The shareholder-stakeholder debate may be closer to political economy than to financial economics.
Coincidental pairing of issues has a way of shaping discussion, if not necessarily improving it. But if issue pairing does nothing else, it makes for interesting rhetoric. It turned out that the 50th anniversary of Milton Friedman’s Sunday New York Times magazine article -- “The Social Responsibility Of Business Is to Increase Its Profits” -- occurred in the middle of a debate over Colin Mayer’s advocacy of the need for a “corporate purpose” beyond the interests of maximizing shareholder wealth and his leadership of The British Academy’s project on the Future of the Corporation and the corporation’s obligation to stakeholders – all those people and institutions affected by corporate action. It is fair to say that absent the use of Friedman’s informal account as a foil, the debate might have been more focused.
U.S. CEOs of very large corporations acknowledged that they needed help to protect both their discretion to select the corporation’s purpose and their positions.
On the U.S. side of the Atlantic and at roughly the same time, the Business Roundtable, the quintessential U.S. representative of large public corporation senior management, shifted its position from Friedman’s to Mayer’s in a public about face. Abandoning its 1997 statement that a corporation’s purpose is to “generate economic returns to its owners”, in 2019 it redefined corporate purpose as a “fundamental obligation to all of our stakeholders.” (emphasis in the original). To its credit, the Roundtable acknowledged that the shift was motivated at least in part by “growing pressures from corporate raiders.” Put simply, U.S. CEOs of very large corporations acknowledged that they needed help to protect both their discretion to select the corporation’s purpose and their positions. From managerial capitalism to shareholder value maximization and back again with raiders driving the cycle.
But the dispute between the Friedman and Mayer positions, and the gymnastics of the Business Roundtable, are hardly the only coincidences of issues that have driven the framing of the current corporate purpose debate. I want to illustrate the phenomenon by reference to two other related coincidences. The first is the virtually simultaneous publication in the mid-1970s of The Visible Hand: The Managerial Revolution in American Business, Alfred Chandler’s iconic account of the development of the U.S. structure of managerial capitalism and the complementary corporate governance, and Michael Jensen and William Meckling’s classic framing of the role of agency costs with respect to both management and governance. The second is the evolution of the debate over the competing claims that, on the one hand, the capital market is myopic and, on the other, that managers are hyperopic.
The Coincidence of Chandler and Jensen and Meckling
Jensen and Meckling saw the separation of ownership and management not as a problem, but as efficient specialization between the providers of managerial talent and the providers of capital.
In the Visible Hand, Chandler tells the story of how in the period between 1840 and World War I, U.S. corporations grew in scale and scope (the title of Chandler’s second account of the evolution of the organization of modern American industry – Scale and Scope, The Dynamics of Industrial Capitalism) by shifting the organization of production and distribution from transactions between small single purpose firms to the vertical integration of the firm with the resulting increase in the firm’s scale of manufacturing and distribution. The rapid growth in firm size and complexity then required sophisticated internal management to undertake the coordination and monitoring of production that previously had been provided through markets; in Chandler’s terms, “why the visible hand of management replaced the invisible hand of market mechanisms.”(p.6) In turn, the visible hand necessary to support the new organization of production became an increasingly technical and professional “managerial hierarchy.“
The development of a hierarchy of professional managers in turn reshaped what the current debate now calls the corporate purpose of large companies. The corporation’s strategy was no longer driven by owners or capital providers, but by the demands of the new organizational structure that Chandler called “managerial capitalism.” “Part time owners and ordinary shareholders left current operations and future plans to career administrators: In many industries and sectors of the American economy managerial capitalism soon replaced family or financial capitalism.” (p. 10).
The result of this evolution provides the link to Jensen and Meckling and the framing of the tension between managerial capitalism and capital market monitoring that drove the current corporate law debate starting at least in the early 1980s. In Chandler’s words:
“ [I]n making administrative decisions, career managers preferred policies that favored the long-term stability and growth of their enterprises to those that maximized current profits.
For salaried managers the continuing existence of their enterprises was essential to their lifetime careers. The primary goal was to assure continuing use of and therefore continuing flow of materials to their facilities. They were far more willing to than were the owners (the stockholders) to reduce or even forgo current dividends in order to maintain the long-term viability of their organizations. …If profits were high, they preferred to reinvest them in the enterprise rather than pay them out in dividends.” (p. 10).
And now the coincidence of issues between Chandler and Jensen and Meckling starkly appears. Jensen and Meckling saw the separation of ownership and management not as a problem, but as efficient specialization between the providers of managerial talent and the providers of capital. To be sure, the incentive of managers to favor growth and stability over profits was in Jensen and Meckling’s terms an agency cost, but from their perspective, the issue was how to organize the firm in a fashion that maximized efficiencies from specialization while minimizing the agency costs of managerialism. The debate over one of the techniques through which to accomplish the Goldilocks goal of getting the enterprise size just right – the 1980s bust up takeovers – highlights how the coincidental pairing of issues shaped discussion.
Conclusion: Corporate Governance versus Real Governance
The political economy question then is to whom is the corporation accountable for the two categories of decisions.
I have argued elsewhere (2022) that the shareholder-stakeholder debate may be closer to political economy than to financial economics. In very general terms, public corporations make two categories of decisions: allocative decisions that address the efficiency of the corporation’s activities and distributional decisions that allocate the value created by those activities differently than would be dictated by the factor markets that mediate between the corporation and its various stakeholders. (Of course, if those markets were perfectly competitive, the corporation would have no influence over allocation.) The political economy question then is to whom is the corporation accountable for the two categories of decisions. The short answer is that allocative decisions are made through the corporate governance structure for which corporate management is accountable to markets: product, input and control. In contrast, distributional decisions are made by real governance through transfer payments dictated by, for example, social welfare programs, regulation of working conditions and environmental obligations. For these, corporations are accountable to the political system, rather than to a board of directors elected increasingly by large institutional investors. This leaves open the more difficult question: Under what circumstances is corporate governance and real governance better suited to accountability.
At this point, the second issue pairing becomes obvious. Mark Roe has written convincingly that the immediate precursor to the corporate purpose debate -- that managerial short-termism resulted from, in the Business Roundtable’s framing, the pressure from raiders to pursue shareholder primacy – was not convincing. But taking Roe’s point a step further, the problem was not just that the market might be myopic in over discounting the long term. It was also that managers might be hyperopic in under discounting it: if only management were given enough time, their long-term strategy would prove right (the same argument that would be supported if management were treated as holding an out of the money call option whose value would be increased by extending the term). Here the prominent anecdotal examples are the evolution of GM and GE.
Insight from this short discussion is that corporate governance issues run in pairs, and the terms of each are shaped by the those of the other.
* Ron Gilson is an ECGI Fellow, and Stern Professor of Law and Business, Columbia Law School; Meyers Professor of Law and Business emeritus, Stanford Law School; Senior Fellow, Stanford Institute of Economic Policy Research.
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