Wednesday, February 4, 2009

CORPORATIONS, PRIVATE INTEREST & CYNICISM

During a conversation I had yesterday, an acquaintance said: “Isn’t it amazing that XYZ Corporation invested money in environmental cleanup and ‘green technology?’ Maybe big corporations are not so bad after all.” I smiled and said: “Sure they are. You really don’t think they are investing that money because they care about birds, do you?” He nodded and responded: “So you think they are doing it for profit?” I replied: “Absolutely. It’s just cost-benefit analysis. They know that if they don’t invest in the cleanup, the EPA will hound them later, which will cost more than paying for a cleanup today. They might say they love wildlife, but basically they are just trying to avoid losses.” My acquaintance seemed persuaded but added: “God, you are cynical.” I continued: “Yes, I am cynical. But when it comes to analyzing corporate behavior, cynicism is the only way to understand it. You see, corporations are legal entities that exist for no other reason than to enrich their private shareholders. Any other purpose is actually against the charter. If you understand that, you can safely trace every single corporate action to one thing: Private self-interest. If directors pursue loftier aims or, God forbid, public ones, the shareholders can sue to stop them.”

“Oh really?” The acquaintance looked puzzled.

Ah, another person who did not truly understand how corporations operate. Now he knows.

For a long time, I did not know, either. Like my acquaintance, I had an intuitive sense that corporations were “bad” because they seemed to control massive amounts of money and did not seem to care about anyone. But not until law school did I grasp the institutional structure that sustains every corporation. Through my studies, I saw that corporations were not just bad in practice; they were bad on paper, too.

Corporations emerged in the 17th Century for a simple reason: To pool capital into productive commercial ventures without exposing individual investors to personal financial risk. After all, partners in business risk their own money and names. If the partnership goes down, so do they. Corporations avoid that problem by shielding individuals’ personal assets from seizure if the business sinks. If a corporation succeeds, the shareholders get rich. If the corporation fails, the shareholders lose however much money they invested, nothing more. This “limited liability” principle helped spur the industrial revolution, since people did not hesitate to invest in promising new ventures. After all, they knew they would not lose everything if they failed. Historically, corporate investors generally have had much to gain, and only a little to lose.

Corporations generate profit because they are “dedicated business machines.” When shareholders invest money in a corporation, they want the corporation to “work for them.” They want their money to make more money. Corporations accomplish this by concentrating business management in a “Board of Directors” that ostensibly makes prudent decisions solely to benefit the shareholders. Shareholders want a return on their investments. They trust their directors to steer the business in such a way that they will get their wish. If the directors do not generate the desired cash, the shareholders can vote them out. If the directors manage the business for themselves—but not the shareholders—the shareholders can sue to stop them. In essence, corporations are “all about the shareholders.” And shareholders are “all about the money.”

This may sound like left-wing hippie propaganda. Perhaps, but I would not write it if I did not have a reasonable grounding in law. The reality is that corporations channel human self-interest and multiply it a thousandfold. Corporations have only one value: Profit. They are technically not allowed to focus on anything else. There are, of course, “not-for-profit” organizations that pursue other purposes. But the classic “business corporation” has no other goal than producing maximum cash for individual shareholders, to the exclusion of all the world. In that light, when critics speak about “corporate responsibility” or “corporate community awareness,” they completely fail to understand why corporations exist. Corporations have no responsibility beyond enriching their shareholders. They have no responsibility to the public, nor need they express any “community awareness” beyond the awareness necessary to generate maximum profit. And because they are private bodies, the United States Constitution generally does not bind them.

Why do we hear so much rhetoric about “corporate duties” and “corporate responsibilities?” People really think that private corporations have obligations to the public. To some extent, they can be forgiven. After all, big corporations have an authoritative air. To a layman, Burger King® looks official and powerful, just as the police look official and powerful. Burger King® has thousands of buildings across the country, their employees wear uniforms, everyone knows their logo and their advertising bombards the senses every day. Major corporations have a real presence in Americans’ lives. Consumers turn to them for recognizable goods and services. They seem to be well-organized, wealthy and strong, just like the government. That perception leads people to think that major corporations owe similar duties to the public. This is the great misconception about corporations. And this is why people cannot understand why corporations seem so callous.

From a legal perspective, corporations actually have a duty to be callous and selfish. If they stray too far from the path to shareholder enrichment, they will suffer. A classic case illustrates this “private profit principle” in action: Dodge v. Ford Motor Co., 204 Mich. 459 (1919). In that case, Ford’s shareholders sued the company after Henry Ford announced that he would spend the company’s $60 million profit on major capital projects in order to: “extend the business;” “provide employment to more people;” “spread the benefits of the industrial system to the greatest possible number;” “help [people] build up their lives and homes;” and to “lower the price of cars for the public.” Ford’s plan actually envisaged lowering the company’s profit on each car sold in order to make more cars available to the public. The shareholders were aghast. They demanded that Ford take the profit and declare a dividend “no less than 50%” of the total profit, or at least $30 million. They sued Ford and won an injunction ordering the company to pay a $20 million dividend.

On appeal, the Michigan Supreme Court upheld the injunction. Beyond that, it sang an ode to corporate selfishness. The Court chided Henry Ford for frustrating the shareholders’ “just expectations” that they would be massively enriched after a “most prosperous” year. It criticized Ford for spending the company’s surplus for “humanitarian purposes,” and allowing the stock values to drop as a result. It even agreed with the shareholders that Henry Ford was transforming the company into a “semi-eleemosynary society, not a business institution.” Put another way, the Court rebuked Ford for thinking about anything other than the shareholders’ profits.

In the Court’s words, “business institutions” do not consider “spreading the benefits of the industrial system to the greatest possible number.” Nor do they focus on providing jobs or lowering prices for consumer benefit. Instead, the Court candidly remarked: “A business corporation is organized and carried on primarily for the profit of the stockholders.” Any other purpose, according to the Court, would violate the corporation’s charter. Interestingly, the Court found particular fault with Henry Ford’s “altruistic motives.” While it would have been permissible for Ford to spend the company profits on expansion “for the purpose of enriching the shareholders,” it was not permissible for him to spend the same money for “the primary purpose of benefiting others.” The problem, then, was mental: A corporate leader cannot intend to benefit anyone but the shareholders, everyone else be damned.

Does it get any clearer than this? How can people talk about “corporate responsibility” or “corporate public duty” when the law actually requires corporations to doggedly advance only their shareholders’ private interests? When companies lay off workers, pollute the environment or engage in borderline criminal behavior for more profit, they are actually fulfilling their legal mandate and answering shareholders’ “just expectations.” If such actions are profitable, they will be done. If they were not, the shareholders—like the shareholders in the Ford case—would have a claim against the corporation. Corporations follow the law because breaking it would be costlier, and more costs would hurt the shareholders. But if it appears reasonably possible to take an illegal—but more profitable—course, then a corporation should act illegally. Otherwise, it would be a “semi-eleemosynary society,” not a “business institution.”

People criticize corporations for greed. They say: “How can XYZ corporation do this? How can they be so greedy? How can they build a factory there? Don’t they care about the people?” Legally, no. Corporations cannot care about “the people.” They are not allowed to. If they did, the shareholders would call them to account for neglecting their profit expectations. If it would be profitable to build the factory and force people off the land, then it should be done. True, it may be “greedy” for the corporation to consider only its shareholders before undertaking an action that could harm others. But that is what it is supposed to do. Again, we see that corporations channel narrow individual self-interest and transform it into a guiding principle—with the full support of the law. In essence, corporations both institutionalize and glorify private self-interest. No matter how much wealth they produce, there is nothing memorable or praiseworthy about their basic purpose: To maximize private profit over all else.

Bearing these observations in mind, it is easy to apply cynicism in analyzing any corporate action. Cynicism immediately assumes that a person acts only for selfish reasons. It focuses on motives. As we saw in the Ford case, corporations have very simple, selfish motives. The law even criticized Henry Ford because he expressed motives inconsistent with bare profit-seeking. To understand a corporate action, one must merely assume that profit motivates it. After all, it if did not, then the corporation would violate its own charter. Still, sometimes corporations seem to do altruistic things. Sometimes they donate millions to charity. They proudly declare: “We donated $5,000,000 to the Children’s Cancer Society.” To an untrained listener, this sounds like the corporation actually cares. It sounds like the corporation gives money for reasons other than profit. But applying cynicism, we see a more plausible explanation: By giving $5,000,000 to a Cancer Society, the corporation wins several selfish advantages, namely: (1) It can deduct that amount from its taxes, increasing shareholder wealth at year’s end; and (2) It can foster an image that it is a “kinder, gentler corporation,” leading to increased publicity, more sales and more profitability later. In other words, corporations spend no money in vain. And they do not know the meaning of the word “generosity.” For every dollar spent, at least $1.50 must return.

No one likes unapologetic selfishness. It sounds crass and ugly. Although every individual must to some extent consider selfish motives to survive in our commercial world, there is a socially acceptable limit on how much selfishness we can express in everyday exchanges. No one likes a guy who talks about how much money he makes, then announces how much more he plans to earn. Many people may think like he does, but they do not publicly broadcast it. In public, individuals need to at least appear that they care about other people.

Not so in corporate life. Corporations must be unapologetically selfish. That is their purpose. As the Court explained in the Ford case, corporations exist to profit the shareholders; any other purpose violates the charter, especially “a purpose to benefit others.” In that light, corporations need not even appear to care about others. Legally, they have a duty to enrich shareholders and no one else. If a corporation even considers acting to benefit others, the shareholders can stop it. Against this background, it is unrealistic to expect that corporations observe a “duty to the public.” They have only one duty: The private duty to enrich their shareholders.

Corporations are undoubtedly important. They encourage economic expansion and risk-taking. They efficiently distribute goods and services throughout society. They employ millions. But this does not make them thematically appealing. In essence, corporations institutionalize human self-interest and greed. While channeling greed may bring many benefits to our society, there is nothing noble about it. I find it helpful to remember that when considering corporate problems. After all, self-interest is a two-edged sword: It leads to prosperity and plenty on the one hand, but it also leads to corruption, plunder, callousness and treachery on the other. It is no surprise, then, that we hear both bad and good stories about corporations. As long as we understand human self-interest, we can understand corporations. Despite all the jargon and media gloss, they are not complicated.

And we should stop expecting corporations to be saints. They are not allowed to care about others. It’s the law.

1 comment:

SteveW said...

This is fascinating. I agree with everything you say except your characterizations. I do find selfishness and self-interest appealing. I think it is a wonderful characteristic.

The problem with corporations is when they misunderstand what their self-interest actually is. If they take too short-term of a view on self interest, they will do things that are "evil" or "treacherous".

If McDonald's gives $5,000,000 to a charity, and it's completely in their own self-interest, rather than being ominous that is wonderful. First, the charity gets the $5,000,000 which is more than any individuals have the power to convey. Further, they know that next year McDonald's will give another $5 MM, likely indexed for inflation, because it is still in McDonald's self-interest.

Acts that occur out of charity, good-will, or whatever other nebulous motivation that people seem to think is more appealing, are acts that cannot be relied upon. They are likely to be small, irregular, and sometimes occurring for an unknown motivation. Acts that occur out of self-interest are large, reliable, enthusiastically pursued, and occurring for a known motivation. What's not appealing about that?

Corporations are beginning to think longer than the next quarterly statement, they are beginning to think about the environment and the community, and their impact on those. They are beginning to think about how they are perceived in the public conscience. And it's all for their own narrow self-interest, so we know that activity will continue and even grow. That's beautiful, not dark and scary.