Corporate Agency Problems and Hybrid Financial Instruments
Abstract: The design of legal and contractual mechanism to control agency problems between firms and investors, namely the asset substitution (AS) and the private benefits’ extraction (PBE) problems, has long represented a core issue of the corporate governance agenda. This Essay suggests that hybrid financial instruments (HFI) including options may provide efficient solutions to such problems. More specifically, it makes three claims. First, the instruments conventionally adopted by the governance system to contain corporate agency problems, namely corporate fiduciary law and standard corporate contracts, implement a constraint strategy that fails to respond to a welfare-maximization criterion. Second, HFI contracts provide an option-based incentive strategy against the undertaking of AS and PBE, which is superior to the constraint strategy adopted by conventional instruments. Third, because the mandatory nature of corporate fiduciary law may jeopardize the incentive scheme provided by HFI, existing law should be amended so as to implement a permissive regime of fiduciary duties.
