An article co-authored by Fordham Law Professor Richard Squire has been chosen as a top 10 corporate and securities law article of 2017 by the Corporate Practice Commentator. The article was selected by corporate and securities law professors, who reviewed over 565 competitive articles.
In the article, “Principal Costs: A New Theory for Corporate Law and Governance,” which was published in the Columbia Law Review, Squire and Zohar Goshen (Columbia Law School) argue against mandatory, one-size-fits-all legal rules that aim to reduce agency costs by obliging corporations to give more control to shareholders. Goshen and Squire claim that, because business firms vary in the costs they accrue from mistakes and disloyal conduct, the optimal division of control, including the optimal degrees of shareholder and managerial empowerment, is firm-specific. Thus, according to Goshen and Squire, lawmakers should permit each firm to develop its own corporate governance structure.
To support their claim, Goshen and Squire make an important distinction between agency costs, produced when managers exercise control, and principal costs, produced when investors exercise control. In shaping their argument, the authors employ what they call “principal-cost theory,” which posits that a firm’s optimal governance structure minimizes the sum of both agency and principal costs.
To further illustrate their claim on the importance of both cost forms, Squire employed a metaphor likening firms’ needs for suitable governance structures to nearsighted and farsighted peoples’ needs for appropriate eyeglasses. If an eye specialist seeks to achieve optimal vision for each patient but believes that only nearsightedness is a problem and thus only designs eyeglasses tailored for nearsighted people, then only nearsighted people will benefit from the eyeglasses.
Applying the metaphor to his and Goshen’s argument, Squire explained that those who advocate solely for the reduction of agency costs fail to address the differing needs of various firms.
“The agency-cost fundamentalists think that agency costs are the only problem, so they want one-size-fits all rules,” said Squire. “We argue that principal costs and agency costs are both problems, and the degree they are problems depends on the particular firm. So we expect firms to select the structure that strikes the right tradeoff for them, and to have about the same economic performance.”
Squire noted how some critics of the article have claimed that he and Goshen have wrapped old ideas in new terminology. In response, Squire notes that prior literature fails to recognize principal costs as an important, distinct category, equal in relevance in corporate governance to agency costs.
Furthermore and perhaps above all, the article gives theoretical and linguistic ammunition to people who resist proposed legal restrictions employed for greater shareholder empowerment. Through a careful articulation of their ideas, the two authors grant people a new model and lexicon with which to argue against a one-size-fits-all model.
“The people who want to resist those laws now have a paper to reference and a theory to cite,” said Squire. “We have given the people who want a more hands-off approach to corporate law a framework from which to present about their concerns.”
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