Nexus of Contracts
Every organization has as a nexus of contracts. This nexus is made up of many interested parties.
To look at any one aspect of a company in isolation is inherently
incorrect. Similarly, a “holistic” view of the corporation is needed
before finance can be investigated.
To get this understanding we need to
start at the very beginning (a very good place to start!–apologies to the
Sound of Music).
What is a corporation? Can you hit it? Of course not. A corporation is
merely a group of people. To make things more difficult lets call of the
people– stakeholders. Thus whenever you hear stakeholders, think all of
the people who have an interest in the corporation.
So a corporation is a group of stakeholders. Who are these stakeholders?
Oh, just about anyone you can name. CEOs, Employees, Bondholders, Vendors,
Customers, and most importantly Stockholders (some books say shareholder and
stakeholders are separate but I like to think of stockholders as a subset of stakeholders).
. These stakeholders all have
a stake in the firm. (hence the name–pretty imaginative, huh?) Another
way of saying that is to say they have a contract with someone else who is
also a stakeholder. These contracts may be implicit (not written or
stated) or explicit. As everyone has these contracts we have a Nexus of
contracts. (and you thought this was going to be hard!)
Why are shareholders so important? Several reasons: They are the
owners and have taken the biggest risk. More importantly they are the
residual claimants (fancy way of saying they get paid last) they are usually in
the best position (have best incentives) to monitor the firm. Further, as
residual claimants maximizing their returns in a world of efficient
markets and available information leads to all other claims also being
satisfied. Thus the implicit and explicit contracts that make up the
“nexus of contracts” have all been satisfied. Thus, to maximize shareholder value, is also to satisfy all of the other
contracts. Now I am not so naïve to realize that the assumptions that
underlie that last statement (notably perfect information) are always met,
but that is our goal.