Further to John’s post (on which this should have been a comment, but it growed), 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.
Pretending not to understand the meanings of common English phrases is a stock tactic for creating the impression of profundity (cf philosophers, who are always pretending not to understand the meaning of words like “is”, “would” and “must”). But sometimes you have to do it – my view is that in any view of the world more complicated than a very elementary blackboard model, the phrase “maximise profits” can’t be unpacked into a coherent decision rule which rules out any of the things which Posner talks as if it does. First, let’s look at some things that it can’t possibly mean.
It can’t possibly mean “in any given period, maximise the bottom line of the income statement”. As everyone knows, there are any number of tricks that can be done to achieve this end – channel-stuffing, cutting marketing spend, etc. It’s for this reason that people try to unpack “maximise profits” as “maximise the present value of future profits” and then hope that nobody’s looking while they make the slide to “maximise the stock price”. But this actually helps a lot less than one would think, because, of course, being the price of a tradeable asset, the stock price of a corporation isn’t actually something that the management control (this version of the maximisation thesis also doesn’t work for companies that aren’t quoted).
So we’re left with “maximise the present value of future profits”, or maximise the intrinsic value of the company, which is already a bit of a problem because our maximand is now an intrinsically unobservable quantity, which reasonable people can differ wildly in their subjective assessment of. But even if we grant a massive epistemological free lunch and pretend that managers have a set of reliable conditional forecasts of the consequences of different courses of action, we’re still surprisingly far from a workable decision rule.
The reason is that all the paradoxes of choice theory which arise at the individual level are still there when you try to impose a maximisation rule for corporate decisions. For example, it can’t possibly be the case that we want an interpretation of “maximise the value of the shareholders’ equity” to mean that corporate managers have a fiduciary duty to play the (Defect) strategy in a business situation analogous to a Prisoner’s Dilemma game. Or for that matter to be two-boxers in a business situation analogous to Newcomb’s Problem (such situations are incredibly common, as the kind of deals you are offered are very definitely related to people’s assessment of whether you’re the kind of guy who grabs every nickel he sees). Economists can ignore these problems and paradoxes in choice theory with a shrug of the shoulders, a mutter of “oh ordinary people, will you never learn” and a few quid for the Experimental Economics lab. But fiduciary duties are important things, so if we’re going to make our maximisation criterion into a fiduciary duty, then we have to interpret it in a way which allows for strategic behaviour.
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.
In real life, the business judgement rule protects more or less anything that the Creative Capitalism gang might want businesses to do. Even the paradigm example used by Posner – of a corporate chief executive making charitable donations and specifically saying that they weren’t doing it for PR purposes and that they didn’t run the company in the interests of the shareholders – doesn’t actually necessarily give rise to a situation which would fail the business judgement test, because that’s pretty much the story of Body Shop, and if the only way that a company can secure the services of a talented and energetic cosmetics executive like Anita Roddick is to give away money without regard for shareholders, then that’s in the interests of shareholders. There is, of course, a cottage industry in business school cases and the funnies pages of the Economist in proving that instances of corporate philanthropy are actually in the interests of shareholders in the long term.
And, of course, the long term is a terribly difficult thing to forecast. It would, we can presume, be pretty bad for the S&P500 index if the Antarctic ice cap melted and we all drowned. Conversely, if the continent of Africa were to develop a billion consumers in a first world economy, that would be pretty good for the share prices of most companies on the stock exchange. There is a general long time interest of all humanity in doing good (that’s why it’s called “good”) and corporations and their shareholders do, in fact, share in this general interest of humanity. If you want to argue in any particular case that an act of corporate philanthropy isn’t connected tightly enough to a specific benefit which can be appropriated by the company and that this is wrong, then go for it but don’t expect the courts to agree with you.
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.