Corporate Law and Corporate Governance

Abstract

Transaction cost economics has done much to illuminate the working of corporate governance devices, and we have seen a revival of interest in corporate law and corporate governance since the 1980s, as researchers applied the tools of the new institutional economics and modern corporate finance to analyze the new transactions emerging in the 1980s takeover wave. This article focuses on three mechanisms of corporate governance, to illustrate the analytical usefulness of transaction cost economics for corporate law. It begins with the role of the board of directors, the principal governance structure for shareholders in diffusely held firms, for which Oliver Williamson provided the key conceptualization. It then extends that analysis to a form of block ownership known as relational investing, in which a large shareholder is more actively involved in firm management than is ordinarily expected of non-management shareholders. It concludes with an examination of the choice of law governing shareholder-manager relations, referred to in the literature as state competition for corporate charters, and how Williamson's framework can be fruitfully deployed for understanding the success of US corporate law. Each of the three sections sketches first the theory of the corporate governance mechanism from the perspective of transaction cost economics and then addresses the question whether corporate governance matters by discussing the empirical evidence on whether the mechanism is effective. In addition to limning Williamson's contribution, the objective is to relate theory and data, to ascertain where we are, 20 years after Williamson's fundamental contribution was first articulated in Markets and Hierarchies, and over a decade after the corporate law applications were first explicitly worked out.