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Washington University Law Quarterly

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corporate governance - directors of corporations


Commercial Law | Law


One of the most pressing questions facing both corporate scholars and business people today is how corporate directors can be made accountable. Before addressing this issue, however, it seems important to consider two antecedent questions: To whom should directors be accountable? And for what? Contemporary corporate scholarship often starts from a "shareholder primacy" perspective that holds that directors of public corporations ought to be accountable only to the shareholders, and ought to be accountable only for maximizing the value of the shareholders' shares. This perspective rests on the conventional contractarian assumption that the shareholders are the sole residual claimants and risk bearers in a public firm. More recent work in economics suggests, however, that this assumption is false. In particular, options theory and the growing literature on the contracting difficulties associated with firm-specific investment both support the claim that a wide variety of groups are likely to bear significant residual risk and enjoy significant residual claims on firm earnings. These groups include not only shareholders, but also creditors, managers, and employees. Thus economic efficiency may be best served not by requiring corporate directors to focus solely on shareholders' interests, but by requiring them instead to maximize the sum of all the interests held by all the groups that bear residual risks and hold residual claims. In accord with this view, we argue that corporate directors ought to be viewed not as "agents" who serve only the shareholders, but as "mediating hierarchs" who enjoy ultimate control over the firm's assets and outputs and who are charged with the task of balancing the sometimes-conflicting claims and interests of the many different groups that bear residual risk and have residual claims on the firm. This mediating model of the board's role offers to explain a variety of important doctrines in U.S. law that preserve director autonomy and insulate the board from the command and control of the shareholders or indeed any other group. At the same time, the mediating model raises the question of why directors who are largely insulated from outside pressures should be expected to do a good job of running the firm. We suggest that answers to this question are available, but only if we are willing to look beyond the homo economicus model of rationally selfish behavior commonly employed in economic analysis and to consider as well the extensive empirical evidence in the social sciences literature on the phenomenon of intrinsically trustworthy, other-regarding behavior. We briefly explore how this literature both supports the claim that directors may behave trustworthily even when they do not have explicit incentives to do so, and suggests some of the circumstances that are likely to promote accountable director behavior.



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