INSEAD Presentation - Fontainebleau, France

1. The Invisible Hand Theorem,
Modern Finance Theory, and the
Need for a New Theory of the Firm
and Its Governance
DAVID J. TEECE
INSEAD, FONTAINEBLEAU, FRANCE
SEPTEMBER 21, 2018

2. The Invisible Hand
 The “invisible hand” theorem … reflected Adam Smith’s amazement
at the power of self-interest (allowing decentralization). However,
Adam Smith did not advocate selfishness.
 Smith’s economic man was both self-interested but also
“sympathetic” and wished to be well thought of by others.

3. Smith was not just about selfishness
 Smith saw no tension between his “Wealth of Nations” (1776) and his Theory
of the Moral Sentiments.
 Smith rebutted Bernard Mandeville’s “The Fable of the Bees” (1714) in which
immoral and selfish bees nevertheless create a happy society.
 Smith was critical of businessmen who “love to reap where they never sow.”
 Smith favored rigorous self-scrutiny and virtue.
 Smith saw ethics, jurisprudence and economics as inexorably linked.
Wealth of Nations and The Theory of the Moral Sentiments together create a
recipe for sustainable capitalism.

4. SHAREHOLDER VALUE
 Smith’s Theory of the Moral Sentiments has been ignored.
 Current corporate law does not impose a legal duty to maximize
(short-term) shareholder value.
 Short-term shareholder value maximization is a creature of Jenson
& Meckling and related property rights theories of the firm.

5. CONFUSION IN THE LITERATURE AROUND
SHAREHOLDER THEORIES
 Shareholder’s value (Friedman) maximization does not mean
ignoring other stakeholders.
 A long-term focus on shareholder returns increasingly requires
attending to other shareholders so as to maintain “evolutionary
fitness.”
 John Kay’s (strategic) principle of obliquity is relevant: in complex
situations, objectives are best pursued obliquely, not directly.1
1John Kay, Obliquity: How our goals are best pursued indirectly (Penguin, 2010)

6. A NEW THEORY OF THE FIRM IS NEEDED TO
GUIDE NEW THEORIES OF GOVERNANCE
“In the simple nexus of contract world, the maximization of a firm's value
corresponded, with few exceptions, to the maximization of shareholders' value.
Consequently, the traditional precepts of corporate governance were all aimed at
empowering shareholders...In the current environment, where human capital is
crucial and contracts are highly incomplete, the primary goal of a corporate
governance system should be to protect the integrity of the firm, and new precepts
need to be worked out.”1
1L. Zingales, In Search of New Foundations, The Journal of Finance, August 2000, 1643-44