Peoples and cultures are largely defined by the rules and institutions they have created to manage their relationships and interactions with their fellow man. Speaking in the broadest terms, I tend to think of the political struggles of our time as between those who trust individuals to make the decisions that best serve their own interests and those who do not thus preferring to give such power to higher authorities. Safety nets consisting of a minimum guaranteed income to be used as its recipient sees fit vs government designated expenditures targeted at what the government thinks is best represent the two extremes of these attitudes. All societies exist somewhere between these polar cases. Those of us who trust individuals to make decisions for themselves rather than for others, look to government to provide a secure legal framework for individual liberty (the establishment and protection of property and human rights) and to provide frameworks for developing and communicating the information that can help inform individual decisions.
Between the state (municipal, state, federal) and individual families (the fundamental unit of existence), every society has developed intermediate groups/institution to facilitate cooperation and coexistence with other families. We come together in groups of common interest (clubs, churches, cultural centers, etc.) for fun, learning, cooperative undertakings. The rules and quality of these institutions profoundly influence the nature and quality of our societies and thus of our individual lives.
Importantly, in the area of production, the advent and expansion of specialization and trade has enormously increased what individuals could produce and thus our standards of living. This led to new structures of cooperation in which individuals worked together to enhance their productivity (cooperatives, partnerships, companies, corporations). As collaborative production became more and more complex (and productive) and benefited more and more from the use of equipment (machines, factories, i.e. capital), new forms of organizations emerged including a distinction between the owners of capital and the suppliers of labor. These were codified in laws of the state to document the rights of each. Ronald Coase’s foundational work on this subject is well worth rereading: “The Nature of the Firm”
The owners of capital were responsible for its uses and workers were responsible for their labor. The establishment of a limited liability company–a corporation–fundamentally altered the relationship between owners of capital and renters of labor (workers). It was a new institution that weakened the responsibility and role of owners in the operation of firms but greatly broadened access to ownership. The owners of companies often no longer managed them. Ownership shares were held by people with little direct involvement in the firms they owned (e.g. pension funds). They were sometimes traded from one owner to another frequently. This weakening of owner oversight and control increased the quasi-independent control of businesses by corporate managers, creating the so called “managerial class.” The challenge became how to incentivize corporate managers to act in the interest of the owners for whom they worked. “When corporations changed their social role and upended our politics”
Tying the interests of managers to those of a company’s owners is a work in progress. Incentives were created, such as stock options, to reward managers for serving the interests of the owners as reflected in share prices. When poorly structured they incentivized short term gains at the expense of the long-term profit and value of firms. Lessons were learned and are still being learned. But key to the harnessing of the managerial class was acceptance that the goal of a firm (of any economic activity) is to maximize the profits of its owners. Attention focused on how best to do that in the long run.
A profitable firm is one that has created and produces products valued by customers at the least cost. Costs are minimized by using capital and labor efficiently. Labor costs are minimized by providing a work environment that attracts and keeps workers with the relevant skills at the least cost. This often involves firms providing training in the skills needed, etc. Approaches vary between countries and are reflected in different business cultures and institutions.
In Japan, for example, until recently firms offered their employees lifetime employment with wages and promotions based on seniority. Choosing a university and course of study was simultaneously the choice of a career in a particular firm. While providing great security for Japan’s labor force, it did not encourage innovation and entrepreneurship and made corporate adaption to changes in market preferences and conditions difficult.
Germany has taken a different approach in which workers are more formally involved in how labor is reduced during recessions or more permanent declining product demand. As reported by the Wall Street Journal, “rather than resorting to mass layoffs or plant closures, they will often reach for instruments created by government and unions that allow executives, often with considerable state support, to weather economic storms, or reduce their workforces through voluntary methods…. Sparing staff in a short downturn can allow companies to ramp up activity quickly when demand rebounds without having to hire and train new workers. But it can also slow necessary adaptations when companies are faced with structural changes, resulting in some businesses sticking to outdated business models for too long.” “Germany offers a model to corporate America on labor relations”
U.S. labor practices are very different. Jobs are less secure, and promotion is based on performance. More of the burden of corporate adjustments to new products and/or new conditions fall on workers who thus rely more on governmental programs to facilitate the transition to new skills and/or firms. The inadequacy of such programs may have contributed to anti-immigrant and anti-trade sentiments fanned by President Trump. Trade is often unfairly blamed for the loss of manufacturing jobs (the primary cause is increased productivity allowing fewer workers to produce the same output), though a strong majority of American’s still think that trade is a good thing. “Trends in international public opinion”
Until recently discussions of corporate governance focused on how best to maximize share holders’ value. As The Economist magazine recently put it: “In a free market, pursuing shareholder value would in and of itself deliver the best goods and services to the public, optimise employment and create the most wealth—wealth which could then be put to all sorts of good uses.” “Big business is beginning to accept broader social responsibilities” This was recently challenged by the prestigious Business Roundtable, which stated in August that hence forth the objective of American corporations should be “to create value for all our stakeholders.” “Lobbying group powerful CEOs is rethinking how it defines corporations purpose”
“On August 19th the great and good of CEO-land announced a change of heart about what public companies are for. They now believe that firms should indeed serve stakeholders as well as shareholders. They should offer good value to customers; support their workers with training; be inclusive in matters of gender and race; deal fairly and ethically with all their suppliers; support the communities in which they work; and protect the environment.”
Many of these goals are fully compatible with and contribute to maximizing shareholder value. But obviously, there are some potential business behaviors beyond producing desirable products cheaply that can impact society as a whole, such as one form of pollution or another. These externalities are rightly dealt with through taxes and subsidies or legal restrictions. But should companies keep some of the shareholders profits to support or promote other social objectives? Directing the resources of a firm to all stakeholders, the community and general public in essence, sounds like a very decent thing to do. For example, should a company donate to the political campaign of a candidate expected to support policies favorable to the company or to the local YMCA?
“The most quoted assertion of the primacy of shareholder value comes from Milton Friedman, an economist. In 1962 he wrote that ‘there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.’” (The Economist 8/22/2019)
The prevailing model has been for companies to maximize their profits from the production of the products they were established to provide and to leave to their owners the choices of how to use those profits for the betterment of the community. Diverting shareholders’ profits to other worthy causes chosen by firm managers would be a bad idea for several reasons:
- A firm that has succeeded in profitably suppling things the public likes might not have the expertise to make the best choices about using the company’s resources to serve the community in other ways. Put that way it should be obvious that the talents needed for the one are not very likely to be the same ones needed for the other.
- Some corporate donations will almost surely go to support and protect business interests of the donating company thus invariably reducing economic competition. This incentive has very likely contributed to the increased concentration of corporate empires.
- In an excellent oped Phil Gramm and Mike Solon note that: “Seventy-two percent of the value of all domestically held stocks is owned by pension plans, 401(k)s and individual retirement accounts, or held by life insurance companies to fund annuities and death benefits. This wealth accumulated over a lifetime and benefits all Americans…. Eliminating corporations’ duty to serve investors exclusively and forcing them to serve political interests would represent the greatest government taking in American history.” “Warren’s assault on retiree wealth”
The following articles explore these, and other dangers posed by the pollyannaish appeal of serving the interests of stakeholders at the expense of shareholders: “A reexamination of ownership in the age of the public corporation”, “Stakeholder capitalism-business roundtable” In claiming to set out how it should be done, none other than Larry Summers knifes the idea to death: “If business roundtable CEOs are serious about reform here’s what they should do”