Agency v. Contract
Corporate law exists on the boundary between agency and contract.
Contract is formally equal, acontextual, and relationship-free. Two parties come together in a Lockean, if not Hobbesian, state of nature as disinterested strangers each interested only in himself (and they are characteristically gendered male) and his own wellbeing. Each is entitled to think only of himself, to exploit any natural or situational advantage he may have, to make the most of what God, or the government, luck or his natural abilities or hard work, have given him. The only consideration he owes his counterparty is honesty, and a fairly thin form of that: he may, for example, deliberately lie (bluff) about the price he is willing to pay or accept. Moreover, he has no obligation to disclose information about the property he is buying or selling, at least so long as he doesn’t intentionally and explicitly lie about it; still, puffery is permissible under the bluffing rule. Rather, each contracting party is entitled to treat information he has (regardless of how he acquired it) as part of his endowment, like his brains and brawn, bank account and real estate, which he may use as he sees fit for his own purposes.
The contracting party who sees an advantage should take it. If I see a diamond in the rough or a Rembrant in the flea market, I’ve done something clever and smart by purchasing it from its unsuspecting owner. I may buy your lot knowing it has oil under it without telling you. I may arbitrage between markets for parts and wholes without disclosing the opportunity to you: individual shares are usually worth more if they are purchased in connection with a sale of the company; individual city lots may be worth more if they can be combined to create a larger one. If I can use your expertise or hard labor to make a product worth far more than I am paying you, the difference is mine and, labor theories of value notwithstanding, you have no claim on it. The inventor of the Nike swoosh sold his labor at an hourly rate. So much the worse for him and the better for Nike. If a contracting party knows that the value of property (a painting, a city lot, a share of stock) is worth more than the owner thinks it is (because it isn’t what the owner thinks it is, or because fashions have changed, or because someone is assembling a collection and needs the property to make a whole worth more than its parts), the knowledgeable one is entitled to arbitrage my knowledge, to contract with the owner in his ignorance. In contract, knowledge is property, and property owners may use it as they please.
A contracting party who sees a need may exploit it or ignore it. Starvation reigns. Pharaoh has grain. In contract, he may eat, drink and be merry while the world suffers. Or he may sell his grain for the price the market will bear. Shortage creates opportunity. The employer realizes the employee has no comparable alternative employment, or the employee realizes that without him, the employer’s project is sunk. Each is entitled to demand as much as he can get away with, to threaten to walk if his demands are not met. Every negotiation book begins by emphasizing the importance of being able to abandon the deal: he who is less committed shall gain the surplus. Trade creates a surplus, but in contract the surplus is zero-sum: whatever one party gets the other has no longer.
The paradigm of contract is a sale in a market. A buyer and a seller meet momentarily, inspect each others goods and cash, trade, and depart, never to meet again. Think of the medieval market or the suk in the pre-modern Near East. Traveling traders, peasants from different regions, a polyglot interface of strangers with no other connections. Market transactions need only a minimal context: traders may be foreigners (Jews, gypsies, Arab caravans) or even anonymous (the modern stock market). One can hate, even kill, trading partners on Wednesday and meet to do business on Thursday.
Government is needed to set the market day, build the marketplace, limit deceit that cannot be policed by the parties themselves (shaved or counterfeit money, hidden defects in goods), prevent violence and theft. Within this framework – the stronger the better– strangers can deal on bases of social equality and meritocracy. Lower caste money is as good as upper case money; heredity and pedigree are irrelevant; family and respectability are redundant; skill is all. With a strong enough governmental background, as in our financial markets, parties may trade without even knowing the identity of their counterparties. Contract has no history: the present is all that counts.
Agency is opposite. Agency exists only in society, not states of nature, only between people and through time, not only in momentary contacts in the isolated forest or the marketplace. An agent is a fiduciary, working for someone else. Agency requires two people to work together over time. Agent and principal are in relationship, not isolated. A agent works for her principal. She cannot be self-interested, because the essence of the relationship is that she must take her principal’s goals as her own, that her work is for the principal and what she makes or does belongs to the principal. She cannot be an equal, because the relationship is asymmetrical at its core: agents work for principals but not the other way around. She cannot be anonymous or a stranger, because she must understand her principal’s needs and her principal must rely on her, not merely an externally verifiable product. In the market, the contracting party sells or buys a thing; agents sell themselves.
An agent’s information is the principal’s, just as an agent’s work is the principal’s. If a lawyer discovers the client’s vulnerability, she must respect it, cure it, reduce it – not exploit it. The employer’s secrets are the employees’ responsibility to keep.
The rules for agents are in every instance the opposite. Agents must disclose their information. The expert uses her expertise for her principal, not against. The employee’s actions are the employer’s. The game is not zero-sum but cumulative. As employee, what I create is not my own and I may not use it against my employer. The fiduciary has done a good job if the beneficiary gets rich. The agent’s good is the principal’s.
When starvation reigns, the fiduciary must protect the client. Parents may not stand aside and watch their children starve, nor may trustees charge the trust beneficiary whatever the market will bear. Civilized governments differ from their Pharaonic counterparts in that they do not view their citizens as strangers, subjects to be treated according to the norms of contract, but as themselves: what is good for the citizenry is good for the country.
Agency is the law inside the corporation; contract its rule outside. When the corporation hires its employees, they are contracting strangers. Once hired, they its agents. Once retired, it is their fiduciary. When the corporation seeks funds in the financial market, it does so as a contracting stranger. Once obtained, equity investors are beneficiaries and the firm their fiduciary. The firm, usually, may treat its debt as a product it has sold to a stranger in a market, but near insolvency, the relationship reappears and transforms as the firm becomes a fiduciary for its creditors.
Because the norms of agency are opposite those of contract, it matters which applies. But there are no lines to be discerned. Most relationships can be characterized one way or the other at one time or another. The standard employment contract is at will: terms of the contract may be renegotiated at any time according to the norms of self-interested contracting between strangers. But the standard employment relationship is agency: as employee, the employee is an agent, required to set aside her own interest in favor of the employer’s. The two roles are simultaneous and conflicting.
The shareholder is an outsider, buying and selling shares in a secondary market of strangers with no responsibilities whatsoever for the firm. But shareholders elect directors, and selling shares also means selling votes. So the impersonal market of contract buys and sells votes, that elect fiduciaries in relationship to shareholders with no responsibilities back.