Natural Law and Agency Theory

Abstract

Corporate governance scholarship is awash with theories of the firm: these are "stories" or metaphors that try to shed light on the nature and purpose of the firm as an institution and on one or more of the following questions:

(i) how the institution of the firm "evolved" (or its economic or social purpose); (ii) whether "the firm" is a reality or a rhetorical device; and (iii) the relationship between "the firm" and stakeholders, political society and so on.

Theories of the firm are used both to explain and to help develop law and policy. If the theory is misconceived, or pushed too far, then policy based on that theory can be destructive.

This paper will argue that John Finnis' natural law theory (John Finnis, Natural law and natural rights, (Oxford, 2003)) provides:

(i) an understanding of the firm as a human community; and (ii) a framework that can be used to evaluate more specialised theories of the firm.

No single theory of the firm can capture the full reality and, so, there is a need for a meta-theory capable of evaluating and sifting the more partial and specialised theories of the firm.

The first part of this paper will explain John Finnis' natural law theory and show how it can be applied to our understanding of the firm. The second part will critique Williamsons' Transaction Cost Economics ("TCE") and agency theory from the perspective of natural law theory. It will be argued that they are flawed because of failures to address the goods that drive human behaviour and to understand the nature of human communities (and relations within them). Agency theory can be a useful way of thinking about the relationship between passive investors and management but not as a generalised account of the firm. Several commentators believe that pushing agency theory and TCE too far has been both morally corrupting and economically inefficient.

Keywords: Natural law, theory of the firm, agency theory, corporate governance

JEL Classification: A12, A13, G3, K22, L2