Corporate governance, capital theory, and corporate finance theory: An approach from property theory

Abstract

An analysis of the corporate governance debate is developed using a descriptive theory about the system of private property and contract in a market economy. There are strong implications for capital theory and corporate finance theory. The structure of the main results is that what often appears as being an owned property right is upon analysis seen to be only a contractual position—and contractual positions only extend a few years into the future. An enterprise could be described concretely as specific people working with specific machines producing a certain product or it could be described more abstractly using the economists’ notion of a production function. But either way, it is not determined who is legally undertaking the enterprise until the contracts between the factor suppliers are given. Thus the determination of who undertakes an enterprise is contractually determined; it is not an owned property right. In this sense, there is no such thing as the "ownership of the firm" since the party undertaking an enterprise, the residual claimant, is determined by the direction of the hiring contracts. There is the ownership of a conventional joint stock corporation, but a corporation does not "own" the enterprise that it is currently undertaking by virtue of its contractual position. For another party to take over the enterprise, it is sufficient to redo the contracts, not "buy the firm." Since a corporation’s paid contracts at best extend only a few years into the future, there is no basis for the common assumption in capital theory or corporate finance theory that the corporation "owns" the future enterprise cash flows in perpetuity. This simple result thus has rather strong implications for considerations of enterprise governance as well as for capital theory and corporate finance theory. Many of the "ownership" assertions that fuel the debate about enterprise governance are groundless, and the discounting of future enterprise net returns beyond the horizon of current contracts does not represent the valuation of current property rights.