Shirking and Sharking: An Economic and Legal Theory of the Firm

Abstract:     
This article reexamines economic theories of the firm from a legal perspective. Focusing on the importance of legal agency authority, it recommends a revision in economic theories of the firm which emphasize agency and transactions costs, contracts, property rights and employment. A theory of the firm is advanced which combines both legal and economic principles. This theory is comprehensive enough to accommodate the fundamental insights of competing economic theories. From a legal perspective, it suggests a solution to a problem that economic theories have in defining the boundaries of firms. Business enterprise is described as involving both consumer markets for goods and services and organizational metamarkets of firms. The costs of agents and principals, among other important factors, determine which firms survive over time. Firms are described in terms of control, ownership, and employment on a spectrum ranging from pure sole proprietorships to corporate groups. The article also recommends that a theory of the firm should include the costs of opportunism or sharking by principals or quasi-principals through the misuse of power and authority within firms, as well as the more commonly recognized agency costs of shirking. It concludes with the implications of this analysis of the firm for the regulation of opportunism in the law of enterprise organization. In particular, the costs of sharking support judicial review of fiduciary duties in four different areas: oppression of minority shareholders, executive compensation, noncontractual harm to creditors, and financial reengineering of capital structure.

JEL Classification: D23, G38, K22

working papers series