Corporate Finance, Incomplete Contracts, and Corporate Control∗
نویسنده
چکیده
This essay in celebration of Grossman and Hart (1986) (GH) discusses how the introduction of incomplete contracts has fundamentally changed economists’perspectives on corporate finance and control. Before GH, the dominant theory in corporate finance was the tradeoff theory pitting the tax advantages of debt (relative to equity) against bankruptcy costs. After GH, this theory has been enriched by the introduction of control considerations and investor protection issues. This essay assesses how our understanding of corporate finance has been improved as a result and where the incomplete contracts perspective has not yet been successfully applied. ∗I am grateful to two anonymous referees and the editor (Al Klevorick) for very helpful comments. †Columbia University, 804 Uris Hall, 3022 Broadway, New York, NY 10027, e-mail: [email protected], http://www0.gsb.columbia.edu/faculty/pbolton This is a pre-copyedited, author-produced PDF of an article accepted for publication in the Journal of Law, Economics, and Organization following peer review. The version of record: Bolton, Patrick. "Corporate Finance, Incomplete Contracts, and Corporate Control." Journal of Law, Economics, and Organization 30, suppl 1 (May 2014): i64-i81, is available online at < http://dx.doi.org/10.1093/jleo/ ewt010 >. It is a great pleasure to write this essay in celebration of Sandy Grossman’s and Oliver Hart’s classic 1986 article “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”. To appreciate the importance and novelty of their contribution it is helpful to put it into context of their earlier research and the state of economic theory at the time. Among the hottest research topics in economic theory in the early 1980s were General Equilibrium (GE) Theory, Rational Expectations, and Information Economics (Mechanism Design). Both Grossman and Hart had made several important contributions in these general areas. Hart’s thesis was in the area of General Equilibrium theory with Incomplete Markets, and in the early 1980s he was working on General Equilibrium with Imperfect Competition. One central conceptual issue arising in GE with incomplete markets or imperfect competition is what the objective function of the firm is and to what extent there can be shareholder unanimity. Grossman and Hart had written several major articles on this topic. They had also made important contributions on implicit labor contracts and involuntary unemployment, and on a general characterization of the Principal-Agent problem with Moral Hazard. Much of this work appeared in the most prestigious journal at the time —Econometrica —and achieved the highest standards of mathematical rigor and generality. Indeed, both Grossman and Hart were seen as belonging to an elite group of young theorists taking over the field of economic theory from the founding giants of mathematical economics, Kenneth Arrow, Frank Hahn, Gerard Debreu, and Robert Aumann. It is important to emphasize that there is virtually no hint in this earlier work of the ideas Grossman and Hart were about to develop in their 1986 article, which by all appearances is a complete break from their earlier research both methodologically and conceptually. What explains this sharp break? What prompted Grossman and Hart to embark on this path-breaking endeavor? There are mainly two motivations. First, although Oliver Hart has long had a deep interest in Coase’s (1937) theory of the firm and the early managerial theories of the firm of Penrose (1958), Baumol (1959), Cyert and March (1963), Williamson
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