Tuesday, November 29, 2011

The Corporation

In my many and varied writings there is one issue that is central, and that I very seldom discuss directly. That issue is an understanding of the Corporation as an economic and political institution. My understanding of the Corporation informs my overall "socialist" bent - wherein I read the "socialisation of the means of production etc" to not mean social ownership but directed to social not private goals. (see note)

As such I was pleased to see a short item by Lynn Stout in today's SMH. The piece says that it is time to recognise shareholder value as an ideology, not as a legal requirement. She notes that focussing on shareholder value often translates into share price and how focussing on share price may not really be in the interests of "shareholders" once they as a class are properly understood.

All this will be anathema to a modern business executive, especially one who is trained by a leading business school or one who reports to a Board of Directors that responds more to the commentary of analysts than the advice of managers.

Stout's academic writing however addresses much of the history.

In her paper Why we should stop teaching Dodge vs Ford she outlines the US case in which the statement about the purposes of the firm came to prominence. It said;

There should be no confusion ….A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of the directors is to be exercised in the choice of means to attain that end, and does not extend to … other purposes.

She outlines three reasons why this statement should not be relied on. First it is an old case, second it was not a particularly expert court that ruled that way, and thirdly the statement in fact played no part in the actual judgement. It was what the lay would call commentary. Dodge vs Ford was not really a case of directors responsibility to shareholders, but about majority shareholders suppressing minority rights.

Stout goes on with some other reasons why it is not good law, but from my point of view the issue is that it is simply not good reasoning.

The history of corporations certainly provides plenty of evidence that the policy intent of enabling incorporation is anything but maximising profit. From the observation of Adam Smith that;

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.

Governments did not permit individuals to work together in creating "firms."

However, certain activities were identified as entailing too much risk or too high a capital sum, or both, to be conducted other than through the combined capital of many people. So the trading companies were chartered, as were corporations to undertake municipal works. In this early era where a corporation had to be explicitly chartered the first requirement was to demonstrate a purpose that could not be fulfilled other than through a corporation.

And today no corporation is formed by someone going to investors saying "invest in this corporation so I can maximise shareholder value." They go to the market saying "I have identified this opportunity because there is a need we can fulfill, in doing so I need your money and I will provide this return to you."

By both history and formation a business organisation is carried on primarily for the purpose outlined in its "prospectus".

John Kay in his book Obliquity has emphasised that the best way to some goals is to not work on them directly. To make money for shareholders focus on meeting customer needs, not on making money. In meeting customer needs focus on doing it efficiently, not on making money.

In her Bad or Not-So-Bad Arguments for Shareholder Primacy Stout relays how long running the debate about shareholder value has been. In doing so she notes the protagonist for the view that firms exist to make money for shareholders was one of Berle & Means who had concluded in The Modern Corporation and Private Property that this was not how executives actually acted. Thus was born agency theory in corporate governance and the trend that has seen ever greater efforts to "align the interests of the executive with shareholders" which has seen its practical consequence of ever bigger remuneration to executives - remuneration that is at best only notionally related to shareholder return.

Stout in her writing generally raises the concern that belief in "shareholder value" extends to "shareholder primacy" and then the conclusions from that, like shareholder rights to call EGMs to vote for the remuneration report etc. Stout is generally concerned that these are policy proposals based on misconceived views of the firm.

Surprisingly, I find myself in agreement. (Note Stout also does some great work separately analysing the Efficient Capital Market Hypothesis and why in the premise of heterogeneous investment preferences you will get under-pricing of assets.)

Much else follows once you dismiss the inaccurate representation of the purpose of the firm. Another consequence is an increase in the transparency of the true purpose of the firm - that is active engagement with investors on an ongoing basis on strategy.

Finally, those on the socialist side need to reject the language adopted by Friedman (see the reference by Stout in the Ford & Dodge) piece. Firms are collusive acts of capital, a collusion authorised by the state because of the value that can be obtained by society. That authorisation entails obligations. That collusion creates the right and need for other economic agents to also be allowed to "collude" in their dealings.

Note: It is sometimes unfashionable to refer to "society." I make no apologies.

The film The Iron Lady about Maggie Thatcher will soon be released. She, with Ronald Reagan, epitomises the rise of the "cult of the individual" ... a cult among whose thought leaders was Ayn Rand. Thatcher expressed the view that there is no such thing as society. (full quote below)

Her views really went further and entailed the mutual obligation element, but overall suppresses the reality that humans are social animals. We are "designed" to live in groups, we act co-operatively by nature and we value fairness.

I think we have gone through a period when too many children and people have been given to understand "I have a problem, it is the Government's job to cope with it!" or "I have a problem, I will go and get a grant to cope with it!" "I am homeless, the Government must house me!" and so they are casting their problems on society and who is society? There is no such thing! There are individual men and women and there are families and no government can do anything except through people and people look to themselves first. It is our duty to look after ourselves and then also to help look after our neighbour and life is a reciprocal business and people have got the entitlements too much in mind without the obligations.

Novae Meridianae Demetae Dexter delenda est

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