Corporate law's limits

A strong theory has emerged that the quality of corporate law in protecting distant shareholders primarily determines whether ownership and control separate. The theory helps to convincingly explain why separation is weak in transition and developing nations. But in several rich nations, although legal structures as measured protect shareholders well, separation is shallow. Something else has impeded separation. Separation should be narrow if shareholders face high managerial agency costs if ownership diffused. But most managerial agency costs are not corporate law's focus. Judicial doctrine attacks self-dealing, not business decisions that hurt stockholders. Indeed, the business judgment rule puts beyond direct legal inquiry most key agency costs - such as overexpansion, overinvestment, and reluctance to take on profitable but uncomfortable risks. Even if a nation's core corporate law is perfect, it directly eliminates self-dealing, not most managerial mistake or most misalignment with shareholders. If the risk of managerial misalignment varies widely from nation to nation, or from firm to firm, ownership structures should also vary widely, even if conventional corporate law tightly protected shareholders everywhere from insider machinations. I show why this variation in managerial alignment is likely to have been deep.