Corporate Governance and the Cult of Agency

Abstract

Agency theory - as applied to debates in corporate governance - rests on a myth of separated ownership and control. The true separation, however, is between ownership and ownership: ownership of shares by shareholders and ownership of assets by the corporation. Shareholders are not principals; directors, officers, and managers are not shareholders' agents. Shareholders do elect directors, but directors then act according to corporate law, which rarely requires maximizing current shareholder value. To the contrary, corporate law allows - even encourages - directors to work for corporate longevity so long as directors have a plausible argument that their actions are in shareholders' "long-run" interests. Agency theory ignores this reality. Instead, much as early civilizations interpreted real-world phenomena by reference to their relationship with unseen deities, agency theorists tell tales of shareholders who struggle to keep peace with sacrifices (paying monitoring expenditures), managers make divine promises to behave (incurring bonding costs), but shareholders in the end are left to deal with the gods' uncontrolled whim (remaining managerial discretion). Yet despite thousands of articles, there is no evidence this battle is real. Managers are usually loyal, probably because so much of the focus of existing corporate law is on the control of managerial disloyalty and because the business world is far more competitive than most agency-cost models assume, leaving little scope for managerial slack. What evidence shows instead is that managers suffer from cognitive biases; most importantly, they are too optimistic. Managerial optimism and the flexibility of corporate law explain most arguable failures to maximize current shareholder value. Scholarship in both economics and law would improve if researchers faced these realities and left the cult of agency behind.

Keywords: Agency Problems, Agency Costs, Corporate Governance, Behavioral Law and Economics, Behavioral Finance, Corporate Law

JEL Classification: K22, G02, G31, G32, G34, G35, G38