Abstract:
The performance of firms and the functioning of capital markets are determined by multiple factors, of which the formal law is only one. Unlike other factors, it is fairly easy to trace the evolution of the formal law and changes therein over time. Assuming that laws are changed not arbitrarily, formal legal change may be used as a proxy for broader change. This may include changes in the relation of the corporation vis-à-vis the state, the allocation of control rights among different stakeholders of the corporation, or changes in the mechanisms of accountability. An analysis of the areas within corporate law that have been subject to the most extensive change over time can inform us about the actual and perhaps changing function of the corporation. Current theories of the firm and previous cross-country analyses of corporate law are preoccupied with the principal-agent problem, i.e. the problem of how to make management accountable to shareholders. Our analysis suggests that the actual challenge for corporate law - including statutory and case law - was much more complex. The task was to balance solutions for the principal agency problem on the one hand with sufficient flexibility for the firm to adapt to a rapidly changing environment on the other. The basic mechanisms for addressing the principal-agency problem were known by the late nineteenth century. The challenge since has been to relax these mechanisms so that firms could quickly adapt and capture new opportunities without creating a control vacuum that would be exploited by those who hold the de facto control rights. The main difference between legal systems is not how well they protect property rights, but their ingenuity in finding solutions for these conflicting tasks.