A managerial revolution in reverse: finance market control of the corporation and the triumph of the agency theory model

Alexander Styhre*
 
School of Business, Economics and Law, University of Gothenburg, Gothenburg, Sweden
 
 
Corporate governance denotes different practices and procedures in economic sociology and in the economic theory literature; while economic sociologists are concerned about understanding the institutional features of corporate law and other corporate governance vehicles, economists are primarily interested in theorizing how capital owners can reduce agency costs. In pursuing the latter objective, agency theory has been remarkably successful in advancing shareholder value creation as the only legitimate objective of firms. This accomplishment is deeply entangled with a series of political, macroeconomic and institutional changes in (primarily) the US economy and political life, including the financialization of the world economy. The article examines these changes and stresses the capital funding of free-market advocates in academic communities as a decisive factor that contributes to the popularity of shareholder value creation. The study thus calls for a broader institutional view of the political economy of corporate governance and in the study of the ‘managerial revolution in reverse’ taking place as managerial capitalism is displaced by investor capitalism.
Keywords: financialization; agency theory; corporate governance; agency costs; managerial control
 
 
Introduction
Corporate governance means different things to economists and sociologists. For the sociologically minded scholar, ‘Corporate governance is concerned with the institutions that influence how business corporations allocate resources and returns’ (O’Sullivan 2000, 1, emphasis added), while for economists, the term largely denotes a ‘set of mechanisms through which outside investors protect themselves against expropriation by the insiders’ (La Porta et al. 2000, 4). For sociologists like Fligstein and Choo (2005, 63), stressing an institutional view, corporate governance includes three elements: (1) corporate law, which defines the legal vehicle by which property rights are organized; (2) financial market regulation, which sets the rules governing how companies obtain capital for their operations and specifies the various relationships between finance market actors and creditors, owners and managers; and (3) labor law, which ‘[d]efines how labor contracts will operate in a particular society’ (Fligstein and Choo 2005, 63). For economists, eager to cut down on assumptions and complexity, only the finance market relations are truly valid since financial worth can be calculated on the basis of market operations, and not be subject to lengthy legal negotiations and bargaining. Consequently, for sociologists and corporate law scholars, corporate governance is the outcome of the historical and political
 

 
*Email: alexander.styhre@handels.gu.se
 
q 2014 Taylor & Francis

 
processes balancing many different stakeholders’ interests (Gourevitch and Shinn 2005; Roe 2003; Roy 1997); for economists, corporate governance is a matter of efficiency (Hart 1995). ‘[S]ystems of corporate governance result from political and historical processes rather than from efficient solutions to the functional needs of the owners of capital who seek to maximize profits for themselves,’ suggest Fligstein and Choo (2005, 66), pointing to the fault line between the economic sociology view and the economic theory view of corporate governance.
Agency theory has been the dominant corporate governance model since the early 1980s, when finance markets were deregulated (Daily, Dalton, and Cannella 2003; Dobbin and Jung 2010; Lazonick 2013), and has paved the way for what Useem (1996) refers to as investor capitalism. ‘Agency theory has colored the air we breathe,’ claim Dobbin and Jung (2010, 32). Despite being portrayed as theoretically simplistic (Daily, Dalton, and Cannella 2003; Perrow 1986), ignorant of corporate law (Rock 2013; Stout, 2012, 2013) and empirically unsubstantiated (Dobbin and Jung 2010), agency theory and its primary mechanism for reducing so-called agency costs, shareholder value creation, is today dominant. Michael C. Jensen, the foremost advocate of agency theory, has thus been remarkably successful in portraying salaried managers and directors as being less qualified than shareholders to make finance capital investment decisions. This accomplishment needs to be understood not primarily as an academic breakthrough, but rather as a broader institutional shift in politics, economic policy and the advancement of neoclassical economic theory and, more specifically, the new finance theory being developed at North American elite universities and primarily by so-called ‘freshwater economists’ operating in the Chicago School of Economics tradition (see e.g. Quiggin 2010). Moreover, it is important to trace the money that has enabled this shift from state-regulated embedded capitalism to a free-market and neoliberal (a term rejected by what Mirowski 2013 refers to as the Neoliberal Thought Collective see e.g. Burgin 2012, 175) competitive capitalism. From the early days of the neoliberal program shift to today’s deregulated and financialized economic system, private funds and sponsoring have been an essential component of the neoliberal mobilization to advance an alternative to the Keynesian economic theory, emphasizing what neoliberal intellectuals refer to as ‘collectivist solutions’.
This article will examine how agency theory has been part of a wider change in economic policy as well as the advancement of neoclassical economic theory over the last three and a half decades. In addition, the article also addresses how private interests and private money have served to financially support the development of the free- market economic theory that preceded what Fourcade and Khurana (2013) spoke of as ‘a managerial revolution in reverse’ (151), whereby salaried managers and directors were increasingly theorized and treated in terms of being drivers of agency costs and, ultimately, in terms of being guilty of managerial opportunism and malfeasance. Prior to the 1970s, proponents of free-market capitalism were largely treated as ‘eccentric right- wingers’ (Jones 2012, 178); rather than being able to compete over positions at mainstream economics departments in the USA, dominated by Keynesian economic theory, free-market proponents acquired positions at business schools, increasingly concerned about the scientific status of their research work and thus treating mainstream neoclassical economic theory, which relies on mathematical modeling and a formalist vocabulary, as a ticket to scholarly legitimacy. In addition, certain business schools were receiving research grants and financial support from private funds and foundations, which encouraged free-market and pro-business research work and ideologies. Jensen’s own career at Rochester University and, once his ideas had been widely recognized, at Harvard Business School, is indicative of the various institutional, financial and political changes

 
occurring at the intersection between the regime of managerial capitalism during the post- Second World War period and investor capitalism emerging from the early 1980s.
The remainder of the paper is structured accordingly. First, the agency theory view is presented, paying specific attention to the concept of shareholder value. Second, the critique of agency theory and the shareholder value model presented by economic sociologists and legal scholars address what they regard to be the limitations of shareholder value as a general corporate governance model. Third, the institutional and political changes that served to advance agency theory and the shareholder value model are examined. The role of business schools as a vehicle for advancing new economic theory and corporate governance theories during the era of financialization is examined. In this section, the capital funding of business schools and other institutions advocating free-market policies and regulations receives some attention. In the final sections, some theoretical and practical implications are sketched out.
 
Agency theory and its critics
Agency theory and the disqualification of managerial capitalism
Michael C. Jensen, a long-term Rochester University faculty member who then went on to Harvard Business School, is one of the most prominent proponents of the virtues of shareholder value-oriented corporate governance practices. By the early 1980s, as an effect of the inflow of foreign capital into the US economy (Stearns and Allan 1996) (caused by the high-interest rate policy of Paul Volcker, chairman of the Federal Reserve
– often referred to as the ‘Volcker chock’), the deregulation of financial markets and the low valuation of stock-listed US companies (Krippner 2005), the new financial strategy of the hostile takeover – defined as takeover bids not approved by the board of directors (Davis and Greve 1997, 9) – became a new worry for chief executive officers (CEOs) and directors (Davis and Stout 1992; Hirsch 1986). For some commentators, hostile takeovers were hailed as ‘an effective way to discipline managers and maximize shareholder wealth’ (Schneper   and   Guille´n   2004,   263),   while   others   treated   it   as   one   of   the   worst manifestations of ‘predatory’ capitalism. The risk of a hostile takeover made CEOs and directors increasingly concerned about the market evaluations of the companies that they were managing (Dobbin and Zorn 2005, 185).
In Jensen’s (1993) view, the American takeover wave of the 1980s was indicative of a vital and dynamic finance market capable of carrying out a final check on managers by monitoring how value is created for the shareholders. ‘Jensen .. . legitimized takeover activity as a mechanism for ousting poorly performing chief executives and giving control of the firms to those better suited to run them,’ argue Dobbin and Zorn (2005, 187). They continue: ‘In the end, takeover specialists convinced the world that what they did for a living, far from threatening the corporation, was efficient. That it was in the interest of shareholders.’ While many commentators were alarmed by the aggressive takeover activities being orchestrated by the new category of finance industry actors during the 1980s, questioning the empirical evidence of the poorly performing firms being divested (e.g. Davis and Stout 1992; Fligstein and Brantley 1992; Franks and Mayer 1996; Schneper and Guille´n 2004), Jensen praises their role as enterprising figures who were cleaning up the mess primarily caused by managers of large US corporations:
The merger boom of the 1980s brought about a massive consolidation of independent firms and the closure of marginal facilities. In the 1980s the capital markets helped eliminate excess capacity through leveraged acquisitions, stock buybacks, hostile takeovers, leveraged buyouts, and divisional sales. (Jensen 1993, 832)

 
‘During the 1980s, the real value of public firms’ equity more than doubled from $1.4 to $3 trillion,’ adds Jensen (1993, 837), mindfully ignoring the fact that the sheer inflow of capital is one key explanatory factor worth considering in this respect. Consistent with his theoretical convictions, Jensen suggests that we should not view these new finance industry actors with skepticism and contempt, but rather be thankful for their work of imposing a decisive control mechanism on managerial opportunism. ‘Jensen described the hostile takeover not as a form of disruptive speculation, but as a restraint on managerial malfeasance,’ say Dobbin and Jung (2010, 42).
In a seminal paper, published in 1976, Michael C. Jensen and William H. Meckling argued that the firm should be understood as a bundle of legal contracts specifying the rights of the various constituencies. In Jensen’s publications during the 1980s, and later, this view increasingly stressed the right to what he speaks of as the residual cashflow (Fama and Jensen 1983) or the free cashflow (Jensen 2002), that is, the cash that is left when all other costs are covered by the firm. What Fama and Jensen (1983, 302) speak of as the ‘residual claimants’, ‘those who contract for the rights to net cash flow’ (i.e. the owners of stock who receive net profits), are thus the key stakeholders of the corporation. In fact, as Jensen (2002, 239) emphatically makes clear, the residual claimant is the only stakeholder that matters to the corporation. ‘Maximizing the total market value of the firm .. . is one objective function that will resolve the tradeoff problem among multiple constituencies’ (239). At the heart of this argument lies the core assumption of agency theory, its Euclidean axiom – that executives, managers and (internally recruited) directors will always fail to make more efficient use of the residual cash flow than any market-based finance industry actor. The hostility toward managers of corporations is a strong thread in Jensen’s oeuvre and he does not hesitate to address managerial work in derogatory terms. ‘[M]anagers with unused borrowing power and large free cash flows are more likely to undertake low-benefit or even value-destroying mergers,’ says Jensen (1986, 328). CEOs ‘tend to engage in activities that increase their own well-being’ and thus, claim Jensen and Murphy (1990, 138), ‘one of the most critical roles of the board of directors is to create incentives that make it in the CEO’s best interest to do what’s in the shareholders’ best interests.’ Elsewhere, Jensen (2002, 242) suggests that ‘with no criteria for performance, managers cannot be evaluated in any principled way’, thus proposing that, unless shareholder value maximization becomes the sole objective of the firm, managers will be able to ‘to invest in their favorite projects that destroy firm-value whatever they are (the environment, art, cities, medical research) without having to justify the value destruction.’ This is the very core of the argument: CEOs act opportunistically or fail to see the best opportunities for capital investment, and therefore the residual claimants need to be protected against such incompetent handling of the net cash flow that they have contracted for: ‘Without separation of decision management from decision control, residual claimants have little protection against opportunistic actions of decision agents, and this lowers the value of unrestricted residual claims’ (Fama and Jensen 1983, 304–305).
The agency theory model and its proposed solution to agency costs have been
criticized from at least two perspectives: (1) by corporate law scholars emphasizing the weak connections between the axiomatic claims made by Jensen and colleagues; and (2) by economists and management scholars questioning the assumption that markets are capable of efficiently pricing assets. These two critiques will be examined below.
 
 
The critique of agency theory by legal studies and economic sociology
The first round of critique against agency theory and its prescribed shareholder value model is based on a limited understanding of corporate law. As historical accounts of

 
corporate governance demonstrate (e.g. Roy 1997), corporate law has always ‘[p]erformed a balancing act with management discretion and shareholder power’ (Bratton and Wachter 2010, 659). Historically speaking, corporate law has always privileged the directors and their appointed managers in business policymaking because they have been assumed to be better informed than shareholders and thus also ‘[b]etter positioned to take responsibility for both monitoring and managing the firm and its externalities’ (Bratton and Wachter 2010, 659). This historical perspective and actual corporate law are ignored by Jensen and his collaborators, argues Stout (2012). According to her, agency theory is based on ‘three mistaken assumptions’ that make its claims unsubstantiated by corporate law and therefore inadequate. First, shareholders do not, and cannot, ‘own corporations’ since ‘corporations are independent legal entities that own themselves, just as human beings own themselves’ (Stout 2012, 10, original emphasis). Second, outside of the specific case of bankruptcy law, shareholders are not the residual claimants (Stout 2012, 38 – 41), that is, they do not ‘contract’ for the right to free cash flow. Third, and finally, according to corporate law, the shareholders are not ‘the principals’ or the directors ‘their agents’, as the directors have the prerogative to enjoy an independent position vis-a`-vis the shareholders. In summary, Stout argues that ‘shareholders’ rights turn out to be illusory’:
Executives and directors own a fiduciary duty of loyalty to the corporation that bars them from using their corporate position to enrich themselves at the firm’s expense. But thanks to the business judgment rule, unconflicted directors remain legally free to pursue almost any other goal. Directors can safely donate corporate funds to charity; reject profitable business strategies that might harm the community; refuse risky projects that benefit shareholders at creditors’ expense; fend off hostile takeover bids in order to protect the interests of employees or the community, and refuse to declare dividends even when shareholders demand them. Contrary to the principal agent, shareholders in public companies cannot successfully sue directors simply because those directors place other stakeholders’ or society’s interest above shareholders’ own. (Stout 2012, 44)
The agency theory view of the firm is therefore unsubstantiated by corporate law. One of the major consequences of the influence of agency theory and shareholder value enrichment is the balance of corporate law between different stakeholders, including long- and short-term shareholders and creditors, being disrupted and increasingly favoring short-term share- holders. In the shift from what Rock (2013, 1910) calls a ‘management-centric system’ to a ‘shareholder-centric system’ during the early 1980s, managers and directors were disciplined to ‘think like shareholders’. This shift in turn created conflict between the interests of creditors and those of shareholders. In addition, as Stout (2012, 54) remarks, the strong emphasis on the short-term financial benefits to shareholders may affect the ‘corporations’ willingness to have public investors at all’. For instance, from 1997 to 2009, ‘[t]he number of public companies listed on [US] stock exchanges has declined by 39 percent in absolute terms, and by a whopping 53 percent when adjusted for GDP growth’ (54). Encouraging shareholders to act as if they had contracted for all privileges may undermine the very institution of the public company itself. In addition, there are other externalities from the shareholder value regime that undermine the long-term competitiveness of the listed firm:
[S]takeholders rationally distrust dispensed shareholders who can personally profit from threatening to expropriate or destroy the value of stakeholders’ specific interests. This makes it harder for shareholder-focused public corporations to attract dedicated employees, loyal customers, cooperative suppliers, and support from local employees. Shifting public corporations from the managerial model to the shareholder-centric model thus can produce a one-time increase in “shareholder wealth,” while simultaneously eroding public corporations’ long-term ability to generate profits, just as fishing with dynamite produces a one-time increase in catch size while eroding long-term fishing returns. (Stout 2013, 2016)

 
All in all, the corporate law view of agency theory and its shareholder value creation model stresses the inadequate support in corporate law and points to some unintended consequences that would ensue if it were to be followed. While corporate law seeks to establish sustainable legal arrangements enabling various stakeholders to collaborate, agency theory proposes an entirely different model, one that is more concerned with finance market efficiency than long-term stability.
A second round of critique against agency theory and the shareholder value model draws on the assertion made in agency theory that markets are, in fact, efficient mechanisms for pricing assets and commodities, ultimately rooted in what is called the efficient market hypothesis (EMH). Jensen’s strong belief in the rationality of the finance market is grounded in the EMH – ‘Chicago finance’s perhaps best known product’ (Fourcade and Khurana 2013, 149) – the idea that market prices contain all the available information at every single instant: ‘No other proposition in economics has more solid empirical evidence supporting it than the Efficient Market Hypothesis,’ claimed Jensen (cited in Fox 2009, 201). There are two principal objections to the EMH, one conceptual and one empirical. First, as Bratton and Wachter (2010, 660) argue, ‘the shareholder proponents depict agency costs as a static, historical constant’, indicating that no regulation, auditing, or finance market reporting reform would be able to counteract what agency theorists regard to be managerial malfeasance. Bratton and Wachter question this assumption, suggesting that ‘the information gap between those inside and outside of the corporation has narrowed, due in part to stricter mandatory disclosure requirements and in part to more liquid markets and a larger sector of information intermediaries’ (668). Agency costs are thus dependent on regulatory control and accounting procedures and thus can be influenced.
In addition, there is also a massive body of literature questioning the EMH; today, it is ‘[w]idely understood that stock market prices can deviate significantly from underlying value and that shares in diversified conglomerates often trade at a discount that does not necessarily reflect diminished operating performance’ (Stout 2013, 2008). In other words, there is no evidence that finance market actors are in a better position to determine where to allocate the residual cash flow than are managers and directors. All in all, there is ample evidence to suggest that agency theory is neither theoretically credible (Donaldson 2012; Erturk et al. 2004; Davis and Stout 1992) nor supported by empirical evidence (Dobbin and Jung 2010; Westphal and Clement 2008; Westphal and Graebner 2010; Westphal and Zajac 2001). Instead, agency theory may have served a performative role (Mackenzie 2006; Mackenzie, Muniesa, and Siu 2007; Svetlova 2012) in advancing shareholder enrichment as a legitimate and widespread corporate governance practice. Regardless of its inaccurate interpretation of corporate law, and its reliance on overtly abstract theoretical reasoning (the EMH), agency theory and its relatively simple modeling of corporate governance practice as a matter of balancing a few key analytical categories, including principals and agents, agency costs and residual cash flow, served to inform a new way of thinking of the firm, what Rock (2013, 1910) calls ‘the shareholder-centric system’ of investor capitalism. Agency theory led many academic scholars to believe that they ‘[h]ad better insight into how to run businesses than businesspeople themselves’ and that ‘[u]niform, “one size fits all” practices produced better corporate governance than diverse, individualized arrangements’ (Stout 2013, 2007). Agency theory did not singlehandedly create the shareholder-centric system of investor capitalism, but the theory is definitely coproduced with what is called the financialization of the economy (Krippner 2005; Orhangazi 2008; Skott and Ryoo 2010).
The criticism leveled against agency theory and the shareholder value model is substantial and includes a variety of issues (e.g. the content and intentions of corporate law

 
and factual evidence regarding market efficiency); any analysis of the remarkable success of the agency theory model of corporate governance needs to be understood on the basis of the economic, social and institutional changes in the US economy and society during the 1970s and 1980s. In the sections below, the advancement of agency theory is embedded in this historical framework.
 
 
Institutional changes and the advancement of agency theory
The role of business schools in promoting finance-market-based corporate governance
Fourcade and Khurana (2013) stress that the increased jurisdiction of economists and the economics discipline is closely bound up with the development of the business school as an institution within the medieval university system. As economists like Jensen have advocated finance market control as the ultimate check on managerial opportunism, Jensen’s solution to corporate governance problems, operationalized as ‘agency costs’ – ‘the costs of structuring, monitoring, and bonding a set of contracts among agents with conflicting interests’ (Fama and Jensen 1983, 304) – presupposed an already-functioning finance market where active investors allocate free cash flow to new and daring investments, that is, the finance market effectively supplies capital to what Schumpeter (1991, 66) speaks of as the ‘entrepreneurial function’ of the economic system. This shift in perspective is based on what Fourcade and Khurana (2013, 123) speak of as ‘linked ecologies’, including the co-evolution of economic science, business education and ‘markets for corporate control’ (Manne 1965). In Fourcade and Khurana’s (2013) understanding, American business schools are based on the three principles of being ‘practically relevant’, having ‘academic authority’ and ‘doing good’. This combination of virtues and liberties offers a specific combination of opportunities and benefits:
The practice-oriented constituencies toward which business schools directed their knowledge brought to the fore concerns and political design of corporate actors. The academically- oriented constituencies within universities exerted a powerful pull in the opposite direction – often expressing a sharp disdain for anything practical (e.g., by preferring “pure” sciences and liberal arts), and urging for more scientific approaches to practical problems (e.g., the development of engineering and the applied sciences). Finally, philanthropies (on which the new schools were financially and symbolically dependent) had their own agenda, too: they saw themselves as agents of social progress, moral education, and institutional innovation. (Fourcade and Khurana 2013, 124 – 125)
While the early business schools were primarily concerned with their practical relevance, downplaying the role of academic rigor, by the end of the 1950s and the beginning of the early 1960s, there was an increased emphasis on the capacity to produce scientific research and to substantiate what was taught at business schools. The Ford Foundation spent a total of $19 million on business school programs ($138 million in 2011 dollars) in the period following the publication of the Ford Foundation Report, and five top schools received $15 million (Fourcade and Khurana 2013, 142). Individual schools, such as the Carnegie Institute of Technology’s Graduate School of Industrial Administration, ‘sought to boost their academic status by ruthlessly proclaiming their scientific purity’ (144). Business school training was no longer a matter of learning a few business practices and the ‘tricks of the trade’; it was transformed into something that relied on scholarly discipline (Whitley 1986). In addition, within the business community, basic training in the liberal arts (the classical Oxbridge education) was no longer seen as relevant to a career in industry and its growing corporate structures. Instead, the traditional subjects of accounting and calculation in combination with the emerging behavioral sciences and

 
leadership training were advocated as the best preparation for a career in business (Khurana 2007). To this date, this shift in research policy is still under dispute (Hitt and Greer 2012; Chia and Holt 2008; Huff and Huff 2001).
Simultaneous with business schools being professionalized, jurisdictional struggles were ongoing in the field of economics, essentially centering on the distinction between the Keynesianism of so-called saltwater economists on the East Coast and the monetarist and anti-Keynesian freshwater economists at the University of Chicago, and later at Rochester University. Massachusetts Institute of Technology (MIT) economist Paul Samuelson represented the former school, while the flamboyant Milton Friedman represented the latter standpoint. Friedman was both a respected economist and a well- known public figure, writing newspaper columns and publishing best-selling books wherein he defended free-market competitive capitalism (e.g. Friedman 2002; Friedman and Friedman 1979). In Burgin’s (2012, 187) account, Friedman’s role in advancing free- market competitive capitalism, not only as a more efficient but also as a morally superior mechanism for regulating economic transactions, cannot be underrated. In fact, Friedman’s ‘argumentative framework’ would provide the foundation for ‘[m]uch of the Republican’s Party’s policy platform in the decades that followed’ (187). As many of the most prestigious economics departments at, for instance, MIT, Harvard, Yale and Princeton were dominated by Keynesian economic theory, graduates working in the Chicago tradition were not offered very much in the way of work opportunities, claim Fourcade and Khurana (2013, 144 – 145). Instead, graduates trained in a milieu hostile to Keynesianism; what Chicago economists regarded to be collectivist solutions to economic and social problems and costly welfare state programs were, suggest Fourcade and Khurana, ‘relegated’ to the business schools, who were now seeking to improve their legitimacy by instituting rigorous scientific, preferably quantitative, approaches (144 – 145). The unintended consequences of the jurisdictional struggles and the Keynesian/ monetarist free market approaches to economics, and the ‘scientification’ of the business schools, included the ‘business schools [becoming], over time and through the massive expansion of business education in the following decades, an important vehicle for the broader diffusion of Chicago approaches’ (144 – 145).
 
 
The funding of free-market theorists
The increased emphasis on scientific rigor in the business school and the jurisdictional struggles within the discipline of economics were accompanied by the mobilization of capital owners who wanted to counteract the economic stagnation in US industry at the start of the mid-1960s. Between 1965 and 1973, the profit rate in manufacturing fell by ‘nearly 41 percent’ and, in the private business sector, by 30% (Van Arnum and Naples 2013, 1160). The bear market of the 1970s – adjusted for inflation, Standard & Poor’s 500 share prices dropped more in 1973 – 1977 than during the entire period of 1929 – 1933 (Fox 2009, 163) – the oil crisis, and general concern regarding soaring inflation and growing unemployment mobilized the business community and made it fund pro-business and free- market think tanks and institutes. In addition, the counterculture of the late 1960s, including the civil rights movement, and a more liberal lifestyle had made conservative voters restless (Mizruchi and Kimeldorf 2005, 217 – 218); in 1968, Richard Nixon was elected President.
From the very outset, free-market advocates and intellectuals critical of the Keynesian welfare  state  endured  a  very  marginal  position  in  academic  circles.  The  Mont  Pe`lerin Society (MPS), funded in 1947 by Friedrich von Hayek, was a ‘club of losers’ for a long

 
time (Peck 2010, 40). Even though Hayek’s (1944) bestseller The Road to Serfdom had garnered substantial attention by the end of the Second World War, the postwar period was characterized by economic growth, stability and social progress rather than the route to what Hayek had gloomily predicted: that the welfare state would lead to economic decline and to the development of a semi-totalitarian state apparatus. When Hayek was invited to the London School of Economics in 1950, private money funded his position, something that was indicative of the MPS members’ marginal influence and prestige (Mirowski 2013). Similarly, Ludwig von Mises’ work at New York University was financed by a private benefactor. By the end of the 1960s, Chicago economists like Friedman were serving as economic advisers to the Nixon Administration; during the economic downturn of the 1970s, MPS members found themselves in the limelight after more than two decades at the margins of the profession.
The 1970s was a period when neoliberal and neoconservative intellectuals and activists were able to advance their positions and raise funds for their theory work (Akard 1992; Nik-Khah 2014; Vogel 1983). The American Enterprise Institute (AEI), a flagship of the conservative think tanks, increased its budget tenfold between 1970 and 1983 thanks to corporate largesse and the fundraising efforts of neoconservative intellectuals, from
$0.9 million to $10.6 million (Himmelstein 1992, 147). The Hoover Institution at Stanford University, on the verge of bankruptcy during the early 1960s, increased its annual budget from $1.9 million in 1970 to $8.4 million by 1983 (147). There was also evidence of new funds and think tanks being started during this period that were committed to the cause of advancing free-market capitalism, including the Heritage Foundation, started in 1973 on the basis of a donation of ‘several hundred thousand dollars’ by the industrialist Joseph Coors. By 1983, the Heritage Foundation had a budget of $10.6 million (147). Beginning in 1977, the John M. Olin Foundation, funded by the former head of the Olin Corporation, started to spend about $5 million a year on supporting ‘scholarship in the philosophy of a free society and the economics of a free market’ (149). The Olin Foundation was directed by William Simon (more about Simon shortly), a key figure in the mobilization of industry to finance free-market theorists. Additionally, in the 1970s, free-market, pro-business and libertarian think tanks and foundations were funded (Smith 2007, 89), for example the Cato Institute (in 1977) and the Manhattan Institute (originally the International Center for Economic Policy Studies) (in 1978). In contrast to the inflow of financial resources into neoconservative and libertarian think tanks and foundations, organizations on the left, in what would eventually be referred to as the Washington Consensus, for example the Economic Policy Institute, which relied on trade union funding, were at a significant disadvantage (High 2009, 484).
Smith (2007, 90, original emphasis) writes: ‘ A compilation of a large sample of think tanks found that the conservative institutes oversaw budgets four times as large as the liberal ones ... Budgets probably bear some relationship, however imperfect, to the policy influence of think tanks. He summarizes: ‘The 1970s were remarkable years for the formation and growth of conservative and libertarian think tanks’ (89).
The recipients of these donations were not silently contemplating what they regarded to be the flaws of the Keynesian economic doctrine and the welfare state; they were actively serving to advance the interests of their financiers and were promoting new economic policies. When Ronald Reagan took office in 1981, as the ultimate breakthrough of the neoconservative and free-market activism that had been going on since the late 1960s and of the more subterranean collaboration that had been taking place at, for instance, the MPS, these new institutions were ready to take their seats in the new administration and to serve as its advisers: ‘The major think tanks provided a great many

 
high-level appointees to the Reagan administration. In Reagan’s first term alone, fifty came from Hoover, thirty-six from Heritage, thirty-four from AEI, and eighteen from the Center for Strategic and International Studies’ (Himmelstein 1992, 150 – 151). A similar level of neoconservative and pro-business think tank influence was observable in the more recent Presidency of George W. Bush, in many ways the second coming of Reagan-era neoconservatism (Smith 2007, 91 – 92).
 
 
Supporting free-market thinking: the case of Rochester University and the recruitment of Michael C. Jensen
Rochester University, the ‘[e]astern outpost of Chicago economics’ (Fourcade and Khurana 2013, 150; See also Amadae and Bueno de Mesquita 1999, on public choice theory), has an interesting history as it has been significantly funded by private capital owners in order to advance a specific free-market economic theory in the Chicago tradition. Olin Foundation President, William E. Simon, Secretary of Treasury in the Nixon and Ford administrations and a member of the Heritage Foundation and the Hoover Institute, is one key figure in the story of the political economy of corporate governance and American neoconservatism more broadly:
[Simon] played an important role in resurgent conservative activism ... Simon articulated a coherent vision of a reinvigorated conservative political network that included think tanks, media organizations, and policy actors. Further Simon bridged policy making, business, activist networks, developing efficacious strategies in each realm and making connections among them. (Asen 2009, 264)
In 1978, Simon published the book A Time For Truth, wherein he claimed that business must protect itself from government interventions and liberal elites’ attempts to achieve egalitarianism, for Simon a distorted transfiguration of equality and an impossible as well as an undesirable objective. Instead, Simon argued, in a neoconservative tradition of thinking, that freedom, properly understood, is defined negatively, that is not as ‘a presence but an absence – an absence of governmental constraints’ (cited in Asen 2009, 277, original emphasis). The best way to counteract the project of the liberal elites, ruining American capitalism and society and violating the American constitution as laid down by the Founding Fathers of the Republic, and to secure the permanent withdrawal of the state, is to ‘funnel desperately needed funds to scholars, social scientists, writers, and journalists who understand the relationship between political and economic liberty’ (Simon, cited in Smith 2007, 90). ‘I know nothing more crucial than to come to the aid of the intellectuals and writers who are fighting on my side,’ he added.
The choice of words here is indicative of the sense of urgency of Simon’s project, ‘fight [ing] for’ independence from state regulation rather than reforming industrial relations through the regular institutions. Simon used the term ‘counterintelligentsia’ to denote these intellectuals working on a pro-business agenda (Asen 2009). Simon’s call for money to support academic economists was hugely successful; the conservative William Volker Fund financed the University of Chicago’s Department of Economics (Chabrak 2012, 460) while the Olin foundation has thus far financed a series of Nobel Prize-winning economists, including Gary Becker, who was the proponent of rational choice theories in the study of virtually all social phenomena, and Vernon Smith, another MPS member (464). Smith has also received substantial funding from Kansas industrialist Fred Koch, a member of the John Birch Society and a financier of the Cato Institute (Frank 2004, 82 – 83).
Simon was appointed Dean of Rochester University and one of the first persons he hired for his faculty was Michael C. Jensen. Simon did a remarkable job of developing Rochester

 
University into a stronghold of free-market, pro-business economic theory; in 1986, the Graduate School of Management at the University of Rochester was renamed the William
E. Simon Graduate School of Business to honor his work (Chabrak 2012, 466). The connections between private capital owners and their interests, pro-business think tanks and foundations, and academic research work conducted, published, communicated and taught at places like Rochester University are closely interwoven. Regardless of the theoretical inadequacies of agency theory, and its proposed solution to agency costs, and not least the ample research demonstrating how managers engage in, for instance, stock repurchases (Kahle 2002; Dittmar 2000; Grullon and Ikenberry 2000), agency theory arguably serves to justify the widespread use of the shareholder value version of corporate governance:
Drawing on the legitimacy of economics, agency theory in the business school had the authority to redefine managerial action and the nature of the corporation, setting in motion a “managerial revolution in reverse,” whereby managers were transformed, both symbolically and materially, into major corporate owners. (Fourcade and Khurana 2013, 151)
Jensen’s endorsement of the EMH and his claim that shareholders hold the rights to residual cash flow, as well as being in a better position than managers and directors to determine where to invest the capital generated, was thus coproduced with a general shift during the 1970s away from the embedded liberalism of the Keynesian welfare state toward a free-market competitive capitalism model as proposed by Chicago economists and their freshwater economist allies in the newly funded business schools at Rochester University and elsewhere. Studies show that foundational work such as Jensen and Meckling’s (1976) seminal paper was not widely cited until after shareholder value practices had already been adopted by industry (Heilbron, Verheul, and Quak 2014). Such evidence suggests that the inflow of capital into the US economy at the end of the 1970s and the beginning of the 1980s (Stearns and Allan 1996), and the new pro-business policy of, for instance, the Reagan administration during the 1980s (Jones 2012; Mizruchi 2013; Mizruchi and Kimeldorf 2005), leading to the risk of hostile takeovers and, consequently, more attention being paid to market evaluations and stock prices (Zorn et al. 2005; Dobbin and Zorn 2005), played a more decisive role than academic theorizing. Nevertheless, the theoretical work conducted by free-market protagonists such as Jensen has arguably played a part in justifying the shift toward shareholder-centric governance systems beyond the first hostile takeover wave that ended by the mid-1980s (Zorn et al. 2005, 273). Agency theory and shareholder value policies are today embedded in policies and regulations, and in the operative vocabularies of managers, finance market actors, regulators and policymakers. They are part of the infrastructure of investor capitalism.
 
Discussion
This paper has underlined the differences between economic sociology and legal scholars’ views of corporate governance as the outcome of intricate and highly politicized processes of balancing interests and legal, practical and political issues, and the neoclassical economic theory view whereby corporate governance is a matter of creating the most ‘efficient’ systems for controlling corporations. In the view of the economic sociologist and the legal scholar, ‘efficiency’ must be understood here as the establishment of a resilient corporate governance system taking many actors’ interests into account, while the shareholder value model prescribed by agency theorists rejects such a system of corporate governance as it would not provide any straightforward instructions to executives and directors regarding how to allocate residual cash flow, in turn leading to the possible squandering of resources.

 
As Owen-Smith (2006, 66) clarifies, ‘political economies of power and being are fundamentally relational’. Power results here from the ‘relative position in an objectified hierarchical order’, with the distribution of resources and opportunities ‘favor[ing] those at the top’. ‘Being at the top’ means that you are in control of significant economic resources
– economic capital – that can be translated into other forms of capital, for example what may be called here ‘academic capital’. The funding of free-market economic theory and research is an exemplary case of how finance capital transduces into academic capital. In the era of free-market capitalism, the University of Chicago has served as the principal source of new economic thinking and as a motor for new policies, commonly aimed at either deregulating existing markets or making the state a partner in market creation (Burgin 2012; Nik-Khah 2014). The emerging finance theory, the very basis for the finance market that Jensen advocates as the ultimate control mechanisms counteracting managerial malfeasance, is firmly rooted in the Chicago credo, claims Mirowski:
[The] Chicago [School of Economics] was the prime initial incubator for modern finance theory, which has indeed provided direct intellectual inspiration and justification for most of the so-called innovation in financial derivatives and automated equity trading of the last three decades. (Mirowski 2013, 181)
Jensen’s agency theory is truthful to his neoclassical disciplinary convictions since he mistrusts anything happening inside organizations (O’Sullivan 2000). he therefore postulates that managers are, by definition, acting opportunistically and thus squander and waste the free cash flow being generated; the managers’ gain (i.e. prestige, job security, growing firm size granting additional compensation, etc.) is treated as the shareholders’ loss (i.e. the lost ability to invest free cash flow in high-growth industries, or, more simply, to acquire the capital as private equity, etc.). Fortunately, in this view, the efficient market hypothesis offers a mechanism for reducing agency costs since finance market actors can curb managerial malfeasance by disciplining managers to ‘think like shareholders’ (Rock 2013, 1935). Ample evidence demonstrates that Jensen’s solution to ‘agency costs’ – a key problem in the corporate governance literature since the publication of Berle and Means’s (1934) seminal work – does not, in fact, solve agency problems but leads to other forms of opportunistic behavior (Westphal and Clement 2008; Westphal and Graebner 2010), or even violates the efficient market hypothesis, the axiomatic assumption of agency theory and its proposed shareholder value policy, as in the case of stock repurchases (Dittmar 2000; Grullon and Ikenberry 2000; Westphal and Zajac 2001). However, these new managerial behaviors tend not to reduce returns to short-term-oriented shareholders (e.g. mutual funds) but may lead to additional agency costs for other constituencies protected by corporate law, including creditors and long-term-oriented shareholders. As Jensen has faith in the finance markets’ ability to discipline inefficient managers, agency theory appears less concerned with these additional externalities of the shareholder value creation model.
Over time, agency theory has been modified to accommodate new regulatory frameworks, new economic policies and new behaviors on the part of both managers and finance market actors; however, its principal message – that finance market control remains superior to the managerial control of organizations – has been maintained over a period of almost four decades. In Jensen’s version of corporate governance, where the market is understood as a superior processor of information, managerial skills are ignored or treated as irrelevant, an assumption that speaks against studies of economic growth in comparative corporate governance systems (Fligstein and Choo 2005, 66 – 67) and that proposes that alternative corporate governance systems ‘leave big money on the table’, a proposition that Bratton and Wachter (2010, 675) say is ‘counterintuitive’. In other words, the agency theory assumption that ‘managers will systematically fail to maximize value in

 
predictable ways’ (Bratton and Wachter 2010, 676) and that finance market actors will counteract such incompetence is not widely endorsed among scholars. More research into the history of corporate governance and the popularity of agency theory and its shareholder value solution to agency costs may reveal why shareholder value became highly influential after the first wave of hostile takeovers as well. Agency theory was part of a shift in economic policy away from Keynesian economic theory toward free-market doctrines, with the academic as well as non-academic institutions that shared this commitment benefitting from increased capital funding during the 1970s and 1980s; however, it is most likely the case that there were other factors involved, including regulatory control and new legislation (see e.g. Zorn 2004), which served to make shareholder value the privileged corporate governance model for more than three decades.
 
Concluding remarks
Corporate governance theory has contributed quite directly to the gradual shift away from the conglomerate corporate form managed by executives trained in the engineering sciences (Davis, Diekmann, and Tinsley 1994) toward the finance-market-dependent firm governed by a combination of business-school-trained and finance-savvy executives and externally recruited directors. Agency theory justified shareholder value policies that were coproduced with the growth of the finance industry. The long-term consequences of the financialization of the economy (Krippner 2005; Orhangazi 2008; Skott and Ryoo 2010; Stein 2011; Stockhammer 2013), both in the USA and elsewhere, are significant and complicated to comprehend in their full scope; however, agency theory and its shareholder value solution to agency costs form part of the same shift in neoclassical economic theory away from the Keynesian-regulated economy toward a free-market and finance-market- dominated economy. For scholars of management and organization history, the shift in corporate governance, carefully balancing the interests of a variety of stakeholders, toward the idiosyncratic agency model enactment of corporate governance, granting privileges to short-term-oriented and finance-market based shareholders, is perhaps the most conspicuous and pervasive shift in organization during recent decades. In consequence, as proposed by (Starbuck 2014), for instance, the doctrines underlying the shareholder value model and its historical roots, as well as its champions, financiers and sponsors, should become the subject of increased scholarly attention.
 
Disclosure statement
No potential conflict of interest was reported by the author.
 
Notes on contributor
Alexander Styhre, Ph.D. is chair of organization theory and management at the Department of Business Administration, School of Business, Economics and Law, University of Gothenburg. Styhre has published widely in the field of organization and his work has appeared in such journals as the Journal of Management Studies and Organization Studies. His most recent books published are Biomaterials Innovation: Bundling Technologies and Life (Edward Elgar, 2014) and Management and Neoliberalism: Connecting Policies and Practices (Routledge, 2014).
 
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