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The Contractual Theory of the Corporation


Henry N. Butler


George Mason University School of Law

1989

George Mason Law Review, Vol. 11, No. 4, pp. 99-123, Summer 1989
George Mason Law & Economics Research Paper No. 12-19

Abstract:     
The modem corporation is one of the most successful inventions in history, as evidenced by its widespread adoption and survival as a primary vehicle of capitalism over the past century. Economists, however, have only recently begun to understand the economic nature of the corporation. In the last fifteen years, the economic theory of the firm has advanced from a struggle with the identification of the economic conditions that lead to the formation of firms to a discourse on sophisticated issues concerning intrafirm relationships. As a consequence of these developments, economists have come to view the firm as a "nexus of contracts" among participants in the organization. When applied to the corporate form of organization, the theory of the firm is often referred to as the contractual theory of the corporation.

This paper offers a summary of the contractual theory of the corporation and considers some of its general implications for corporate law. Section I sets the stage for the discussion by presenting a summary of the traditional legal view of the modem corporation. Section II presents a summary of the theory of the firm as it relates to corporate organization. Section III describes the market and contractual constraints that force managers of large, dispersed-owner corporations to act in their shareholders' best interests. Section IV considers the implications of the contractual theory of the corporation for private ordering of corporate governance issues. Section V offers some concluding comments.

Number of Pages in PDF File: 26

Keywords: ALI, Adolph A. Berle, Armen Alchian, American Law Institute, Cheung, Crawford, corporate governance project, directors, entity, Gardiner C. Means, Harold Demsetz, Jensen, Klein, managers, Meckling, modern, officers, private property, Ronald Coase, shareholders, transaction costs, Williamson

JEL Classification: G32, G34, G38, K22, K23, M14, R34, R38

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Date posted: February 23, 2012  

Suggested Citation

Butler, Henry N., The Contractual Theory of the Corporation (1989). George Mason Law Review, Vol. 11, No. 4, pp. 99-123, Summer 1989; George Mason Law & Economics Research Paper No. 12-19. Available at SSRN: http://ssrn.com/abstract=2008965

Contact Information

Henry N. Butler (Contact Author)
George Mason University School of Law ( email )
3301 Fairfax Drive
Arlington, VA 22201
United States
703-993-8644 (Phone)
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