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.(ed.) Foundations of the Economic Approach to Law, Oxford: Oxford University Press,11 18.57 See Walras, L.(1954) Éléments d Économie Politique Pure, Lausanne: Corbaz,1874 1877, Jaffé, W.[transl.] (1954) Elements of Pure Economics, London: George Allenand Unwin; and Marshall, A.(1920) The Principles of Economics, 8th edition, London:Macmillan.58 Jensen, M.and Meckling, W.(1976) Theory of the Firm: Managerial Behaviour,Agency Costs, and Ownership Structure , Journal of Financial Economics, vol.3, 305 at 307.59 Some prominent exponents of the theory are Machlup (Machlup, F.(1946) Marginal Analysis and Empirical Research , American Economic Review, vol.36, 519);Oliver (Oliver, H.(1947) Marginal Theory and Business Behaviour , American EconomicReview, vol.37, 375); Friedman, M.(1953) Essays in Positive Economics, Chicago:University of Chicago Press; and Stigler (Stigler, G.(1947) The Theory of Price, London:Macmillan).Some classic neoclassical models of the firm have been developed by Hicks(Hicks, J.(1939) Value and Capital, 2nd edition, Oxford: Clarendon Press) and Arrow andDebreu (Arrow, K.and Debreu, G.(1954) Existence of an Equilibrium for a CompetitiveEconomy , Econometrica, vol.22, 265).60 The assumption is that natural prices of goods are reflected by market prices whichare determined by the matching of supply and demand. 20 The Globalization of Corporate Governancethan in B, then X will move to A until the price difference disappears.In thisway the market determines the prices and automatically marks out what the bestallocation choice is.This implies that the role of management, if any, is a passiverather than an active one.Thus, in neoclassical economics there is no theorizingabout managerial coordination and the firm is assimilated to a factory withoutan administrative hierarchy.61 Even where an administrative hierarchy exists, theneoclassical assumption is that it merely coordinates factors in the same way thatthe price mechanism would.Alternatively, the theory assumes that the firm isowned by a single entrepreneur.Again this single owner makes all managementdecisions according to the price-theoretic assumption.The second assumption, based on the classic axiom that all economic actorsseek to maximize profit, is that the firm pursues the single objective of profitmaximization.This is achieved by applying the marginalist principle whichassumes that the change in total revenue resulting from selling an additional unitof commodity (Marginal Revenue) equals the change in total cost resulting froma unit change in output (Marginal Cost).Profit maximization is attained whenMarginal Revenue equals Marginal Cost (MR = MC).This occurs in series ofindependent time-horizon periods which are determined by technological change,capital intensity of production, product life, and so on.Profit maximizationwithin all these independent short-term periods leads to profit maximization inthe long-term as well.That is, the relation between short-term and long-termprofit is harmonious.Moreover, when pursuing their goals firms act without beingconscious of other firms reactions.Finally, the third main assumption of the neoclassical theory is that the firmoperates in perfect certainty as it has full knowledge about all present and futurecircumstances that affect its operations.Irrespective of whether production factorsare coordinated by an administrative hierarchy or by a single entrepreneur, thefirm has unlimited information on production costs and revenues.The lack ofinformational asymmetries excludes any uncertainties and enables the firm tomake all rational decisions in order to achieve its profit maximization goal.62 Inthis way, all alternative strategies are evaluated and compared with certainty sothat only the profit-maximizing ones are chosen.In fact, as Loasby claims, firmsand other economic agents choices are absolutely predetermined:[i]f knowledge is perfect and the logic of choice complete and compelling thenchoice disappears; nothing is left but stimulus and response & if the future iscertain there can be no choice.6361 See Chandler, A., above n2, 490.62 This is the well-known global rationality assumption of neoclassical economics.63 Loasby, B.(1976) Choice, Complexity and Ignorance: An Inquiry into EconomicTheory and Practice of Decision Making, Cambridge: Cambridge University Press, 5.See also Latsis, S.(1976) Method and Appraisal in Economics, Cambridge: CambridgeUniversity Press. Corporate Governance Convergence and Corporate Theory 21The neoclassical theory of the firm is essentially a theory of equilibrium whichis achieved in markets characterized by perfect competition.64 It is in such marketsthat the price-theoretic assumption that firms are passive price-takers ratherthan active price-makers applies and where Pareto optimality is achieved.In theneoclassical equilibrium a single price prevails in the market according to whichall rational profit-maximizers make their adjustments to their output in order toequate Marginal Cost with Marginal Revenue.Thus, profit-maximizing firmsachieve their goals by using the prices formed by the market according to the lawof supply and demand.It should be noted here that subsequent formulations of the neoclassical theoryhave allowed for the possibility that non-profit maximizing firms may exist atleast in the short-term.For instance, in a classic paper published in 1950 Alchianused the Darwinian natural selection example to claim that the achievement oflong-term profit maximization is crucial for the firm s survival in a perfectlycompetitive market.65 Profit maximizing firms enjoy an advantage over non-profitmaximizing firms, since they have the financial resources to grow faster than thelatter who will be out-competed and eventually eliminated.The significance ofAlchian s model is that, although it allows the possibility of firm-level divergencefrom profit-maximization, the neoclassical objective applies at an industry-widelevel through an evolutionary process and thus the neoclassical equilibrium holds.Profit maximization is then not a choice objective but it is one externally imposedon the firm s owner as a necessary precondition for survival.The equilibrium assumptions of the neoclassical theory have some importantimplications for corporate governance.First, since both managerial hierarchyand sole entrepreneur ownership are treated as equivalent coordinationmechanisms within the firm, the relationship between ownership and controland its organizational implications are rendered irrelevant.There is no differencebetween a non-owner manager and an owner-entrepreneur since both are simplyassumed to make optimal decisions based on given (perfect) information.Insuch a theory where discretion is completely ruled out managerial innovationand motivation have no relevance.Irrespectively of who is in control of the firmthe profit-maximization objective will be pursued
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