**1. Overview of the chapter**

In what follows, the author attempts to evaluate the concept of the theory of firm value as it has passed through its interpretive history. For example, the earlier stage of the concept maintained the interpretation that a firm is merely a legal device through which the private business transactions of individuals are maintained and operated. Such a concept has dominated business, finance, and economic understanding about a firm's theory for a long time. Furthermore, as we pass through time, many views emerge from business and finance academicians who compete to explain what should be the meaning of the term "firm." This chapter is designed to outline to readers the evolution of the terms *firm* and *firm value* through the lens of academic study in business and finance (or economics perhaps?) through prior literature surrounding the issues. The essential point of the chapter is simple: to provide an

© 2016 The Author(s). Licensee InTech. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. © 2018 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

answer to the fundamental question of "what is the meaning of the term 'firm' and what do we know about the value of a firm?" Along with the detailed explanation, the author points to the central theme in major theories and concepts so that the reader can follow the theories and concepts when they are applied to business. Also, some important empirical papers are discussed throughout the chapter.

Back in the 1960s, many researchers whose works related to the theory of firm or firm value cited the classic paper of Ronald Coase when they wrote about firm theory. Coase [21] was the Nobel Prize laureate in politics and economics and held the view that firms can be composed of many "nexus of contracts" or "nexus of parties" and, when there is a conflict of "property rights," parties within the nexus can bargain or negotiate terms that are more beneficial among them. In the nexus, the "Pareto efficient" is obtained by bargaining among the nexus. Coase's theorem is therefore known as property right theory. The concept of a firm derived from Coase's explanation is the springboard for many subsequent business and finance theories, including the classic paper, *Theory of the firm: Managerial behavior, agency costs and owner-*

Firm Value

5

http://dx.doi.org/10.5772/intechopen.77342

Property right theory was defined as "separation of ownership and control" by Jensen and Meckling [53] and signified the separation of ownership and control that underlines the main nexus of firms into two groups. One is the group who has the property rights as the "owners" of firms. The other one is the section of the management who has the right to operate or "control" firms. The relationship between the groups is called the principal-agent relationship. Nexuses have many types of this kind of relationship, that is, the owners (principal) and management (agent), the shareholders and bondholders, or the minority shareholders and

In the standard contractual concept, shareholders offer money as capital to a firm in return for residual claims on returns of capital after money is paid to other groups. The attribute of the residual claim of shareholders is used to distinguish them from others. With this standard concept, it is clear that the shareholders are the group who provide capital to contribute to the overall operation of the firm. Even other groups, such as bondholders or preferred stockholders, can also provide some forms of capital to the firm, but they have no right to directly or indirectly control a firm. The standard argument holds that shareholders, with only residual claims, would bargain for corporate control in return for their residual risk bearers on the claims. Equipped with the power of corporate control, shareholders can assign control to their agents who will work in the firm so as to maximize benefit for them in returns. Clearly, this side of the theory is known as "shareholders theory" [11]. Viewed from the eyes of this separation, modern forms of firms have a lot of advantages as explained earlier, such as continuity, ample resources to expand the boundaries of a firm, and the independence of a firm's site location and owners' locations. Firm theory enjoys these advantages and applies them to the expansion of a given firm to harvest an industrial revolution. The theory also encourages

However, Jensen and Meckling [53] did not just describe the meaning of the term "firm" according to their own view. The great beauty of their work is in showing how we can exploit the fruitful nature of the concept of the "separation of ownership and control" as a magnifier to examine the peripheral events around a firm. They manage to fit the concepts very well with the overall business environment. Furthermore, the concepts can be used as heuristic tools for owners, managers, or any stakeholders to understand the causes and effects in relation to the value of firms and to understand the appropriate solutions for problems related to the principal-agent relationship. Problems arising from this relationship are known as agency

owners to think in more revolutionary ways about their firms.

*ship structure,* of Jensen and Meckling [53].

owners-managers.

The structure of this chapter is as follows. First, the author discusses the relevant concepts as they are presented to us and are used from the past up until current usage. What we have learnt after using this traditional theory for half a century is that the simple focus on single stakeholders creates some important problems that require attention with regard to the drawbacks of the theories in the past. In the second part, the author illustrates the major problems arising from these traditional viewpoints of *firm value theory* and how the modern system of corporate finance can help us to solve this problem. The third part introduces the reader to a theory that challenges long-time traditional use of shareholders' maximization theory (i.e., a theory whose main focus is only on a single group of stakeholders known as *shareholders,*); the more recent theory however focuses on a multifarious-group of stakeholders and is known as *stakeholders theory*. The author shows that stakeholders' theory has been transformed into many versions of the current conceptualization-of-firm theory, such as sustainability concepts, triple bottom lines, or the CSR theory.
