Law, Economics, and Beyond: A Case for Retheorizing the Business Corporation

By Vasudev, P. M. | McGill Law Journal, November 2010 | Go to article overview
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Law, Economics, and Beyond: A Case for Retheorizing the Business Corporation

Vasudev, P. M., McGill Law Journal

This essay presents a critical analysis of the economic theory of corporations and its idioms, such as "nexus of contracts", "agency costs", and "shareholder value". It calls for the development of a richer and more inclusive theory of business corporations that draws on the experience of the last three decades and better addresses the needs of the post-Enron, post-MG world.

The author identifies the following shortcomings of the economic theory of corporations. First, the contractarian interpretation overlooks the role of law and public policy in corporations. Second, using share prices as the yardstick of corporate performance and encouraging practices such as the buyback of shares have serious implications for the competitiveness and sustainability of corporations. Third, there is inadequate attention to the characteristic and normative distinctions between debt and equity. And fourth, hostile takeovers are treated as virtually the only solution to entrenched managements. The problem of managerial power must be reviewed in the light of evidence regarding managerial power and the efficacy of boards. Equally, there is a case for developing a more deliberated, fair, and equitable policy on executive pay.

A travers une analyse critique de la theorie economique des entreprises et de ses idiomes, cet essai appelle au developpement d'une theorie plus riche et plus inclusive qui profite de l'experience des trois dernieres decennies et qui repond mieux aux besoins d'un monde post-Enron et post-MG.

L'auteur identifie plusieurs defauts de la theorie economique des entreprises. Premierement, l'interpretation contractualiste neglige le role du droit et de la politique publique dans les entreprises. Deuxiemement, l'utilisation du prix des actions comme mesure de performance des entreprises ainsi que les pratiques telles que le rachat d'actions ont des consequences importantes pour la competitivite et la viabilite des entreprises. Troisiemement, il n'y a pas assez d'attention accordee aux distinctions caracteristiques et normatives entre la dette et les actions ainsi que l'encouragement indirect de la dette. Quatriemement, le fait de traiter l'achat hostile comme etant essentiellement la seule solution a la question de l'enchassement des cadres est problematique. Le probleme du pouvoir des gestionnaires doit etre revu a la lumiere des faits sur le pouvoir des gestionnaires et sur l'efficacite des conseils. De plus, les politiques de remuneration des cadres doivent etre mieux reflechies, plus justes et plus equitables.



  I. Economic Theory of Corporations: An Outline

 II. Economic Theory: Its Milieu.
     A. Managerial Power and Its Implications
     B. Shareholder Reward and Stagnant Share Prices
     C. Rise of the Anti-regulation Sentiment and the Law and
        Economics Movement
        1. The Anti-regulation Sentiment
        2. The Law and Economics Movement

III. Economic Theory: A Critical Analysis
     A. The Corporation as a Nexus of Contracts
        1. Reporting by Corporations
        2 Audit
        3. Corporate Law and Creditor Protection
        4. Recent Experience: Smith v. Van Gorkom and SOX
     B. Shareholder Reward and Short-termism
     C. Corporate Finance: The Blurring of Boundaries between
        Debt and Equity
     D. Corporate Control." Constitution and Change
        1. Directors' Elections and Takeovers
        2. Corporate Shares: Stock Options and Poison Pills
     E. Managerial Power, Executive Compensation, and Stock
        1. Managerial Power and the Monitoring Board
        2. Executive Compensation and Stock Options

Conclusion: A Case for a New Theory of Corporations

It is embarrassing to admit that, after several hundred years, social scientists have not yet developed a thorough understanding of the advantages and disadvantages of publicly held profit seeking corporations versus other forms of organizations such as cooperatives, nonprofit corporations, universities, proprietorships, joint ventures and mutuals.

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Law, Economics, and Beyond: A Case for Retheorizing the Business Corporation


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