He argued that shareholder primacy acted as a disciplining device on management. Inefficient management would be reflected in a lower share price, making the company an attractive target for a more efficient competitor. In other words, it was possible to create a market in corporate control which could drive out company inefficiencies. The shareholder-centric model also appeared efficient from a risk allocation perspective. If control rights were placed in the hands of the party shouldering greatest risk – shareholders – this provided the strongest possible incentives to safeguard the fortunes of the company. The shareholder-centric model appeared to be a recipe for higher economic returns at the lowest possible risk. This was an awe-inspiring combination. By the 1980s, corporate success and the level of share prices had, in effect, become synonyms. 13 Corporate governance today The UK Companies Act 2006 can, in some respects, be seen as a natural evolution of this historical trajectory. It arose out of the work of The Company Law Review Steering Group, appointed by the government in 1998. 14 Two fundamental issues arose. First, should the law expect companies to consider responsibilities broader than shareholder maximisation? And second, should the law attribute specific responsibilities to company directors? It concluded that directors’ duties should not be recast to include a wider set of stakeholders. Giving directors pluralist duties risked turning “company directors from business decision makers into moral, political or economic arbiters”.

(a)  Classic principal/agent problems  Following the work of Jensen and Meckling (1976), the most extensively studied cost of separation arises when management pursues their own private interests at the expense of shareholders: for example, through corporate perks such as private jets or sponsored football teams, empire-building such as value-destroying acquisitions, or rent extraction through excessive executive remuneration. This is a classic principal/agent problem. Those theoretical concerns gained practical prominence during the 1970s. The response then was, on the face of it, ingenious: to align shareholder and managerial incentives, remuneration contracts for management needed simply to be linked to shareholder returns. This could be achieved by paying managers not in cash but in equity or in equity-linked instruments, such as stock options. And so it came to pass. Between 1980 and 1994, the average value of stock options granted to CEOs of large US companies rose by almost 700%, while salaries and bonuses rose by less than 100% (Hall and Liebman (1998)). The proportion of companies remunerating their CEOs in stock more than doubled. Those trends have continued apace in the two decades since. In 1994, US CEO compensation was split roughly one third salary, one third bonus and one third stock and stock options. By 2006, the dawn of the crisis, that split was less than 20% salary, less than 30% bonus and more than half stock and stock options. Among banks, the latter fraction was higher still. Whether this shift in compensation practices put a lid on CEO rent-seeking seems altogether more questionable.