By Ken Jacobson, a journalist covering business, economics and technology. He served as an investigator on the Democratic staff of U.S. House of Representatives’ Science and Technology Committee between 2007 and 2011. Cross posted from Alternet
Historically, corporations were understood to be responsible to a complex web of constituencies, including employees, communities, society at large, suppliers, and shareholders. But in the era of deregulation, the interests of shareholders began to trump all the others. How can we get corporations to recognize their responsibilities beyond this narrow focus? It begins in remembering that the philosophy of putting shareholder profits over all else is a matter of ideology which is not grounded in American law or tradition. In fact, it is no more than a dangerous fad.
The Myth of Profit Maximizing
“It is literally – literally – malfeasance for a corporation not to do everything it legally can to maximize its profits. That’s a corporation’s duty to its shareholders.”
Since this sentiment is so familiar, it may come as a surprise that it is factually incorrect: In reality, there is nothing in any U.S. statute, federal or state, that requires corporations to maximize their profits. More surprising still is that, in this instance, the untruth was not uttered as propaganda by a corporate lobbyist but presented as a fact of life by one of the leading lights of the Democratic Party’s progressive wing, Sen. Al Franken. Considering its source, Franken’s statement says less about the nature of a U.S. business corporation’s legal obligations – about which it simply misses the boat – than it does about the point to which laissez-faire ideology has wormed its way into the American mind.
The notion that the law imposes a duty to “maximize shareholder value” – a phrase capturing the notion that profits are mandatory and it is the shareholders who are entitled to them – is so readily accepted these days because it jibes perfectly with assumptions about economic life that constantly come down to us from business and political leaders, from academia, and from the preponderance of the media. It is unlikely to occur to anyone under the age of 40 to question this idea – or the idea that the highest, or even sole, purpose of a corporation is to make a profit – because they have rarely if ever been exposed to an alternative view. Those in middle age or beyond may have trouble remembering a time when the corporation’s focus on shareholders’ interests to the exclusion of all other constituencies –customers, employees, suppliers, creditors, the communities in which it operates, and the nation – did not seem second nature.
This narrow conception of corporate purpose has become predominant only in recent decades, however, and it flies in the face of a longer tradition in modern America that regards the responsibilities of a corporation as extending far beyond its shareholders. Owen D. Young, twice chairman of General Electric (1922-’40, 1942-’45) and 1930 Time magazine Man of the Year, told an audience at Harvard Business School in 1927 that the purpose of a corporation was to provide a good life in both material and cultural terms not only to its owners but also to its employees, and thereby to serve the larger goals of the nation:
“Here in America, we have raised the standard of political equality. Shall we be able to add to that, full equality in economic opportunity? No man is wholly free until he is both politically and economically free. No man with an uneconomic and failing business is free. He is unable to meet his obligations to his family, to society, and to himself. No man with an inadequate wage is free. He is unable to meet his obligations to his family, to society, and to himself. No man is free who can provide only for physical needs. He must also be in a position to take advantage of cultural opportunities. Business, as the process of coordinating men’s capital and effort in all fields of activity, will not have accomplished its full service until it shall have provided the opportunity for all men to be economically free.”
This holistic declaration was echoed, albeit in more specific and practical terms, by the chairman of another massive US corporation, Johnson & Johnson, during World War II. In his 1943 “Credo,” a somewhat modified version of which can be found on the company’s Web site today, Robert Wood Johnson II identified five distinct constituencies and established an order of priority in which they would be served by his firm. Johnson & Johnson’s “first responsibility,” he wrote, was to its customers: “the doctors, nurses, hospitals, mothers, and all others who use our products.” In second place came employees; in third, management; and in fourth, “the communities in which we live.” The interests of the stockholders, the corporation’s “fifth and last responsibility,” appear subordinate in his mind both to the firm’s sound operation, which depends on attention to the interests of the other constituencies, and to its long-term welfare:
“Business must make a sound profit. Reserves must be created, research must be carried on, adventurous programs developed, and mistakes paid for. Adverse times must be provided for, adequate taxes paid, new machines purchased, new plants built, new products launched, and new sales plans developed. We must experiment with new ideas. When these things have been done the stockholder should receive a fair return.”
A Shift in Accountability
By 1978 the era of deregulation had begun and signs had appeared that corporate attitudes were shifting. In that year another GE chief executive, Reginald H. Jones, wrote that the “central principle of the present system is that a director’s accountability is to the owners of the enterprise.” Having set aside the broader visions of corporate duty held by his GE predecessor Young and by Johnson, Jones in effect moved the firm’s responsibility to its shareholders from last on the list to first: “If this principle is abandoned, if other corporate constituencies are placed on a plane with shareowners, if directors are required to represent directly the interests of nonshareowner groups…there will be no clear measure of directors’ responsibility because there will be no clear consensus on primary corporate goals.”
His personal preferences aside, however, Jones realized that Americans were not yet ready to accept firms’ turning their backs on the general good, and that he and his fellow executives had something to gain from being accommodating:
“If the concern is social responsiveness, or ‘public accountability,’ the short answer is that in this country at this time, no large corporate enterprise can afford to be perceived as oblivious or contemptuous of matters of genuine social or public concern. These enterprises have to earn from the general public and their political representatives – and earn from year to year – the right to continue to function without radical new governmental constraints.”
The dawn of Ronald Reagan’s presidency found the corporate community on the fence. The “Statement on Corporate Responsibility” issued in October 1981 by the Business Roundtable, which groups the CEOs of the largest US firms, recognizes six constituencies – customers, employees, communities, society at large, suppliers, and shareholders – as forming the “web of complex, often competing relationships” within which corporations operate. It accepts the idea that “shareholders have a special relationship to the corporation” but doesn’t allow their interests to trump all others:
“Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental problems confronting corporate management. The shareholders must receive a good return but the legitimate concerns of other constituencies also must have appropriate attention. Striking the appropriate balance, some leading managers have come to believe that the primary role of corporations is to help meet society’s legitimate needs for goods and services and to earn a reasonable return for the shareholders in the process. They are aware that this must be done in a socially acceptable manner. They believe that by giving enlightened consideration to balancing the legitimate claims of all its constituents, a corporation will best serve the interest of the shareholders.”
Even after eight years of Reagan and amid the burgeoning of free-market ideology, the Business Roundtable remained reluctant to place shareholders first, affirming in 1990 that “corporations are chartered to serve both their shareholders and society as a whole” and adding creditors to the 1981 list of constituencies, which it otherwise retained intact. It was only in 1997, in a new statement whose title substituted “Corporate Governance” for “Corporate Responsibility,” that it renounced attempts to balance the interests of corporate constituents and, having reversed its view, argued that taking care of shareholders was the best way to take care of the remaining stakeholders, rather than the other way around:
“In the Business Roundtable’s view, the paramount duty of management and of boards of directors is to the corporation’s stockholders; the interests of other stakeholders are relevant as a derivative of the duty to stockholders. The notion that the board must somehow balance the interests of stockholders against the interests of other stakeholders fundamentally misconstrues the role of directors.”
This doctrine, known as “shareholder primacy,” now reigns in the corporate world today, and it has so increased the power of those whom it has benefited that it will not be easy to dislodge. Those who propagate it believe, or would have us believe, that it is based in law; in fact, it is supported by no more than ideology. They believe, or would have us believe, that it reflects incontrovertible and eternal truths; in fact, it is an expression of transient self-interest. They believe, or would have us believe, that it honors long precedent – but, as we have seen, its ascendency is recent, and, rather than honor it undermines precedent. Yet despite these contradictions, corporations and their allies have been exceedingly successful at selling their viewpoint to the American people.
An important step toward countering their influence can come in refusing to accept the legitimacy of shareholder primacy. Up to now, this fad has had the power to neutralize opposition in part because it has obscured the tool needed to challenge it: a clear understanding of the economic realities. For this reason, we must learn what contributions all stakeholders – not just the shareholders, but all the others as well – make to the corporation, and the extent of the risks and rewards those contributions truly entail. We must learn about the interrelation of business and government in all its complexity, going far beyond the headlines about taxes and regulation to discover who needs whom for what, and who does what for whom. And we must learn what rights corporations legitimately hold, what privileges they enjoy, and what duties they are obliged to carry out.
Without this effort, without this knowledge, we are in danger of continuing to be held captive by a fad.
“When these things have been done the stockholder should receive a fair return.” Robert Wood Johnson II
Not really. Profits should NEVER be taken out of a business. Instead, the profit should accrue in the value TIMES quantity of the common stock.
How can the public take control of the business corporation and make it work for the real economy? Ken Jacobson
How did corporations get out of control in the first place? Was it not their ability to avoid “sharing” wealth and control with their workers and the general population via loans from the counterfeiting cartel, the banking system? Why issue more common stock when borrowing counterfeit money – so-called “credit” – allows the existing stockholders to retain control and avoid stock dilution?
It all goes back to the banks – the means by which the so-called “credit-worthy” loot everyone else (Supposedly for the general good. How’s that working out lately?).
The corporations got control in the first place by corrupting State legislatures. William Nelson Cromwell wrote the Delaware corporation law for either Dupont or Rockefeller after New Jersey became inconvenient for the sponsor’s interests. The main post is nothing but a hodge podge of corporate public relations and there can be no worse waste of time than analyzing changes over time in the tripe oozing from the speeches of corporate CEOs or flunky organizations like the Business Roundtable (were you expecting King Arthur?).
Public corporations are run for the benefit of their executives, as any shareholder of the past decade can attest. The business system is based upon plunder and recapitalization of assets through mergers financed by debt and paid for by downsizing and substitution of coolie labor from the Third World. The game reduces to looting and asset stripping and the only winners are bankers, executives and hedge fund managers. So called portfolio managers win only because the clip a percentage of assets, win or lose. If they had to win on their stock picking they would starve.
The corporate game is every bit as nasty and futile as politics and we are supposed to support this fandango on the ground that it creates jobs. OK, where are the jobs? What corporations really create is products that fall apart, pollution, climate change, social disintegration, war, mendacious propaganda, and televised sports. I like baseball as much as the next guy, but perhaps the price is a little too high?
Public corporations are run for the benefit of their executives, as any shareholder of the past decade can attest. jake chase
Maybe so but there is no avoiding that the shareholders OWN the corporations. If 51% of them agree, then what they agree on goes. If that is not so then it should be so, Delaware or no.
Put another way to avoid dilution of stock value corporations need to convince their lenders they can support repayment of loans by commanding an adequate and profitable share of their market. Lending would, therefore, appear to be largely determined by price point but this is at the discretion of the bankers who may make more money out of the corporation through fees for other needs. It is achieving price point, however, that drives predatory behavior, the race to the bottom particularly with labor arbitrage on wage rates and the concomitant effect of outsourcing on developed economies. Clearly all not a self-reinforcing circle of virtue that many are starting to realize needs changing.
The Bible has an interesting (no pun intended) take on profit – profit is good yet profit taking isn’t. Yet interest payments to banks and even dividends are clearly profit taking.
I thought the purpose of a corporation was to limit liability. Why is that necessary?
Perhaps it’s because the accumulation of wealth that corporations engage in has such a high likelihood of being destructive enough to other people and the environment that without the ability to abdicate one’s responsibility for these actions one would be exposed to a level of liability that would result in personal financial ruin.
The stockholders should not be liable, imo, but the officers of the corporation and the Board should be.
Why should the owners of the corporation not bear responsibility for the harm the corporation does for their benefit?
Suppose I buy some Exxon stock today. Should I be personally liable for, say, the Exxon-Valdez disaster which happened years ago?
Forgive me for answering with a question: If Exxon had had to consider whether you would be willing to buy their stock years later, would they not have taken better care (and expense) to prevent that disaster?
That’s besides the point. Unless I owned Exxon stock at the time of the Exxon-Valdez incident there is no way I could be personally liable.
If you cannot be personally liable, you should not personally benefit.
If you bought the stock today, and they are paying the fines over time, today included, then yes, you are responsible for your portion of the costs of that crime. You knew the deal going in, or you should have known with a little bit of responsible research.
You and others seem to be inferring that the shareholder should (or should not) be responsible for the incident itself. I would think that logically abstract entities known as Corporations cannot be put in jail (shot, etc), and so clearly the owner/s of the Corp are off the hook in this regard.
In civil cases however, it seems pretty obvious that the shareholders are clearly on the hook for fines, cleanup costs, etc. that should come out of any profit they may have been expecting.
The individual/s that brought about the situation that allowed and/or ordered/committed the crime are in an entirely different position, Directors included, even though it seems they believe they have the right to hide behind the abstract Corporate Entity.
At least, that is how I believe it should work. Unfortunately it does not… anymore.
I also believe that Marjorie Kelly’s “Divine Right of Capital” should be required reading/reviewing before any discussion on who the true stakeholders of a Corporation are.
Bottom line: Do Corporations exist to serve the people and communities where they reside as well as the shareholders, or do people and communities exist to serve Corporations?
That limited liability is the crux of it.
As theologian Emil Brunner noted:
“Capitalism is irresponsibility organized into a system.”
Offload mistakes, risk and effluent onto consumers, workers and communities. What better way to maximize profit?
Nice quote, thanks!
I too think this is the real issue with corporations, everything else is a straw man. Even this article misses the point – arguing about the corporate duty to shareholders vs. employees is like a vegetarian arguing about eating beef that was grain fed vs. grass fed. The vegetarian shouldn’t be eating meat at all (no dig against vegetarians or meat eaters, just the analogy I came up with).
The legal corporate entity is the codified version of the tragedy of the commons.
It’s true the limited liability company works to limit responsibility and therefore attract money into a business, new or existing, but it also works to attract a bank loan/s.
In 1924, the prestigious British Medical Journal began publishing medical papers on asbestosis, which reported indisputable links between asbestos exposure, cancer, and death. By the early-1930s, medical papers such as these began to appear in the United States, much to the dismay of the big asbestos industry. In an attempt to fight back, asbestos companies began a campaign to suppress the truth about asbestos exposure. Using power plays, closed-door deals, false evidence, bribery and more, the asbestos industry created one of the biggest cover-ups in U.S. history.
Great series of posts.
‘These well known cases of corporate corruption have been associated with lack of transparency, inadequate disclosure of
accounts, withholding of information from shareholders and regulators, collusion between banks, firm management and auditors, and spectacular financial disasters.’ – Michael Dietrich and Abhijit Sharma
private businesses have to apply for corporate charters..this would (seemingly) give power to the state to make demands on corps that are (as evidenced by their anti-society behaviors)only interested in hollowing out the community (i.e. a danger to the community) to produce ‘profits’ for the small group of private parties who own the business that is seeking incorporated status-
I think Ken Jacobson misunderstands the problem.
The board of directors is supposed to represent the shareholders. Instead, they are more likely to collude with the management. Nobody is protecting the shareholders’ interests.
Shareholders are being ripped off by the board of directors approving rockstar compensation for the management, and approving stock buybacks to run up the stock price so management and directors can profit big on their options.
“Maximize shareholder value” actually translates to “maximize share price to profit from stock option value”. If these companies were run for the benefit of stockholders they would either pay dividends or reinvest profits into the company.
Dividends are dumb. The whole point of a common stock company is to consolidate capital not diffuse it.
Typically in the past, particularly the earliest form of Corporation Entities such as the Hudson Bay Company and others, the purpose was to consolidate the capital needed at the front end for the formation of that corporation (they were expensive to get off the ground) in order to distribute profits during the ongoing operations as well as at the end-of-life/dissolution of that corporation. Profit or loss from the sale of the share during that operation was, more or less, a separate piece.
So what am I missing here? Why would I want to contribute to the consolidation of capital if I were never to see a profit come from that contribution? I wouldn’t… obviously.
So what am I missing here? JCC
That profit can accrue in the value of stock regardless and especially if dividends are never paid.
Why would I want to contribute to the consolidation of capital if I were never to see a profit come from that contribution? JCC
But you could – by selling the stock at a higher price than what you bought it at. But if you take dividends then you are reducing the value of your company by bleeding it of resources!
I wouldn’t… obviously. JCC
I used to wonder why people bought common stock if it paid no dividends. Now I understand that common stock itself is a form of private money and a very sophisticated form at that.
Absolutely stunning post. I look forward to learning how the current immorality of corporations (oh please, the corporate mantra of profit maximization is immorality writ large, i.e. greed) could be returned to the halcyon days of customer first.
This misses the real point:
“To a large extent our government has not yet realized that the self-interests of our corporations, especially our large global corporations, can diverge from the interests of our country.”
The interests of our “government” and its “leaders” diverge from those of the citizenry.
The author’s basic thesis is misleading at best: statute law doesn’t say that the purpose of a coproration is to maximize profits at the expense of all else; instead, this is how the courts have interpreted the fiduciary duty (which in US law is itself a creature of judicial precedent, not statute).
See the 1919 Michigan Supreme Court case of Ford v. Dodge.
While each economic crisis tends to drive the preceding one out of our minds, it is worthwhile to review the recent sequence of events and ask where did all this come from? First we had globalization and offshoring destroying productive industries and, with them, productive and well-paying manufacturing jobs. Then it was the financial crisis, with the sudden disappearance of familiar names like Merrill Lynch and Lehman Brothers; next came the plunge in share prices on the stock exchanges followed by the auto company crisis. Now we have a full-blown economic recession with job losses and uncertainty everywhere.
While it is tempting to blame this succession of crises on greedy executives, sub-prime mortgage pushers and others of that ilk, it is in fact much more a system problem than a sudden widespread collapse of human nature. Since 1980 we have gradually developed an economic system that drives corporations to maximize profit at any cost. If corporate leaders conform to this goal, they are rewarded with huge sums. If they don’t, they are likely to be replaced by those who do.
If you are the CEO of a major firm and can increase your profits by offshoring, why not do it? You would be successfully fulfilling what has become the dominant purpose of the corporation: to maximize profit at all costs. Wall Street will cheer, economists will say that what you are doing is inevitable because of “comparative advantage,” and your compensation — tied to stock options and bonuses — will soar to heights that earlier generations of CEOs never dreamed of. If you don’t relocate some of your operations offshore and your competitors do — and increase their own profits in the process — you are unlikely to last.
If you head a major financial services firm and see the high profits that others are making on dubious subprime mortgage-based securities you might well say, as Chuck Prince, the former CEO of Citigroup, did in 2007: “As long as the music is playing, you’ve got to get up and dance.” Commenting on Chuck Prince’s remark, John Gapper wrote in the Financial Times, “His offense was not that he misunderstood or misstated how banks have operated over the past few years but that he blurted out the truth rather too openly.”
Although this pursuit of profit at any price may well have a negative effect on the economy as a whole, the response of the previous administration was to endorse offshoring and maintain unlimited faith in the operation of free markets. In the absence of any accepted view opposing what was and is going on, how can we expect the individual CEOs and boards of directors to act against their own self-interest?
To a large extent our government has not yet realized that the self-interests of our corporations, especially our large global corporations, can diverge from the interests of our country. We need to find ways to fundamentally change the motivations of corporations to align with those of our country.
Is there an alternative to this profit-before-everything approach? Yes there is, and it is a very natural one. Let us take a historical perspective.
read the rest …….
Makes no difference. 270 million firearms in this country of 320 million people. It’s going to blow. As it should.
Then, it will be cleaned up.
Shareholders own a business just like mom & pop own a Mom & Pop store. Owners naturally want their returns on capital invested to be maximized. Why wouldn’t they? It’d be insanity to demand less-than-fair returns for putting your money on the line.
Of course, if maximizing returns on capital produces externalities, those ought to be in some way moderated. Hence dumping toxic waste on school playgrounds to minimize costs is not generally acceptable in the eyes of the law.
The recent move towards Corporate Social Responsibility has been highjacked by demagogues who interpret it as meaning that shareholders, the very owners of the businss, are somehow irrelevant and should be relegated behind the interests of various other parties (of course these demagogues can’t tell us how we should define “stakeholders”, where to draw the borders of the said takeholders, which stakeholders to care for first when conflicts of interest arise, etc.).
But shareholders will never be irrelevant and corporations will always seek to maximize shareholder value, as they should. I am sure mom & pop wouldn’t be too happy if a bunch of the store’s employees comandeered the store’s vaults and started distributing income and assets to themselves.
Asking corporations not to put shareholder interest firsts is like allowing various arbitrarily selected “stakeholders” to raid mom & pop’s vaults without their permission.
Corporate Social Responsibility programs are a means to maximize shareholder value. By internalizing any externalities privately, corporation can create value by putting themselves in good stead with consumers, preempting government actions, etc. By building stronger societies and communities they can help develop bigger markets for their products.
Ultimately, the goal is to benefit the owners of the business, who put their capital at risk and bear the most volatility.
This, of course, is ignorant.
One fundamental difference between a large-scale corporation and a Mom-and-Pop business is that the folks who manage most large corporations own little or none of the company.
By contrast, if Mom’s Diner is incorporated as an LLC, Mom probably both owns the diner and is responsible for managing it.
Mom also probably does not have a diversified portfolio, so if the diner flames out, she may be on the street. (Unlike the management or shareholders of Faceless International Inc., Mom probably has to give a personal guarantee or second mortgage for the diner to get bank credit.)
To the Auther, Ken Jacobson. Enough already.we know you get it but can you explain it in such a way that someone withh barely an eighth grade education will read and understand it? Because if you can’t you are just preaching to the choir .
With so many unemployed lawyers and law students you’d think that maybe you or Alt Net or the author of this article could have taken the time to actually look up corporate law in its present state in America.
There is no statute, its true. But there is 100 years of case law that are explicitly clear. The duty of boards of directors is to maximize wealth of the shareholders. And as long as they dont violate their duty of care and loyalty to their shareholders they can be assumed to know what they are doing. And no matter how badly this lazy hack wants the pronouncements of two corporate CEO’s 70 years ago to be law, it aint so.
–Actually it would have been pretty easy to find out the history of corporate law in America, with google legal scholar free and good enough he could have found the question “Do corporations really have a duty to only maximize wealth of their shareholders? When did they acquire this duty?”
And his age-ism is backwards. Shareholders have been more active in lawsuits and some court decisions have been more favorable towards them in the last 20 years than in the previous 60 years. But I guess if you are going to write some bullshit it doesnt pay to research facts, they’d get in the way.
Morality in the English language has three positions. Moral- one knows what it is and does it; immoral – one knows what it is and doesn’t do it; amoral – one never considers morality in the first place.
Morality is comprised of human and social values; none of which can be expressed in terms of dollars.
There can be no better operant definition of amoral than one for whom dollars are the only value considered.
Corporate boards of directors and senior officers only consider dollars before decision and action and therefore are incapable of moral decision or action. Being incapable of moral consideration they are by nature amoral.
Once the amoral environment of the corporation is accepted widely it is copied by all other business types and styles until suddenly you are in 2012 and all business forms have become generally amoral under the notion that greed (measured in dollars) is good. The “greed is good” dogma which was born of corporations has ‘freed’ business of the final vestiges of community, employee, or national morality; and has allowed top Wall Street operators to steal by mis-representation and amorality from society to fill their pockets with extravagant bonuses.
A real democratic government on the other hand is elected by the majority of ordinary voters to represent their human and social values (morality) and therefore democratic government has the capability to be moral. Democratic national government also has the ability to force amoral corporations to be moral because corporations are nationally chartered.
Therefore amoral corporate interests, which would rather cut off their right arms than be moral, (being amoral is soooo much more profitable to their bank accounts) hate democratic national government and they attempt in every way including corrupting politicians and government employees to hurt, reduce, and if possible reduce to insignificance democratic national government and therefore government’s ability to force them to be moral.
It needs to be pointed out that only a democracy which represents the human and social values of its citizens operates in this way.
The USA is a republic with a lot of elections, not a democracy. Unless Plato was an idiot it is impossible to have a democratic republic. Plato created the republic form of government because the Greek democrats had forced Socrates to suicide by hemlock as a result of Socrates refusal to recant his public statement that “Not all positions in government should be elected, some should be appointed because they require special skills which cannot necessarily be acquired in a general election.”
Plato designed the ‘republic’ to be run by elites; in the modern incarnation ‘wealthy elites’.
It is impossible to have a government run by wealthy elites and the majority of average voters at the same time; therefore one can have either a democracy or a republic.
A democratic republic is an oxymoron, a contradiction in terms, an impossibility.
Democracy constrained and warped by ‘checks and balances’ is democracy stalemated and therefore denied. If one has a true democracy where all votes are counted etc., by what logic does this need to be “checked” or “balanced”??
The USA was by design never a democracy. The USA is a true republic and is run and controlled by wealthy elites NOT the majority of voters. For many elections the USA has not even bothered to count all the votes and has had vote counting stopped by politically affiliated judges which gave the election to the political party of the politically appointed and openly political judiciary.