54 Pages Posted: 29 Jun 2011 Last revised: 28 Jun 2013
Date Written: November 1, 2010
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-AIG world.
Several deficiencies are identified in the economic theory of corporations. First, the contractarian interpretation of corporations overlooks the role of law and public policy in the creation and governance of corporations. Second, using share prices as the yard stick of corporate performance and encouraging practices such as buyback of shares have serious implications for the long-term competitiveness and sustainability of corporations. Third, there is inadequate attention to the characteristic and normative distinctions between debt and equity. In the framework of economic theory, the problems of managerial power, board efficacy and executive pay also do not receive the sophisticated treatment they require.
In general, economic theory overlooks the impact of microeconomic prescriptions on macroeconomic welfare. This is especially important for the globalized markets of today with the ubiquitous phenomena of outsourcing of manufacturing and business processes. Referring to the experience, the article calls for revisiting the theory underlying business corporations to better address the needs of the present and the foreseeable future.
Keywords: corporate governance, economic theory, agency costs, nexus of contracts, shareholder value, executive pay, globalization, dividends, share buybacks, Enron
JEL Classification: B21, B22, G30, G32, G34, G35, G38, G39, K22, L20
Suggested Citation: Suggested Citation
Vasudev, P. M., Law, Economics, and Beyond: A Case for Re-Theorizing the Business Corporation (November 1, 2010). McGill Law Journal, Vol. 55, No. 4, 2010. Available at SSRN: https://ssrn.com/abstract=1874272