Who's in charge of a company, anyway?
April 2, 2010 1:10 PM   Subscribe

The myth of shareholder capitalism. It's commonly believed that a company's primary duty is to maximize shareholder value. Anything that might reduce the returns to shareholders is questionable, including giving employees good wages and benefits. According to a recent article in the Harvard Business Review, this is a misconception, and corporate management is being taught the wrong lessons based on obsolete case law.
…we conducted a systematic analysis of a century’s worth of legal theory and precedent. It turns out that the law provides a surprisingly clear answer: Shareholders do not own the corporation, which is an autonomous legal person. What’s more, when directors go against shareholder wishes—even when a loss in value is documented—courts side with directors the vast majority of the time. Shareholders seem to get this. They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times. In short, directors are to a great extent autonomous.

And yet, in an important 2007 article in the Journal of Business Ethics, 31 of 34 directors surveyed (each of whom served on an average of six Fortune 200 boards) said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximize shareholder wealth, they believed it was their duty to do.
Another HBR article advocates shifting from shareholder capitalism to what they call customer-driven capitalism.
posted by Lexica (40 comments total) 42 users marked this as a favorite

 
sure. and the beat goes on...why not question the notion that corporations are granted personhood while my moneky is not?
posted by Postroad at 1:14 PM on April 2, 2010 [3 favorites]


Well that's obvious. Otherwise, shareholders would be violating the 13th Amendment!
posted by anotherpanacea at 1:16 PM on April 2, 2010 [1 favorite]


Peter Drucker:
A company's primary responsibility is to serve its customers, to provide the goods or services which the company exists to produce. Profit is not the primary goal but rather an essential condition for the company's continued existence.
If I remember correctly, he compares profitability to electricity. You need electricity to run an office, but keeping the power on is not the purpose of the office.
posted by russilwvong at 1:23 PM on April 2, 2010 [6 favorites]


...a company is about far more than the price of its shares. It's about "people, relationships, knowledge, reputation, all of which have enormous impact on long-term value. Firms are social and political, not just economic and financial.
Is John Lewis the best company in Britain to work for?
It is owned by its employees – or partners – who have a say in how it is run, and receive a share of the profits. Surely this the way every organisation should be run . . .
posted by adamvasco at 1:27 PM on April 2, 2010 [2 favorites]


They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times. In short, directors are to a great extent autonomous.

Great Extent = 2/3 of the time, for clarification.

And yet, in an important 2007 article in the Journal of Business Ethics, 31 of 34 directors surveyed (each of whom served on an average of six Fortune 200 boards) said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits.

Maybe they're all just pricks.
posted by filthy light thief at 1:27 PM on April 2, 2010 [3 favorites]


What’s more, when directors go against shareholder wishes—even when a loss in value is documented—courts side with directors the vast majority of the time. Shareholders seem to get this. They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times.

Right, so instead, shareholders just sell their shares when the quarterly profits fail to meet the estimates. And if that happens too often, the CEO and whoever else made decisions that weren't profitable enough get fired. Over time, the companies and individuals that focus on short term profits stay in business and keep their jobs, and the rest are SOL. No lawsuits required.
posted by burnmp3s at 1:28 PM on April 2, 2010 [3 favorites]


they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximize shareholder wealth, they believed it was their duty to do.

Or jack up their customers health insurance rates 30%, or drop their coverage based on alleged pre-existing conditions, or deny coverage for an "experimental" treatment that isn't actually experimental, etc.
posted by rtha at 1:28 PM on April 2, 2010 [3 favorites]


UK's John Lewis department store chain sounds like a large scale version of what Bob's Red Mill Natural Foods is now. 69,000 employees owning the place is a big difference from 209 people who probably know even know everyone else by name.
posted by filthy light thief at 1:30 PM on April 2, 2010 [1 favorite]


A company's primary responsibility is to serve its customers, to provide the goods or services which the company exists to produce. Profit is not the primary goal but rather an essential condition for the company's continued existence.

Say, what's that whirring I hear? Oh, right, it's Ayn "Pinwheel" Rand spinning in her grave [cackle].
posted by FelliniBlank at 1:44 PM on April 2, 2010


People who rise to power are the people who want power, and people who want power are usually dicks.

Film at 11.
posted by klanawa at 1:57 PM on April 2, 2010 [8 favorites]


burnmp3s: "Right, so instead, shareholders just sell their shares when the quarterly profits fail to meet the estimates."

Each company is unique, but in general, Boards of Directors are elected, and can be challenged for their seat. See Carl Icahn. Generally activist investors are fought and resort to proxy fights or outright takeovers.

It should be obvious to anyone who's studied business governance that shareholders are generally screwed. Take a look at the Wikipedia list of defenses against takeover and ask yourself how many are in the shareholder's interest.

At the moment I think there's three roles locked in a struggle: investors, management and labor. Each have unique interests, yet individuals may change their role over time.
posted by pwnguin at 2:03 PM on April 2, 2010


I worked at now-defunct chain of copy shops back in the '90s and the primary responsibility was always to serve the customer. That got changed in the late part of the decade when they were preparing to go public. The new primary responsibility was shifted to the share holder.
Just throwin that out there.
posted by NoMich at 2:07 PM on April 2, 2010


If you think greedy people are maximizing profits at the expense of everything else because of case law you have another think coming.
posted by DU at 2:23 PM on April 2, 2010 [13 favorites]


NoMich's comment reminds me of once coming across an anecdotal story i must have read about a company taking the decision to buy itself back from the "owners/shareholders" (anyone remember this? and were the employees also involved?) so that they could focus on making good products. was it harley davidson?
posted by infini at 3:13 PM on April 2, 2010


It is owned by its employees – or partners – who have a say in how it is run, and receive a share of the profits. Surely this the way every organisation should be run . . .

All publicly traded companies are run that way -- so long as the employees purchase shares when they are hired.
posted by esprit de l'escalier at 3:54 PM on April 2, 2010


I think it's important to remember that "investors" in this context usually means "institutional investors" who run their companies in exactly the same way the companies in which they invest do. Also, most people who run institutional investors form a (relatively small) peer group with the people running the companies in which they invest.

In other words, we're not generally talking about mom and pop individual investors having a say in corporate governance; we're talking about a smallish group of mostly likeminded who see the world mostly the same way.
posted by digitalprimate at 4:17 PM on April 2, 2010


At the moment I think there's three roles locked in a struggle: investors, management and labor.

Has there ever been a Marxist analysis of the role investors play vis a vis the traditional capitalists vs workers?
posted by GuyZero at 4:30 PM on April 2, 2010


I'm pretty sure that a company's primary duty is to pay its CEO as much as it can.
posted by five fresh fish at 4:58 PM on April 2, 2010 [1 favorite]


It's too bad they don't elaborate on their argument and explain how they would rebut, for instance, a recent Delaware Supreme Court opinion (in North American Catholic v. Gheewalla) which appears to confirm the conventional wisdom that "directors must...discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners."
posted by shivohum at 5:00 PM on April 2, 2010


As for consumer-driven businesses (as if there were businesses that weren't), I can't read the whole thing but this quote:
Have shareholders actually been better off since they displaced managers as the center of the business universe? The simple answer is no. From 1933 to the end of 1976, when they were allegedly playing second fiddle to professional managers, shareholders of the S&P 500 earned compound annual real returns of 7.6% From 1977 to the end of 2008, they did considerably worse—earning real returns of 5.9% a year.

is not enough to dismiss investor run companies. Perhaps the full article addresses this, but here's the deal: the S&P weights you by market cap (until recently); if you lose money, you're weighted less, and if you fail, you don't count at all! Just comparing two ranges doesn't account for this survivorship bias.
posted by pwnguin at 6:15 PM on April 2, 2010


People who rise to power are the people who want power, and people who want power are usually dicks.

Film at 11.


Golf clap. Very clever.

But aren't we discussing how these dicks can hide behind this "shareholder value" horseshit which lets them behave even more like dicks?

I'm surprised it's taken so long for this to finally be questioned. What, with all the post Enron navel gazing and Sarbanes-Oxleying and Smoot-Hawleying going on.

ps: I read [CITATION NEEDED] that Sir Richard Branson believes his companies' primary duty is not to shareholders or customers... but to the staff. Sounds like it could work.
posted by uncanny hengeman at 6:17 PM on April 2, 2010


*Nothing to do with the Smoot-Hawley Tariff Act, I just wanted to say "smoot."
posted by uncanny hengeman at 6:19 PM on April 2, 2010 [1 favorite]


It turns out that the law provides a surprisingly clear answer: Shareholders do not own the corporation, which is an autonomous legal person. What’s more, when directors go against shareholder wishes—even when a loss in value is documented—courts side with directors the vast majority of the time. Shareholders seem to get this. They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times. In short, directors are to a great extent autonomous.

This is a good thing, but for the wrong reason. Basically, the article is saying that directors should instead be accountable to nobody. When this makes it out into the field, there will be a great opportunity for the assholes in charge to become even more so. It's not like by dumping toxins into the environment they really thought they were doing the shareholders a favor. Statistically speaking, there is a good chance that at least one of them would be harmed by such an event, and that's not even considering the damage done to the goodwill of the company when it becomes known. (I know I know, they're answer to that would be to cover the thing up.)

The whole problem began, not when corporations became allowed to act in an immoral manner, but when anyone became so allowed. How could such a thing ever be considered to be acceptable by any thinking person? How could they construct a system of ethics that places the value of a hypothetical entity above human lives?

There will come a time in the future when the bland acceptance of the evils of corporations will be looked upon in the same light as Aztec human sacrifice. Provide we all live that long.
posted by JHarris at 6:30 PM on April 2, 2010 [6 favorites]


Interesting article. As I get older and the companies I work for keep getting swallowed up by large publicly owned companies, I'm increasingly aware of how things can change and usually not for the better. This answers some of the questions I've had in my mind about what the options are. Not that I'm leaving a job in this economy though....
posted by Big_B at 7:35 PM on April 2, 2010


And here's how when even convicted, corporations get out of trouble.

The law is just a cost of business.
posted by five fresh fish at 7:42 PM on April 2, 2010 [1 favorite]


Daniel Davies:
… I have a real bee in my bonnet about the claim made by Richard Posner that ” The managers of corporations have a fiduciary duty to maximize corporate profits”. It raises a whole load of topics relevant to plenty of my favourite economic hobby-horses as soon as you start to look remotely critically at what the seemingly simple phrase “maximise corporate profits” actually means anyway.[…]And at this point, of course, the Davies-Folk Theorem kicks in; if you allow strategic and reputational issues to be given weight in managerial decisions, then it is very hard indeed to think of something that can’t be justified as being in the best interests of maximising shareholder value over the long term. Paying above-market wages? Efficiency wage argument, maximises shareholder value. Donating to charity? Part of the marketing budget, don’tcha know. Voluntarily refusing to sell violent video games to children? Forestalls the danger of much more punitive government regulation down the line. Etc etc. It’s pretty much accepted that if the Dodge vs Ford case (which is more or less the basis of the view that directors’ common law fiduciary duty of care implies an obligation to maximise equity value) came to court tomorrow, it would be a pretty shoddy legal team that couldn’t win it for Henry Ford.
(Lots of stuff omitted in the ellipsis; read the whole thing, as they say.)
posted by kenko at 8:49 PM on April 2, 2010 [3 favorites]


Oh, actually one of the best parts is the final paragraph:
Just as a footnote: in comments to John’s post, somebody raised the hypothetical case of whether a corporation would have a fiduciary duty to use slave labour if it was legal to do so. Actually, this isn’t a hypothetical case at all – in Nazi Germany it was legal for industrial companies to make use of slave labour (this is the plot of the film Schindler’s List). Some companies used it, some didn’t. The Nuremberg trials did not recognise the fiduciary duty to maximise profit as a defence.
posted by kenko at 8:50 PM on April 2, 2010 [1 favorite]


While their point is kind of correct - the board is not compelled to do anything other than serve at the discretion of the shareholder- their logic is pretty silly - they analyzed a methodology for effecting board change that no one uses and used that to justify their argument. To top that off they end it with what sounds like an advertorial for a director's education program the no doubt HBS would be happy to sell them.

No one sues to oust a board, they contest a proxy - that's why this article is absurd. Additionally they allude to the Cadbury - Kraft deal as some example of directors dropping the ball while ignoring the fact that there are reams and reams of case law that relate to how a board has to behave when approached with an offer. Not to mention the "voluntary" take over code in the UK which controls the whole process.
posted by JPD at 12:10 AM on April 3, 2010 [1 favorite]


A company's primary responsibility is to serve its customers, to provide the goods or services which the company exists to produce. Profit is not the primary goal but rather an essential condition for the company's continued existence.

Goal - for whom? Profit is absolutely the primary goal for investors. Production of goods and services is the purpose of a company for consumers. Payment of a wage is the purpose of a company for employees. Which of these goals takes precedence, and to what extent, is decided by politics, but under capitalism nothing can ever trump profit for any sustained period. That's part of the definition of capitalist production.

The analogy of electricity is very bad. Electricity comes from outside the office, so of course production of electricity isn't the purpose of running the office (unless the offie is a power plant). Profits aren't purchased from outside, they must be generated within the firm. If firms had to generate their own electricity, you bet it would be their top priority.
posted by stammer at 5:22 AM on April 3, 2010 [2 favorites]


Additionally they allude to the Cadbury - Kraft deal as some example of directors dropping the ball

Interesting little soap opera that deal has been, and many lessons and talking points.

The board of Kraft this past week awarded the CEO a 41% raise (26 mil and change, ten more than the heads of Coke and Pepsi) for her visionary work in seeing through the takeover.* A takeover that major Kraft investor Warren Buffett publicly said was stupid, which required selling not one but two frozen pizza companies that were making good money, which involved laying off Cadbury workers who had been told they would not be laid off, which coincided with some fairly major layoffs within Kraft and the announcement that senior salesmen would get a 10% reduction in their remuneration. All in the middle of the worst recession since the nineteen thirties.

The stock price itself is lower than when she came on board and lower than comparable companies.

Make of it what you will.

*(She, by the way, sits on the board - though not on the compensation committee - which old fashioned I would consider a conflict of interest.)

(By the way, if stockholders don't own the company, what exactly do they own? Or is the answer one of those legal definitions that just make people angry?)
posted by IndigoJones at 9:08 AM on April 3, 2010 [3 favorites]


And I suppose people thought I was being overly cynical.

The days of being a small investor in stocks are over, I think. Between Goldman Sachs insinuating itself into each and every trade, taking advantage of millisecond profit-taking; and CEOs being phenomenally over-rewarded for fucking things up; and the outright lying that goes down every time they produce an annual report — well, the sum of it all is that there is no rational basis for making an investment decision any more. It's all lies and cheating and fucking-over.

I don't know what a person is to do these days. Mutual funds are a ripoff. Invest in the indexes?
posted by five fresh fish at 10:38 AM on April 3, 2010


GuyZero: "Has there ever been a Marxist analysis of the role investors play vis a vis the traditional capitalists vs workers?"

Curious myself, I decided to google up what Marx thought about the subject. Marx took it for granted that workforce didn't have enough income to consider saving. It's important to note that Eurpoean banks at the time were largely regulated national entitles. England and the Netherlands had one; Bismark hasn't yet founded Germany as we know it, but I think the constituent states all had central banks. Hence his accusation 1a that banks are a tool of the status quo.

If you look at his rebuttals with the hindsight of history, it reads like satire. Everything proposed that he derides as counterproductive or impossible has been done and has brought wealth to the poor where it was implemented. We have banks and unions and family planning and child labor laws and public education, which the bourgeoisie where I live absolutely love. Hell, he cites Malthus! I feel fairly confident that the price of wheat fell between 1850 and 1950 (an inflation adjusted time series isn't readily available to me).

I suppose Marx's main problem was either insufficient data or not reconsidering the opinion as new facts arrived. Labor was not yet well compensated when he wrote his most famous publications; with hindsight it's become clear now that economic development can and did lead to growing wages among the poor. But it seems you'd be hard pressed to call yourself a Marxist thinker and write in favor of banking. Not sure what that means for Gosbank.

The modern truth is that Western labor holds a lot of money to invest with in pension funds. CalPERS for example, is known for it's shareholder activism.
posted by pwnguin at 1:20 PM on April 3, 2010 [1 favorite]


At the moment I think there's three roles locked in a struggle: investors, management and labor. Each have unique interests, yet individuals may change their role over time.

I would add consumers, but only for specific industries where product choice is wide and varied. Example: handheld electronics. It would only take Apple making one incredibly shitty product for the tide to shift completely. It would take them one incredibly good product to recover most likely, but it's still a power struggle.
posted by swimming naked when the tide goes out at 2:09 PM on April 3, 2010


uncanny hengeman: "But aren't we discussing how these dicks can hide behind this "shareholder value" horseshit which lets them behave even more like dicks?"

They'll hide behind whatever gives 'em enough cover. Sure, it'd be nice if this particular excuse went away, but there are a million more waiting to be exploited. Saying that it's the loophole that causes people to act like dicks, rather than the fact that they're dicks, is just another incarnation of the short-skirts-cause-rape argument.
posted by klanawa at 2:23 PM on April 3, 2010


The current problem in corporate and shareholder diligence is that all costs are not computed; thus, ideas about what constitute "value" become perverted to the detriment of the shareholder, and society.

Current understanding has it that shareholder value lies in the direct value of ownership of discrete corporate assets, with the corporation responsible for the optimization of the dollar value of those assets. This is a very myopic definition of shareholder value.

If a corporation performs acts that maximize immediate dollar value, but do near- and long-term social, fiscal, environmental and other kinds of (measurable) harm that actually cost those same shareholders to lose some of all of the dollar value of their shares in other ways, how is that optimizing shareholder value? In fact, it's just the opposite. If I make a profit in my corporate holdings because Corporation A exploits the environment in ways that hurt my (or another's) health, how does that increase my shareholder value? In fact, it's robbing Peter to pay Paul.

The idea that one's corporate shares, and the value they hold, are somehow separate from other parts of one's "value-environment" is a convenient myth. Everything is connected (John Donne could be quoted here - i.e. "For Whom the Bell Tolls"); "shareholder value" is not a discrete quality, separate from other kinds of (measurable) value that directly impact the real value of the shareholder's holdings (shares).

What are the overall social and fiscal costs of discrete corporate actions in pursuit of profit? How can we better learn to measure those costs, and then apply them back into the corporate balance sheet? Until we have a better answer to questions like this, and become rigorour in measuring negative value, we will we not have an accurate measure of corporate shareholder wealth- a measure that appropriately ties into relationships among the entire social, fiscal, environmental , educational, etc. ecological spectra, because the value created or lost by corporate action has a direct bearing on the discrete value of shares held by any one stockholder, including future of the corporation.

In sum, "shareholder value" is defined more by a spectrum of impacts caused by corporate action; it's more a feedback value loop than a one time, discrete measuring of value. Until we better understand that, and enforce it with policy, we will continue to hamper ourselves with an outmoded way of thinking about "shareholder value", up to and including stripping far more value from our world than we realize when we cash in faux, "winnings".
posted by Vibrissae at 3:50 PM on April 3, 2010 [2 favorites]


I wonder whether it would be possible or viable to establish an enterprise where the customers are all shareholders. Perhaps a company which only sells to shareholders, but allows one to buy shares easily with one's first transaction, and to keep track of them, collect dividends and vote. It would be easiest to do online through the internet. Has anything like this been tried?
posted by acb at 5:04 PM on April 3, 2010


that's what a co-op is
posted by JPD at 5:16 PM on April 3, 2010


Has there ever been a Marxist analysis of the role investors play vis a vis the traditional capitalists vs workers?

Yes, lots. Don't pay attention to pwnguin's source (it's dated 1847 - Marx wrote it in his 20's). Marx himself made a brief, notorious remark that the joint-stock company was the "negation of capitalism within capitalism", or something like that, but most Marxists disagree with this and see distributed ownership as allowing capital to operate more "purely", to realise its inner tendencies more fully.

The best-written Marxist analysis of this kind of thing - what investment is, what publicly traded companies are, how stock exchanges work, and the relationship between investors and managers - is Doug Henwood's "Wall Street: How It Works and For Whom" (382-page PDF), which is also free because Verso let it go out of print and Henwood resents it. It's a really terrific book.
posted by stammer at 6:45 PM on April 3, 2010 [3 favorites]


I quoted Peter Drucker: A company's primary responsibility is to serve its customers, to provide the goods or services which the company exists to produce. Profit is not the primary goal but rather an essential condition for the company's continued existence.

stammer: Goal - for whom?

For management, i.e. the class of employees responsible for running the company. Drucker is arguing that management's primary goal should be to serve its customers. Profit is necessary, but not the primary goal.

How much influence do Drucker's ideas have in practice in American corporations? At Hewlett-Packard and Agilent, where I worked for 20 years, I'd say they were pretty influential (and HP's corporate culture in turn has been broadly influential in the high-tech sector). At HP, the idea is that profit is a measure of the value that you're providing to your customers. They buy goods and services from you at a profit because they value them.

Of course, I can't comment on what corporate culture is like in other sectors, like pharmaceuticals or investment banking.

Profit is absolutely the primary goal for investors.

As an investor myself, I want to earn a reasonable rate of return--something higher than I would get from an interest-bearing investment, because there's more risk involved--but I'm not interested in maximizing profits at the expense of everything else. In that respect, I think Drucker's argument is reasonable: a company needs to produce sufficient profits to satisfy shareholders, but it doesn't need to maximize them.

The analogy of electricity is very bad. Electricity comes from outside the office, so of course production of electricity isn't the purpose of running the office (unless the office is a power plant). Profits aren't purchased from outside, they must be generated within the firm.

Whoa, profits aren't "generated within the firm"--they come from customers! (More precisely, revenues come from customers, and profits are what's left after subtracting costs.)

Companies do lots of things internally which aren't their primary purpose. Large companies typically have internal IT departments which run their computer systems, for example. That doesn't mean that IT is the primary purpose of the business.
posted by russilwvong at 4:44 PM on April 4, 2010


Profit is necessary, but not the primary goal. ... At HP, the idea is that profit is a measure of the value that you're providing to your customers. They buy goods and services from you at a profit because they value them.

OK, so profits aren't the goal. Being good to customers is the goal. And how do you measure your goodness? In profit...

Large companies typically have internal IT departments which run their computer systems, for example.

A firm can purchase electricity from a supplier, or run its own generator. A firm can outsource IT, or handle it internally. But it cannot under any circumstances outsource profit, nor can it buy profits from the Profit Company so it can devote its time and resources to more constructive pursuits.
posted by stammer at 8:33 PM on April 4, 2010


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