System and Evolution in Corporate Governance

In the paper, System and Evolution in Corporate Governance, which was recently made publicly available on SSRN, my co-author, Fabio Carvalho, and I explore the relevance of systems theory for an understanding of legal evolution, with specific reference to the law and practice of corporate governance. Evolutionary ideas play an important role in the contemporary corporate governance debate, being regularly deployed to support deregulatory initiatives and encourage belief in the likelihood of the global convergence of governance regimes. Close inspection suggests that many of these analyses are based on false analogies, drawn from misunderstandings of natural selection processes in the biological realm. They also suffer from a failure to address the issue of the social ontology of law. The key assumption in most law and economics analyses is that legal rules operate as surrogate prices. Given the importance of this step in law and economics reasoning, it is surprising that so little attention has been given to articulating and defending it. The effect, though, is severely to limit the value of the resulting analyses, by dissolving the distinction between the legal and economic systems.

Social systems theory offers an analysis which, while in some respects highly abstract, is more realistic than that of mainstream law and economics in the sense of being more faithful to the social practice and experience of law. At the same time, the focus of systems theory upon the role of meaning as the precursor to social interaction throws light on some of the questions addressed by new institutional economics. From the standpoint of a theory which accepts the bounded rationality of the individual economic agent, and which sees a role for norms and conventions in overcoming coordination problems, a new field of inquiry is opened up by an understanding of law as a complex, self-referential system of communication. From this point of view, the important methodological issue is not how to understand the law in the terms of the market, but to understand the distinctive and separate qualities of the legal and economic systems.

The most significant normative implication of a consideration of systems theory in this context is that the efficiency of the law cannot be measured solely in terms of the degree to which it ‘interferes’ with the autonomy of the contracting parties. Nor is it the role of the legal system to ‘adjust to’ changes in its external environment. Rather, the efficiency of the legal system is concerned with how successful it is in ordering the complexity of the external environment to which it relates. In order to undertake this task, the legal system must be able to maintain the principle of system congruence which is the precondition of its autonomy and self-reproduction. To that end, the legal system will maintain a set of ‘foundational’ concepts which are to a large extent free from immediate evolutionary pressures, and which tend to be manifested in the form of mandatory legal rules which leave little or no room for bargaining between the parties. In practice, there are many such rules, even in the common law systems which are said, above all others, to comply with the contractualist model of corporate governance. By enabling us to understand these rules, systems theory offers the possibility of a more complete theory of company law than any offered to this point by the law and economics literature.

The full paper is available for download here.