In finance, the contractual theory on the nature of the firm (Alchian 1982; mama and Jensen 1983) had become a widely held one at the end of the last century. In that respect, firms are perceived as a network of contracts, actual and implicit, that specifies the roles of the various participants or stakeholders and defines their rights, obligations and their payoffs under different conditions. Their interest must be harmonized to achieve efficiency and value maximization. Williamson (1988) proposed a combined treatment of corporate finance and corporate governance. Debt and equity were treated not as alternative financial instruments primarily, but rather as alternative governance structures. Williamson analyses extensively the commonalities and the differences between transaction cost analyses and agency relations (Williamson 1988). In the transaction cost approach, the transaction is the basic unit of analysis, whereby the most important dimension is asset specificity.
In spite of the broad theoretical scope of the transaction cost approach concerning all possible stakeholders of the company, it is the neoclassical value-maximization of the firm that restricts the conclusions of the models implied. Many stakeholders’ transactions are “implicit” transactions and therefore not traded (or inefficiently priced) in markets. This is a severe restriction of the quality of the conclusions of this neoclassical set of models. The microeconomic decision process of firms depends on more factors than those priced in capital markets. Templar (1991) also comes to a similar conclusion in an extensive overview of the theoretical developments in finance. He concludes that as long as the goal of the company is the value maximization of the company in the capital market, its holistic-market oriented concept lacks several elements of the firms’ decision-making process. This disturbs the modeling of a firm’s microeconomic decision-making process.
In security design literature, institutional ownership of financial assets is analyzed regarding its consequences for the optimal allocation of securities among investors. All securities are interpreted as claims on the cash flow ensuing from a firm’s real assets. Security design literature emphasizes the minimization of the “verification cost” (Townsend 1979). Townsend describes optimal security as being an endogenous asset that minimizes the verification cost of the owner of the cash flow. Verification costs are seen as “dead weight loss” reducing the value of the firm.
Clientele effects and microstructure analysis enable optimal allocation of heterogeneous risk preferences of investors. The “costly state verification” approach of Diamond (1984) is comparable. In this view, the “insiders” of a company observe the cash flows without costs, while the “outsiders” must pay verification costs.
It is important to note that all the types of costs stated above (verification, costly state) can be seen as a generalization of the minimization of agency costs. All assumptions and critical remarks concerning agency theory and ethics apply here (e.g., Bowie and Freeman 1992). It is remarkable that concepts such as fairness and democracy are not at stake when discussing the ownership of the company and its influence on cash flow. In neoclassical theory, it is simply assumed that if there is a distinction between management and ownership, the goals of both groups are not congruent and that “costs” must be made to convince the agent that full cooperation is agreed. This individualized and contractual approach of human (i.e., financial, managerial) behavior is at odds with modern approaches as illustrated in the following sections. Firstly, we will elaborate on the shareholder paradigm and its theoretical criticism before discussing the core aspect of this contribution: sustainable governance.
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