An Economic Theory of Fiduciary Law

I’ve recently posted to SSRN a book chapter called “An Economic Theory of Fiduciary Law,” which will be published in Philosophical Foundations of Fiduciary Law by Oxford University Press. The editors are Andrew Gold and Paul Miller.

The purpose of my chapter is to restate the economic theory of fiduciary law. In doing so, the chapter makes several fresh contributions. First, it elaborates on earlier work by clarifying the agency problem that is at the core of all fiduciary relationships. In consequence of this common economic structure, there is a common doctrinal structure that cuts across the application of fiduciary principles in different contexts. However, within this common structure, the particulars of fiduciary obligation vary in accordance with the particulars of the agency problem in the fiduciary relationship at issue. This point explains the purported elusiveness of fiduciary doctrine. It also explains why courts apply fiduciary law both categorically, such as to trustees and (legal) agents, as well as ad hoc to relationships involving a position of trust and confidence that gives rise to an agency problem.

Second, this chapter identifies a functional distinction between primary and subsidiary fiduciary rules. In all fiduciary relationships we find general duties of loyalty and care, typically phrased as standards, which proscribe conflicts of interest and prescribe an objective standard of care. But we also find specific subsidiary fiduciary duties, often phrased as rules, that elaborate on the application of loyalty and care to commonly recurring circumstances in the particular form of fiduciary relationship. Together, the general primary duties of loyalty and care and the specific subsidiary rules provide for governance by a mix of rules and standards that offers the benefits of both while mitigating their respective weaknesses.

Third, this chapter revisits the puzzle of why fiduciary law includes mandatory rules that cannot be waived in a relationship deemed fiduciary. Committed economic contractarians, such as Easterbrook and Fischel, have had difficulty in explaining why the parties to a fiduciary relationship do not have complete freedom of contract. The answer is that the mandatory core of fiduciary law serves a cautionary and protective function within the fiduciary relationship as well as an external categorization function that provides clean lines of demarcation across types of relationships. The existence of a mandatory fiduciary core is thus reconcilable with an economic theory of fiduciary law.

My bottom line is this: In contrast to an arms-length relationship, in which each party is free to be self-serving, in a fiduciary relationship the law requires the fiduciary to be other-regarding because of the potential for abuse inherent to the agency structure of the relationship. What is meant by other-regarding is defined by general primary fiduciary duties of loyalty and care and a host of specific subsidiary fiduciary duties. Fiduciary duties are subject to refinement by agreement of the parties, so long as the fiduciary remains obligated to act in good faith and in the best interests of the principal. Agency theory, and in particular its emphasis on the problem of opportunism in circumstances of asymmetric information, explains these basic contours of fiduciary doctrine.

The full chapter is available for download here.