Dynamic Governance: Rethinking the Purpose of the Corporation
In his classic treatise on the Wealth of Nations, Adam Smith noted a discrepancy between the interests of owners and the managers who are handling those “other people’s money.” In the twentieth century, Michael C. Jensen and William H. Meckling—citing Smith as well as Adolf A. Berle and Gardiner C. Means’s The Modern Corporation and Private Property—gave new urgency to this issue by introducing the concept of agency costs—the costs of aligning the incentives of these different corporate actors. This led to more than four decades of searching for the best way to align the interests of shareholders and managers.
At first it seemed that the solution would be stock price, since shareholders and managers alike want to optimize that. The advent of the efficient market hypothesis reinforced the focus on market pricing as the arbiter of corporate performance, and of short term shareholder value as the purpose of the corporation. We have learned, painfully, that neither of these ways of thinking about governance issues is adequate.