Economics, Capitalism, and Corporations: Contradictions of Corporate Law, Economics, and the Theory of the Firm (original) (raw)

2020, Economics, Capitalism, and Corporations: Contradictions of Corporate Law, Economics, and the Theory of the Firm

This book is an extension of Corporate Law and the Theory of the Firm: Reconstructing Corporations, Shareholders, Directors, Owners, and Investors, which was an exposé of the contradictions of contract law, property law, agency law, trust law, and corporate law and from which some portions of this book are adopted and summarized with permission. This book delves much more deeply into the contradictions between corporate law and the economic theory of the firm and expands the analysis into the contradictions between corporate law and economics, finance, and accounting. It reveals how the term, and therefore the concept, of “capital” has been distorted and how “capitalist” and “capitalism” as a social system have been twisted and perverted. The book begins with a brief review of corporate law and its contradictions, including property law and agency law, in order to establish the context and provide a foundation for an analysis of corporations and economic considerations, finance considerations, investment considerations, and accounting considerations. Jensen and Meckling’s (1976) Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure is considered the classic on the “theory of the firm.” Jensen and Meckling attempt to “integrate elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm” (p. 305). While it was successful in launching an entirely new branch of literature on the economic theory of the firm, it was an abject failure in achieving its objective. It did not integrate elements from the theory of agency with the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm because it not just ignored, but made assumptions contradicted by, corporate law, property law, and agency law. Their approach was backwards. They (attempted to) use the theory of agency, the theory of property rights, and the theory of finance to develop a theory of the ownership structure of the firm rather than establishing the legal ownership structure of the firm as determined by agency law and property law to develop an economic theory of the firm. Property law determines the ownership of the firm, and agency law determines the relationship of directors and shareholders. It is only after the legal ownership structure of the firm and the relationship of corporations, directors, and shareholders are determined that the economic and finance theory of firm can be developed. But Jensen and Meckling completely ignored an analysis of property law and agency law, choosing rather merely to rest on invalid assumptions and unjustified conclusions about the relationship of property law and agency law to corporations. Jensen and Meckling’s Theory of the Firm, along with Fama and Jensen’s 1983 Separation of ownership and control laid the groundwork of the economic “theory of the firm.” The economic “theory of the firm” is grounded in agency theory which is a function of Berle and Mean’s theory of the separation of ownership and control in corporations. The separation of ownership and control takes as an axiom that shareholders are owners of the corporation. Thus, corporate ownership necessarily determines the economic theory of the firm. But since shareholders do not own the corporation, there are no owners to be separated from. If shareholders do not own the corporation, directors are not their agents. Therefore, there can be no agency theory of the firm or agency costs on which the theory of the firm is grounded and the entire economic “theory of the firm” falls apart. The entire economic theory of the firm stands or falls on whether shareholders own the corporation. It is inexplicable how Jensen and Meckling, and Fama and Jensen, and those who followed them were able to create an entire body of literature on the theory of the firm based on agency costs without ever at least acknowledging the requirements of agency law. Referring to directors as agents of shareholders is legally incorrect and misleading economically.