by Professor Janet Dine - University of Essex.
The use of economic analysis
in the Law Commission’s Consultative document on Director’s Duties
is to be welcomed but it should not be forgotten that economic analysis is a
tool and not an ideology. Korten
has given us a chilling analysis of the consequences of becoming enslaved by
market liberalism fuelled by free market liberalism using money as a sole
measure of value;
freedom of the market is the freedom of money, and when rights are a function of
property rather than priesthood, only those with property have rights.
Furthermore, by maintaining that the only obligation of the individual is to
honour contracts and the property rights of others, the “moral” philosophy
of market liberalism effectively releases those who have property from an
obligation to those who do not. It ignores the reality that contracts between
the weak and powerful are seldom equal and that the institution of the contract,
like the institution of property, tends to reinforce and even increase
inequality in unequal societies. It legitimises and strengthens systems that
institutionalise poverty, even while maintaining that poverty is a consequence
of indolence and inherent character defects of the poor.”
economic analysis starts from the perspective that “the company has
traditionally been thought of more as a voluntary association between
shareholders than as a creation of the state”.
Cheffins argues that “companies legislation has had in and of itself only a
modest impact on the bargaining dynamics which account for the
and form of business enterprises. Thus, analytically an incorporated company is,
like other types of firms, fundamentally, a nexus of contracts”. For the
purposes of economic analysis individuals rather than the state are the
legitimisation for the operation of the commercial venture. Denial of
personality to the group of actors
is a necessary foundation for the application of market theories since the
underlying assumption is the creation of maximum efficiency by individual market
players bargaining with full information.
Taking the view that free markets are the most effective wealth creation system
neo-classical economists including Coase have analysed companies
as a method of reducing the costs of a complex market consisting of a series of
bargains among parties.
Transaction costs are reduced by the operational design of the company.
theories rest on notions of rationality, efficiency and information. The
economists posit that a person acting rationally will enter into a bargain,
which will be to his benefit. In a sale transaction both parties acting
rationally will benefit both themselves and therefore society.
However, notions of the measurement of efficiency vary. Pareto efficiency
requires that someone gains and no one loses. However, the Kaldor-Hicks test
accepts as efficient “a policy which results in sufficient benefits for those
who gain such that potentially they
can compensate fully all the loses and still remain better off”.
explanation of what is “rational” also varies widely, from simple wealth
maximisation to complex motives including altruism leading to the somewhat
exasperated criticism that “From the point of view of understanding motivation
in terms of rational self interest ... if we expand backward with self-interest
as an explanation until it absorbs everything, including altruism, then it
signifies nothing- it lacks explanatory specificity or power”.
third pillar for the economic analysis is information flows. The rational actor
is seen as making rational choices with full and perfect information at his
actors utilising perfect information will produce maximum allocative efficiency
by making choices, which exploit competition in the market. However, allocative
efficiency by making choices which exploit competition in the market. However,
allocative efficiency will not occur unless all the costs incurred in the
transactions are internalised. Thus, if a company pollutes a river, causing
damage to other river users but incurring no penalty, the goods produced by that
company would be underpriced. That this type of behaviour causes real problems
for those whom would impose minimal regulation and rely instead on market
behaviour and private law instruments are evident.
market economics to company law involves seeing the company not as a free
standing institution but a network of bargains between all involved, all acting
rationally with perfect information. The utility of company law is to prevent
the high costs of reaching individual bargains with every involved person.
Company law thus reduces transaction costs.
Criticism of economic theories
The economic contractualist attracts criticism both at the level of the conception of companies and company law and on the basis of the perceived political results of the analysis. The formers are criticisms, which go to the utility and accuracy of the analysis itself. Further problems may arise when the economists view the company in action and designate the interaction between the company and the state (the justifications for regulation) and the relationships between individuals concerned with the working of the corporate constitution. It is at this level that the theory impacts with the designs for regulatory structure.
the first level we have seen that the conception of rationality is variously
perceived and that the further away from pure wealth maximisation as motivation
the less valuable it is as an analytical tool. Further, rationality is bound up
with the amount of information possessed by the rational factor. Accepting that
“perfect information” is a myth, most economists accept the notion of
“bounded rationality” or “satisficing”. Bounded rationality accepts that
the capacity of individuals to “receive, store and process information is
Satisficing is “searching until the most satisfactory solution is found from
among the limited perceived alternatives”.
Thus, the “pure” concept of rationality suffers from the twin problems of
simplistic motivation and a defect in the theory of perfect information.
a political level, economic contractualism has the effect of putting the
corporation into the sphere of private law, of viewing the legitimisation of the
power it wields as coming from the entrepreneurial activities of the members and
lessening the state’s justification for regulatory interference.
As Korten has shown the results of a wholehearted espousal of this philosophy is
a type of corporate colonialism which widens the divide between the very poor
and the very rich. “Markets are useful for implementing public priorities but
inappropriate for setting them”
implications of the UK’s position in the European Union is not the subject of
extensive analysis in the consultation document
although one important thrust behind recent European Initiatives is to build a
real partnership between capital and labour, and to replace the outdated fiction
of the shareholder control with the “community interest” identified by the
Davignon group. The report of the group was published in May 1997. The group
took as a starting point the importance of the involvement of the workforce in
company decision making:
of the economy and the special place of European industry raises fundamental
questions regarding the power of social partners within the company. The type of
labour needed by European companies – skilled, mobile, committed, responsible
and capable of using technical innovations and of identifying with the objective
of increasing competitiveness and quality – cannot be expected to obey the
employer’s instructions. Workers must be closely and permanently involved in
decision making at all levels of the company” (Davignon para19).
the group accepted that a concerted approach to work organisation within the
company “will improve industrial relations, increase worker participation in
decisions and is likely to lead to an improvement in product quality” (para
20). The One successful initiative has been the directive establishing European
Once established a European Works Council is “to be informed and consulted ...
on the progress of the business ... and its prospects ... in particular
... the structure, economic and financial situation, the probable
development of the business and of production and sales, the situation and
probable trend of employment, investments, and substantial changes concerning
organisation, introduction of new working methods or production processes,
transfers of production, mergers, cut-backs or closures of undertakings,
establishments or important parts thereof, and collective redundancies.”
The “definitions” provide that “consultation” means the exchange of
views and the establishment of dialogue between employees’ representatives and
central management or any more appropriate level of management”.
This is a minimum requirement. Thus, the requirements go someway to meet the
call for “a framework of labour law which circumscribes and limits
management’s control of the enterprise”.
Thus, despite the provision which asserts in relation to ad hoc meetings where
exceptional circumstances ‘affecting the employees’ interests to a
considerable extent’ that this information or consultation meeting “shall
not affect the prerogatives of the central management”
it seems clear that these prerogatives no longer extend to the ability to take
unilateral action in the absence of consultation with an EWOC.
tools have we at our disposal in order to ensure the comfortable implementation
of such a restraint on managerial power?
author has argued elsewhere
that the development of fiduciary duties can be a central plank in meeting these
challenges, moving the law away from its contractual emphasis in this regard and
putting employees in a central corporate governance position. It is to be hoped
that the final report of the Law Commission makes no recommendations, which
prejudice taking on board these wider concerns.
Directors: Regulating Conflicts of Interests and Formulating a Statement of
Duties Law Commission Consultation Paper No 153.
Company Law: Theory, Structure and Operation. P.41. Gower disagrees: “...it is clear that without the legislative intervention, limited liability could never have been achieved in a satisfactory and clear-cut fashion, and that it was this intervention which finally established companies as the major instrument in economic development. Of this the immediate and startling increase in promotions is sufficient proof” Gower, 6th ed. Paul Davies, Sweet and Maxwell 1997.
S.J. Stoljar Groups and Entities: An Enquiry into Corporate Theory, ANU Press, Canberra 1973, p.40 and G. Teubner “Enterprise Corporatism: New Industrial Policy and the “Essence of the Legal Person” (1988) 36 American Jnl of Comparative Law 130.
Alice Belcher The Boundaries of the Firm: the theories of Coase, Knight and Weitzman Legal Studies (1997) Legal Studies Vol. 17 No. 1, p.22.
O E Williamson Contract analysis: “The Transaction cost approach“ in P. Burrows and C G Velanovski (Eds.) The Economic Approach to Law, Butterworths, London 1981, Williamson, Transaction-Cost Economics: The Governance of Contractual Relations 21 Journal of Law and Society 168.
gives the following example;
“Bill agrees to sell a car to Ben for 5,000 pounds. In normal circumstances it is appropriate to infer that Bill values the car at less than 5,000 pounds (say 4,500) and Ben values it at more given than 5,000 (say 5,500). If the contract is performed, both parties will gain 500 pounds and therefore there is a gain to society- the car has moved to a more valuable use in the hands of Ben ... this is said to be an allocatively “efficient” consequence.
Explanation given by Ogus, op cit, 24, who immediately points out that there is no requirement for the gainers to compensate the losers, see below in criticism section.
Ogus, op cit, p.41.
Directive 94/45/EC of 22nd September 1994. And see Wheeler (1997) Journal of Law and Society 44.
Bercussion in Workers, Corporate Enterprise and the Law in R. Lewis (Ed) “Labour Law in Britain” OUP 1986. Can Company law be integrated into labour law so that employees become a central concern of the law governing the enterprise? Could the functioning of enterprises become dependent on compliance with standards and procedures laid down by the labour law? So long as the two spheres of company and labour law are kept distinct, “one is necessarily led” in the words of an eminent French labour lawyer (Lyon-Caen 1983) “to the conclusion that non-compliance with a labour law obligation [will] not affect the validity of a transaction in commercial law.”