Corporate Agency Problems and Dequity Contracts

Abstract

The primacy of the principal-agent model of corporate governance is largely undisputed in the existing law and economics literature. Contrary to the prevailing opinion, this Article contends that the bilateral agency paradigm fails to accurately describe the incentive problems arising in the modern corporation. This Article’s first contribution is to show that viewing managers as common agents of several types of investors can better capture the reality of corporate relationships, where incentive problems can arise both vertically - between each investor type and the managers - and horizontally - among the different investor types.

This Article’s second contribution is to show that dequity contracts, which blend together debt and equity features, can better solve corporate agency problems than existing legal and contractual remedies. By making the undertaking of value-decreasing projects costly for managers and investors alike, conversion and/or redemption options granted by dequity contracts can both (i) improve managers incentives to behave, and (ii) mitigate the problems arising from the divergent preferences of different investor types.

Two policy recommendations follow from this analysis of corporate agency problems and dequity contracts. The first is the imposition by law of a standardized disclosure format for the issuance of dequity instruments. This would help reducing dequity complexity, promoting use of these instruments by corporate actors. The second is the adoption of a strict interpretative policy of the shareholder primacy rule, where the right to enforce managerial fiduciary duties is exclusively granted to the common shareholders. By avoiding uncertainty over the ex-post content of the rule, this interpretative regime would allow the implementation of private ordering solutions - such as dequity contracts - that make this rule always an optimal proxy for aggregate corporate value maximization.

Keywords: Corporate Governance, Common Agency, Hybrid Securities, Fiduciary Duties

JEL Classification: G3, G34, K12, K22