Trust versus contracts in corporate governance: agency theory, contractual theory and the fortification of shareholder welfare governance

Agency theory, despite its influential normative prescriptions, has been subject to a long-standing critique from management scholars for being theoretically inconsistent and empirically unsubstantiated. The article examines how agency theory is rooted in contractarian theory of the firm that by and large renders extant corporate law irrelevant and instead emphasizes the auxiliary benefits of the market (i.e. financial markets). What is addressed as 'the market for corporate control', based on the ceaseless pricing of the shares and bonds issued by public firms, is portrayed as a more effective mechanism for disciplining managers and monitoring the corporate system than corporate legislation and court ruling. This argument, derived from elementary neoclassic economic theory, turns a blind eye to the historical roots of corporate law and overstate the ability of the, e.g., shareholders to assess managerial decision-making on basis of information available in the market. Ultimately, agency theorists and contractarians, in their pursuit of free-market capitalism, seek to disconnect the corporate system from the authority and regulatory control of the state.