Chapter 4: Investor capitalism and the nexus of contract view of the firm: assessing the consequences
By the early 1990s, after roughly fifteen years of mobilization of the business community and free market advocacy and reform, the new theory of the firm was conventional wisdom. It consisted basically of two principal ideas, both rooted in the combination of theoretical perspectives, derived from the same propositions and methodological assumptions, mutually reinforcing one another and yet representing their own specific interests including price theory (in economics), contractual theory (in legal studies), and agency theory (in corporate governance and management theory): (1) the firm was understood as a nexus of contracts, a ‘legal fiction’, that granted owners of stock the right to claim their proportional share of the residual cash flow generated by the firm; and (2) corporate governance practices were strongly oriented towards shareholder welfare at other principals’ and stakeholders’ expense. Gordon (2007: 1535) summarizes the essence of the new conventional wisdom as ‘[t]he 1950s tendency was to believe that firms could create and manage markets. By contrast, as evidenced by the growth of disaggregated, networked firms, the 1990s tendency was to use market signals to manage the firm’. In this new milieu, it was asserted, shareholders claimed their share of the residual cash flow but also provided the auxiliary benefit to reduce agency costs and better allocated the stock of finance capital to industries and niches in the economy with a better growth potential than mature or stagnating industries. To act in accordance with these prescriptions, executives were incentivized to fully commit to cost-cutting...
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