managerial agency costs, does not translate into more external finance a firm can attract and thus stimulation of economic growth for all.