Exit, Voice, and Liability: Mechanisms for Constraining Managerial Agency Costs

Henry Hansmann (Yale Law School)
Reinier Kraakman (Harvard Law School)

Abstract : The contemporary literature on organizational law focuses with singular intensity on managerial agency costs. We offer a systematic perspective on the mechanisms that have been employed to limit those costs. We identify, describe, and analyze the four such mechanisms most heavily employed, in both commercial and non-commercial organizations, since the Renaissance. Two of our four mechanisms -- the right to withdraw from the firm, and the right to participate in its management – are, respectively, analogous to the late Albert Hirschman’s famous concepts of “exit” and “voice.” In contrast to Hirschman, however, we find that these two mechanisms are typically complements rather than substitutes. And the same is true of our third mechanism, which is the right to bring suit against managers for breach of fiduciary dutiy. It is only in our fourth mechanism – constraining the scope of delegation to managers – that we find substantial substitutability with the other three. This strong complementarity, we suggest, results from another fundamental agency problem in organizational design, which is the exploitation of non-controlling owners (or beneficiaries) by controlling owners. Though exit, voice, and liability can help assure that an organization’s managers serve its owners well as a class, these mechanisms can also be used to redistribute value among the owners themselves. This conflict of interest among owners commonly overshadows managerial agency costs. Indeed, the managerial agency problem seems generally a second-order concern in organizational design.

Borrowing Apollo’s Money: Incentivization and Enforcement of Loan Contracts from the Temple of Apollo at Delos

Michael McGlin (State University of New York at Buffalo)

Abstract : Over the course of the fifth to the second-century BCE, hundreds of individuals contracted loans from the Temple of Apollo on the Aegean island of Delos. The terms of these agreements included the amount of principal and interest, the property that was placed as security, loan guarantors in case of default, and a list of witnesses. Commentators have used these loans in an attempt to reconstruct the bureaucratic operation of the temple, the amount of money the temple handled, and to analyze the geographical extent of its lending activities. Despite the amount of information these loan documents provide, two central questions have not been answered in either the primary or secondary literature concerning their operation: How does one explain the sheer number of debtors to the temple? And, also, why does the temple continue to lend money in the face of increasing numbers of debtors? I argue that the large number of debtors was a product of the Temple of Apollo’s aggressive growth strategy. When the temple’s larger financial operations of property and land rentals, tax collection, and loans are viewed together, it is clear the temple wanted to maximize its revenue through the use of loans. It embraced loans as its preferred means of rapid growth and manipulated its contractual incentives in order to encourage borrowing in the expectation of future interest revenue. The most important of these incentives was the lack of penalties in case of late payment or default. The results of such aggressive tactics succeeded in luring borrowers away from traditional lending sources, but it resulted in hundreds of defaults and the limited ability to enforce repayment. This was an acceptable risk for the temple, as it did not change its lending practices during the entire time during which it loaned money. I propose that the temple relied upon religious obligation as a culturally self-enforcing mechanism in order to transfer the burden of enforcement onto the borrower.

How to Copy Informal Institutions: the Role of British Colonial Officers During the Decolonization of British Africa.

Valentin Seidler (University of Warwick)

Abstract : Institutional reform in developing countries often involves an element of copying institutions from developed countries. However, such institutional copying is likely to fail if formal institutions alone are copied without the informal institutions on which they rest in the originating country. How can informal norms successfully be copied from one country to another? This paper investigates how informal traditions of the British civil service were copied into British Africa after independence. I argue that this was achieved by the physical presence of former British colonial officers who remained in the services of the newly independent states. During the period of decolonization in Africa 1957-1968, British African territories imported the same British institution safeguarding the political impartiality and the integrity of civil servants. While the necessary formal rules and legal entities were integrated into the legal bodies of all former colonies, they are practiced only in those colonies where British officers maintained a substantial share in the civil services for an extended period of time. I use a series of qualitative interviews with retired officers to explore the mechanisms behind this effect. A natural experiment around compensation payments for the loss of career at independence serves to explain the variation in British officers remaining in service after independence. The findings contribute to a deeper understanding of institutional copying, in particular the transfer of informal institutions.