One of my pet peeves is the degree to which the notion that corporations exist only to serve the interests of shareholders is accepted as dogma and recited uncritically by the business press. I’m old enough to remember when that was idea would have been considered extreme and reckless. Corporations are a legal structure and are subject to a number of government and contractual obligations and financial claims. Equity holders are the lowest level of financial claim. It’s one thing to make sure they are not cheated, misled, or abused, but quite another to take the position that the last should be first.
If you review any of the numerous guides prepared for directors of corporations prepared by law firms and other experts, you won’t find a stipulation for them to maximize shareholder value on the list of things they are supposed to do. It’s not a legal requirement. And there is a good reason for that.
Directors and officers, broadly speaking, have a duty of care and duty of loyalty to the corporation. From that flow more specific obligations under Federal and state law. But notice: those responsibilities are to the corporation, not to shareholders in particular…Shareholders are at the very back of the line. They get their piece only after everyone else is satisfied. If you read between the lines of the duties of directors and officers, the implicit “don’t go bankrupt” duty clearly trumps concerns about shareholders…
So how did this “the last shall come first” thinking become established? You can blame it all on economists, specifically Harvard Business School’s Michael Jensen. In other words, this idea did not come out of legal analysis, changes in regulation, or court decisions. It was simply an academic theory that went mainstream. And to add insult to injury, the version of the Jensen formula that became popular was its worst possible embodiment.
One good source for the fact that economists, rather than legal decisions, were the basis for the acceptance of this idea, is a 2005 article by Frank Dobbin and Dirk Zorn, “Corporate Malfeasance and the Myth of Shareholder Value.” This paper looked back to the 1970s, the era of diversified and often underperforming firms (remember the conglomerate discount?). Deregulation, high inflation, and a lax attitude towards anti-trust enforcment stoked a hostile takeover boom. Economists celebrated this development as disciplining chief executives and moving assets into the hands of managers who could operate them more productively. In reality, the success of these early deals depended mainly on asset sales, both of non-core operations and of hidden sources of value, like corporate real estate, as well as leverage and slashing bloated head office staffs (the across-the-company headcount efforts became more prominent in the 1990s).
But I’m now reading an advance copy of terrific book, Private Equity at Work by Elaine Appelbaum and Rosemary Batt, which adds important detail to the Dobbin and Zorn’s account. It’s done a remarkably impressive job of marshaling data about the private equity industry and explaining how it operates, which means debunking its claims about how it adds value. And even its asides are rigorous. For instance, its four page treatment on the origins of the “maximize shareholder value” line of thought showed real mastery of the source material.
Appelbaum and Batt trace the origins of the managerial model of capitalist enterprise to the New Deal securities laws. They helped institutionalize dispersed shareholding, and with it, a separation of ownership and management. From the 1930s onward, there was an active debate between two schools of thought. Adolf Berle and Gardiner Means were concerned that this new approach neglected shareholder interests. By contrast, Harvard law professor Merrick Dodd contended that large-scale corporations had broader social aims, including providing employment and useful goods. By the early 1950s, the Dodd view had clearly prevailed.
Although the writers of that era would never have used this framing, large corporations created reasonably efficient internal markets. Both employers and their workers benefitted from investing in a workforce that was also their main source for supervisors and managers of all levels. Indeed, middle and senior level executives hired in from the outside often found it hard to adapt to these well-established, tightly knit corporate cultures (note that well-established does not necessarily mean “well functioning”). The tendency of companies to promote from within versus the generally lower odds of succeeding in another company meant that most employees’ best prospects were within their current company, which gave them strong incentives to make it successful.
This was also the era when unions had clout. That assured that productivity gains were shared among workers, management, and investors. The fact that labor participated in these improvements helped propel a robust consumer economy, fueling more business growth. These enterprises typically took a long-term view, and used retained earnings to fund investments and research.
This model prevailed until the 1970s. Even though corporate profits as a percent of GDP grew in the 1970s even under stagflation (after the oil shock recession of 1974-5 had passed), return on capital had plunged from 12% in 1965 to 6% in 1979. Appelbaum and Batt describe the rise of the diversified corporation as one of the biggest culprits. They’d become popular in the 1960s as a borderline stock market scam. Companies like Teledyne and ITT, that looked like high-fliers and commanded lofty PE multiples, would buy sleepy unrelated businesses with their highly-valued stock. Bizarrely, the stock market would valve the earnings of the companies they acquired at the same elevated PE multiples. You can see how easy it would be to build an empire that way.
But these sprawling conglomerates had lots of managerial downside. Top brass often didn’t understand the operations of these new businesses. They became more dependent on finance staff to impose metrics across businesses to have a handle on what was going on. The formerly virtuous internal labor markets became balkanized and less salutary. And at a higher level, the various businesses were more likely to operate like fiefdoms competing for corporate resources. Finally, because the top executives treated these units as portfolio holdings that could be sold at any time, they were less certain of the necessity and value of investing in them.
So who was the first to insist that the old managerial model needed to be turned upside down and shareholders interests should be paramount? It turns out it was Milton Friedman, in a widely-cited 1970 New York Times op-ed. And Friedman being Friedman, he advocated an extreme form of his thesis. A key excerpt:
The businessmen believe that they are defending free enterprise when they declaim that business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact they are–or would be if they or anyone else took them seriously–preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.
The discussions of the “social responsibilities of business” are notable for their analytical looseness and lack of rigor. What does it mean to say that “business” has responsibilities? Only people can have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but “business” as a whole cannot be said to have responsibilities, even in this vague sense. The first step toward clarity in examining the doctrine of the social responsibility of business is to ask precisely what it implies for whom….
In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom
You can see how incoherent this is. Shareholder are not bosses of corporate executives. They are diffuse and large in number, and if you got them all in a room to tell the corporate executive what to do, you’d be more likely to see fisticuffs than agreement.
Moreover, Friedman simply dismisses the corporate form, when that is precisely what is operative here. You can’t treat shareholders as being remotely the same as owners in a private, closely held business. A share in a public company is a very weak and ambiguous legal claim. You get dividends when the company has enough profits and is in the mood to pay them, and you have a vote on some limited matters, but the company has the right and ability to dilute that too. So Friedman has to utterly misrepresent the fundamental nature of ownership in public corporations to wage his war against big busseses serving broader social aims along with Mammon.
Steve Denning, who called this Friedman article “The Origin of the World’d Dumbest Idea” was even more vituperative:
It’s curious that a paper which accuses others of “analytical looseness and lack of rigor” assumes its conclusion before it begins. “In a free-enterprise, private-property system,” the article states flatly at the outset as an obvious truth requiring no justification or proof, “a corporate executive is an employee of the owners of the business,” namely the shareholders….[I]n the magical world conjured up in this article, an organization is a mere “legal fiction”, which the article simply ignores in order to prove the pre-determined conclusion…. The article thus picks and chooses which parts of legal reality are mere “legal fictions” to be ignored and which parts are “rock-solid foundations” for public policy. The choice depends on the predetermined conclusion that is sought to be proved…
How did the corporation’s money somehow become the shareholder’s money? Simple. That is the article’s starting assumption. By assuming away the existence of the corporation as a mere “legal fiction”, hey presto! the corporation’s money magically becomes the stockholders’ money.
But the conceptual sleight of hand doesn’t stop there. The article goes on: “Insofar as his actions raise the price to customers, he is spending the customers’ money.” One moment ago, the organization’s money was the stockholder’s money. But suddenly in this phantasmagorical world, the organization’s money has become the customer’s money. With another wave of Professor Friedman’s conceptual wand, the customers have acquired a notional “right” to a product at a certain price and any money over and above that price has magically become “theirs”.
But even then the intellectual fantasy isn’t finished. The article continued: “Insofar as [the executives’] actions lower the wages of some employees, he is spending their money.” Now suddenly, the organization’s money has become, not the stockholder’s money or the customers’ money, but the employees’ money.
Is the money the stockholders’, the customers’ or the employees’? Apparently, it can be any of those possibilities, depending on which argument the article is trying to make. In Professor Friedman’s wondrous world, the money is anyone’s except that of the real legal owner of the money: the organization.
But dissatisfaction with large companies was high and only continued to rise as they floundered in a more globalized, less stable world. Friedman’s simplistic, barmy idea found fertile ground. And it became self-reinforcing as executives learned to use it to line their wallets. The long-lived, difficult to displace but not lavishly paid corporate chieftan was over time supplanted by wildly overpaid straight-from-central-casting CEOs. Why worry overmuch about longevity if you can rake it in a 3 to 5 year tenure? And even really disastrous CEOs like Robert Nardelli and Mike Zafirovski find a happy home at private equity firms.
So again, repeat after me: “maximizing shareholder value” is an idea made up and promoted by economists, starting with Milton Friedman and his Chicago School cronies. And like many ideas that came out of the Chicago School, the public as large has suffered from treating a soundbite like a serious policy proposal.
Friedman’s thesis is another reminder of why economists exist….to make weather forecasters look more believable. That bit about “conforming to the basic rules of society” almost made me fall out of my chair. If the corporate structure has proven anything in recent years, it’s the fact that there apparently are no “rules” or laws too sacred to be trashed in the name of profit.
I would think William Black would have a good laugh at a re-read of that Times op-ed. What a magical (imaginary) world it must have been in 1970 with all of those benevolent corporations laying the groundwork for what would later become some of the most elaborate control frauds the world has ever seen.
I remember it well. My father in law was a VP at Swift which then took on new executives from the big business schools and within about 5 years Swift was no more. Folded. The crazy thing was that patriotism got confused with this detour of the economy, a hijacking by any definition, and even my father in law couldn’t bring himself to contest the course of the next 20 years because he believed in capitalism.
But you agree with Friedman that corporations’ purpose is to serve their owners? The 50’s myth is nothing but. Back then, the world was in shambles. It was a golden period because with Mao and the Soviets, those areas were toast, and Germany and Japan were ruined. The UK was badly damaged. So, only the US could meet US and global demand. The result was that business was great, and US corporations needed workers. Now, with global competition, the game has changed. No longer can you graduate from HS and get a job at GM and make $100k within a few years.
Maximizing shareholder value has taken root in the most insidious ways. Corporate heads have been beating the term into their employees ad nauseam. Rank and file employees don’t criticize this mindset and take it as gospel. What the execs fail to tell their employees is maximizing shareholder value is a backdoor (frontdoor?!) way to boost bonuses for the directors and CEOs and has nothing to do with improving a shareholders bottom-line.
This has created a corporate culture for people up and down the chain to do whatever is necessary to get the sales numbers. Sometimes this means cutting corners. Once good people now turn a blind eye to company malfeasance. Bad behavior becomes accepted practice.
Greed, crappy products and service, and shortsightedness are the outcomes of maximizing shareholder value. Also, of course, ensuring the CEO has a golden parachute.
Indeed. Thanks to stock option compensation of the C-suite company officers the focus on shareholder value is in reality limited to a tiny subset of shareholders. The focus on shareholder value is better understood as the focus on *shareholder* value.
This is a really good post, Yves, and it’s critically important for all of us to understand this drift in U.S. capitalism. I think that Friedman’s ideas were important because they offered an uncomplicated and clear sense of mission to corporations and their executives. The old idea of corporations and being chartered for both the public good and profit (in that order) is now ancient history and probably cannot be revived. Why? Because the simple need to turn a profit provides meaning to all employees–it makes decisions heartbreakingly simple–I will sign this order today because TINA–we must make a profit this quarter or I’m out. I can go home at night and sleep knowing, as CEO, that I had to do what I did to maximize shareholder value–my hands were tied–never mind that people died–if I didn’t do it those guys who want my job would do it. The point here is that the system works for those in it and there is, at the moment, no vital alternative.
The issues you bring up here is precisely the reason capitalism cannot reform–it is stuck in this position. People have adjusted to this system and, on the whole, are ok with this model. There is very little dissatisfaction, except among leftist intellectuals, with the capitalist system because, as a practical matter, no one seems to be offering any alternatives. Of course, this system is not sustainable and will evolve into full-fledged neo-feudalism unless alternative visions are articulated and the mainstream media (forget the politicians) can be persuaded, through agitation to examine alternatives.
Good Points Banger, I agree the if you don’t hew to the party line (of Mammon capitalism) as CEO you’re out. You are right that US “free-market profit-maximizing shareholder-value” capitalism has become a culture, even a monoculture – somewhat like finance kudzu swallowing up any other way of looking at organizing the “means of production” as Marx put it. And Friedman admirably waves the red-herring of “Socialism” in that article excerpt from Yves as well. But… it is a culture, the arguments Friedman used have been repeated endlessly by a set of people who have a shared interest – a class if you will. Those “arguments” are actually rhetorical devices, logical fallacies and lies perpetuated for the control of the hearts and minds of the laboring 99%. That class has CREATED the current monoculture since 1970 and it can (and probably will be) recreated differently, probably by collapse and the need to rethink everything in a world with neither oil nor arctic ice.
This is one I don’t have an answer for. We say that corporate CEO’s are now rogue, naming their own boards and setting their own compensation. Then we turn around and say that if they don’t maximize profit every second of the day, they’re out on their ass.
I’m not criticizing anyone, because I can’t resolve the contradiction either. Are CEOs hyper-powerful rulers of their domains, or slaves of the system that will jettison them at a moment’s notice if they don’t tow the line and maximize shareholder value? Because if they are that powerful, we could get some of them to see the counterproductive aspects of their actions and maybe get them to change course. If they aren’t, and it’s all system and the individual doesn’t count, then things are hopeless until the system collapses.
If CEOs don’t please the capital markets, they’re out. If they do, then they are allowed to behave in any fashion they like. Making Wall Street happy today virtually required officers who engage in unsafe or outright fraudulent behavior, creating a Gresham’s dynamic whereby honest people cannot compete and are either driven out or succumb to the pressures.
We tend to want a specific agent to blame for these ills, but the feedbacks, opportunity costs, false signaling and overall breakdown in the concept of public integrity create a dynamic where different agents feed off of and pressure each other to act in perverse ways. If we made a flow chart of these abuses we wouldn’t see straight arrows going from Wall Street to CEO to lawmaker to regulator, we’d see multiple arrows looping back up to every level and that the system as a whole has become one big Gresham’s dynamic.
This is why taxation or focusing on some monetary reform is not going to cut it today. Public governance at all levels is dysfunctional and cannot be repaired without a comprehensive plan of attack to reverse the dynamic and chase out the undesired bad behavior. That plan needs to start at the corporate and regulatory level from where it can then propagate into the greater system.
Thank you–most illuminating.
Friedman also twisted the red herring. Sounds naughty. My impression of “consumerism” was that it originated in Europe as a way to salvage a certain level of socialism whereby corporations do retain an obligation to society. But Friedman, as Denning so amusingly puts it (whose money is it?) tried to make consumers the foot soldiers of capitalism. It’s just that soon their jobs would be gone and consumption would fail. Friedman was so self satisfied he didn’t bother to think thru it. The Europeans held off eating their seed corn until more recently. So how does PE continue to survive in a world that will soon be unable to subsidize all those private interests? Ha.
Friedman uses a red herring with socialism, and you quote Marx? When do the socialists admit defeat? Look at the great socialist experiments and how they ended up. Friedman believed socialism was nothing but coercion. While you may not like corporations and/or their executives, the system is far superior to coercion. Some of us believe that hanging on to more of the money that we make is our right. Any social program, any, some of them good mind you, relies on the opposite view. Ellison, the congressman from Minnesota recently showed his cards. In looking for funding for something, healthcare, global warming, whatever, he stated: “We have to get it done. We just need the money. We know it’s out there, we just have to get it.” That sums up socialism. Maggie Thatcher nailed it, “the problem with socialism is that sooner or later you run out of other people’s money.” Ellison’s trying to get past that fact.
Here’s one alternative vision down in your neck of the woods (relatively speaking):
Jackson on the Rise! ~GEO
Here’s a pic of the New Economies Conf. that happened this weekend. #JXNRising on twitter for more.
Thank you for this one, in particular, among your consistently excellent body of work. It is wonderful, as far as it goes. If the shareholders are not the “owners” we’re looking for are we left with just the Executives? Or are the Banksters, in various forms and ways, also part of the problem? Who are the puppet-masters behind these artificial corporate people? And if governments are not to hold them accountable (a la the TPP), who is?
What is your take on Drucker’s view of the corporation as a democratic institution, then? I don’t think this ideology started with Friedman entirely. In the context of its time, Friedman was challenging self serving corporate bureaucracies, generally described as bloated. Perversely, maximizing shareholder value has become a rational for excessive management compensation.
The view that companies were “self serving bureaucracies” didn’t really get traction until later in the 1970s, when the business and product press increasingly took note of how ineffective many American companies were in responding to Japanese and German competitors.
Drucker in fact celebrated American-style managerial capitalism. He thought the development of a specialized cadre of management experts (and I don’t mean MBAs, Drucker was more into expertise than formal credentials) was critical to the success of large corporations, as in the former developed to meet the demands of the latter.
I read some of Drucker’s key work decades ago and don’t have his texts on my bookshelf, so I’m loath to opine more specifially based on old and potentially faulty memory. But Demming argues that Drucker’s views are diametrically opposed to Friedman’s:
Not everyone agreed with the shareholder value theory, even in the early years. In 1973, Peter Drucker made a sustained argument against shareholder value in his classic book, Management. In his view, “There is only one valid definition of business purpose: to create a customer. . . . It is the customer who determines what a business is. It is the customer alone whose willingness to pay for a good or for a service converts economic resources into wealth, things into goods. . . . The customer is the foundation of a business and keeps it in existence.”
Interesting quote from Drucker about customers. I often respond to the claim that corporations and the rich are “job creators” by saying that the real job creators are customers.
Well, it’s certainly congruent with Adam Smith, who thought that the point of economic activity was to get the most quality goods to the largest number of people at the lowest cost. But if you point out to modern Republican/Conservative types that Smith’s work wasn’t about profits, but products and promoting the general welfare, they look at you like you are insane. Of course, almost none of the people who revere Smith have ever read him. Starting with Reagan, his name became an incantation, not an argument or body of thought.
I’d say Drucker’s right, but so is Friedman. Obtaining and keeping customers is key. But that’s serving owners/shareholders. Growing a business, or more specifically, net worth per share aka equity is the key. I think Buffett’s companies employ 300,000 people and he has $220 billion in equity, up from $10 billion when he bought his Coke stake in ’87/88. And he owns GEICO. Ya think he’s trying to woo customers for that business? They are complimentary, not mutually exclusive. He employs all those people, profitably, and serves his customers well enough to have those businesses grow. But his real mission is maximizing value in his businesses. Make no mistake about that. Shareholders and employees benefit from his acumen in doing so.
I think that M E Porter has had some direct influences in the 80´s on how to enhance the meaning of the word “VALUE” for corporations. This later became a synonym for all kinds of values which in the 90´s grew on to express consumer-value, employee-value and lately the shareholder-value which has been heavily exploited in the financial media after pensionsfunds and other stockfunds (as majority-owners) gave corporate-managements room to “maximize shareprices” in the short run. I am speaking about “hi-jacking” the firm.
Friedman was just another Hired Gun for all the CentaMillionaire$ and Billionaire$ who refuse to be regulated and pay taxes! Ultra High Net Worth Individuals always have been the driving force behind the brainwashing of any society! We are FUBAR and few know it! The 99% are puppets on a string, uneducated and ignorant, incapable of seeing or ever knowing that TRUTH!
Although this is interesting, and it is probable that Milton Friedman is the origin of the concept of maximizing shareholder value, I think it ignores the real reason for all the focus on shareholder value. In my opinion, it is simply the magician’s trick of distraction, a real-world translation of “maximizing shareholder value” is “maximizing the extraction of corporate profits to the executives of the corporation.” It is perhaps one of the largest scams in the stock market, corporations are taken public not to benefit shareholders, but to use shareholders as pawns and marks, to give them all the downside risks while allowing the executives to skim profits, to commit fraud, to cheat, to manipulate, and to feed their own psychopathic greed. When corporations are fined for “their” bad actions, it is the shareholders who pay, while the executives continue with their bad actions unimpeded. It’s really too bad that the idea of “maximizing shareholder value” has been adapted to public life in the number of things that supposedly are good for “the people” but are in reality good for one corporate executive or another. Privatization, fighting terrorism, education (it’s for the kids), Affordable Care Act, energy independence through fracking, carbon credits… all this is done to benefit the average citizen, right? Right. Like benefiting shareholders.
Why do i get the feeling that Friedman would be considered a troll had he tried to bring this kind of reasoning to the internet?
The guy seems to have been the a “useful idiot” for fascism, dressing it in palatable words from an academic.
I don’t think the kinds of rational arguments and analysis most of us would consider powerful and persuasive works in a mentally closed shop like neoclassical economics. Everything proceeds from first principles and those principles, as Krugman and others truly believe, are ipso facto correct and beyond reconsideration. They have been PROVED via mathematical formalisms and are true with a capital “T”. Friedman can’t be effectively refuted because his notions are perfectly congruent with reigning orthodoxy and established models. And, most importantly, they hide their normative aspects behind jargon, math, and appeals to efficiency and “natural law”. Pointing out to a neoclassical economist that their theories don’t jibe with reality is like telling a Catholic that there is no evidence that the bread and wine turn into the body and blood of Christ or an Orthodox Jew that there is nothing bad about pork or shellfish. Faith cannot be in error; reality must be faulty. And I got a Ph.D. from MIT so who the fuck are you to doubt what I tell you!!! The appeals to doctrine and hierarchy are so powerful in Economics that you’d have to blow the entire profession apart to make any progress in changing it at this time. And if the Great Depression and the command economy of WWII didn’t discredit neoclassical orthodoxy, what could?
“an Orthodox Jew that there is nothing bad about pork or shellfish.”
This one i think hinges on observations that has since been lost in the mists of time.
At least with pork there is a illness that don’t really affect pigs, but can be very bad for humans. Easy to detect with modern science, but back then it was likely a case of observing a group getting ill after eating pork and so declaring it taboo.
Wow… as the first three comments suggest, this topic/post digs up the foundation/roots of Bill Black’s “control fraud epidemic”. This sounds like a must-read book! Please Yves… when/where will the book be available? Here’s what I was thinking while/after reading this post…
Where I work, the old man sold his engineering consulting company to private equity #1 which quickly flipped it to PE #2 within five years for 60% higher price. The original engineering operations management is still there and rumor-is they’re very dissatisfied with PE management. Two years into PE #2 I was standing with the two top engineering managers (president and VP) at the front door where a huge glass award sits atop the reception desk congratulating the company for receiving the bank debt used for the PE #2 acquisition. I asked the president “why are you displaying this ‘award’ so prominently when it represents nothing but a huge burden to the company… literally a rope around it’s neck?”. I was very surprised to discover that the award was gone the next time I walked by the front door. Here’s my point… this sounds like the book I’ve been looking for to distributed to management and associates at work. There are many indications that my coworkers are finally becoming suspicious that the game is not going to work in their favor… and they might just finally be willing to listen/read an explanation of how the game is rigged against them.
Is this the book? I hope so!
I’m only about 50 pages into it, and I can already tell it’s great. But bizarrely, the publication date looks to have been pushed back. Amazon says it’s May 1 but shows you can’t get a copy for 2-4 weeks. Barnes & Nobel says the pub date is May 28, and it and Powells allow you to pre-order.
A bit older book that is also very good that has a lot of detail on how PE damages companies and industries is Josh Kosman’s The Buyout of America:
Equity holders are the lowest level of financial claim. Yves Smith
Equity owners are the OWNERS of the corporation. How difficult a concept is that? Just as a single person may own a company, several can jointly own a company with voting power proportional to the number of shares owned, hence the little used “joint-stock company.”
You make it sound like a corporation is some sort of free-floating entity when in principle it is just a jointly owned company. Limited liability could apply to a company owned by a single individual so that is not necessarily a defining concept of a corporation.
Correct me if I’m wrong but you seem to miss a vastly simplifying notion of what a corporation is.
No, tell me what rights you as an individual shareholder have versus the rights of an “owner”.
Can you hire or fire any of the managers? Do you control the product pricing? Do you have any say in important matters of strategy? Do you have access to confidential information, like internal profit and loss statements for each product or office? Do you have any say over litigation strategy, or whether the company obeys regulations fastidiously or cheats at the margin or cheats a lot?
You really don’t get it, do you? The rights of a shareholder in a public company do NOT correspond very much to the rights of a sole owner of a private company. All that “ownership” of public means is you are free to sell the shares, collect dividends when and if paid, vote on annual and special proxies, and have access to information filed with the SEC. That’s it. It does not mean that you have any meaningful say over what management does.
You are a victim of Friedman’s propaganda.
And your main contention, that corporations should not maximize share-holder value (if 51% so vote), is really based on the injustice that the workers and population are not roughly equal owners, correct?
And why is that? ans: Because the government-backed credit cartel allows companies to avoid issuing new shares and instead legally steal the purchasing power of the workers and general population.
It all goes to government-backing for the banks – the cookie that Progressives can’t let go of. Google cognitive dissonance.
Yes, because among other things, it’s counterproductive. A focus on “maximizing shareholder value” has produced rampant short-termism and disinvestment:
And I’ve quoted this repeatedly, but I gather you missed it. This is from John Kay in the Financial Times in 2004. Because the FT maintains archives for only 5 years, my bad habit in my early days of blogging means I now have material on my site you can’t find otherwise on the web (although Kay also wrote a book called Obliquity that expands on this thesis):
Experience has shown that too much effort devoted to fire extinction is counterproductive. Time demonstrates, but only slowly, whether policy has gone too far in one direction, or the other. Forest management illustrates obliquity: the preservation of the forest is not best pursued directly, but managed through a holistic approach that considers and balances multiple objectives.
Forests are not the only systems structured in this way. Obliquity is equally relevant to our businesses and our bodies, to the management of our lives and our national economies. We do not maximise shareholder value or the length of our lives, our happiness or the gross national product, for the simple but fundamental reason that we do not know how to and never will. No one will ever be buried with the epitaph “He maximised shareholder value”. Not just because it is a less than inspiring objective, but because even with hindsight there is no way of recognising whether the objective has been achieved.
For most of the 20th century, ICI was Britain’s largest and most successful manufacturing company. In 1987, ICI described its business purpose thus: “ICI aims to be the world’s leading chemical company, serving customers internationally through the innovative and responsible application of chemistry and related science.
“Through achievement of our aim, we will enhance the wealth and well-being of our shareholders, our employees, our customers and the communities which we serve and in which we operate.”
ICI’s corporate portfolio had evolved over the decades – the company’s traditional strengths had been dyes and explosives, but its chemical expertise had taken it into other industrial feedstocks and agricultural fertilisers. After the second world war, the management of ICI concluded that in future “the responsible application of chemistry” was most likely to be found in pharmaceuticals. ICI recruited a team of able, young, academic scientists but the team was slow to bring returns.
The pharmaceutical division was a drain of ICI resources until, in the 1960s, the discovery of beta-blockers gave the company the first effective drug for controlling hypertension. More discoveries followed and, by the 1980s, pharmaceuticals had become the growth engine of the company.
In 1991, Hanson, the predatory UK conglomerate that had successfully acquired and reorganised sluggish British manufacturing businesses such as Ever Ready and Imperial Tobacco, bought a modest stake in ICI. While the threat to the company’s independence did not last long, the effects were galvanising. ICI restructured its operations and floated the pharmaceutical division as a separate business, Zeneca. The rump business of ICI declared a new mission statement: “Our objective is to maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge and a world competitive cost base.”
While the National Parks Service had moved from a narrow, focused objective to a broader holistic view of forest management. ICI made the opposite shift – from a grand vision of the responsible application of chemistry to a narrow concentration on established, successful activities. The aim of bringing benefit to a wide range of stakeholders was replaced by the specific objective of creating shareholder value from narrowly focused operations. The company translated this into an operational strategy by disposing of the company’s interests in bulk chemicals to acquire a niche group of speciality businesses: ICI, once the main supplier of chemical products to one third of the world, was reinvented as a smells company.
The outcome was not successful in any terms, including those of creating shareholder value. The share price peaked in 1998, soon after the new strategy was announced. The decline since then has been relentless. After two successive dividend cuts the company was ejected in early 2003 from the FTSE 100 index, the transition from industrial giant to mid-cap corporation had taken only 12 years.
ICI is not the only company for whom greater emphasis on corporate financial goals led to less success in achieving them. I once said that Boeing’s grip on the world civil aviation market made it the most powerful market leader in world business. Bill Allen was chief executive from 1945 to 1968, as the company created its dominant position. He said that his spirit and that of his colleagues was to eat, breathe, and sleep the world of aeronautics. “The greatest pleasure life has to offer is the satisfaction that flows from participating in a difficult and constructive undertaking,” he explained.
Boeing’s 737, with almost 4,000 aircraft in the air, is the most successful commercial airliner in history. But the company’s largest and riskiest project was the development of the 747 jumbo jet. When a non-executive director asked about the expected return on investment, he was brushed off: there had been some studies, he was told, but the manager concerned couldn’t remember the results.
It took only 10 years for Boeing to prove me wrong in asserting that its market position in civil aviation was impregnable. The decisive shift in corporate culture followed the acquisition of its principal US rival, McDonnell Douglas, in 1997. The transformation was exemplified by the CEO, Phil Condit. The company’s previous preoccupation with meeting “technological challenges of supreme magnitude” would, he told Business Week, now have to change. “We are going into a value-based environment where unit cost, return on investment and shareholder return are the measures by which you’ll be judged. That’s a big shift.”
The company’s senior executives agreed to move from Seattle, where the main production facilities were located, to Chicago. More importantly, the more focused business reviewed risky investments in new civil projects with much greater scepticism. The strategic decision was to redirect resources towards projects for the US military that involved low financial risk. Chicago had the advantage of being nearer to Washington, where government funds were dispensed.
So Boeing’s civil orderbook today lags that of Airbus, the European consortium whose aims were not initially commercial but which has, almost by chance, become a profitable business. And the strategy of getting close to the Pentagon proved counter- productive: the company got too close to the Pentagon, and faced allegations of corruption. And what was the market’s verdict on the company’s performance in terms of unit cost, return on investment and shareholder return? Boeing stock, $48 when Condit took over, rose to $70 as he affirmed the commitment to shareholder value; by the time of his enforced resignation in December 2003 it had fallen to $38.
In Yellowstone National Park, at ICI and at Boeing, the attempt to focus on simple, well defined objectives proved less successful than management with a broader, more comprehensive conception of objectives.
The 20th century saw the rise and fall of modernist rationalism in many activities. Nowhere was the change more visible, or the results more disastrous, than in architecture and town planning. In the modernist vision, technology emancipated builders from tradition and accumulated knowledge. Twentieth- century planners could redesign our environment from first principles.
Charles Jencks, the architectural commentator, announced that modernism ended at 3.32pm on July 15 1972, when demolition contractors detonated the fuses to blow up the Pruitt-Igoe housing project in St Louis, Missouri. Less than two decades earlier, the scheme had won awards for its pioneering, visionary architecture. Tower blocks were the supreme expression of Le Corbusier’s view that “a house is a machine for living in”. Corbusier himself designed the first such buildings, the Unite d’Habitation on the edge of Marseilles.
But a house is not simply a machine for living in. There is a difference between a house and a home. The functions of a home are complex and the utility of a building depends not only on its design but on the reactions of those who live in it. The occupants of the Pruitt-Igoe scheme, like those of similar buildings, were alienated by the isolation of a living environment that saw no need for accidental, unplanned social interactions. They showed no respect for its public spaces. The functionality of the blocks proved, in the end, not to be functional.
Communities are complex organisms, imperfectly understood, and their functioning depends on their social relations. Great architects implicitly understand obliquity, but obliquity is so important to the design of towns that the most successful towns have no designer at all. The planned city was conceived in the late 19th century. Baron Hausmann swept away the jumble of Paris streets that had developed over the centuries to create grand boulevards. From the 1920s to 1968, the powerful, autocratic Robert Moses controlled the physical environment of New York, driving expressways through apartments, offices and factories.
The zenith of these ideas was reached in planned cities such as the designed capitals of Brasilia, Canberra and Chandigarh. But all these cities are dull. They lack the vitality of real communities. As with tower blocks, their very functionality is dysfunctional.
The National Park officials who thought they could eliminate fire; the managers who thought they could reinvent ICI and Boeing; the architects who believed they could discard thousands of years of experience and redesign buildings on purely functional lines; the planners who attempted to rationalise the patchwork evolution of historic cities: all made the same mistake of underestimating the complexity of the system with which they dealt and the value of the traditional knowledge they inherited. And the answer to their problem is not better analysis and more sophisticated modelling, but more humility.
Such humility is not commonly found in the business world. Re-engineering the Corporation by Michael Hammer and James Champy became a New York Times bestseller in 1993. Hammer and Champy are as radical in aspiration as Le Corbusier: “Re-engineering means asking the question `If I were re-creating this company today, given what I know and given current technology, what would it look like?’ Re-engineering a company means tossing aside old systems and starting over. It involves going back to the beginning and inventing a better way of doing work.”
Obliquity gives rise to the profit-seeking paradox: the most profitable companies are not the most profit-oriented. ICI and Boeing illustrate how a greater focus on shareholder returns was self-defeating in its own narrow terms. Comparisons of the same companies over time are mirrored in contrasts between different companies in the same industries. In their 2002 book, Built to Last: Successful Habits of Visionary Companies, Jim Collins and Jerry Porras compared outstanding companies with adequate but less remarkable companies with similar operations.
Merck and Pfizer was one such comparison. Collins and Porras compared the philosophy of George Merck (“We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear. The better we have remembered it, the larger they have been”) with that of John McKeen of Pfizer (“So far as humanly possible, we aim to get profit out of everything we do”).
Collins and Porras also paired Hewlett Packard with Texas Instruments, Procter & Gamble with Colgate, Marriott with Howard Johnson, and found the same result in each case: the company that put more emphasis on profit in its declaration of objectives was the less profitable in its financial statements.
Boeing developed problems due to its aggressive anti-union stance. People won’t develop the highly specialized skills needed for high-tech manufacturing without a commitment that they won’t be exploited, and Boeing has made it plain for years now that they’ll do everything they can to break that. They moved headquarters half the country away from manufacturing, to keep executives and workers from knowing each other. They transferred work for the Dreamliner literally all over the world – and very nearly failed at the Dreamliner as a result, since different manufacturing teams couldn’t communicate.
You can make a very good case that this obsession with beating up workers came out of the “shareholder value” myth, but I’m inclined to think it goes beyond that.
Yes, the obsession with beating up workers goes well beyond that.
Gotta love George Merck if he was genuine.
Look up his role in the development of biological warfare sometime. Quite a shadow side.
The issue you overlook is that the corporation is an artificial construct. It is not like the traditional business that you have as an image in your head. It operates by rules that have nothing to do with a single proprietor or partnership before limited liability. Since the government rights the charter and makes the laws that apply to the corporation, they can give it any set of objectives the government wants (and, in the 19th century, governments did set those rules and guidelines).
It’s a given that corporations with government privileges should be under government control but very often that’s not the case or at least should not* be.
*However, to the extent that corporations have used the public’s credit (and which large corporations have not?) it can be argued that they are privileged and such things as nationalization and the equal redistribution of their common stock be considered.
No, that’s not correct since we are talking about public companies. They are subject to SEC requirements and considerable state law requirements, and those in turn reflect a considerable body of case law. Even a Delaware corp (the most friendly jurisdiction) can’t be set up in a way that violates Federal and state laws. For instance you could not set up a corporation to make snuff movies (where the women actors were killed) or that would hire only athletic blond men or set out to earn better profits by violating labor laws.
WOW! Totally brainwash . You have to be blind! Recent history has clearly proven the BANKS are running the government!
Trillion$ were stolen from million$ of homeowner$ when the MBS Market collapsed under the weight of massive financial corruption and extremely well documented fraud! Not one of the CentaMillionaire$ or Billionaire$ responsible for that theft has been prosecuted! All politicians are owned by this CARTEL and they know it. We are a Nation of fools for allowing their society corrupting GREED to rule the Nation and the World!
I hear what you’re saying, but at the same time, what you are saying is that our federal republic is not governable.
Citizens have none of those powers. Our entire system of governance is based upon representatives acting on behalf of a much larger group of people, from prisons to potholes to patents, and the only real choice a citizen has on a day to day basis is to comply, resist, or leave.
I agree with Yves wholeheartedly. But I wonder if the issue can be expressed more constructively as “ownership” vs. “control”. Friedman was a genius at the half-truth and “Jesuit logic”, often weaving words and concepts into any tapestry necessary to illustrate a “truth” he desired. Here is an example of his best work.
Here, the problem comes down the difference between ownership and control. Yes, the shareholders “own” the company, but only in a very particular sense. The control of the company resides with the elected board of directors and the managers. The board hires the CEO who in turn hires the managers. The CEO and managers run the operations of the company. Board and management compensation are directly ties to the stock value of the company, which is not the same as the valuation used to determine what the shareholders “own”. Here, I think, we see the genesis of the control fraud, since the Board and management are compensated for a different reality from that of the shareholders.
In a privately held company, ownership and control reside in the same people, and there is no “market value” (i.e., stock price) to create the bifurcation of interests of a publicly traded joint stock company.
Why would Friedman do such a thing? Obviously, I can’t say for certain, but I’ve been reading a lot about my alam mater, the University of Chicago, during the ’30s and ’40s when there was a huge fight over whether and how to retain the classics as a core of undergraduate teaching. Various commentators point out how the philosophy of the economics department and law school were heavily dominated by Midwestern industrialists who abhorred the New Deal as the corrosion of the American and Protestant work ethic. Chief among them was Frank Knight, Friedman’s mentor. In fact, in one of academia’s great ironies, Chicago’s president during that time, Robert Hutchins (and a staunch antagonist to Knight), hired Friedman. So, much of what Friedman did reflects a virulent dissent from the New Deal among the wealthy and powerful.
Indeed. Which is why I believe that all public companies shares should be very explicitly non-voting, and “voting shares” could be purchased only in blocks which would guarantee a place on the board (which makes the concept of “voting shares” self-defeating, you’re basically buying a directorship + ownership). That would make the difference explicit.
As it is now, it’s this ambigous structure which actually best serves the management..
and you have a vote on some limited matters, but the company has the right and ability to dilute that too. Yves Smith
Are you telling us that 51% of the share owners could not, in principle, do anything legal to the company they own including firing all the management or not renewing their contracts and dissolving the company?
As for dilution, are you saying that 51% of the share owners could not FORBID share owner dilution without a 51% vote OKing it?
I’d say it’s you who have a bizarre view of corporations but if it’s the correct view then the law is screwy – most likely because the government-backed banking cartel has corrupted nearly every thing in business.
Minority shareholders have strong protections against the actions of a simple majority. Pretty much all boards have staggered terms, so it would take three years for your majority owner to get control of the board and get rid of current management (although activists with lower ownership stakes can usually rattle boards and managements to take specific actions to get rid of them, like issue special dividends or sell an underperforming businesses). Most companies also have “poison pills” that allow them to issue up to 20% more shares to ward off raiders who acquire a bare majority.
And poison pills are necessitated by the unlimited ability of the banking cartel to finance hostile takeovers, no?
Well, it sounds like some Federal legislation to make the boards and managements of corporations be 100% accountable to a simple majority (51%) of the share-owners is called for, though in principle, I’d bet, a truly free market would make such legislation unnecessary. But such legislation seems harmless at worst so why not? Until we have a truly free market some scaffolding seems reasonable though it might eventually be redundant.
It seems that the principal of maximizing shareholder returns being a company’s main obligation originates from common law, rather than statute, starting in the mid-nineteenth century. (See my short quote below from Marjorie Kelly’s book.)
Yves, I was a bit mystified by your assertion that
So I did what you suggested and found this handy overview.
While the comparison notes in several places that Directors do not RUN the company and hence are not directly responsible for shareholder value, there on page 4 I find under “Corporate Objective and the Mission of the Board of Directors:”
American Law Institute: “corporation shall have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain…:” and “the responsibility of the Board is limited to overseeing such operation.”
Even our friends at CalPers have in their Principles: “Corporate governance practices should focus the Board’s attention on optimizing the company’s performance, profitability and return to shareowners.”
While it is strictly true that Directors don’t optimize shareholder value, the pursuit of profit and return is always paramount. As someone once said:
“Money isn’t everything, but it’s way out ahead of whatever is in second place!”
In my older post, I link to some of the most widely cited board guides, and they uniformly describe the role of directors in terms of duties to the corporation. Shareholders are one constituency that boards should be mindful of, but they are far from the only one.
CalPERS is a government agency of the state of California. It does not have “shareowners”. It has beneficiaries. Whoever wrote those principles has rocks in his head. Seriously. That’s a sign of how widely this propaganda is accepted. For instance, see how CalPERS’ board is selected:
CalPERS is overseen by a 13-member Board of Administration whose members are elected, appointed, or ex officio:
Six are elected from CalPERS members (two by all CalPERS members, one by active State members, one by active CalPERS school members, one by active CalPERS public agency members, and one by retired members of CalPERS)
Three are appointed (two by the Governor, one by specified leaders of the Legislature)
Four are ex officio (California State Treasurer, California State Controller, Director of the Department of Personnel Administration, and designee of the State Personnel Board)
So “members” (see the lack of “shareowner” language???) get to vote on less than half the board members.
Yves, Actually if you read the first pages of the Comparison, the CalPers “Principles” are for the company’s it invests in… so they are in fact enshrining their investments and themselves as the shareowners with that principle – not their pension holders… that would be silly. ;)
CalPERS ignores this principle. It invests in index funds. It runs its own ginormous S&P index fund in house.
And even if it did, as I point out in this comment, it’s a bad investment strategy. Companies that focus on “maximizing shareholders value” underperform those that adopt loftier, broader objectives:
Much to be said for this – and I read recently that lean companies don’t do as well as ones with fat. Yet with no thought of MSV cost-cutting hits one hard in the face once you see real accounts. I’m yet to meet anyone who believes mission BS for more than a few weeks anyway, I can’t see that the rhetoric matters. I used to write City prospectuses for a living and don’t remember putting the truth in any of them.
Kudos to the two authors of the book you mentioned. This dilettante will get it to try to learn better arguments for future ‘disputes’ with the uninformed.
The DIY Bigg Boxx Store I used to work in is a perfect example of the evolution of this “maximizing shareholder value” theory. (Let us treat it as what it is, a Theory. One that is failing its’ real world shake down cruise.) Unlike some comments above, I found the people enduring the effects of this ideas’ implementation to be quite aware of what was really going on. Once their eyes were opened, recognition of the crappiness of the work environment proceeded apace. As Banger mentioned above, “no one seems to be offering any alternatives.” More precisely, I’d say that viable alternatives there are, but they are being given an overwhelming dose of good old Nixonian “Benign Neglect.” This is a case where the education of the general public is important. If we fall back into the days of Samizdat, so be it. Now, however, the technology of “private” information dissemination is vastly more efficient than in the old mimeograph machine days. There will always be an underground for dissidents. Now, it’s a lot bigger, and houses a lot more people. There lies strength.
Directors have a duty to the corporation. It’s the corporation that has a duty to its shareholders.
I know this has been a pet peeve of yours Yves, but I think we can give this formula too much power. Most of the practical problems in corporate governance are caused by management not doing what it is in the interest of the ownership. Maximizing shareholder value is a useful shorthand for the reminder that incorporation is supposed to be for the benefit of the owners, not the managers. Of course, it is the state that does the incorporation – so if an entity isn’t fulfilling a public purpose, then it should be dissolved (and it certainly shouldn’t be bailed out!). The costs of bargaining are quite similar when talking about ownership vs. management and citizen vs. politicians.
And as issues like unions show, the drive for mismanagement comes from our political leadership. Workers that are able to cooperate and assert a decision-making role in an institution are a direct threat to the desired authoritarianism of our Fearless Leaders in DC.
It’s really more than an annoyance. It’s a contradiction at the heart of the system.
The Friedman quote contains the distinction between the corporation and the business. It notes that a corporation is a legal fiction (legal structure, more properly) while the business is real.
Yet, the shareholders have a connection only through the corporation. It’s a contradiction to dismiss the people connected through the corporation, and then turn around and claim their interest is what drives the business. Are they ridealongs or the chosen few? Can’t have it both ways.
Union-busting is a plausible tactic for short-term profit maximization. Long term it’s the path to ruin, for the nation, the society and the shareholders, but that’s never mind. The silence of the pols just shows they’re in it for a little short term gain, not the broader social interest. Loot ‘n scoot. Pirate capitalism.
I would offer a different perspective here. What is contradictory? Friedman says in pretty clear language he thinks the general way a company should be run is for management to carry out the wishes of ownership. That he observes ownership generally wants to make money is perhaps awkward because it indicts ‘liberal’ institutions like universities and pensions? Because it makes us grapple with why so many even leftist-leaning intellectuals supported the bailouts of the very companies figuratively and even literally polluting our society?
One can critique the existence of property rights, but within a system where we recognize private property, that is a fairly non-radical position where people can legitimately take both sides of the argument. To argue that widely disbursed ownership is incapable of acting collectively is an important logistical challenge to explore, but it is hardly unique to large, publicly traded, for profit corporations. 80% of the US population didn’t vote for our current President. If this line of reasoning really cuts to the heart of the system, then what is flawed is the US Constitution itself, whose fundamental governing premise is one of representation. We are a republic guided by individual rights and checks and balances, not a true democracy where citizens directly make decisions.
As far as the pols being silent, I find that to be exactly backwards. The political leadership has been setting the tone, pushing the business world to be more authoritarian and unconstitutional, from the air traffic controllers strike to FISAAA. Friedman I think would be quite happy with much of the looting going on today, but he is not the common denominator here. He spoke out vigorously against the drug war, too, yet that didn’t gain any traction amongst the pols.
To argue that widely disbursed ownership is incapable of acting collectively is an important logistical challenge to explore, but it is hardly unique to large, publicly traded, for profit corporations. washunate
What he said.
I have referred repeatedly to Amar Bhide’s seminal 1993 Harvard Business Review article, Efficient Markets, Deficient Governance. Bhide argues that it is impossible for anonymous, arm’s length investors to supervise a company adequately. Companies cannot make information that is critical to assessing the company and its management public because much of it is competitively sensitive. Moreover, transient, arms-length investors cannot readily judge the temperament and acumen of management. They don’t have remotely enough intereaction with them.
Investors been upset enough to vote (at some companies) in “say on pay” resolutions expressing their disapproval of lofty executive compensation. They’ve been ignored. Private meetings of powerful investors with management (such as the one investors had with Lloyd Blankfein, IIRC in 2010) also had no effect.
Bhide says publicly traded stock is an inherently flawed investment vehicle. He has repeatedly urged that it be eliminated.
Bhide says publicly traded stock is an inherently flawed investment vehicle. Yves Smith
Then democracy is inherently flawed too.
I lay the blame (like almost everything else) at the feet of the government backed credit cartel, which is based on usury for stolen purchasing power. Otherwise, companies would be MUCH more dependent on the sale of their common stock to finance new operations and thus MUCH more likely to be honest and open with potential stock buyers out of NECESSITY.
This is not to say that non-voting shares don’t have a place so long as the company is firmly bound to its charter so that investors are both adequately informed and protected.
I don’t know that democracy is inherently flawed but I do know that systematic theft from the poor is and so is usury from one’s fellow countrymen. Yet our money supply is based on BOTH!
But please inform what vehicle should be used instead of corporations for small investors to consolidate capital for economies of scale in a democratic manner?
I wholeheartedly agree that governance is at the heart of our challenges today. I’m suggesting that description could just as easily apply to our nation’s universities or hospitals or legal system or military.
The great development of the 20th century was the scale at which bureaucracy could organize resources (both public and private). If we conclude with Bhide that such scale is ungovernable, then the logical conclusion is that our task in the 21st century is to shrink that bureaucracy.
There are basically two ways to do that. Kill a lot of people or split the large countries up into much smaller independent states. If we split the US into 60 countries, that would give each one about the population of Switzerland.
This is why I’m so hesitant about all policy advocacy that focuses on money as the solution – from corporate bailouts to JG buffer stocks – because they are designed around more centralization when we can’t even supervise the existing government adequately. We can’t even supervise just the post-9/11 expansion of government adequately.
I don’t go so far as to say that the solution is to abolish the republic, but I am sympathetic to Bhide’s observation that nobody has thought of a better idea to this point.
Companies cannot make information that is critical to assessing the company and its management public because much of it is competitively sensitive Yves Smith
So what? We have a REPRESENTATIVE government too; people elect representatives who are then privy to the details.
Abolish government-backing for credit creation and then companies will have a huge incentive to please actual and potential share owners since bypassing new share issue would not be the option it currently is.
P.S., it’s interesting going back and reading the details with two decades of hindsight. In Section 4.2 on Policy choices, there is an excellent line:
The analysis in this paper suggests that the governance problem lies in inadequate incentives for internal monitoring…
I would contend that this is precisely what the authoritarians want. The place where whistleblowers are most fervently persecuted and fraud allowed to blossom most freely is the United States Federal Government itself.
I had a short stint at financial market and am still a investor in selected stocks with long view. I generally invest in fundamentally strong stocks that have performed well consistently in the last five years or more than that. However, I’ve found out in my short financial stint in the market that there are many stocks that have weak fundamentally but are doing remarkably well just by showing profit out of selling its own assets. I’m not naming the stock here but what I found out that the company has been posting profits quarter after quarter by selling the assets and lands it has accumulated. Though the prospect of stock is extremely poor in the coming years and may be declared bankrupt in a span of two years or so, it is trading at high premium only because it is showing profit to the stake holders currently. This is baffling but true.
This can only be true because stocks are now casino chits and not, as some people maintain here, primarily or even significantly ownership stakes in a permanent venture. Perhaps as I read my history 100 years ago in Britain (perhaps even here) people bought stocks to provide steady, long-term income from the dividends. This is hardly ever true today. The vast majority of stocks bought and sold on a daily basis are for speculative purposes based on notions of the valuation of the stock (is it a “steal”? is it likely to go up soon so I can dump it and pick another “winner”? or, with high speed trading, can I manipulate the price in the next few seconds, minutes, or hours to score a quick buck?).
The purpose of a corporation is quite simple. To limit or eliminate the legal liability of the officers and/or owners of the corporation.
Modern society has applied anthropomorphism to corporations and the STATE.
“Walmart ripped me off!”
“NYPD assaulted me!”
No, none of that happened. A guy/girl did those things and then hid behind the law of Principal/agent …. i.e. the agent is not responsible for carrying out actions on behalf of the principal that he/she represents.
The people need to realize that this form of immunity only applies when the acts are conforming with the duties of the particular “office”.
Otherwise , they are simply lawless trespassers.
Stop going for the windfall lawsuit and hold people PERSONALLY accountable.
The society has a foundation that promotes irresponsibility both in defending rights, knowledge of rights and performance of obligations and duties.
I noted in another context, Holder has expanded the immunity from civil liability to criminal liability. The next expansion will be into treason, if it hasn’t happened already.
I can not explain your use of Modern Society doing something you later claim can only be done by people as individuals, and not by various institutions. Modern Society is also made up of individuals and could not be have the systemic effect on the state or its corporations, if that is what you are saying. The socialization and acculturation of people who learn how to behave in any society and any sub-culture or formal organization such as the military, a commercial company or a bureaucracy of government at any level from local to national explains the widespread experience that Walmart ripped me off.
Modern Society is the antithesis of traditional society, where you knew who you were and what you were expected to do. The distance from birth to death was not an unknown journey of discovery, but a well worn path that your father and his father and now you will tread. Modern society set you free from formal roles set at birth. The bureaucracy, if anything, creates regularity and uniformity in the absence of the structured experience from unwavering adherence to tradition. The people who work at Walmart are interchangeable instruments of company policy, written by the interchangeable cogs of management. Improv is done at comic clubs and experimental theaters, people at work accept their roles and learn the behavior that the company expects from them, they do not as individuals make things up on their own. If they do, and it goes to far from policy, they are soon enough gone.
“Modern society has applied anthropomorphism to corporations and the STATE.”
“The people who work at Walmart are interchangeable instruments of company policy, written by the interchangeable cogs of management.”
You just did it too.
The bottom line is John Whoever and Sally Whatever wrote the company policy.
Not Walmart Management. Management like government is a function not an entity legal or otherwise.
But look the government could allow no corporations to get a corporate charter unless they were forced to compete on a triple bottom line – not just profits, but society and environment. Corporations that are socially damaging should AT THE VERY LEAST have their corporate charter revoked (oil companies, I’m looking at you). Never mind preaching to them to make them ethical (or whether Friendman’s preaching makes them more unethical), has preaching ever been enough?
This is good stuff Yves. Thanks!
Good post. As anybody now knows, CEOs espousing “shareholder value” are more generally addressing their own reimbursement. It is the CEOs who run the companies, and most generally into the ground all to maximize short term profits.
Corporate management has turned into another example of IBGYBG.
Given how Republicans have mismanaged the Federal government into a huge hole, it’s not surprising to find that their corporate brethren are turning companies into smoking holes in the ground.
Not my words, but wise ones:
“If the Government is a car setting out to give every one a ride to work, then for 40 years the Republicans have been puncturing the tires, pouring sand in the gas tank, stealing the distributor cap, and, whenever they can get their hands on the wheel, driving it straight into the nearest ditch and then, pointing to the wreckage as the tow truck backs up to it, saying, ‘See, this proves that people were meant to walk.’
And they do this so that they don’t have to chip in on gas.”
As I have written often in the past, in kleptocracy, it is imperative to split all things economic off from their social purposes. Great wealth becomes an object in and of itself needing to justify itself to no one. Corporations become machines to maximize looting/profits for shareholders in theory and CEO wealth in reality at the expense and usually to the great detriment of society.
Friedman as the avatar of modern economics wasn’t a useful idiot. He was a knowing, willing participant in the looting of our country and our society. That he believed the shit he was selling in no way lessens the criminality of his actions.
We would have no difficulty proving his guilty knowledge. I’m not sure where this stops though. Where is the line? I’ve had to do some pretty rough stuff in my time, including teaching university economics (which barely extends beyond sums and systems explanations on which to do more sums). Yet I couldn’t go anything as disgusting as pulling austerity levers or preaching World Bank transitional economics propaganda. I’m fairly sure from criminal experience these politicians and economists get their jollies in very strange ways. They have found ways to enjoy the distant misery and killing. Just look at Blair, or Osbourne, Cameron, Kerry, Clinton/s …
The corporation is simply the most effective contemporary method to steal the most from the most [although government, as always, does the criminal community quite proud].
“That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”
Maybe it is just my interpretation, but the above passage (along with everything else I have read from Friedman) is intellectually lazy, and that is putting it mildly. His writings lack vigor and necessary description. I just can’t acknowledge an economist unless they embrace a form of heterodoxy while writing in a meticulous manner, otherwise it is like listening to a high priest.
Anyone wanting to know Peter Drucker should not waste any money and perhaps scan this:http://home.base.be/vt6195217/neworganization.pdf
Drucker was typical of the ‘genial old fart’ school of managem,ent learning and development. The UK classic was Reg Revans who gave us ‘action learning’ (managers learn by talking to each other – wowser!). Typically, they appear erudite by citing philosophers and participative methods. John Kay was the guy who said economics had a lot of difficulties, but deserved real argument. Management theory was only fit for ridicule. He explained in detail why Liverpool FC were world-beaters just as they weren’t any more, and soccer went the way of most money best team.
I have no time at all for any of this management prattle. It all assumes a vital, privileged role for management.and never does any joined-up thinking. If you can read Drucker’s HBR article, explain why we were expanding management teaching for 15 years either side of it, given the prediction of the ‘management lean’ organisation. The easy and probably best answer is no one believes these management futurologists anyway.
There are alternatives to thinking about any of this in terms of management or economic text. All of it is barking wuckfittery to me, and gets worse the more familiar you get with it all. The stuff defies rational argument by excluding what matters. Go and see Billy Graham and Tom Peters on the same day. Read Dick Hobbs’ ‘Lush Life’ on organised crime and the normalisation of criminality. You can’t argue directly with management and economic jive. It’s worse than arguing with a creationist. I’ve known managers argue for months on such as the location of a works canteen in the hope that when you won that one, you’d be too exhausted to negotiate on pay! Don’t even read Piketty – go and spend time with a poor family. They distance us from the real issues, even if they preach Marxism.
Old Milton influenced nothing. The crooks were already running the show. USUK had never really been competitive nations. Manufacturing profits were already screwed down and had to be re-fixed by trade agreements. Competitive advantage BS burgeoned, but none of it was ever true. Market segmentation, mass customisation, technology, quality, quality and more quality, organisational culture, training and development, research and development (but spend no money on it), making the country ‘open for business’ and vast swathes of rubbish on SMEs and thrusting entrepreneurs who wanted to open a coffee franchise. It was all rubbish. The crooks wanted control of the books and that’s what Milton had on offer. He was a front for that is all. There is no arguing with these crooks in their language. We need to flush them into the open and deal with them in the ordinary language of the people. Friedman and his buddies should have been given up to the Chilean people long ago.
If argument was anything to do with any of this I’d expect:
1/ people to recognise 9 basic types of argument
2/ people to recognise basic rhetorical ploys
3/ people to see MSM (and fringe niche) argue through shiny things once human and by never presenting full argument from the way the world is
4/ people to be good at argument
None of the above apply and argument has been around for 2,500 years without fixing an egalitarian society default in our system. We either do argument very badly or it is irrelevant in power games other than to reinforce power. Maximising shareholder return started when a few crooks realised that a few tricks let them steal tax, employee pensions, wages and dignity (they are libidinal perverts remember). This spread like monkeys copying the first one to wash food in the sea. Friedman didn’t think this up. His ilk aren’t as smart as the food-washing monkey. He was co-opted as PR by the thieves of Wall Street and the City.
Read the Drucker stuff I linked to if you get chance. You’ll find text far too large to print here on the lean management organisation of the British Raj. Nip over to Wiki on BRaj and then wonder why the Harvard Business Review would give space to such rubbish. Not only is this muck not relevant to future lean management organisations, it’s historically wrong on a level even a trip to Wiki can expose. What does this say about HBR?
somepeople who own corporations actually care about making something good.
I, for example, recently saw a video on the Men’s Wearhouse website about the Joseph Abboud factory in Massachussets. Mr. Abboud himself was in the video, carefully examining a suit for stitching quality and fabric quality. I think I have one of his suits, although I always cut the labels out at the tailor and then I forget where the suit came from. Sorry Mr. Abboud, if it was your suit. he looks like he cares.
I’ll be the first to admit I’m not a clothes horse. I would never look as good in a suit as Andrew Haldane from the Bank of England (I’m a straight guy, dude, so don’t crimp you butt up when you read this, if you read it). but he looked pretty smooth in what looked like a very pricey suit on that INET video a while back. it looked like it must have cost $5000. If you go to men’s Wearhouse and get a Joseph Abboud suit, it’ll set you back maybe $400 tops. Most people won’t be able to tell the difference.
I don’t think any suit I have looks that good. But anyway, back to Mr,. Abboud. he looks like he cares. But if you take a business and you hire management and you sell to shareholders and there’s enough of them — they don’t care. They just want the money. They don’t take pride in product, they don’t take pride in craft, they don’t take pride in community relations, they don’t take pride in anything. There’s a hunter who brings back a deer to the tribal kitchen and he feels pride. There’s no pride in owning a piece of the hunger.
Mr. Friedman suffers from “The Disorder” (TM) and he also suffers from “The Ascension of the Absolute”. that’s another disorder. it’s the property of analysis that reduces multiplicity to unity for the convenience of perception and analysis. It’s a form of laziness, actually, But they call it effiiciency.
faaak it should be a piece of “the hunter”, but it could work either way if you think about it long enough
Thanks! I’ll need a suit that fits eventually and $400 sounds reasonable.
I guess I should just bite the bullet and buy one that fits my fat gut. The jacket and pants can later be taken in, no? When I get’s all fit and handsome on myself?
Oh no, “piece of the hunger” is much better, imo. Keep it in.
“Mr. Friedman suffers from “The Disorder” (TM) and he also suffers from “The Ascension of the Absolute”. that’s another disorder. it’s the property of analysis that reduces multiplicity to unity for the convenience of perception and analysis. It’s a form of laziness, actually, But they call it efficiency.”
In my defective view, that has to be the most concise summery I’ve yet to see.
skippy… Kudos craazyman….
Marjorie Kelly’s book “The Divine Right of Capital” deals with this topic in detail (the origin of priority of maximizing shareholder returns). She traces it back to the mid-nineteenth century, through a growing body of common law–decisions made by judges, rather than statutes. Milton Friedman’s perspective was apparently shaped by the preceding judicial decisions that had accumulated over the previous century.
A short excerpt, from p. 52:
There’s not a lot of governance going on in corporate boardrooms. And the first thing that’s not going on is that boards are not establishing the purpose of the corporation. Board members believe their only choice is to follow the prime directive, which is to maximize the returns to shareholders.
The genesis of this directive is worth exploring a bit. It may have a feeling to it of long-settled and inviolable law, but it does not arise from either federal or state constitutions, nor is it in any solid sense found in state statutes. Indeed, it contradicts America’s early tradition of chartering corporations to serve the public good–to construct bridges, for example. Shareholder primacy emerged from the ether in the midnineteenth century, when it was articulated by the courts. (Chapter 9 discusses these issues in depth.) The basis of shareholder primacy is thus primarily common law, judge-made law. In state statutes, directors have a duty of loyalty to the corporation. But in common law, this is interpreted as a loyalty to shareholders alone.
You are missing that those common-law decisions were for closely-held corporations. Those are like venture capital investments, where the investors know management personally and are actively involved in its affairs. The model of diffuse, arm’s length shareholders started in the US, with the railroads in the late 1900s. That was a hotbed of speculation and NOT investment, and pretty much all of them went bust. That model was tamed by the securities laws of the 1930s.
The decisions you refer to simply aren’t germane. They apply to a different legal arrangement between owners and investor. Publicly traded companies bear no resemblance to equity ownership in the 1800s.
The irony of MSV is that the public shareholders whom it holds up as the only risk bearers typically never invest in the value-creating capabilities of the company at all. Rather they invest in outstanding shares in the hope that they will rise in price on the market. And following the directives of MSV, a prime way in which corporate executives fuel this hope is by disgorging the so-called “free” cash flow.
http://www.theairnet.org/files/research/WorkingPapers/Lazonick_InnovativeEnterpriseandShareholderValue_AIR-WP14_0301.pdf – and for a good history and critique based on the notion of the ‘innovative firm’. Most of us who have dawdled here will have read many of the points through Yves.
Yves is right Friedman provided a lot of justifying BS for MSV, ‘Capitalism and Freedom’ (1962) was probably the classic. I tend to a ‘it won’t be clever’ analysis of managerialism, so I see MSV as a typical power play like, say, the Scottish enclosures. Power simply strips away other rights in a value extraction, whilst paying bailiffs, stewards and judges to authorise and execute land grabs and replacing people with more economic sheep (etc).
I would see Cat’s ‘Divine Right of Capital’ as indicative of a longer history of power and inheritance that regularly emerges in a history of the rich stealing from everyone else. MSV is essentially the current form of charismatic leadership.
Yet the railroads got built?
“Divine Right of Capital” – priceless. NOt seen the book – thanks Cat.
I found it an excellent book–well written, readable, well referenced.
The author is also an excellent speaker. (I heard her once on radio and once in person.)
Just ordered a secondhand copy. You’d think, given all the claims to being super-smart, thrusting, innovative and the rest, that these people maximising shareholder capital wouldn’t want to be anywhere near stuff like power generation and supply, health services and supermarkets – and would recycle anything beyond subsistence pay back to the beloved shareholders, like some old duffer in Queen Victoria’s time who saved up half-a-million quid in old half-pennies. He died after lugging the last sack round to the palace. Should we expect less ‘devotion’ from today’s CEOs?
Thanks to this exchange, I just discovered M. Kelly also has a new book out, “Owning Our Future”. I’ll have to get a copy–it’s of immediate relevance regarding more constructive business structures that are pointing the way forward.
As William K. Black ceaselessly highlights to us all, publicly listed corporations – be they banks or other institutions – now exist to be plundered by their C-Suit executives and Board of Directors – shareholders come a poor second in all this theft and personal greed.
I was always of the opinion that it was “bond holders” or holders of debt who had any primacy within law with regards publicly listed businesses – but again, this has been perverted.
Best we ignore all these institutions and only deal personally with “co-operatives” or businesses that are actually run on strict moral and ethical codes – does it not shock us that banks and life insurance businesses founded originally by Quakers, Baptists and Methodists are now among the most predatory and dishonest businesses out there?
Time for Yanks to abandon 401K’s, and time for Brit’s to curtail excessive management fees for pension and life insurance products – we are being “arse-fucked” left, right and centre and prostrate ourselves in order for TPTB to continue this assault upon us.
Best we ignore all these institutions and only deal personally with “co-operatives” or businesses that are actually run on strict moral and ethical codes Christopher Dale Rogers
– does it not shock us that banks and life insurance businesses founded originally by Quakers, Baptists and Methodists are now among the most predatory and dishonest businesses out there? Christopher Dale Rogers
Pulling out Occams’s Razor, I’d say the government-backed credit cartel is responsible, e.g. how many hostile takeovers are financed therewith?
Soon they will leave no orifice untouched Christopher. Public spending is set to fall at 1.7% a year (which is 2.4% once you include the 3.5 million population increase from 2010 – 2018). The top 1% are paying 27.5% of all income tax compared with 11% in 1979 – but we obviously have to do something much more radical (all Institute for Fiscal Studies Green Budget). We need a new plan.
Corporations exist because they are natural extensions of a productive capacity to meet the Demand for goods/services. That they also cater to their shareholders equity value is natural – after all, ownership obtains a Return on Capital Investment (ROCI).
That is obviously not the whole story. Since time immemorial mankind learned how to multiply individual output by means of the Division of Labor. Which is the fundamental reason that corporations exist. That is, in order to achieve the output necessary to satisfy Demand, the Labor Input must be multiplied and the skill-sets broad.
Till now, we have organized our notion of “law and order” around the concept of Property Rights as an integral part of our Civil Justice. What is mine is mine, and the law recognizes and protects that idea. Corporations were founded based upon it – and in order to multiply output, it hired manpower. By extension of the notion of property rights, manpower had no right to share the benefits of the Return On Capital Input (RoCI). It was paid for the employ of skills in the production/delivery of goods/services – no more, no less.
Of course, what happened is that the Total Return on both capital and labor accrued marvelously well – for the shareholders. And, by means of offering stock-options to TopManagement, they became preferred share-holders. All that was arranged nicely amongst the cronies running the BoD. And it still is done in that manner by the BoD’s Compensation Committee.
One might ask the question, “If capital is necessary to the production of goods and services and obtains an RoCI, then why not a Return on Labor Input (RoLI)?” Well, there is, some will say. It is called a Salary. So, why does Labor Input by TopManagement earn such colossal returns when compared to the rest of a company’s personnel?
“Because it’s always been that way” … which is the most pathetic answer I can think of presently. The only one to ever challenge that notion was Karl Marx, and his solution, called Communism, proved to be intrinsically faulty. But, the notion of Social Justice never died – it was still-born in America, just lasting only 3/4 decades during the Progressive Era at the turn of the 20th century.
What’s a country to do to address a revenue unfairness that translates directly into Income Disparity? Pass laws that somehow maintain a reasonable cap on corporate salaries. Peter Drucker suggested the cap at 20 times the average salary. Also, Net After Tax Revenues that are shared-out in terms of bonuses, should be company-wide – as should be granted stock-options. These are all rewards for achievement to a select group that was most certainly not alone in achieving corporate objectives.
A preferred stock-option given out (not equally but equitably) for purposes of rewarding achievement would have two benefits:
*It would be an incentive to achievement and reward all within a company, in keeping with the existing HR-process of “pay-rises for achievement of job objectives”. In that manner, the employee preferred stock would be allotted in proportion to one’s grade-level.
*Since the reward, however, comes out of Net After Tax Revenues, then “wage-increases” could be moderated, which thus protect a company’s competitiveness. In turn, by moderating costs, such preferred stock dividends also help to support Sales and therefore Profits (and therefore shared dividends on preferred employee stocks.)
*And during times of depressed sales and therefore profits, the company need not automatically employ a reduction-in-force policy – thus saving jobs.
*And the preferred-stock would carry employee rights to elect two members to the BoD.
Just a thought – along the lines of “run it up a flagpole and see who spits at it” …
Since the time that MSV became the dominant ideology of corporate governance in the
1980s, the ratio of dividends to net income for all US corporations rose from 37% in both
the 1960s and 1970s to 46% in the 1980s to 58% in the 1990s to 63% in the 2000s.
Meanwhile the buyback payout ratio went from miniscule to massive, with buybacks
surpassing dividends as a mode of distributions to shareholders in 1997. For the 251 companies in the S&P 500 Index in January 2013 that were publicly listed back to 1981, the buyback payout ratio was less than 5% in 1981-1983 but 39% in 2010-2012, with a three-year peak of 70% in 2006-2008. By decade for these companies, the dividend payout ratio was 50% in the 1980s, 44% in the 1990s, and 41% in the 2000s while the buyback payout ratio rose from 22% to 35% to 50%.
Much more than this financialisation was taking place. The firms became worse places to work in in terms of wages, security, training, industrial democracy and worker dignity. And we did very little, if anything to shift to green projects, energy and to sensible quality of life growth. Possession of liquid assets by the bottom 50% crashed from 14% to 1%. What went on was a “victimless crime” of which we were, in fact, almost all victims.
The key block to fixing this is the globalisation of money, against which no country, even the US, can stand alone.
May I suggest some reading: “Being Done with Milton Friedman”, Accounting, Economics, and
Law: Vol. 2: Iss. 2, Article 3 (2012).
I think one thought that is implicit in some of the comments is that the untoward behavior by CEOs is somehow a “maximization of shareholder value”. Clearly, in the short-term, quarterly earnings ADHD world we find ourselves in, that is what is rewarded, but you have to wonder (hope?) whether it is not in the long-term interests of the same shareholders .. oh, wait, no one buys stock to invest .. they buy to trade … ah .. I guess everything is working just fine, after all.
I totally agree that the idea of corporations only being run for profit is disgusting. Unfortunately, you a taking on the wrong villain here.
There is a legal basis for the fact that “corporations exist to maximize shareholder value.” The 1916 case (yep, before all of the economics trends you discussed) of Dodge v. Ford Motor Company established that managers owe a duty to the shareholders of the Ford Motor Company to operate his business to profit his shareholders, rather than the community as a whole or employees.
This isn’t a Milton Friendman idea – this is the US judicial system writing the law.
It might help to represent the fact in Wikipedia more accurately and grasp their implications before opining so confidently.
First, the Ford decision was a Michigan state court decision. Most corps are incorporated in Delaware or else the state in which they do business. The decision has no relevance save to Michigan corps. And it says only the directors have to try to make a profit, not “maximize”, so the assertions about it go beyond the language of the decision. The court said Ford could not run the business like a charity.
Perhaps even more important in this 1916 decision was that Ford was private, so the Dodge brothers were hostages. By contrast, the overwhelming majority of shareholders in public companies can exit at any time without depressing the price if they don’t like the way the company is being run. Hence it’s hard to see it as germane. As a result, the Dodge decision has effectively been superceded by the 1933 and 1934 securities acts.
It might help if you read this article: Corporate Malfeasance and the Myth of Shareholder Value: http://scholar.harvard.edu/files/dobbin/files/2005_ppst_corpmal_zorn_0.pdf