7 Governance
7.1 Introduction
We pointed out above that, as a matter of analytical convenience, the existing literature on incomplete contracts tends to abstract from the problems of governance and agency that are central to the management of large firms (and large public-sector organisations). However, this does not mean that the incomplete contracts literature is irrelevant to questions of governance; indeed, quite the opposite is true. In a world where complete contracts could be written (that is, where it is feasible and efficient to formalise all future contingencies in a contract), there would be no role for governance because all material decisions would be made ex ante. But in a world where contracts are incomplete, corporate governance may be defined as the set of conditions or the institutions that shapes the rights to make ex post decisions in relation to unspecified contingencies, and in particular to determine the ultimate unspecified contingency—the allocation of the surplus between owners and management.[32] The importance of this literature is that it shifts the focus of the analysis of governance and boards of directors away from agency (incentive) problems and towards decision and investment problems.
We begin by defining governance. We then consider the difference between the agency and the incomplete contracts view of governance. We outline the lessons from the recent literature on governance, before considering how those lessons might relate to the governance of public-sector organisations.
Notes
- [32]Or, as we explain below, where there are no owners allocating surplus, however defined, among stakeholders.
