Law

1

SEMINAR 1 Week 27 Theories of the Company and of Corporate Governance In the first seminar, we move on from the initial discussion of definitions by considering some of the key theories that have sought to explain and account for the nature of the company and of corporate governance. In the first part of the class we will discuss economic approaches and, in the second, so-called stakeholder approaches. Given the apparent position of the company as the pre-eminent expression of capitalism, it is not surprising to find that it has been the focus of considerable attention by economists who have sought to explain its nature and, as a consequence, how it should be governed. What is perhaps more surprising is that there is little agreement among economists on these issues. As the Harvard economist Oliver Hart has expressed it:

An outsider to the field of economics would probably take it for granted that economists have a highly developed theory of the firm. After all, firms are engines of growth of modern capitalistic economies, and so economists must surely have fairly sophisticated views of how they behave. In fact, little could be further from the truth.

In the first part of the seminar, the aim will be to gain an impression of some of the major schools of thought regarding the company within the economic literature and to consider what their implications are for corporate governance. It will also be important to bear in mind the relationship between economic thinking and the legal understanding of the company. As lawyers, we are ultimately concerned with what law has to say about corporate governance. It is important to realise, however, that the legal model of the company in any given jurisdiction is an implicit or explicit reflection of a set of underlying economic, social and political decisions. Thus, in order to understand the legal position, we need to understand the models that have informed those decisions. We begin by looking at economics. Some of the papers listed below are quite complex, some are quite long. DON’T PANIC! You are not expected to understand complex equations or complex economic concepts. In each case, there is a fairly straightforward message relating to the company and its governance, which the authors discuss in relatively straightforward language. This is what you need to identify and focus upon. Even if you still find the exercise difficult, again please don’t worry. We will ensure in the class that the key points are identified and after the class a short document will be made available which summarises the lessons to be drawn from these important and influential texts.

Reading

• Coase, Ronald, ‘The Nature of the Firm’, Economica, November 1937, 386-405

• Alchian, Armen & Harold Demsetz, ‘Production, information costs, and economic organization’, The American Economic Review, Vol. 62, No. 5 (Dec., 1972), 777-795

• Jensen, Michael and William Meckling, ‘Theory of the firm: managerial behavior, agency costs, and

ownership structure’, Journal of Financial Economics, 3, (1976), 305-360

• Williamson, Oliver, ‘The Modern Corporation: Origins, Evolution, Attributes’, Journal of Economic Literature, Vol. 19, No. 4 (Dec., 1981), 1537-1568

• Hart, Oliver, ‘An economist’s perspective on the theory of the firm’, Columbia Law Review, Vol. 89, No.

7, Contractual Freedom in Corporate Law (Nov.,1989), 1757-1774 The following questions will help us to focus our discussions:

1. For Coase, why do firms emerge? Or, in other words, why is it suddenly the case that the market is no longer good enough?

2. What is the essence of the firm as far as Alchian and Demsetz are concerned?

2

3. What are the implications of Jensen and Meckling’s ideas on agency costs and the firm as a ‘nexus of

contracts’?

4. How does Williamson suggest that asset specificity affects the emergence of firms and by extension their governance?

5. For Hart, how does ownership of physical assets lead to control over human assets?

6. Which economic account of the firm do you find most convincing and why?

Following on from the examination of the relatively narrow view of the company and its governance allowed by economic accounts, this seminar will consider more recent theorising which understands the company as being composed of a broader range of interests or stakeholders. Such thinking is intuitively attractive, especially in the face of concerns about corporations acting with a lack of concern for social responsibility, environmental protection, etc. It is necessary to consider, however, whether such a broad understanding of the company could usefully inform practical corporate governance arrangements. In particular, how might a decision be made about which interests are to be included within the company? Assuming that such a decision could be made, what mechanism might allow these interests to be integrated so as to ensure its governance?

Reading

• Donaldson, Thomas and Lee E. Preston (1995) ‘A Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications’, Academy of Management Review, 20(1), 65-91.

Consider especially the following questions when reading this paper.

1. How do Donaldson and Preston categorize different versions of stakeholder theory?

2. What is their critique of the different categories of the theory that they identify?

3. What is the basis of their proposal for stakeholder theory? Does this resolve the problems they have identified with existing varieties of the theory?

All articles cited for this seminar are available online via the University Library, most easily by using the Primo search facility.