Corporate Governance 325
is often referred to as the “shareholder model.” It can be characterized as
a model where (i) shareholders ought to have control, (ii) managers have a
fi duciary duty to serve shareholders’ interests alone, and (iii) the objective of
the fi rm ought to be the maximization of the shareholders’ wealth.
This traditional defi nition of corporate governance, propounded by
economists and legal scholars, is based on the agency relationship between
the investor and the manager and is concerned with the protection of share-
holders’ or investors’ interests only.
The neo - institutional economists rely on the traditional agency theory to
defi ne the fi rm as a “nexus of contracts” and consider agents and transactions —
institutionally, socially, legally, and culturally — as contingent (incomplete)
constructs. They argue that the fi rm’s claimants go beyond shareholders and
bondholders to include others with whom the fi rm has any explicit and/or
implicit contractual interaction. In this nexus - of - contracts view, each cor-
porate constituency, including employees, customers, suppliers and inves-
tors, provides some asset in return for some gain. Contracts are the result of
bargaining by these constituencies over the terms of their compensation, as
well as the institutional arrangements that protect this compensation from
post - contractual expropriation.^3 According to this view, there is nothing
unique to corporate governance; it is simply a more complex version of the
standard contractual governance.^4 All stakeholders are regarded as contrac-
tors with the fi rm, with their rights determined through bargaining.
Stakeholder theorists reject the three main propositions of the share-
holder system and argue that all stakeholders have a right to participate
in corporate decisions that affect them, managers have a fi duciary duty to
serve the interests of all stakeholders groups, and the objective of the fi rm is
the promotion of all interests and not just those of shareholders. This view
is commonly referred to as the “stakeholder model” of corporate governance,
where “stakeholders” include customers, suppliers, providers of comple-
mentary services and products, distributors, and employees. Therefore, this
theory holds that corporations ought to be managed for the benefi t of all
who have some stake in the fi rm.^5
The stakeholder model is largely normative and is still evolving; it is yet
to fi nd a sound theoretical foundation in conventional economic literature. In
this respect, the distinction between explicit (or formal) and implicit (or rela-
tional or self - enforcing) contracts and claims is the key to understanding the
basis of the stakeholder model. When it is diffi cult to write complete state -
contingent contracts, people often rely on “unwritten codes of conduct” —
that is, on implicit contracts — which implies that in addition to the obligations
on explicit contracts, obligations arising out of implicit contracts have to
be incorporated into the “nexus of contracts” theory with convincing argu-
ments. This can only be articulated by expanding the scope of analysis to
encompass ethics, morals and the social order. Hart (2001) forcefully argues
that many economic transactions are sustained by self - enforcing (“implicit”)
contracts or norms of behavior, such as honesty or trust; concepts which so
far have proved diffi cult to formalize in economic theory.