Friday, 26 March 2010: 14:50
The traditional property conception of the corporation which holds that the shareholders are its owners is questionable in today’s large public corporations. This concept of ownership was valid during the pre-Industrial Revolution up to the early part of the 1900s. In today’s modern public corporations, there are no owners in the traditional sense, only investors. Yet, the traditional concept of property and property rights was used by Jensen and Meckling as foundation for the agency theory and the theory of the firm for over three decades until today.
Why then the agency theory and the theory of the firm became the dominant theories in business and finance for over 30 years since 1976, as well as points of intense validation and replication by scholars and researchers on the subject? The fundamental reason perhaps is that these theories are open to mathematical manipulation with the advent of advanced computer technology. Unfortunately, these scholars and researchers appear to have accepted without question and scrutiny the theoretical foundation of the agency theory (the principal-agent relationship of the stockholders and managers of the corporate enterprise) and the theory of the firm (the “nexus of contractual relationships” in the corporate setting). If the scholars and students of these theories have questioned or scrutinized their basic foundation, they must have found that any reference to the works of Berle and Means regarding the development and ownership of the modern corporation was based on the 1932 treatise which was revised and updated in the follow-up treatise by the same authors to reflect the change in the environment of the modern corporation. The change was so dramatic that Berle and Means concluded in their updated treatise of 1968:
From the economic point of view, the crucial implication of the corporate revolution was the extent to which it made obsolete the basic concepts underlying the body of traditional economic theory which was then the basis of public policy. Wealth, enterprise, initiating the profit motive, and competition, each was shown to have become so changed in character with the revolution as to make traditional theory no longer applicable. The conclusion was reached that new concepts must be forged and a new picture of economic relationships created.
In the years that followed since the introduction of these theories, particularly the agency theory, countless accolades and awards were handed to scholars and researchers who replicated, validated and extended their coverage and applicability. While questions were raised over the years regarding certain assumptions of the agency theory, volumes of literature were generated by researchers to validate the theory. In this paper, the writer concluded that the agency theory is defective from its inception and should have been discarded long time ago. This writer proposes the enterprise theory to replace the agency theory..
Why then the agency theory and the theory of the firm became the dominant theories in business and finance for over 30 years since 1976, as well as points of intense validation and replication by scholars and researchers on the subject? The fundamental reason perhaps is that these theories are open to mathematical manipulation with the advent of advanced computer technology. Unfortunately, these scholars and researchers appear to have accepted without question and scrutiny the theoretical foundation of the agency theory (the principal-agent relationship of the stockholders and managers of the corporate enterprise) and the theory of the firm (the “nexus of contractual relationships” in the corporate setting). If the scholars and students of these theories have questioned or scrutinized their basic foundation, they must have found that any reference to the works of Berle and Means regarding the development and ownership of the modern corporation was based on the 1932 treatise which was revised and updated in the follow-up treatise by the same authors to reflect the change in the environment of the modern corporation. The change was so dramatic that Berle and Means concluded in their updated treatise of 1968:
From the economic point of view, the crucial implication of the corporate revolution was the extent to which it made obsolete the basic concepts underlying the body of traditional economic theory which was then the basis of public policy. Wealth, enterprise, initiating the profit motive, and competition, each was shown to have become so changed in character with the revolution as to make traditional theory no longer applicable. The conclusion was reached that new concepts must be forged and a new picture of economic relationships created.
In the years that followed since the introduction of these theories, particularly the agency theory, countless accolades and awards were handed to scholars and researchers who replicated, validated and extended their coverage and applicability. While questions were raised over the years regarding certain assumptions of the agency theory, volumes of literature were generated by researchers to validate the theory. In this paper, the writer concluded that the agency theory is defective from its inception and should have been discarded long time ago. This writer proposes the enterprise theory to replace the agency theory..