Using Game Theory and Contractarianism to Reform Corporate Governance: Why Shareholders Should Seek Disincentive Schemes in Executive Compensation Plans

Employing a model of game theory, this Article shows how current judge-made law in areas of the duty of loyalty does not adequately prevent corporate managers from violating their fiduciary duty. This Article presents a solution, advising shareholders to reform corporate governance through executive compensation contracts that would properly incentivize corporate managers to comport with their duty of loyalty. Part I examines the rise of contractarianism, the prominent legal academic view of a corporation that helps to guide judicial interpretation of corporate law pertaining to managers’ fiduciary duties. Part II examines agency costs, a subset of transaction costs, and the role of fiduciary duties. Part III employs lessons from game theory to show how courts have effectively created incentives for managers to violate their duty of loyalty. And Part IV examines how executive compensation contracts can be structured to properly incentivize managers to comply with their fiduciary duties. Cite as: 42 Golden Gate U. L. Rev. 349 (2012