Economic-based legal research normally assumes that market or allocative efficiency is about the maximization of total value. In a recent working paper, we argue that consumer and shareholder value can emancipate from total value. That is to say, the methods of economic research and their wealth of insights about economic activities can be saved, while throwing away the instrumental relation between consumer/shareholder value and total value.
From the perspective of corporate governance and company law research, the total value assumption is not easy to accommodate, at least not prima facie. The normative foundations here are all about shareholders and their conflict of interest with managers (caused by the separation of property and control), as evidenced by concepts like shareholders primacy, shareholders supremacy, and shareholder value. Coherently, agency costs are defined since Jensen and Meckling’s seminal research in terms of their effect on shareholder value. The resulting framework is thus at odds with a total value approach, where purely distributive effects ought to be irrelevant. As a consequence, agency costs should be defined in terms of reduction of total value and not of shareholder value.
The problematic relationship between total and shareholder value is typically circumvented by positing that shareholder value is a means to total value. However, this strategy is adopted with some caution, ultimately to save the coherence of the mainstream economics-based research. The Anatomy of Corporate Law is very illustrative in this regard: ‘the overall objective of corporate law … is presumably to serve the interests of society as a whole’ and ‘focusing principally on the maximization of shareholder returns is, in general, the best means by which corporate law can serve the broader goal of advancing overall social welfare’; ultimately, however, the authors disclose reservations about the effectiveness of corporate law as a means to total value and limit their commitment to ‘offering an analytic framework within which this question can be explored and debated’.
We offer an alternative way to save the coherence of the conceptual framework based on shareholder value: we challenge the idea that allocative efficiency is about total value by asking whether allocative efficiency is about consumer value This idea, it turns out, used to be quite attractive in economic literature. For example, in The Wealth of Nations, Adam Smith wrote that the ‘maxim’ according to which ‘the interest of producer ought to be attended to only so far as it may be necessary for promoting that of the consumer … is so perfectly self-evident, that it would be absurd to attempt to prove it’. Looking further into economic theory, we found that the total vs. consumer value disagreement also surfaces in the use of two important economic expressions: ‘consumer sovereignty’ and ‘principal-agent model’. From a broader perspective, we observe on the one hand that a symmetry exists between the position of a consumer in the market and the shareholder in a company, and on the other hand that the two roles overlap in that an investor is often both a consumer and a shareholder.
An important methodological consequence of our claim is that economics-based legal research can be done while rejecting the instrumental relation between shareholder and total value. However, the fact that this rejection is possible does not make it desirable. In this regard, we share Calabresi’s view that in economics-based legal research, economic theory has to fit with legal practice. Fitness with legal practice is a particularly strong criterion when – like in this context – the choice is not a threat to the methods of economic research, and it boils down to a matter of ethics and/or politics. After all, economists tend to shy away from value judgments, which suggests they can comfortably accept a division of labour where other disciplines handle disagreements about them.
For illustrative purposes, we show that with the concepts of consumer and shareholder value we can easily describe the goals and the choice between empowerment and protection techniques in the 1999, 2002, 2003, 2005, 2007, and 2012 Communications of the Commission about consumer and company policy as well as key choices in the recent reforms in the governance of financial and credit markets. To the contrary, the explanatory power of total value is very limited.
On these grounds, we conclude that challenging total value is an interesting and promising direction for economics-based legal research.
Stefan Grundmann is Professor of Transnational Private Law at the European University Institute (Florence) and Professor of Private and Business Law at Humboldt-Universität (Berlin).
Fabrizio Esposito is a PhD Candidate at the European University Institute (Florence).