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.
{ 84 comments }
hardindr 07.25.08 at 1:57 pm
And at this point, of course, the Davies-Folk Theorem kicks in[1];
Dangling footnote. What is it supposed to refer to?
Daniel 07.25.08 at 2:08 pm
A footnoted summary explanation which grew too long and got removed. I’ll clear that up, thanks.
John Emerson 07.25.08 at 2:19 pm
As I said on the other said, libertarians (I should have said, Chicago school economists) are so cute when they drop their bland, snarky cynicism and become passionate about something they really care about, like the fiduciary duty to maximize profits.
Sk 07.25.08 at 2:25 pm
A new record. Godwin’s Law in the initial post (i.e. in the zeroth comment).
Sk
Dan 07.25.08 at 2:52 pm
I guess the big problem here (I’m lazy and don’t read things properly, this point has probably been made) is that the discounting rate of a business (or of its shareholders, if you want to look at it that way) is much greater than that of “humanity” in general. Maybe we should let the unborn buy shares too.
robertdfeinman 07.25.08 at 3:05 pm
Excellent!
As with much libertarian posturing what they say and how they act are two different things. The libertarians are owned (whether they know it or not) by a group of super wealthy capitalists (Scaife, Koch, Walton, Coors, Mars, etc.). They get their ideologically motivated followers to spew things about “free”markets and maximizing profits, but all this is a cover for their true agenda – making them even richer.
So, yes, the firms are maximizing profits – but only for the true owners. Of course there has been a diversion in some cases, where ownership is sufficiently diffuse that a CEO can take effective control of a firm (for awhile) and monkey with the stock prices so as to enrich himself quickly. He then takes his golden parachute and departs.
The more outrageous cases concern those who depart with the big package and leave behind a sinking ship. I’ll only site Home Depot and United Health as two recent examples, add your own.
What this shows, aside from how easy it is to get to people to support positions which are against their own self interests, is that corporate governance is non-functional. Boards of directors are self perpetuating, so stockholders never have any control over the firms they “own”. In fact recent rulings have made it clear that boards are free to ignore stockholder proposals that pass.
So “maximize profits” is just another one of those catch phrases meant to distract the unwashed from the real game – maximize wealth for the plutocrats. And it’s working!
From a list of the top 10 highest paid executives:
What’s missing from this is that the Walton family takes in about $1.3 billion in dividends, now that’s maximizing profits.
abb1 07.25.08 at 3:22 pm
You maximize the stock price. How do you know how to do it? You talk to Wall Street analysts, you’re trying to guess how they are going to judge your actions. If you believe they will look favorably upon you developing Africa, then you’ll do it. But they won’t. So you don’t.
Corporate Schill 07.25.08 at 3:27 pm
Daniel,
Great post. But where does that leave us? My impression of Posner is that he is too sharp not to realize that the whole “fiduciary duty” thing is really just a legal fiction once we factor in the business judgment rule and the difficulty of bringing meritorious derivative suits. The way it stands now, a company can spend its money however it wants and absent illegal behavior or the presence of self-dealing, a court will not second-guess the board’s judgment.
Overall, I think this is a good thing. We want companies to have the flexibility to try new strategies to attract investment and customers. If this means being environmentally friendly as a way of attracting business, all the better. We have definitely come a long way in that consumers are more concerned now with the impact their choices have on the world. Not to mention it makes us feel better about ourselves. I am no bleeding heart, but I go out of my way to buy coffee beans from cooperatives that provide higher returns to coffee farmers in other countries. Of course, it helps that the coffee tastes good. It is even better that I can feel smug at the same time.
I am not sure if this is the sort of thing the Creative Capitalism people had in mind, but I do not see how changing corporate objectives would really alter how things are now. Likewise, I do not really understand Posner’s objections, given that the practical effect of the business judgment rule is to render the whole notion of fiduciary obligations and duty of loyalty a legal fiction.
Tracy W 07.25.08 at 3:37 pm
I am not a lawyer, but my understanding of “fidicury duty” is that first and foremost it is a duty to refrain from using the money for yourself. There can be many differences of opinions about what maximises profits in the long-run, but I think it’s reasonably safe to conclude that if shareholders wanted the CFO to take their millions and gamble it away in Las Vegas they would have just given the CFO the millions in the first place.
More generally, when it comes to deciding what is long-term profit-maximising behaviour is, my solution is to allow multiple different views:
1. Don’t make the “maximise long-term profits” a fidicury duty in the sense that the courts should get involved in trying to second-guess business decisions.
2. If shareholders think whatever the company is doing isn’t increasing long-term profits, then they are free to sell their shares.
3. If non-shareholders think that whatever the company is doing is increasing long-term profits, they are free to buy the company’s shares.
This creates an incentive for shareholders to try to be right in their forecasts of what increases profits. It also allows for multiple different beliefs about what increases long-run profits.
Shareholders should of course be free to write more restrictive contracts with the managers of the company if they think it is wise.
As far as I can tell, more expansive legal enforcement of fidicurary duty is mostly a way to transfer wealth to lawyers.
Have separate organisations aimed at other long-term goals that should not be measured in financial returns (eg getting prisoners of conscience released from jail). If people think that the organisation is really effective at getting prisoners of conscience released, they can make more donations. If people think that it sucks at getting prisoners of conscience released, they can stop donations. If people think that clean drinking water is just as important, they can donate to multiple organisations.
Righteous Bubba 07.25.08 at 3:41 pm
The Nuremberg trials did not recognise the fiduciary duty to maximise profit as a defence.
Well, those guys lost. What I don’t get is why pharmaceutical companies aren’t lobbying to put narcotics in gumball machines.
aaron_m 07.25.08 at 3:53 pm
Most of the objections here are the following sort, if a company does not do good thing X ruled out on Posner’s list there could very well be negative effects on profits. Of course this is not challenge to Posner’s position. He could easily say yes the Corporation should do good thing X, but not because it is good in any other sense than that doing it is good for profits. Also note that what is good for the current owners of a corporation is not at all the same as what is good for humanity in the long-term and for this reason the personification and immortality imposed on Corporations in the post is misplaced.
The other problem suggested in the post is that we do not know what counts as maximizing profits. Maybe this idea would work (although it is not explained in the post) if we were really in the dark about this and corporate choices were more arbitrary than on target, but it seems to me that corporations have a pretty good rough idea of what it means to maximise profits. After all what we are concerned with is questions like treat workers fairly vs. make 10 billion more in profits and not the optimal metric of profit given the optimal model of shareholders’ preferences structures.
The point is that the empirical arguments offered in the post do not get us very far and the only way to attack the ‘fiduciary duty to maximized profits’ principle is at a normative level. I do think one can argue against the claim quiet easily. But let us say you can’t, the obvious consequence is that corporations must act on such morally abhorrent standards that the government has a clear duty to its citizens to regulate them in great detail. Kind of like the government’s duty to put criminals in jail.
Daniel 07.25.08 at 3:58 pm
it seems to me that corporations have a pretty good rough idea of what it means to maximise profits. After all what we are concerned with is questions like treat workers fairly vs. make 10 billion more in profits
I can absolutely assure you that not one single corporation in world could really tell you what the profit impact of “treating workers fairly” would be, positive or negative, and if you find one that thinks it can, sell the stock.
ajay 07.25.08 at 4:00 pm
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).
I must be missing something, because it seems to me that management could fulfil their duty to “maximise the stock price/present value of the company” by following this rule:
1. Do something.
2. Announce that you have done it.
3. Observe the behaviour of your stock.
4. If the stock goes up, then, whatever it was, keep doing it. Return to 2 and keep going until the stock price stops going up. Then proceed to 5.
5. If the stock goes down, then stop doing it. Pick another thing and return to 1.
aaron_m 07.25.08 at 4:08 pm
I can absolutely assure you that not one single corporation in world could really tell you what the profit impact of “treating workers fairly†would be, positive or negative, and if you find one that thinks it can, sell the stock.
Even if that were true it would not save your post and 2) it is just a silly statement. Corporations may often make bad decisions and be ineffective but to say that they do not have any understanding of labour costs and the benefits and costs associated with labour relations is just wrong.
Righteous Bubba 07.25.08 at 4:21 pm
understanding of labour costs and the benefits and costs associated with labour relations
Compare and contrast with “treating workers fairly”.
noen 07.25.08 at 5:09 pm
aaron_m , “treating workers fairly†could mean anything from employing child labor, paying them 1$ an hour and working them 16 hours a day to giving your employees full medical plus dental and three weeks paid vacation a year.
aaron 07.25.08 at 5:12 pm
@aaron_m
Various companies in the U.S. take different approaches to how they treat their workers. There are also definite contrasts between the U.S. and, say, Germany. Unless these major companies are all avoiding their “fiduciary duty”, then I think we can conclude that there are a variety of ways that you can treat your workers and still be said to be trying to maximize profits. In addition, there is the question of whose profits are being maximized. If you consider your workers to be stakeholders in the company, you might want to value them more even if it hurts the “bottom line” in the short term. Of course, companies put more value on pandering to their white-collar workers, but consider the case of Japan or Germany, where companies put more value on retaining workers to avoid having to constantly retrain new ones.
Daniel 07.25.08 at 5:13 pm
Corporations may often make bad decisions and be ineffective but to say that they do not have any understanding of labour costs and the benefits and costs associated with labour relations is just wrong
Well perhaps, but I didn’t make that claim. The sheer fact that companies have such a variety of different labour arrangements and strategies ought to give you a little pause, however.
Will Roberts 07.25.08 at 5:19 pm
aaron_m:
Will Roberts 07.25.08 at 5:21 pm
oops…messed up my block quote. Me @ 19 refers to aaron_m @ 14, 1st paragraph.
Matthew Kuzma 07.25.08 at 5:25 pm
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.
That’s hilarious. Y’know what would be a great way to maximize profits? File frivolous lawsuits against anyone who buys from your competitors. It’s legal, and once word of your courtroom terrorism spreads people are bound to think twice before shopping at the competition’s stores. Turns out even when it’s legal, overt monstrous evil isn’t the winning strategy it may seem to be.
Walt 07.25.08 at 5:29 pm
You’re supposed to maximize the present value of the series of cash flows the firm will produce in the future, Daniel. Your business school wants its degree back.
(Since this is the Internet, let me explicitly say: I’m joking.)
ogmb 07.25.08 at 6:44 pm
Uhh, wrong.
What “fiduciary duty to maximize corporate profits” means in the context of Friedman’s infamous claim is that the contractual relationship between investor and manager is (or should be) governed by an objective (profit max). This differs from the relationship between public hand and investor, which is/should be governed by constraints (laws). A contract governed by objective is very simple: the principal simply expresses the objective and measures how well the agent meets it. If the principal thinks the agent failed at it, s/he terminates the contract. A contract governed by constraints is very complex: the principal sets out all the rules which the agent has to follow, but leaves the agent free reign to act as s/he pleases within those bounds. The contract can only be terminated if the agent breaks one of the stated rules, but not if the agent failed to meet the principal’s objective. So “fiduciary duty to maximize corporate profits” simply means that the manager agrees to enter an employment contract which the investor can terminate at will.
PreachyPreach 07.25.08 at 6:51 pm
To be honest, I suspect it’s as close a euphemism as we’re ever going to be able to get in a legal framework that’s not absurdly over-prescriptive to the principle of ‘please just don’t take the money and piss it up a wall’…
Which to be honest, is what most legal contracts between companies are – they’re a matrix to sue each other should they fall out…
dsquared 07.25.08 at 7:09 pm
No, “fiduciary duty” has a specific meaning in common and case law and I hardly think that a jurist of the calibre of posner would use it incorrectly.
ogmb 07.25.08 at 7:32 pm
It means that the manager is entrusted with the assets of the investor with the mutual understanding that the manager acts in the investor’s interest. Acting against this understanding is a breach of fiduciary duty.
The Posner/Friedman thrust on this is very simple: a CEO using corporate monies for his own interests is committing CEO theft, and it’s still CEO theft if his own interests are charitable in scope. He uses other people’s money that was entrusted to him for other than the agreed-upon goals. Investors can spend their own money on charitable goals rather than investing them in a profit-seeking enterprise. CEO’s can use their compensation and spend it on charitable goals. But a CEO who uses entrusted money for charitable goals against the beneficiaries wishes commits a breach of duty.
Righteous Bubba 07.25.08 at 7:37 pm
the mutual understanding
If I understand it correctly this mutual understanding exists between Posner and readers of Posner.
Walt 07.25.08 at 8:02 pm
OGMB: Part of Daniel’s point is that that’s not what the law says. It’s fine that’s what Friedman meant, but Friedman was not, in fact, a judge or legislator.
ogmb 07.25.08 at 8:31 pm
I don’t even know what this means, or where people see a fundamental disagreement about the definition of fiduciary duty. From what I see, Posner, Daniel and I all use it in the same way.
What this disagreement is about is the term profit maximization. Daniel seems to be under the impression that there must be an objective definition of profit maximization that is ascertainable by outsiders for Posner’s argument to make sense. And my response was no, it makes perfect sense if profit maximization is simplyw hat the principal thinks it is.
To offer an example: if Manchester United offers Christiano Ronaldo an ongoing contract on the premise that he score at least 30 goals in each season, it’a contract by constraint. Every football fan can observe fulfillment, and Ronaldo can sue for breach of contract if he scores 32 goals and his contract gets terminated. On the other hand, if ManU just stipulates that he should play as well as possible to help the team get as far as possible, it’s a contract by objective. Ronadlo is under a fiduciary duty to further the team’s goal. What this “as well as possible” means is only known to the management, and Ronaldo has no recourse if his contract is terminated even if he scores 50 goals.
Bruce Baugh 07.25.08 at 8:39 pm
What’s fascinating about this is just how vigorously pro-business folks defend such a profoundly stupid phrasing.
All businesses have an obligation to obey the laws of the areas in which they operate. Beyond that, their only imperative is to satisfy those who hold the power over appointments and decisions about activities. A business that passes up an opportunity for (legal, etc.) profit in favor of something else that satisfies the stakeholders is well-run. It is not the business of those engaged by a particular company to try and impose their moral vision on shareholders, nor of any outside parties to try to intimidate management and owners into adopting this particular shibboleth.
I used to hear (and still do, from libertarians who actually have hearts and souls in working order) that the essence of a free market is the ability to make choices on the basis of criteria besides money. If I want to operate a business in accordance with my religious values, I can and should. If I want to operate with an eye toward promoting social conditions I find desirable, I should give it a shot. And if I find that I can do it and somehow keep paying the bills, that’s a free-market success story. This “fiduciary responsibility” thing is an effort to destroy the moral foundation of libertarian and conservative principles about business operation, without admitting to it. Anyone who tells you that a business must do things besides obey the law and pay for things like the costs of its polluting is telling you that free choice in the marketplace is actually a bad idea.
abb1 07.25.08 at 9:09 pm
Bruce, you can apply whatever conditions you want – to be socially responsible, environmentally-friendly, employee-owned, race-gender neutral, whatever – and still, seems to me, within all these parameters your only goal is to maximize the ROI. Am I wrong?
George W 07.25.08 at 10:04 pm
“Maximize corporate profits” is not all that complicated a concept, come on. If you have a problem with the use of “fiduciary duty” in this sloppy way, fine, but much shorter post.
bruce101 07.25.08 at 10:35 pm
the bottom line is if they lose money i sell and buy gold.
aaron_m 07.25.08 at 10:45 pm
@aaron
Various companies in the U.S. take different approaches to how they treat their workers. There are also definite contrasts between the U.S. and, say, Germany. Unless these major companies are all avoiding their “fiduciary dutyâ€, then I think we can conclude that there are a variety of ways that you can treat your workers and still be said to be trying to maximize profits.
1) The differences between the US and Germany etc… are largely driven by political policies and not corporations.
2) Nothing I said denies that there are different ways to get to maximizing profits. My point was that these types of empirical claims will not due to challenge the principle proposed by Posner but only to challenge specific kinds of analysis on how to apply the principle. Thus, if focusing on retention is good for profits one should not rule out this approach following Posner but that says nothing about the principle/duty he is arguing for itself. The claim that retention is a good profit making strategy is no kind of argument against the supposed norm that corporation are duty bound to pursue the best profit making strategy.
@daniel 18
Same point; what you say does not improve your empirical approach to challenging the Posner duty.
Bruce Baugh 07.26.08 at 1:16 am
Abb1: It’s a matter of overall emphasis. I know several business owners whose priorities are pretty much “pay the bills, and make it possible for me to do X”, for widely ranging values of X. Posner and Friedman would say they’re bad owners by definition; I’d disagree. (I also think that the category you describe, “maximize profits within the operating constraints we’ve chosen beyond what’s required”, is an interesting one, but a distinct thing of its own.)
John Quiggin 07.26.08 at 1:19 am
“So “fiduciary duty to maximize corporate profits†simply means that the manager agrees to enter an employment contract which the investor can terminate at will.”
By “terminate at will” do you mean “sell your shares” (at the price determined by the CEOs choices)? If so, the remedy is ineffectual. If, on the other hand, you mean that investors can sack the CEO at will, this has been known to be false since the work of Berle and Means in the 30s, well before Friedman wrote. In practice, the only remedy available to shareholders is that provided by a hostile takeover.
John Emerson 07.26.08 at 1:41 am
Maybe a dead thread, but media groups that go public and acquire this Posner fiduciary obligation to maximize return always get worse. Often family owned media groups do this when the time comes to divide up the inheritance.
One reason why Republicans push the inheritance tax so hard is that a lot of media groups are family owned. The publisher of the Seattle Times has admitted that the inheritance tax was the major reason he supported Bush.
Pretty much lose-lose from our point of view. When truth is put on the market, it becomes expensive and scarce.
Bruce Baugh 07.26.08 at 6:25 am
I would take the outcry against non-profit-maximizing management decisions if it showed any sense of proportion. Most mergers destroy value, but there is no huge outcry among libertarians or conservatives to subject mergers to serious, sustained scrutiny and criticism. Nobody’s routinely writing essays to remind business owners and the general public that most mergers are a bad idea, that managers inclined to promote mergers should be challenged to a very high standard of justification, that shareholders should assume that mergers will hurt their assets and require very serious argument to the contrary with reference to the specifics of the merger they may be subjected to, that merger-favoring analysts and pundits should be portrayed as advocates of folly, and so on. Some of this happens occasionally, but not nearly as often as expressions of hostility to ideas like compensating employees well, honoring commitments to retirement and health care funds, promoting community goods as a general investment in the well-being of the operating environment, and like that.
This is part of why it’s exactly right to treat the “fiduciary responsibility” thing mostly as a way for people who want to indulge in a particular, very narrow kind of business operation to laud themselves as heroes. It isn’t applied nearly consistently enough to warrant respect as a real principle.
abb1 07.26.08 at 10:23 am
Bruce: I know several business owners whose priorities are pretty much “pay the bills, and make it possible for me to do Xâ€, for widely ranging values of X.
I am sure there are tens of thousands of business owners like that; hell, I wish I was one of them. But I highly doubt that a publicly traded corporation could operate this way. Would you buy its stock? Would anyone?
Jeff Darcy 07.26.08 at 11:12 am
It seems to me that the enforceable fiduciary duty here is to do whatever the hell the stockholders want. It is *assumed* that the stockholders primarily want their stock to appreciate. The recent plethora of shareholder lawsuits shows us what happens when shareholders and managers assumptions about means or time horizons turn out to be different, and I can also imagine managers defending against such a suit by claiming that shareholders had signaled a preference besides profit. For example, a company that positioned itself as being very environmentally or socially conscious compared to competitors could claim that shareholders had signaled such a preference, therefore the outcomes of that preferences were the shareholders’ own responsibility. In fact I’d love to see such a case clearly decided against the “only money (now) matters” position.
ogmb 07.26.08 at 11:15 am
If, on the other hand, you mean that investors can sack the CEO at will, this has been known to be false since the work of Berle and Means in the 30s, well before Friedman wrote.
I think at-will employment is a clear enough doctrine that I don’t need to explain it. It almost feels like it’s been this long ago that I read Berle and Means, but how they show termination at will to “to be false” for CEO contracts. Are you saying that there are also incentive misalignments between shareholders and board? Or that in practice, (minority) shareholders rarely ever succeed in ousting a CEO? I don’t even see how this is relevant to the discussion. I’m not aware of a jurisdiction where the investor is legally required to write a CEO contract that can only be terminated with cause. That CEO’s are often in the position to negotiate better provisions for themselves than the legal minimum is undisputed. In fact, quick googling for “CEO contract” gives me this aptly titled document, which seems about as boilerplate as it gets for a contract for executives, pro athletes and coaches, tenure-track faculty and elected officials: a fixed-term contract with termination at will at the end of duration and a termination with cause or compensation exit clause.
ogmb 07.26.08 at 11:43 am
Bruce: I know several business owners whose priorities are pretty much “pay the bills, and make it possible for me to do Xâ€, for widely ranging values of X. Posner and Friedman would say they’re bad owners by definition; I’d disagree.
Bruce, you’re falling into the common trap of conflating owners and managers. There is, in the Posner/Friedman world, no obligation to the owner to invest only in profit-maximizing ventures. Both offer a limp-wristed caveat if too many investors spend their money on non-profit ventures, but they both make clear that as the investor, you can spend your money on whatever you want. The “fiduciary duty” exists only between the manager as hired employee and the investor as the employer, not between the investor and the public.
abb1: But I highly doubt that a publicly traded corporation could operate this way. Would you buy its stock? Would anyone?
Was it The Gap that famously advertised in its IPO prospectus that the company might engage in social activities that can hurt the bottom line?
Jeff: The recent plethora of shareholder lawsuits shows us what happens when shareholders and managers assumptions about means or time horizons turn out to be different, and I can also imagine managers defending against such a suit by claiming that shareholders had signaled a preference besides profit
The general defense is that at the time they made the decision the CEO’s thought the decision would maximize profits. Termination with cause, and recouping the investments the CEO wasted due to bad decisions, are susually held to a very strict standard. You generally have to show that the actions of the CEO broke the law or were made in bad faith. Claiming “incompetent management” is usually not enough.
Psuke Bariah 07.26.08 at 2:52 pm
@abb1 But I highly doubt that a publicly traded corporation could operate this way. Would you buy its stock? Would anyone?
I would…but then I realize that money only means something when there are things worth buying. And a palace surrounded by a slum isn’t the kind of place I’d want to live.
laocoon 07.26.08 at 3:38 pm
The premise of the article is that there exists a single, well-defined mathematical quantity to be maximized. That premise is incorrect.
Consider how evolution works. The infelicitous phrase “survival of the fittest”, led to a long debate over exactly what constituted “fitness”. What is the single measure of “fitness” that is maximized by all organisms, from anerobic bacteria to redwoods to whales to humans? Of course, the premise that there exists a single well defined mathematical quantity called “fitness” is just wrong. In different circumstances, different things might reasonably be called “fitness”. Sometimes it is cooperation, sometimes it is competition. Sometimes it is having lots of offspring who are totally neglected, sometimes it is having very few offspring who are carefully nurtured. Just because there are wildly different answers to the same question in different circumstances does not disprove the theory of evolution.
Similarly, the argument above that different answers to the same question (“what should be maximized?”) does not disprove the notion that maximization is occuring in each case. It merely shows that a different kind of maximization is occuring in each case. Just as in evolution.
If one accepts the general paradigm of evolution (generalized to “replicators”, not just DNA of organisms), then it should be pretty clear that there is no one single criterion that corporations should or could maximize. Moreover, there is not really any reason to suppose that conscious maximization is even being done. After all, T. Rex’s did not try to maximize their fitness anymore than do redwood trees. They just do what they do, and evolution occurs. Post-facto, one might describe it in optimizing terms (“blind cave fish lost their eyes so as to conserve scarce energy”) — but the fish don’t optimize. As the great Herb Simon pointed out decades ago, a lot of corporate behavior can be equally described w/o even assuming profit maximization.
mq 07.26.08 at 3:58 pm
I think Aaron_m is basically correct in 11 that this is a normative principle that can’t really be undermined by pointing out its empirical problems. It’s not uncommon to demand things of others in abstract terms that cannot really be measured objectively, yet still influence behavior when they are taken seriously (“do your best!”).
One such normative challenge is the “stakeholder” idea taught in some business schools — that in return for the legal powers granted to the corporation, the corporate manager should think of themselves as in some sense responsible to a full set of stakeholders (customers / workers / local community / stockholders) instead of just the stockholders. I’m not a lawyer, but I think that understanding clashes with the legal understanding of fiduciary duty to stockholders.
As for empirical difficulties, it seems to me that the deepest one D-squared has identified is the uncertainty of knowing what your stockholders really want. That could be handled by stating your maximand clearly in your prospectus, and only stockholders who shared it would invest. Or, I guess, by taking corporate governance seriously, but that’s a pipe dream.
abb1 07.26.08 at 4:09 pm
Um, Laocoon, but what if ‘corporation’ is not the species here, ‘capital’ is. Corporation is merely a mechanism helping capital evolve and reproduce, one of several mechanisms. One of the claws, or maybe even a pair of testicles.
But claws and testicles don’t evolve by themselves, only with the host. And if they aren’t helpful to the host – they’ll fall off, no matter how perfect they might become for any of the purposes the host doesn’t care about.
mq 07.26.08 at 6:04 pm
abb1, evolution works within the body as well. E.g. many bodily functions are performed by bacteria who have evolved to be efficient in performing them and are rewarded by a symbiotic relationship with the host.
J Thomas 07.26.08 at 6:14 pm
Tracy W. said, 1. Don’t make the “maximise long-term profits†a fidicury duty in the sense that the courts should get involved in trying to second-guess business decisions.
2. If shareholders think whatever the company is doing isn’t increasing long-term profits, then they are free to sell their shares.
3. If non-shareholders think that whatever the company is doing is increasing long-term profits, they are free to buy the company’s shares.
So a shareholder who thinks the company isn’t doing enough charitable work or enough fo community values etc can sell his shares. Or if he thinks the company is doing well enough at furthering his values, he can buy shares.
In short, management gets to do whatever it wants and in response you get to buy or sell stock at the going rate.
In that context the concept of fiduciary responsibility is *nothing* more than empty philosophising. It doesn’t matter what you think a manager’s goals ought to be. If you don’t like what he’s doing, sell his stock and let him do whatever he wants. If you meet a business manager in a coffee shop you can buy him a latte and tell him what you think he ought to do. Your opinion plus $3.50 will buy a cup of coffee.
abb1 07.26.08 at 7:15 pm
Mq 46, certainly ‘corporation’ was meant to be a vehicle for reproducing capital, but I suppose the suggestion that it’s already evolved (or will/might evolve at some point) into its own entity is a fair proposition. But it’s a proposition that needs to be substantiated a little bit; I don’t think it’s obvious.
James Wimberley 07.26.08 at 7:32 pm
Will Roberts in #20: never apologize here for formatting errors and typos. These are entirely the fault of the secretive, unaccountable CT cabal who have cut off our preview.
Joe in Australia 07.26.08 at 9:00 pm
Richard Posner’s statement is extraordinary. Corporations aren’t necessarily engaged in trade; a social club can be a corporation. I agree that the managers of a corporation have a fiduciary duty to the corporation’s shareholders, but the content of that duty will necessarily depend on the circumstances.
Consider the case of an incorporated charity: a soup kitchen, reliant on donations, established to feed impoverished people. In my jurisdiction (Australia) this sort of corporation will be like any other one, with some nominal amount of issued capital. The directors’ duty is clearly to fulfill the charity’s objective and not to hoard the donations. Where is their duty to maximise corporate profits? I suppose we could redefine our terms: “profit” will become “giving food away”, and “maximise” will become something like “discreetly and politely assist those who are in the most need”. But then we’re in Wonderland territory where words mean whatever we want them to mean.
I can’t understand the honorable judge’s statement and I am frankly astonished by it.
Martin Bento 07.27.08 at 12:59 am
It’s not clear to me that the business judgment rule really solves the problem. According to the wiki link, the presumption is that the board acts in good faith in the best interest of the corporation. A lawsuit alleging that the board in choosing not to maximize profit was not acting in the best interest of the corporation would fly under this standard, no?
For those who understand the law here, if I start a company and conspicuously state in my by-laws and shareholder statements that I may have other objectives that can sometime override profit maximization, is that legit or do more general laws override it? For example, suppose I start a company working to reduce fossil fuel consumption so as to alleviate global warming and oil dependency. It is a for-profit company, but I make clear that in some cases I may make decisions that serve the larger goals at some cost to profit maximization: selling the service or technology at a lower cost than I could otherwise, so as to encourage more widespread adoption. I realize that such things are often defensible in terms of longer term market strategies like maximizing share, but I’m asking about the case where those do not apply. Is this legitimate? Should it be? Is there a problem with public ownership for such a company? And how much of this is specific to Delaware law (which is what the wikipedia entry on the business judgment rule seems based on)?
I think an example like this shows why it can be desirable to mix business and “common good” goals: it is the business that will develop the technology to make this difference, and although I as CEO could choose to spend my own money on these other goals, I as an individual will not have the patents, the market partnerships, and the other forms of capital and leverage than the company has. The company can be much more effective than I could, sacrificing the same share of wealth.
concerned bystander 07.27.08 at 2:04 am
Wimberly@50:
The preview function in the last incarnation was dishonest and misleading in key but subtle areas. Though ever so barely slightly better than nothing at all as at present.
Like the blockquote function is now still, the preview of old would show one way in its own little window, as well as in common editing apps, then laugh at you with its askew and unforseen typographies post-irrevocable-post.
Randolph Fritz 07.27.08 at 2:30 am
Professor Alfred Aho, a very excellent computer scientist, used to be fond of reminding his students that code optimization in translation is not possible, since one ends up trying to write a translator which tries to solve the undecidable problem of producing an optimal program. The problem, of course, is even worse in business situations; the truth of the matter is that there is no way to know what business practices are best and, in fact, an obsession with profit to the exclusion of all else is a near-guaranteed path to shareholder loss. I think it’s reasonable legal doctrine to say that managers of a publicly-traded business corporation are obliged to try to make a market return over some period, but the fact of the matter is that many corporations only do so in the very long run, and many never do so at all. In Posner’s legal school, “maximizing profit” is used as a reason to object to taking environmental and labor concerns into account and this of course is the reason his school makes the argument.
Randolph Fritz 07.27.08 at 2:35 am
To which I will add that one way of looking at the undecidability of the profit maximization problem is to say that the invisible hand is not guided by an invisible brain.
MWhit 07.27.08 at 3:50 am
“Turns out even when it’s legal, overt monstrous evil isn’t the winning strategy it may seem to be.” Matthew (21) He may have had something there, but just didn’t take it far enough. Shareholders and “stakeholders” congregate around companies for a reason. Individual reasons may not ever be totally apparent, but it certainly isn’t only about profits in the stock price sense. The ability of capitalism to make something out of nothing (witness ethanol being forced into our fuels and other “government gas” fiascos) is really where it’s at. I only need to have you buy my stock for whatever reason you chose. Even when the young grads of great big Eastern universities said they were “green-minded” in college, they didn’t bring it to Wall Street in the late 90s and early 2000s cause there wasn’t covering fire from the rest of us…Now we have more folks choosing this non-accounting reason to invest, so we’ve invented a new economic reason to buy stocks in socially minded companies. And since we make a lot less of things with “tangible” value (stuff with evident utility) these days, we need the environment, celebrities, fair trade, etc. to have something to sell.
Tom Davies 07.27.08 at 5:16 am
I didn’t understand this key phrase from the post: ‘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. ‘
I think there’s a typo in there somewhere.
Anyway Daniel, do you think that Posner believes that there is some ‘decision rule’ for profit maximisation? He discusses PR-charity, ‘jumpstart charity’ and ‘pro-bono charity’ (which may reduce employment costs by increasing job satisfaction). Each of these is complex, and I don’t think Posner believes that you can determine the correct level of each by some algorithm — he uses the word ‘may’ a fair bit in the discussion.
Bruce Baugh 07.27.08 at 6:46 am
I’m probably going to use that line in the future, Randolph. I’ll give you credit. :)
CSTAR 07.27.08 at 6:46 am
The financial firm of Pedro y Burgos S.A. offers an exciting new financial instrument which offers almost unlimited expected present value potential, competitive even in aggressively unfavorable interest rate environments. The underlying of this instrument, which our firm calls the “Petey”, is the the sequence of first numbers of the Friday drawing of the mega-millions lottery. The holder of the Petey will receive a single cash payment, which will occur on the first week after purchase that the underlying is an even integer. The cash payment will consist of 2^k (two the k-th power) dollars if the if the event occurs on the k-th week after purchase.
This instrument should appeal to financial managers wishing to provide their clients with a stream of income with almost unlimited present value.
Remark inserted for full disclosure. The “Petey” is of course a joke.
aeschenkarnos 07.27.08 at 1:23 pm
Very well put. I question the value of allowing shareholders to have any input into the actual decision-making of a corporation at all, beyond (1) not being lied to, which would include obfuscation or withholding of the truth; (2) being permitted to freely buy and sell stock, and first-order options on stock so that it is possible to bet on price falls (arguably this is undesirable, but cannot easily be prevented).
A stockholder in a corporation, to my mind, has no more involvement than a punter at a horserace, and should have no more rights or recourse: by all means cheer it along, and encourage others to invest, but if it loses, hard luck. If you can’t afford to lose, you can’t afford to play. Owners of horses are expected to make all honest effort to win, and not engage in fraud, doping, collusion, etc, which requirements are enforced by an oversight body and breaches of which are heavily punished. Generally speaking this works quite well to enforce fair dealing, or at least, appears to give horseracing a higher standard of fair dealing (as shown by its higher level of unpredictability) than the stock market has.
Dave 07.27.08 at 1:23 pm
A market economy is like a blindfolded guy riding a unicycle backwards on a rope across the Grand Canyon – he can do it, but only if he doesn’t think about what might happen. The trouble is that the said guy is actually carrying five other guys on his shoulders, all trying to give him advice, shouting out warnings, demanding he go faster, slower, turn back the other way…
The underlying question: is it a *good idea* to ride a unicycle backwards and blindfolded over the Grand Canyon, if only blind optimism and luck will enable success?
Alex 07.27.08 at 5:22 pm
Ajay@13 – the problem here is that directly opposite actions frequently share the consequence that the share price goes up. The City was delighted by Vodafone buying the old BT mobile phone interests in Japan, and just as delighted by their sale.
More generally, a weirder point here is that statements of the problem often explicitly exclude anything but short term (or perhaps better to say instant) maximisation; but as profits over the longer term must mean profit * N years where N is positive, and the total amount of money you might choose to spend in any one year rather than return to shareholders is unlikely to be more than a few N*annual profits (or rather annual free cash flow), it’s pretty doubtful if this makes sense.
Randolph Fritz 07.27.08 at 7:36 pm
Thanks, Bruce.
Randolph 07.27.08 at 7:43 pm
Dave, sigh. Markets do have their uses–in some situations (as economists remind us) nothing improves on them and it’s easy to teach people to participate in them. But they aren’t the godlike AIs that many libertarians claim they are; they’re a method of getting a mass decision from many individuals. Markets also have some well-known failure modes (as the US banking system is now reminding us) and they tend to encourage some destructive behaviors. (Daniel, my apologies for repeating some basics here.)
Jack 07.27.08 at 10:56 pm
Tom @57: I didn’t understand this key phrase from the post: ‘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. ’
I thought that was the critical phrase as well; it’s confusing grammar, but not a typo. It means, the phrase “maximise profits” cannot be used in order to rule out any of the things that Posner implies it can be used to rule out.
In other words, “maximising profits” is not a useful legal concept, because it doesn’t help anyone in judging someone’s actions; there are no real-world actions (other than breaches of loyalty, which is a separate analysis) that reasonable people would agree do not maximise profits. You are therefore no better off in deciding whether a manager has maximised profits than you are in deciding whether they have “done a good job,” so you might as well just say that.
This suggests that, in contracts, we shouldn’t say “maximise profits,” we should just say “you have to leave if we don’t like what you’ve done.”
In litigation, the cause of action of failing in your duty of care can’t be defined by failing to try to maximise profits, because there’s no situation where reasonable people would agree that the defendant didn’t. Given the business judgment rule, a manager who says “I was trying to maximise profits” by definition passes the test, so the cause of action is meaningless.
What’s most interesting though is what this suggests for public discussion, in which a CEO says “I had to do [something bad], because of my duty to maximise profits.” The article suggests the CEO is lying; he could have done the opposite and not have been liable. However, doing anything that he didn’t believe would maximise profits, would have been wrong; therefore, the claim becomes a sort of shield, where once he says it, he’s right.
Martin Bento 07.27.08 at 11:43 pm
Jack, the other problem I have with that analysis is that it means that a CEO who wishes to do something other than maximize profits cannot say so. But saying so can buy valuable goodwill. In fact, saying so could conceivably create greater long term profit than direct maximization. This creates a conundrum: stating a goal other than profit is permissible, if the declaration is assumed to be, or later, in court, avowed to be, made in bad faith; a good faith renunciation of profit, OTOH, still would seem to be off-limits. I don’t think epistemic doubt can save us, when the party can always be placed under oath about his intentions.
JohnnyD 07.28.08 at 12:18 am
So, how, if at all, can this great discussion eventually lead towards the creation of a pragmatic roadmap for actually achieving a “healthier” marketplace? How can incentives be created for CEOs, BODs and shareholders alike to all move in a timely fashion towards manifesting business philosophies and practices that consider “fair” worker wages and benefits, recycling and waste-reduction, etc. as part of what is considered “profitable?” Do we have to wait, as Paul Hawkens pointed out many years ago in “the Ecology of Commerce,” for governments to lead the way with tax incentives and laws? I don’t think it’s as simple as divesting from companies that don’t act in ways we wished they would. Perhaps there is no global formula for this type of paradigm shift…
On the other hand, what do you think would happen if one million US car owners all stopped buying gas from one of the major gas companies (take your pick) on the same day and all e-mailed the company (and their local newspapers and congresspersons) explaining that they will continue to boycott that business until it stops getting petroleum from the Middle East, dramatically improves it’s environmental practices, etc? Bottom line: the most powerful way each of us can vote (and help redefine “profit”) is by voting with our wallets.
Tom Davies 07.28.08 at 3:50 am
@Jack, thanks — I see what the sentence is supposed to mean now.
I agree with your further comments — and I rather think that Posner would too. After reading http://creativecapitalism.typepad.com/creative_capitalism/2008/06/against-creativ.html I’m not really sure what Posner would think the duty could rule out in practice, as he gives a long list of charitable behaviours it shouldn’t rule out.
I don’t see where Daniel gets “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…” — Posner gives several examples where CEOs would not state that their donations were for PR purposes, when in fact they were.
Bruce Baugh 07.28.08 at 6:55 am
When it comes to “I’m not really sure what Posner would think”, I think that the real answer is that Posner is increasingly prone to the outlook Lionel Trilling ably described as “irritable mental gestures which seem to resemble ideas”. He’s not stupid, but he is sometimes profoundly foolish, and more so (it seems to me) with time.
Tracy W 07.28.08 at 9:41 am
So a shareholder who thinks the company isn’t doing enough charitable work or enough fo community values etc can sell his shares. Or if he thinks the company is doing well enough at furthering his values, he can buy shares.
Yep, and I personally do so. I think making donations to a charity is in some ways similar to being a shareholder. Of course as a donor yu expect your return in other things, in whatever units you measure “doing your duty” or “warm fuzzy feelings from helping others”. If I think an organisation is not doing enough charitable work, or it is doing ineffective charity work compared to some alternative, I stop donating to it.
And yes, there are people who want companies to simultaneously make a monetary return on their retirement savings, and pursue some other social goals. I don’t know why people do, and I think it is inefficient, but I think that trying to stop them would be far more inefficient.
In that context the concept of fiduciary responsibility is nothing more than empty philosophising.
No. I think there is still something in that management should not be stealing money or fame for themselves. If a manager wants $2 million of the shareholders’ money to blow at Las Vegas, he/she should go directly to the shareholders and ask them for it.
J Thomas 07.28.08 at 11:32 am
“In that context the concept of fiduciary responsibility is nothing more than empty philosophising.”
No. I think there is still something in that management should not be stealing money or fame for themselves. If a manager wants $2 million of the shareholders’ money to blow at Las Vegas, he/she should go directly to the shareholders and ask them for it.
OK, but they never do. They just take it, or they get their tame board of directors to approve it, and your choice — if you even find out about it — is mostly to sell the stock or choose not to buy it in the first place.
In some extreme cases you might possibly take the top management to court over it, and perhaps win a class action suit. Long after they do the thing you think they should not have done, you might possibly get a check in the mail for it. Will that check come out of the company president’s pocket? Far more likely it will come from the company, and the legal expenses of defending your lawsuit will also be paid by the company. So the end result of the company president stealing money from the company is it gives you the right to take from the company too.
I repeat — if your conclusion is “If management does something I don’t like then I can sell my shares” then all your extended argument about why you’re right to dislike the things you dislike, is only empty philosophising.
You don’t like management paying attention to environmental issues or social issues etc when they ought to be making money for you. Somebody else doesn’t like them ignoring environmental or social issues. OK, given your opinion about why you want to sell the stock plus a sell order, you can sell stock. And given your opinion and $3.50, you can buy a latte.
derek 07.28.08 at 11:56 am
I think Daniel has it quite backwards: the vagueness of the fiduciary duty is not a licence to engage in any altruistic act the director cares to take, justifying it as long-term profit maximisation. It is a licence for the shareholder to crucify the director for any act seen as altruistic, judging it after the fact to have been bad for profits. So the vagueness acts to make directors more cautious in adhering to a strictly rapacious business model than a clearer formulation would.
(note that the soldier’s right to disobey illegal orders is clearly stated in an attempt, not always successful, to forestall the intimidation of soldiers into carrying out illegal acts. The vaguer the formulation, the less likely the soldiers are to disobey, not the more likely)
Fear, uncertainty, and doubt are well known to make people act conservatively. Just as nobody ever got sacked for buying IBM, no director ever got sued for being a Genghis for the sake of the shareholders. But being a Gandhi for the sake of the shareholders might not save you from some irate shareholder’s wrath if it goes wrong.
Some Anarchist Fellow 07.28.08 at 7:54 pm
I think if we all take a step back, and I mean /all/ of us, we can see where the stock-exchange is the root of all problems, not only our problems as a species but the problems held by individual companies. After all, if the government seems to get so little done, it’s because it is a company with 120 million registered “managers”. By divding the responsibility to shareholders who then elect an enactor, the company becomes held frozen by an approval process of 120 million signatures.
A recent example is Google, the up and coming IT punk who seemed destined to change the market forever. Well, they IPO’d, bought a stupid video sharing website, and haven’t made a headline since.
Like politicians, public companies are caught in the sociological trap of pleasing a large group by averaging out their interests to a fuzzy gray mess. Simply by offering shares, a company simultanously makes contradictory promises between any two share holders of “what’s right” and then breaks every single agreement by seizing up. At that point the option is to liquidate or trade into or outto a competitor. Risk is hard to sell when your job description is fundamentally to keep your stack of chips from EVER going down.
The Great American Mess comes from the merging of public and private interests where the contradictions go on forever: A worker’s 401k heavilly invested in a competitor, layoffs to increase shareholder value decreasing the number of available customers, any first year student can do this all day.
However, an abolishment of public trading in favor of a finance-based economy would be at once more honest and healthier for all concerned. The notion of percentage entitlement creates kings where only gentlemen should stand. If a loan were simply paid off and the transaction ended, responsibility of the company would rest squarely upon the proprieter, who would then be judged sqaurely by their market. Actions then become a reflection on a commitment to actual success rather than some fuzzy, over-the-horizon, potential-profitability nonsense that makes only non-producing consultants wealthy and makes everyone involved freeze-up with apprehension.
To put it short (too late), two people can pick a pizza with plenty on it, but after seven or eight in the party, you end up just getting nothing but extra cheese. Let us cast aside the failure of democracy to the federalized spending with which it is so abhorantly and deservedly associated, and leave business to deal with itself as America was intended to do. Though, ironically, we would need a popular (read: federal) action to bring about such a balance.
Sam 07.28.08 at 8:24 pm
Sorry, Dave (heh, sorry, couldn’t resist)
A market economy is not anything like what you described. In fact, it’s rather the opposite. A market economy is like a bunch of people traversing an empty field toward their own destination using whatever means they deem best. You can try peddling backwards on a rope over the grand canyon with a blindfold on if you really want. I would prefer to walk forward on flat solid ground with my eyes open. Now if we were to come to some sort of intersection together, we would have to make some sort of agreement together on how to proceed. And maybe 5 or 6 of us would meet at the same intersection and decide how that intersection would work, and anybody coming along after us would either have to agree to abide by what we decided, or come up with enough people to change our decision.
THAT is a better (but still poor) analogy for what a free market is. What you have done by adding all sorts of restrictions like wearing a blindfold, pedaling backward, carrying other people, etc. is to illustrate what happens after government gets involved.
Robert Waldmann 07.29.08 at 5:14 am
I’d say the body shop application of the DD folk theorem is simple. If CEOs give to charity they have a fiduciary duty to claim (falsely if necessary) that it isn’t PR andthat they don’t care about shareholder value, because this increases the PR value of the gesture.
If Judge Prof Posner wants to append a rule “CEOs had better not ever ever try to deceive customers in an effort to sell product or voters in a effort to influence public policy” to the fiduciary rule, that would be fine by me (I can do without the $35 I’ve earned from google ads so I don’t care if he bans the advertising industry). But I don’t think that was what he had in mind
Martin Bento 07.29.08 at 7:07 am
Tracy, as I pointed out in #52, companies can often do good more efficiently than individuals, even the CEOs of those companies, because companies bring more to the table than cash: they bring intellectual property and established business relationships, for two. My example was a company that has a technology to reduce fossil fuel consumption, so as to aid with global warming and oil depletion. The CEO can contribute his personal wealth to the cause, but he cannot make the company’s product available more cheaply, save by acting through the company.
Let me give an even clearer example. A company develops, at great expense, an HIV vaccine. For the sake of humanity, the CEO wants to turn it over to the public domain. Neither he nor anyone else could do this acting as individuals – couldn’t do it at all, much less “more efficiently”. How could the personal charity of the CEO be more efficient at combating AIDS than having the company surrender its IP? Your premise requires that it be so, but it is hard to see how it can.
Dave 07.29.08 at 12:52 pm
@74: A market economy only ever approaches being a level field after government has intervened: first off by providing through its basic existence a system of guarantees for the stable existence of private property and tradeable economic value, secondly, by defining and upholding criminal and civil laws, including those of contract, and thirdly by regulating markets against, e.g. monopolies, cartels and insider dealing. Without all that ‘government’, you don’t have a market economy, you have the Godfather. So your underlying point is wrong.
Moreover, the functioning of a market economy is not like a field. A field you can sit down in, have a rest, turn round and walk off at right-angles to your path; all without immediate catastrophic consequences. You can’t do that in a market economy. If it is ‘shocked’ by more than a small percentage in any direction, strong positive feedback intervenes to further enhance instability, just like a guy on a rope over the Grand Canyon – markets crash, thousands lose their jobs, their savings, their homes, there is potential for significant political unrest, etc. To deny this is to deny most of modern history…
In such cases, where traumas to the economy are survivable, it is usually because those aspects of society that are least like a market economy step in. I think, for example, of the strong sense of cohesion within Japanese society, or the very generous tradition of charitable giving in the USA, or, indeed, of essentially non-economic ties of national and cultural loyalty in most developed societies.
So, to your fairy-tale of market harmony, I say nyaah!
Tracy W 07.29.08 at 2:49 pm
J Thomas: I repeat—if your conclusion is “If management does something I don’t like then I can sell my shares†then all your extended argument about why you’re right to dislike the things you dislike, is only empty philosophising.
I don’t think it is empty philosophising to worry about management structures and the confusion caused by dual values. Management structure does make a big difference to how effectively organisations perform. Giving someone multiple goals is not necessarily a pathway to success. Management structure is a serious issue in business schools, I would hesistate to say those guys are engaged in empty philosophising.
You don’t like management paying attention to environmental issues or social issues etc when they ought to be making money for you.
A company that is making money for me is paying attention to social issues. If it’s making a profit, it’s doing it by selling people things they find more valuable than the sum of the inputs used to create those things.
As for environmental issues, I think those externalities should be internalised. Or run by a separate organisation that focuses on the environmental issue (eg retaining seed banks).
Somebody else doesn’t like them ignoring environmental or social issues.
I think it would be wise for that somebody to worry about how effective companies are at addressing environmental issues. One of the key things that concerns me about many discussions about CC is that they don’t spend much time talking about how effective companies actually are at achieving those goals – it seems to be enough that they intend to achieve some nice-sounding goal.
Tracy W 07.29.08 at 3:07 pm
Martin: As I pointed out in #52, companies can often do good more efficiently than individuals, even the CEOs of those companies, because companies bring more to the table than cash: they bring intellectual property and established business relationships, for two.
And these business relationships are useful in solving whatever problem they are trying to solve?
As for your example of a company’s product being available more cheaply, the CEO can buy the product and sell it at a loss. I have less worries about you setting up a business that does multiple goals, if you are both the shareholder and the CEO. But if you do set up a company selling equipment that reduces fossil fuel consumption, and you want to sell some of it as a loss, I advise keeping the records of the charitable endeavours explicitly, so you know what you are paying in terms of forgone profits, so if the profit-making side of your company starts to become a loss-making side you can easily tell if that’s because of your charitable donations or for some other reason.
My concern about ineffectiveness really starts to come in when people start hiring agents to run the business. Maximising long-term profits is, as Daniel points out, hard enough to measure in the long run. Knowing if you are actually achieving non-monetary social goals is generally even harder because you don’t have money as a guide. I have yet to learn that an effective management response to unclear goals is to combine them.
Let me give an even clearer example. A company develops, at great expense, an HIV vaccine. For the sake of humanity, the CEO wants to turn it over to the public domain. Neither he nor anyone else could do this acting as individuals – couldn’t do it at all, much less “more efficientlyâ€.
The CEO has no moral right to take that decision, since you specified that it cost the company a great expense. It’s the shareholders’ decision – it’s their money. If the CEO wants to donate the service developed at a great expense, he should seek shareholders’ approval. You have managed to find a case where I reverse my original intuition and are prepared to argue that management should be sued. If a CEO can just take great resources like that and give it away, it is going to be very hard to raise money in the future for any life-saving vaccine and that is very very scary.
As for individuals, who said that people were obliged to act as individuals when they want to act charitably? I explicitly mentioned charitable organisations in both comments I have made so far, in approving ways. There are a lot of organisations that don’t seek to make a financial profit. The UK’s Wellcome Trust is a charity focussing on medical research that has an endowment of around £15 billion.
Tracy W 07.29.08 at 3:26 pm
In some extreme cases you might possibly take the top management to court over it, and perhaps win a class action suit. Long after they do the thing you think they should not have done, you might possibly get a check in the mail for it.
This is a serious problem with all fraud prosecutions, especially if the fraudster has just wasted away the money (and I understand it is very rare for them to do otherwise). For this reason, prison time makes sense. It may not help the victim of the theft directly, but at least it deterrs future theft.
http://www.itbusinessedge.com/item/?ci=21066
http://www.npr.org/templates/story/story.php?storyId=12586282
Martin Bento 07.29.08 at 3:48 pm
Tracy, now you are changing the question. What you said was:
“And yes, there are people who want companies to simultaneously make a monetary return on their retirement savings, and pursue some other social goals. I don’t know why people do, and I think it is inefficient”
and
“I think it would be wise for that somebody to worry about how effective companies are at addressing environmental issues. One of the key things that concerns me about many discussions about CC is that they don’t spend much time talking about how effective companies actually are at achieving those goals – it seems to be enough that they intend to achieve some nice-sounding goal.”
I did not argue that it would be right for a CEO to forgo his intellectual property in this case, but that it would be efficient at achieving the goal of eradicating HIV – more effective than anything the CEO could do acting independently of the company. There may be, as you suggest, other cost in how this affects the market going forward, but there are always possibly other effects. What I am saying is that your position that moral behavior by corporations is necessarily inefficient is not true. And, in fact, you seem to implicitly concede this by dropping the efficiency argument and returning to the shareholders enforcing their rights in court, which is the argument here. My point, and I deliberately chose an extreme case for clarity, is to make clear that corporations are often in a position to achieve a social goal more efficiently than other players. That doesn’t necessarily mean they should, but it does mean that the efficiency argument doesn’t generally hold water, though it may in specific cases.
In the CC example, too, you seem to revert to a shareholders’ right position, by stating that it matters whether the CEO owns the company. While one would have to stipulate a lot of detail to run numbers, suffice it to say that a CEO buying product out of his own product and selling at a loss is not necessarily going to be more effective than the company accepting a reduced profit margin. And, yes, keeping careful books would be advisable, but that is always true.
To be fair, I see your point about how expecting morality complicates the business of corporations, and that charitable acts can have negative unintended consequences (though this is true in non-profit structures too; as when local warlords consolidate their power by confiscating food aid). But the efficiency argument is not a bullet pointing in one direction.
Tracy W 07.30.08 at 7:35 am
I did not argue that it would be right for a CEO to forgo his intellectual property in this case, but that it would be efficient at achieving the goal of eradicating HIV – more effective than anything the CEO could do acting independently of the company. There may be, as you suggest, other cost in how this affects the market going forward, but there are always possibly other effects.
So you’ll agree with me if I amend my statement to:
““And yes, there are people who want companies to simultaneously make a monetary return on their retirement savings, and pursue some other social goals. I don’t know why people do, and I think it is inefficient for the world as a whole.â€?
What I am saying is that your position that moral behavior by corporations is necessarily inefficient is not true.
When did I say that? I have been strongly maintaining that in a system with good property rights, a company that is maximising profits is doing a good thing. I have also, in another thread, argued that honesty (a form of moral behaviour) can well be profit-maximising (of course there are situations, eg the deranged would-be murderer demanding to know where their intended victim is, when lying is the moral thing to do).
While one would have to stipulate a lot of detail to run numbers, suffice it to say that a CEO buying product out of his own product and selling at a loss is not necessarily going to be more effective than the company accepting a reduced profit margin.
Why wouldn’t it be more effective? It would certainly be faster for the CEO to buy the goods directlyk, as the company’s auditors wouldn’t need to look at the transaction except to note $x in sales. I can spend my own money faster than I can the company’s.
To be fair, I see your point about how expecting morality complicates the business of corporations,
It depends which sort of morality you expect. Different organisations should focus on different things. Expecting Amnesty International to return a profit would complicate the business of Amnesty International. Expecting the justice system to also grow food would complicate the business of the police and the courts. That doesn’t mean that making profits or growing food is bad, it just means that organisations run better if they don’t try to solve all of the world’s problems at once.
and that charitable acts can have negative unintended consequences (though this is true in non-profit structures too; as when local warlords consolidate their power by confiscating food aid).
Or when Florence Nightengale insisted the soldiers in her hospital drank lemonade rather than beer. The water supply was contaminated by a dead horse, and after the war she worked out that her hospital had had a higher death rate than the others for that (and other reasons).
I think that it is probably easier to do bad things by accident than by intention.
J Thomas 07.30.08 at 9:41 am
I have been strongly maintaining that in a system with good property rights, a company that is maximising profits is doing a good thing.
Let me amend that a little:
In a system where everything that can result in situations where maximising profits is a bad thing have been removed, a company that is maximising profits is always doing a good thing.
Now I can agree with it without reservation.
Rich 07.30.08 at 8:16 pm
One note: the statement about a corporation serving the interests of shareholders in the Dodge v. Ford case was DICTA. The decision actually rest on a conflicted shareholder argument (Ford was withholding profits because he didn’t want to give money to the Dodge brothers, who were going to go found their own corporation). No court has ever cited Dodge for the “shareholder primacy” notion of a corporation.
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