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.