The Firm, Yet Again
There is a new eBook published by the Stigler Center which is an offshoot of the Booth Business School at the University of Chicago. The publication contains a number of short essays either attacking or defending the infamous pronouncements by Milton Friedman on the role of the corporation. This year, you may recall, is the 50th anniversary of the newspaper article in which Friedman described his view that the purpose of the corporation is too maximize shareholder value. The subsequent decades have seen that view permeate the business and legal systems such that to argue against it is seen as oddball in the extreme.
Steve Kaplan leads the defense of Friedman with the opening essay and slides almost immediately into a humdrum general defense of capitalism rather than staying on the specific topic of the corporation. Thus we read this:
“Many observers, including the organizers of the Stigler Center’s Political Economy of Finance Conference, believe that his view has been extremely influential. It has been implemented in the US and globally starting in the 1980s, encouraged by scholars like Michael Jensen (a Booth alum and my thesis advisor).1What has been the result of corporate shareholder value maximization mixed in with globalization? Let me cite Nicholas Kristof, of the New York Times, who wrote at the end of 2019 (and pre-pandemic): “For humanity over all, life just keeps getting better.” People living in extreme poverty fell from 42 percent of the world’s population in 1981 to below 10 percent today. That is 2 billion people who are no longer suffering extreme poverty. Absolute poverty declined substantially in the US, from 13 percent in 1980 to 3 percent today. And this is more or less what Friedman predicted. The pandemic will affect these numbers, but I am hopeful that the effect will be temporary.”
Notice that the reduction in world poverty is, apparently, a consequence of the acceptance that corporations ought to devote themselves exclusively to enriching their shareholders. This extraordinary over-reach is best left to you to absorb and think over at your leisure. Just make sure you are sitting down when you do so.
This claim follows a subtle revision of Friedman’s intentions. In order to immunize against what he clearly thinks is a vulnerability in the Friedman line of thought, Kaplan adjusts Friedman’s use of the word”profits”: the word is narrowed to mean “long term shareholder value” as if the specification of the longer term somehow eliminates the corrosive worry that corporations have become ever more short term in their focus. Of course they have. The average share is owned for a paltry four months. There are fewer long term shareholders than there were in Friedman’s day, and the manic search for that little extra profit is one of the root causes of the much criticized short term nature of most management nowadays. But, the longer term view is, we are assured, what Friedman “surely meant”.
Then he ought to have said so. Friedman was never one to avoid saying what he meant. So I think when he said “profits” he meant exactly that. Kaplan’s revision is simply an attempt to soften a potential fatal blow against his idol.
It gets better: Kaplan suggests that all those who argue for a return to the older stakeholder focus for management are creating insurmountable difficulties. Just how, he asks, is management supposed to choose between all those competing ends for whatever their limited resources are? Worse still, since, he goes on, corporations compete against other value maximizers, any corporation who fails to maximize will likely invest less efficiently and operate worse. Notice the weasel word “likely”, it sounds as if Kaplan is a little unsure of himself.
And that’s it. That’s all we need to know. Without shareholder value as a single point of focus, our managers will dither, dally, and the world will slide into oblivion. Kaplan’s convinced:
“To conclude, Friedman was and is right. A world in which businesses maximize shareholder value has been immensely productive and successful over the last 50 years. Accordingly, business should continue to maximize shareholder value as long as it stays within the rules of the game. Any other goal incentivizes disorder, disinvestment, government interference, and, ultimately, decline.”
Oh no! Disorder? Disinvestment? Government interference? Decline?
Enough. This is old ground. The fact that the shift towards shareholder value exactly coincides with the stagnation of wages, the helter-skelter dive into globalization, the decline in domestic investment, and the rise of populist politics is just, well, a coincidence.
As ideas go shareholder value has been a failure for most households. CEOs have done well though, and they probably will continue to direct their generous support to the Stigler Center, and the various academics it houses, in return
It is an irony that I came across the Stigler Center eBook this morning just as I was about to comment on the continuing confusion in economics over the firm. It is a stunning omission from mainstream economics that there is no well worked through story of how business sits within the economy. The continued effort to flatten business into the pre-existing, and more easily mathematized, structure of aggressive individualism, distorts reality out of all recognition. It’s as if physicists theorized the universe only as an assemblage of atoms. No stars, galaxies, or even planets, just atoms. Imagine the lack of insight that would result from such an approach. Yet that its exactly what economics does. No intermediate structure is tolerated between the individual and the market [whatever that is].
This is laughable. But that’s what economics is.
When economics tries to engage with the firm is is almost invariably through the lens of contracts and the cost of transacting. This is familiar turf for economists, so they attempt to bash the firm into a shape they can deal with using their preferred methods. They ignore anything that gets in the way of this wholly unscientific approach.
Just too add to the confusion, economists are prone to use the. two words “firm” and “corporation” interchangeably. This is a monstrous error. The two are totally different animals. Confusing them leads to all sorts of subsequent errors. One of which is the notion of shareholder value. Friedman might not have expounded as he did had he grasped the difference between a firm, which is an organization created to undertake economic activity, and a corporation, which is a legal person created as a shell within which a firm may, or may not, sit.
The impact of understanding this separation of the two concepts is profound. One of which is that a corporation is decidedly not owned by shareholders. The entire Friedman project unravels at this point. Corporations are not owned by anyone. They exist at the whim of the state to perform functions that further the ends of the state. In return for so doing they are given all sorts of legal capabilities such as that of limited liability, the ability to sue and be sued in court, to own and dispose of assets and so on. Shareholders are peripheral. They own pieces of paper that give them access to financial rewards as defined by the board of directors. After the initial influx of capital at the launch of the corporation, shareholders contribute nothing. They benefit from the upside potential of the stock price, but are immunized against personal losses if the corporation fails or goes bankrupt. It is rare to hear economists comment on this monumental example of moral hazard. Which is odd because they like to rabbit on about it elsewhere.
Legal personhood is an extremely valuable asset that the state endows a corporation with. It is an ancient concept — the Romans had corporations precisely because of the benefits the concept bestows. It is a privilege to be a corporation. It allows economic activity to be defined and protected against risks that might preclude that activity otherwise. Indeed the modern use of the corporate form since industrialization is a recognition of the immense value legal personhood brings into commerce. It is a vital technology the absence of which would most certainly have hampered modern economic development. We all benefit from the existence of corporations. They mitigate risks as they help stave off uncertainty. Everyone associated with a corporation receives these benefits, not just shareholders.
On the contrary, shareholders rank low within a corporation. Least of all do they “own” the corporation. In David Ciepley’s words:
“And all of the rights over the firm’s assets that we normally think of as bundled into the right of ownership – such as rights to exclude, use, lend out, collateralize, sell, or profit from the use or sale of an asset – are held by the legal entity and exercised on its behalf by the board and its hirelings. The stockholders possess none of them, which makes them very odd “owners.”
Odd indeed.
Perhaps Kaplan and his hero Friedman need to revise not just the word profit, but also their entire notion of ownership.
No one owns a corporation. It is a ward of the state.
