corporations

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Tax Stock Buybacks?

Taking a short break from my crusade to get information taken more seriously in economics …

Yesterday’s Financial Times includes, on page 9 of the print edition, one of its regular “Market Insights” columns.  This is the space the FT allocates to sundry financial market types to opine on subjects of general interest to other financial market types.  It’s always a good read if you want to gain insight into how our magnificent financiers talk to themselves whilst allocating capital appropriately around the economy.  Well that’s what they see themselves doing, so let’s not nitpick.

The column yesterday was written by a luminary of the investment community, someone who sat on the board of a popular retirement fund, and who has written extensively on subjects related to finance, investing and so on through the years.  The subject was the possibility of eliminating the new tax that Congress just established on stock buybacks.  The new tax, all of 1% and thus hardly onerous, has stirred up a ton of ire in the corporate world where stock buybacks are viewed as a centerpiece of good “stewardship”.  That is if you consider stewardship to be centered purely on making shareholders happy.

Stock buybacks have become a go-to method for boosting stock prices at appropriate moments — dare I say just before the CEOs allocation of stock vests?  No that’s me being too cynical.  They have also become accepted as part of the arsenal of good governance of a modern corporation.  Excess capital ought, in the absence of new internal investment opportunities, be returned to the shareholders so that they can then re-allocate it in their portfolios to higher return projects.  It sounds so anodyne when you say it out loud that way.  And from within the hermetically sealed bubble of high corporate finance it is extremely sensible.

Except.

Let’s face it, it’s a tax dodge.  The corporation could pay the cash back as a dividend instead,  But that’s subject to a different tax rate.  Share buybacks make more sense.  They are “tax efficient”.  What an ugly and laden term.

So, the article’s author says, as the cash flows pile up and there are apparently no great opportunities for managers to use it within the day-to-day business, why not give it “back” to the shareholders?  And that new 1% tax is simply an unnecessary dabbling in management by an ungrateful and perhaps spiteful Congress.  Besides, gasp, it might make American business uncompetitive.  If all it takes is a paltry 1% tax on stock buybacks to make American business uncompetitive, then I suggest there are bigger problems to remove.

What the author doesn’t consider are alternative uses for that excess cash.  In his mind it is either retained within the corporation or it is “returned” to the shareholders.  I have other suggestions — I am trying to be helpful here.

How about lowering prices in order to reduce excess cashflow?  Pass the benefit along to consumers.  That would be one option.  It’s one that economics text books like.

How about raising wages?  Or, if you want to be conservative, paying out bonuses to your workers?  That would be another option.  The economics textbooks wouldn’t like this one unless each workers marginal productivity has gone up.  But we can try.

I am just trying to be helpful!

Either of those might get rid of the awful headache of having too much cash on hand.  Both might garner more support and/or enthusiasm for the corporation.  Just think: if people and workers look more kindly on the business they might be more apt to consider those alternative new products that the corporations is currently shelving.  You never know.  The business might grow and gobble up that excess cash.

Who knows?  It’s worth try.

Now, about the scare quotes I put around a couple of words up above.

I object to the trope that corporate cash is the property of shareholders and thus could be given “back” or “returned” to them.  Very very few of the current shareholders have ever contributed cash to a modern corporation.  They have simply bought paper in a secondary market.  They do not “own” the corporation’s cash.  That cash is the property of the business to use as it sees fit.  Like pay workers more.  The idiotic notion that good corporate governance begins and ends with the relationship the business has with the owners of whatever paper it issued in the past is one of the reasons that the economy is less vibrant than in the past.  Good governance extends beyond that.  Way beyond.  The error of blind attachment to the concept of shareholder value is a tragic one for workers, consumers, and society at large.

So let me repeat: yes, there are options for the use of the excess cash beyond stock buybacks.  Like lower prices or higher wages.

That a doyen of the investment community doesn’t comprehend that, or acknowledge it, is a sign of how far we have to travel if we are to rebalance the economy and society away from the real excess: our over-emphasis on finance.

 

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Personhood

Critics of large corporations very often center their anger on the notion of “personhood”.  The concept gained much more notoriety after the terrible Citizen’s United case a few years back.  On the left the idea that a corporation should be a legal person has become an anathema.

They are wrong.  Personhood is a valuable concept that needs to be preserved.  Our criticism ought not be about the legal nature of a corporation, it ought to be about the lack of regulatory enforcement of the contract with society that is a function of our giving corporations that privileged status.  In a nutshell: we have forgotten that the state is the creator of corporations.

There are very few economists who grasp the difference between a firm and a corporation.  I have attempted to describe that difference on more than one occasion and feel I haven’t made much progress!  Personhood is an aspect of the difference and is, in fact, central to it.

We use the word “firm” to describe an economic entity.  A firm is a cooperative structure created to oversee the complicated production processes demand by our increasingly complex economy.  It occupies a space in the economy that opens up because the market can only mediate simple transactions.  As the information content of transactions rises we need to create new institutions to mediate them — institutions that can marshal and channel the information appropriately.  Markets cannot do that without incurring prohibitive transaction costs.  Besides, and beyond transaction costs, the very act of cooperative production implies the need to assemble capital, people, machinery, and expertise of various kinds through time.  That is an order of complication that a market just cannot sustain.

That, of course, is just my version of it, but the general idea is constant.  A firm is an economic concept.

But, during the early years of industrialization, when the need to put economic activity outside the marketplace in order that it could be realized became obvious, early firms looked around for a method to mitigate the risks inherent with that assemblage of assets and, especially, with the problem of time.  Fortunately for those early pioneers there was an existing legal form they could place the firm within.  That form was the legal person known as a corporation.  Being a legal person bestowed on a firm all sorts of vital privileges that went a long way towards solving the business risks that were beginning to pop up in the early industrial era.

Corporations had been around for millennia.  The Romans had their own version.  The Catholic Church had become particularly attached to the idea of legal personhood.  The attraction was, in particular, the longevity of a legal person: it doesn’t die.  So assets owned by a legal person can continue to be in use long after a generation of custodians of those assets has passed away.  The disruption caused by having to dissolve the association and dispose of the assets at the death of a partner, or other custodian, is obviated if the person owning those assets has an infinite life!

Similarly, a legal person is an entity that can appear in court, it can enter into contracts in its town name, it can be sued and it can sue.  These rights massively simplify the social impact of the entity housed within the corporate shell.  Outsiders can easily identify who to sue.  They don’t have to go to the expense of chasing down a whole bevy of miscellaneous actors, they can target just one.  And so on.

Then there is the limited liability of the contributions to the assets housed within the legal person.  Since those assets are not owned by any one individual, but are owned by the corporate person, the financial contributors to the cost of those assets and, crucially, to any liabilities that accrue to the activity of those assets, are shielded from direct personal responsibility for those liabilities.  This is a huge advantage and makes it much more easy to raise sufficient funds to procure the assets needed to undertake large-scale industrial activity.  It also insures against the specificity of those assets: since many industrial assets have only one use, it is a very high risk to fund them.  Limited liability was a significant risk reducer and thus encouraged development that might not otherwise have happened.

So legal personhood was neither a modern notion, nor a creation oof capitalism.  It was a pre-existing notion, much used by medieval and earlier institutions, precisely because it solved major management problems that are not specific to industry.  In the words of Pope Innocent IV during the thirteenth century:

“Cum collegium in causa universitatis fingatur una persona”  The entity is in corporate matters figured as a person

Personhood is a vital piece of legal technology that allows much of modern business to exist.  We ought not decry it.

What we need to do is to focus, instead, on enforcing the state’s supervision of corporations because their ability to use personhood is a gift from the state.  They all exist because they have a state charter allowing them to exist. Society has, therefore, a right to ensure that corporations fulfill their side of the bargain.  They need to behave in a socially responsible manner or risk losing their charter and the benefits that come along with it.

Oh, and that charter creates the corporation.  Which, much to the annoyance of mainstream economists, means that the corporation exists prior to receiving any funding.  Thus the contributors of funds, we often call them shareholders, cannot own the corporation.  It existed before they showed up.  They simply contributed funding to a pre-existing entity.  Corporations, being legal persons, own themselves, they are not owned by outsiders no matter how much funding those outsiders may have contributed.

Which kind of blows up the entire body of thought known as “shareholder value”.  Milton Friedman was in this, as in so many other things, an ideologue and not a very good analyst.

But that’s another story.

 

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Corporate Reckoning

The aftermath of a coup attempt is one of those moments when a nation gets a really serious insight into its values.  Do, for instance, its politicians rally around some higher set of principles, or do they slide quickly back into the day-to-day argy-bargy of political positioning and infighting?

Ours are perilously close to the latter.  And this after their own place of work was invaded and trashed while they hid and cowered in sundry hiding places.  Profiles in courage are few and far between right now within our politics class.

The reason is obvious: one of major political parties is complicit in the ruin of democracy and in the rise of a far right version of populism based on white supremacy, nativism, and grievances of various sorts.  Perhaps this was the inevitable consequence of forty years of false doctrine and anti-social agitation during which the very word government became reviled and scorned by those swept along by that doctrine.  Perhaps it was the inevitable consequence of the highly planned and disciplined attack on democracy orchestrated by the panoply of right wing think tanks and media outlets established during the late 1970s for the specific purpose of ruining the ability of the middle class to protect itself from our oligarchs and big corporate interests.  Or, perhaps, it was simply neglect and complacency on the part of a voter population who bought into the saccharine and sanitized history fed them after World War II — a history in which Americans always wore the white hats and in which the constitution was not a piece of paper to be updated to suit each generation’s context, but which was beyond reproach and beyond amendment.  Is it a coincidence that the last amendment to the constitution came right at the rise to ascendancy of the neoliberal elite?

Our bookstore shelves groan under the weight of recently published screes describing the imminent demise of American democracy.  The topic has become an obsession in leftist circles throughout the country.  These books all purport to describe how democracy ends, and they all target the rise of far right sentiment within the Republican party.

But these books are wrong.

The end of democracy was a long time ago.  It came about when both our political parties succumbed the the false doctrines of extreme thinkers like Hayek and Friedman who both harbored deeply anti-social sentiments draped within a cloak of intellectual righteousness.  The end of democracy began with the publication and circulation of the infamous Powell Memorandum amongst the members of the US Chamber of Commerce.  That terrible, ideologically driven, document became the manifesto of the far right and of its corporate paymasters.  The alliance forged between right wing economists and the corporate sector, which remains solid until today, is a significant aspect of the quiet revolution orchestrated by our oligarchs and supported by the veneer of intellectual rigor provided by economists driven by market sycophancy.

The demise of our middle and working classes was inevitable.  The stagnation of wages was inevitable.  The corruption of our government was inevitable. And the rise of Donald Trump was inevitable.  As was the recently failed coup attempt.

That Powell memorandum set in motion a cascade of capture of the citadels of academia by the false doctrines of Hayek and Friedman.  It encouraged the work of eager academics who were trying to make reputations for themselves rather than pursuing true rigor.  The result was a steady trickle, within the business organization literature, of ideas that sought to cement the libertarian worldview and to supplant the earlier, more nuanced, post-war view.

The rise of this neoliberal order found a welcoming and well funded home in corporate America.  The destruction of the myth of opportunity for all began right there. The blindness of the academic elite that proselytized liberty whilst abetting oligarchy is an astonishing feature of the past forty years.  Still today ardent advocates of whatever it is they describe as liberty fail to see the loss of freedom that their ideas inevitably create.

So, here we are at a point of reckoning.

The decisions made over the next few days and weeks will determine whether America slides further into failed state status, or whether it pulls itself back from the abyss.  Judging by the complete surrender of a large part of the Republican party to anti-social thought, and to their embrace of extreme methods in their attempt to maintain power, the odds of a full recovery are poor.

I have seen commentators talk about the kind of agenda we need to lift ourselves back up.  First, they say, we need to occlude any chance for Trump to will political power in the future.  That is obvious.  He needs to be accused and convicted.  He needs to be banished.  Second, they say, we need to address the long term and deep malaise caused by the neoliberal ideology that has strangled our discourse.  Good.  Let’s begin with economics.  Third, they add although tentatively, we must reform our system of government to protect its values and to make real its claim to be open to all equally.  It never has been open to all: even after the passage of the civil war amendments the reality of racism was allowed to flourish throughout the nation.

I want to add a fourth: we need to revise our relationship with our large corporations.  They are the source of political corruption with their flood of money and lobbying in Washington.  They are the creators of most of our social-economic policies regarding the workplace, work/life balance, affluence, the distribution of wealth, and the pace of technological change.  They play a pivotal political role.  They are major political actors.  Any healthy democracy needs to recognize this fact and regulate accordingly.

Our economy is administered.  It is situated within, and is an artifact of, the rising complexity of life brought about by the steady accumulation of information humanity creates simply by living, interacting, and sustaining itself.  The division of labor long since rendered obsolete any theories dependent upon a simple worldview of individual transactors inhabiting a low information landscape.  Corporations are a necessary feature of the need to administer the mediation of economic activity in a landscape featuring a much more dense information concentration.  We cannot avoid the need for administration.  Business firms housed within the legal shell called a corporation are here to stay.  It is our obligation, and our right, to call them to task for their attack on democracy.

We need corporate reform just as much as we need political reform.

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Under Pressure

I am learning that it takes a while to come to terms with the trauma of an attempted coup.

Various people are reacting differently depending on their state of mind prior to the attempt.  What catches my eye, given my own perspective on the role of business in society, is the pressure emerging on our large corporations.  Having spent the past few years busily ignoring the moral corruption and ineptitude of the Trump regime business leaders are suddenly trying to appear pious.  Many of them are suspending their support for political groups and individuals.  Others are suspending social media platforms that were used to organize insurrection and ferment violence.

This is all too little too late.

The equivocation that allowed major corporations to support Trump whilst overlooking his manifest moral failings simply so that they could benefit from tax cuts and reduced regulation stains those corporations forever.  It is an example of the transactional thinking produced by a rigid application of the flawed notion of shareholder value permeating the business world.

Let’s set the record straight: corporations are wards of the state.  They exist because the state says they can exist.  That’s what obtaining a corporate charter implies.  Actually it is an explicit, not implicit, relationship.  In return for being given a charter a firm, which then becomes a corporation, commits to providing socially beneficial services.  It is a classic example of a state/private sector partnership.  The charter brings with it a variety of benefits available only to corporations.  So as firms accept those privileges they surrender their market purity: they become hybrids, they become agents of the state.

It is the inability of most economists to understand the vital difference between a “firm” and a “corporation” that has bedeviled the development of our understanding of institutions and their role in mediating transactions in the face of radical uncertainty.  Firms and corporations may look similar when viewed through the narrow lens of economics, but they are very different structures with very different consequences for economic development.

This is not the place to opine further on that difference, except to point out to anyone interested, that, as wards of the state, modern corporations are obligated to act socially responsibly.  That includes not funding politicians who advocate violence or who seek to undermine democratic elections.  So acting responsibly is not some amazing attribute of a “woke” corporation.  It is an expected attribute.  It is something we ought to demand.  Indeed: acting otherwise ought to bring with it the potential loss of the charter that is so central to the corporations survival.

This is a moment when getting rid of our muddled thinking about what appear to be arcane definitions of what a “firm” is becomes vital.  We need to shift this discussion out of academia where it is doomed to wallow in endless hair splitting, and get it into a more open domain where we can build pressure on our corporations to be sensitive to the socio-economic consequences of their actions.

Finally: let’s also be clear.  We have for far too long outsourced swathes of socio-economic policy making to the business sector where a transactional attitude born of a false theory has produced a level of inequality, insecurity, and inequity that has undermined the nation and torn its social fabric wide open.

We need to take back into the democratic domain that policy making so that we can all invest in the outcomes.

So it is good that business is under pressure.  It has run free too long.

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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.

 

 

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