The Wrongologist

What’s
Wrong Today:

Readers of
The Wrongologist blog believe that today’s version of capitalism no longer functions in a manner that makes
all stakeholders better off. Let’s remember that a firm’s stakeholders
include the shareholders, employees, customers, suppliers and the communities in
which the firm operates.

Take a look
at the ratio of corporate profits to GDP since 1950:

Without
the inconvenient interruption of the Great Recession, it is almost straight up
since 2000. Let’s also remember that we still have more than 11.5 million
Americans unemployed and that we have 3 million fewer jobs today than in 2008.

In
Big,
Bad and Wrong Ideas, the Wrongologist argued that the idea that mandates
that companies must maximize return to shareholders needs to be reassessed. We
cited the following:

• Today’s shareholders are the most mobile of
  corporate stakeholders:
  High frequency trading represents 70+% of today’s stock trading by volume. High
  frequency shareholders hold their positions for fractions of a second, so they
  are only interested in corporate strategies that maximize short-term profits
  and dividends.

• Professional
  funds managers own large chunks of equity in public firms. They have a free
  hand to get wealthy because they earn management fees tied to the fund’s size, without
  real responsibility for the longer term performance of the corporations whose
  equity they hold.

• Some
  companies even ignore votes by shareholders that turn directors out of office.
  So the power of small shareholders has diminished over time.

How
did the idea of maximizing shareholder value become enshrined in the business
lexicon?  Its intellectual underpinning
is a 1919 case decided in the Michigan Supreme Court called Dodge vs. Ford
Motor Company.

In 1916,
the Ford Motor Company had a capital surplus of $60 million. The price of the
Model T had been successively cut over the years while workers’ wages had increased.
Henry Ford wanted to end special dividends for shareholders in favor of
investments in new plants that would enable Ford to increase production, while
continuing to cut the costs and prices of his cars. Ford declared:

The minority shareholders objected to this
strategy, demanding that Ford stop reducing his prices since they could barely
fill current orders for cars, and to continue to pay out special dividends from the
capital surplus in lieu of his proposed plant investments.

Two
brothers, John Francis Dodge and Horace Elgin Dodge, owned 10% of the company,
among the largest shareholders next to Ford. They sued, won in a lower court,
and the case went to the Michigan Supreme Court.

The
Michigan Supremes held that a business corporation is organized primarily for
the profit of the stockholders, as opposed to the community or its employees.
They found that the directors had to work toward achieving that end, that they
could not reduce profits or fail to distribute profits to stockholders in order
to benefit the public.

Ford was
ordered to pay an extra dividend of $39 million. He bought out the minority
shareholders instead. The Dodge brothers used the money they received from the
case to expand their competitor to Ford, the Dodge Brothers Company,
which was originally an auto parts company that was sold to the Chrysler
Corporation in 1928.

The case isn’t about maximizing profits.
That was mentioned only in passing in the opinion. As Lynn Stout of the UCLA
School of Law has written,
the case and the decision are about breach of fiduciary duty to the Dodge
brothers.

As the majority
shareholder in the Ford Motor Company, Ford stood to reap a much greater
economic benefit from any dividends the company paid than John and Horace Dodge
did. But Ford was at odds with the Dodge brothers, since they wished to set up
their own car company to compete with Ford (as they eventually did). What Ford really
wanted was to deprive them of liquid funds for investment.

Stout concludes:
(emphasis by the Wrongologist)
 

The US
Supreme Court has not decided a case about the purpose of the corporation and
neither has the State of Delaware, the most corporation-friendly location in
the US. So, for all our MBA friends and fellow-traveler legislators who piously
speak of maximizing shareholder value as part of the natural law or as its own
religion, please take a step back and reflect.

In 2005, Joel
Bakan published The
Corporation: The Pathological Pursuit of Profit and Power. Bakan’s thesis is that
corporations are indeed dedicated to maximizing shareholder wealth without
regard to law, ethics, or the interests of society.

Bakan argues
that this means corporations are dangerously psychopathic entities (that can
donate unlimited amounts to politicians, according to Citizens United).

Bottom-Line: We need new and different ideas to inform our effort to steer the ship
of state to higher GDP growth and full employment.

We need to end our love affair with unrestrained, free-market
capitalism and install a better-regulated variety.  

How
about tying executive performance to adequate returns for all STAKEHOLDERS rather than to maximum return to
shareholders?