The past two decades have witnessed a vigorous continuation of the long-standing debate about the proper role of the corporation in our society and the nature. Recently, that debate has centered on the question of who--the directors or the stockholders--should have the ultimate power to decide whether the corporation should be sold. During the 1970s, 1980s and early 1990s, the agency cost economics and its accompanying efficient market theory wielded tremendous influence over academic thinking about corporate takeovers. These two ideas produced a joint prediction that any corporate strategy that increased share price inevitably increased social wealth as well. The principal-agent model believed the market for corporate control allocate corporate resources to their highest valued uses and accordingly consider tender offers and hostile takeovers to be the primary market mechanism to encourage efficient management. A necessary corollary was that any corporate law rule that depressed share price including any rule that discouraged takeovers was inefficient and such rule tend to entrench inefficient managers who would otherwise be fired after a transfer of control. This position follows naturally from the commonly-held beliefs that the primary conflicts of interest in the large corporation are between shareholders and management and that the threat of hostile takeovers is the most efficacious method of resolving such conflicts. So the central theme of contemporary corporations scholarship is that corporations suffer from “an agency problem” and this is the underlying and ultimate justifying force for external regulation of corporate governance.  

More recently, however, in recognition that the agency model reflects both a mistaken view of corporate law, and a mistaken view of corporate economics, a “new generation of Contractarian (transaction cost economics )” is reconsidering the validity of agency analysis.

New Contractarianism is grounded in the conclusion that individual preferences of shareholders lead to the corporate governance forms. The nexus of contracts understanding of the corporation analogizes legal rules to a standard form contract voluntarily adopted--perhaps with modifications--by the parties. As with any standard form contract, the law’s principal purpose is to facilitate private ordering by reducing bargaining costs by adopting the so-called majoritarian default--the rule most parties would adopt if they could bargain without cost.

They argue that limited shareholder voting rights is corporate law’s majoritarian default rule and then that it is, on theoretical and empirical grounds, a intelligible choice: shareholders reasonably might opt for board entrenchment or centralized management in order to enable a board to employ selling strategies more effectively and, thus, to increase the premium shareholders receive when the company is sold. Such a decision is a kind of precommitment whereby shareholders, by binding themselves ex ante, may be able to improve their collective position ex post.

Theoretically, Investors might prefer this for several reasons. First, even finance economists increasingly acknowledge what business people have always known: stock prices don’t always accurately measure value. As a result boards can often do a far better job of picking the business strategy best for the firm in the long run than unorganized, uninvolved, and price-obsessed stockholders can. Second, investors don’t always share common interests. The principal-agent model assumes that shareholders in public corporations are a single, homogenous mass with a uniform interest in raising share price. However, the shareholder body includes short-term investors (such as hedge funds) who may support corporate policies that inflate current share prices at the expense of long-run value. Third, negative portrait of directors required by the agency model--that of officers who cannot be trusted and, in the absence of external incentives, are naturally inclined to pursue their own self-interest at the expense of the corporation and its shareholders--must be rejected as inaccurate and incomplete. Most managers and directors act diligently and in good faith to promote the business success of their corporations.

Empirically, in the real world, shareholders are tying their own hands and ceding control over public corporations to centralized management.

American corporate law gives entrepreneurs seeking to sell stock in the companies they create the freedom to draft their corporate charters almost any way they like. This includes freedom to draft charters that either enhance shareholder voting power, or dilute it. If investors valued strong voting rights, you’d think they would pay more for the shares of companies that granted them. Corporate entrepreneurs would respond by supplying charters that give shareholders greater clout. Yet in the real world, companies almost never “go public” with enhanced shareholder power. Instead, most IPO charters weaken shareholders’ rights. Google is a case in point. Its charter gives its founders shares with multiple votes while the public gets shares with only a single vote. Such “dual class” stock is unusual, but milder forms of shareholder disenfranchisement abound. Most IPO charters these days include “staggered board” provisions making it harder for shareholders to replace incumbent directors. Far from avoiding these IPOs, investors, including sophisticated institutions, snap them up like hotcakes.

Also, Firms in the EU today have the possibility of choosing from a range of control enhancing mechanism giving the controlling owners an amount of influence which is disproportional to their share for cash flow. The list of control enhancing mechanism includes dual class shares, pyramidal ownership structures, golden shares, voting caps and several others.

The justification for these control enhancing mechanisms is currently the subject of much debate within the EU. The opposing positions are that the control enhancing mechanisms are an impediment to takeovers and should therefore be removed to improve the market for corporate control. However, there is no economic evidence of a causal link between deviations from the so-called ‘proportionality principle’ and the economic performance of companies. These control enhancing mechanisms creating concentration management is deeply rooted in all legal cultures. That is the result from shareholders preference. The freedom to negotiate and contract on the allocation of voting and capital flow right in different financial instruments is an intrinsic part of a free market economy. This different share structures can satisfy investors with different preference. The implementation of control enhancing mechanisms may almost always be challenged when it has been carried out in breach of basic principles of corporate law designed to protect shareholders’ right. So, making policy recommendations based on the assumption that all corporations’ shareholders have identical attitudes toward the value of the market for corporate control is unjustified

No empirical study has ever shown any strong or consistent price reaction to defense adoption. It so hard to prove that particular governance measures improve corporate performance, because business firms enjoy a wide range of choice over the governance rules they adopt and work under. Sensibly enough, they choose the rules that work best for their particular business. The prevailing principle on which capital markets should rest is that of freedom of contract, e.g. how companies draft their articles of association should be left to the market.

Ultimately, The modern corporation is the product of an evolutionary process in which entrepreneurs and investors together select governance structures for new firms, which then compete with each other in the markets for products, employees, and capital. So, the authorities should respect that ability rather than imposing its own bureaucratic view of what is good corporate governance.