I agree that there are problems with corporations, in that they have too many legal protections and rights, but I think I disagree with the premise of the OP. I think the best way to get my concerns across is with hypotheticals:
Let’s say I am the single shareholder of a corporation. I take my money (let’s say 10 million dollars) and open a company to produce and sell “Wondrous Wooden Widgets”. I build a factory, buy machines and raw stock, hire 100 people (half in manufacturing, 40 in sales and marketing, and 10 administrative staff - including a president, I don’t want to work there, I am just fronting the cash). Let’s also say I am making a reasonable profit with my money, say 5% annually. Now let’s say that one of my employees invents a method to triple the productivity of the assembly line workers. I can now create my widgets with only 16 people on my manufacturing line! I give a big bonus & promotion to the genius that did this and let go of the 34 unneeded people with a good severance package even though I am making 5% profit while employing them. After letting them go, I can give everybody raises and still bring home 15%. Are you saying that I should retain the 34 people even though they have no work to do?
What if I come across an eco-tourism investment that not only promises a 20% return but will help the green spotted lizards of Patagonia (a species that I have always been passionate about). I would of course try to sell the widget company first, but if no buyers are forthcoming, can I take my 10 million dollars out of the widget business (close it down, let go the workers, liquidate the assets, etc…) and invest in the new business or are you going to require me to keep my money there as I have now somehow become responsible for 100 (or 66) peoples welfare? Telling me I cannot sell what is mine does not seem very fair to me. Or my factory, machines, etc… somehow become the property of the employees? What if my 96 children are now college age (they share the same birthday as I cloned them all on the same day), can I shutdown the business to have the money for their college educations or do the workers take priority? If the answer is that the workers have first dibs, I don’t think I would have opened the company in the first place and instead invested my money in treasury bonds for a measly 3% return…
But realize that the only reason large-scale companies exist is this responsibility shield.
Many people own a very small number of shares in a few corporations-in retirement funds, mutual funds, or just to invest a little savings. That’s something I, at least, would never do if there wasn’t a responsibility shield—otherwise, I would only look at companies i knew wouldn’t get sued, or go broke dramatically—the point of the liability shield is that I can invest, knowing that the most I can lose is my investment.
Similarly, because of that same shield, I don’t much care who the other shareholders are, as all they put in is money-if I owned a business directly with them, I’d have to worry if all of them were good guys, were solvent, weren’t going to misuse company assets–because those things could make me lose out.
Also realize, that at the end of the day, all these corporations are owned by people. (sometimes through holding companies, sometimes through funds or trusts)–so really, the corporation isn’t protecting the interests of workers over some “fictional entity”-it is, but only because protecting the interest of that fictional entity protects its investors. Knowing that that must be the corporation’s goal means I don’t have to closely monitor its management (not that I could do anything beyond sell out if it didn’t).
Again, it’s not absurd to think of a different system. But all of these protections make it possible, and make it far less costly for a company to have a huge number of co-owners, hence get more investment, and do more things. Whether or not a good thing, the economies of scale that this allows are what makes a modern society work.
The corporation is an institution that allows lots of investors to pool their resources and make big investments. For certain particular advances in society, corporations may have been necessary. At the present time, we have allowed corporations to expand way beyond their appropriate size and number. The total amount of economic power wielded by them vastly exceeds everything else. They control most functions of the government and are thus not controlled by anybody.
A group of investors never has and never can put human beings first. Individual investors may be good people who care about the corporation’s employees and customers, about ethics, about communities, and about the environment. But since the idea of the corporation is based on profit, the profit motive will win out in the long run. The corporation as it’s currently designed can never be ethical. To have an ethical society, we need to replace most corporations with something else.
Economically speaking, nobody will ever give you anything. You have to negotiate for what you want. The owners of a company get what they want because they have all the power, unless the work force is organized into a union. People don’t seem to realize that saying “this isn’t fair!” doesn’t count for anything. You can’t expect people to give away part of what they think is theirs, just because it’s fair. Stockholders argue their contribution to the company is more important than a laborer’s contribution, because they’ve assumed the risk and you haven’t. Laborers argue their contribution is more important because they’re doing all of the work. In the end. none of the arguments matter unless you can turn them into bargaining leverage. You can bet your ass the stockholders are organized, and if you want laborers to compete with them on equal footing, laborers have to organize (or threaten to organize) themselves.
There is much to discuss in your post, whorfin, but I am going to select just this as the core of the matter.
First, it was protecting the interests of itself over the workers (or the rest of society, or…) Second, if an investor is unwilling to accept responsibility for what she does with her money, or those acting on behalf of her, then IMO she needs to not invest. Her incentives are totally misaligned. One might make the argument that humans are too risk averse for effecient allocation of resources, so some sort of responsibility shield is necessary. I am fine with this, if it is true, which is more or less an empirical question and in practice I don’t debate empirical questions. But who is then bearing the brunt, if not investors? It must be everyone else. Therefore everyone else should also share in the profits, since they are assuming risk, too.
Let me put it plainly. Some chemical company, hypothetically, destroys local groundwater, causing severe disease and crop damage and so on. These folks seek restitution for this, quite reasonably, only to find that the company has little assets and one cannot squeeze blood from a stone. Investors stand to make the most profit. In this case, did they realistically bear the most risk?
You make a post, some one says you may be right and you ask them to define “right”? If I say you are wrong do I need to define “wrong”? What kind of silly game are you trying to play?
In Martini Enfield’s long post, he suggested that employees and owners should swap places, and therefore, the employees should get first dibs on the rewards (profits). (Setting aside the fact that this idea is 180 degrees opposite of the very meaning of what a “company” is – but I’ve already tried to explain that.)
Nowhere in that same long post does he also recommend that employees be the first to take a pay cut or volunteer to give up their jobs when the company does not make a profit. I don’t see or infer where he suggests the balance of fairness should also be kept by having the employees take a share of the losses.
In some circles this is called, “having your cake and eating it too.”
Hmm… but what if…what if you could create a company of 100% employees?! Yes yes yes! But now, those “employees” are also the “owners/shareholders”! Interesting logic.
So in summary, employees are first in line for profits and last in line (or more likely not in line at all) during the years of losses. Does this sound like the position of an adult in the real world or a child that thinks money grows on trees?
Martini has interesting social goals but he’s going about it in the most naive way.
If you want a corporation that only provides a fixed return to its investors, find one that only used debt instruments. Those have a fixed rate of return, and any cuts to employees are done so that the debt payments can be made.
However, equity is cheaper than debt for most corporations. Investors purchase equity for a lower dividend rate, because they can also enjoy appreciation as well. Divends plus appreciation = TRS (Total Return to Shareholders). If shareholders are not getting a good return, then the cost for a company to get money increases (Cap M calculation).
When you complain that a company pays too much out to its shareholders, you are telling people that they can not get the same level of return on their investment.
If you do that, then your investment capital is doing to dry up and your company will no longer be able to fund growth through equity.
They will turn to debt, and that will signficantly slow down growth prospects.
When you slow down growth, fewer jobs are created.
When you only use debt, a slight hiccup in revenue results in drastic actions to pay the debt. This means that more people lose jobs, salary cuts, etc.
to address these separately (as they are valid points)–I take issue when people contend that a corporation favors a fictional entity over “real people”-which is only true if you ignore the fact that the fictional entity is, when we get down to it, a vehicle that other real people use to invest-and real people lose money/have no pension/go broke when the corporation does.
I was trying to show that the things that most people point to as the corporation protecting “its” interest are really things that investors either want, or that investors need in order to ensure that their own interests are protected.
So one might validly argue that we shouldn’t favor this group of real people (employees) over that group of real people (investors). But it’s not a question of real people or non-real-people.
Well, first note that the liability shield isn’t an elimination of investors’ risk. It merely limits it to the amount they have invested. A pension fund does go broke if it invests in enron, or your hypothetical chemical company. But we can’t go after personal assets. (Also, investors’ profit is proportional to their investment (i.e. the number of shares they have)–so those who stand to gain the most also stand to lose the most).
I’d ask you a related question. I think it’s fairly likely you have some share holdings, somewhere. (say, in a 401(k).
do you know what each of those companies are? Do you know they’re not doing anything illegal? Could you possibly know if you invested in more than one corporation? If you invested in Whole foods, with thousands of employees and hundreds of stores, could you be sure every one isn’t doing something that might lead to that kind of a lawsuit?
Are you willing to bear the risk that if one of them does, and gets sued, the plaintiff can collect directly from you–take everything in your bank account, your car, all your assets?
Because that’s the alternative, at the margin. Either investors’ liability is limited-or it’s not. If it’s not limited, my understanding is (IANAL) that you run the risk of having a loss/judgment collected from your personal assets.
I’m not sure I disagree that we ought to regulate corporate actions more–but messing with the corporate form isn’t the way to do it. Also, I’m not sure that, even taking the various horror stories into account, the empirical benefits of allowing large businesses to function aren’t lots greater than their costs. (as I sit, typing this on a japanese computer, on a desk from a Swedish corporation, getting ready to have lunch in a place owned and operated by one corporation that brings in all sorts of raw materials sold by another, which allows it to have all sorts of things that wouldn’t be available locally, or in the reliable quality provided).
Also, for every horror story, I’m sure there are a hundred businesses that use the corporate form that look to you and I like ordinary local businesses. The corporate form is just a tool-it can be used for good, or for evil, but we shouldn’t cut its head off because it might spread a cold.
As is stand the management of a public company are LEGALLY bound to act in their shareholders best interests. If they fail to do so they can be held legally liable by the shareholders.
Its actually one my (many ) pet peeves, is these adverts that try and convince us that big multi-national company puts the well-being of their community, customers, environment, fluffy kittens, etc. first, and aren’t just out to make a buck, whereas if that WAS in fact the case, their shareholders could sue their ass.
Personally I don’t think its such a terrible system, we have to accept the fact that companies ARE driven by the profit motive and if you want something that ISN’T you have to look to your democratically elected representatives (though of late the profit motive hasn’t been THAT far from their minds either ).
The employees have a share of the losses now. A much bigger share than the owners do, for that matter. Employees will be laid off long before anyone who invested in the company has to take a loss. Employees will get benefits cut and paycheck reductions long before executives give up bonuses and dividends and salaries.
These already exist. Many doctors are in partnerships, not corporations, where the employees do actually make money from the company’s profits. This is because the doctors put down the capital to buy the building, hire the staff, etc. (or “bought in” later). Why should the janitorial staff benefit from capital that they did not put down. They took no risk. They just came in for an interview and negotiated a salary. They do not “deserve” to make money from the company’s profits. They “deserve” what they agreed to be paid for their time and effort.
Valete,
Vox Imperatoris
ETA: Looking at what Mosier, said, that too. The janitors do not *want * to have a share of the profits because if you have a share of the profits, you also have a share of the negative profits.
Uh - no. I have taken losses in my portfolio before from companies that were not laying off people or cutting salaries. The claim that investors are the last to feel the pain is not supported by evidence.
You are mixing up Executives with Shareholders above as well.
Salary & Bonuses: Go to employees based on criteria agreed upon as part of the employment contract.
Dividends: Go to the shareholders based on a vote by the Board of Directors.
If you’re just getting by with mild profits and an economic disaster hits that eliminates 1/3 of the market overnight you’re going to be in serious trouble. This is exactly what’s happened to the domestic auto industry. Losing market share in a tough competitive enviroment can be managed. Even rising gas prices that shift the market mix to less profitable product can be managed. A closed credit market has a two fold effect, customers can’t get credit to buy product, and companies themselves can’t borrow money to be able to weather the storm.
I don’t necessarily agree with the notion of maximizing shareholder value above all else, but having big profits can also lead to large cash reserves. The principal reason Ford is in better shape than the other two is that they were able to borrow a huge sum for restructuring before the economic crisis hit.
Personally I’d be happy with a law that required any reduction in payroll (i.e. lowering wages or laying off people) to be matched to an equivalent reduction in ALL salaries of the executives (including any and all bonuses) as well as any managers who lost people under them.
This would be for publicly traded companies, not ma & pop shops.
But this is too much of a simplification. It’s not just an investment vehicle. If it were, it would not represent any kind of responsibility shield. It is an investment vehicle, yes, but my point is that it is unreasonably distortive in that it acts as a responsibility shield.
I agree with this, please don’t misunderstand. My point is that this is the whole picture for investors, but not the whole picture for Everyone Else.
It is. If it were about real people, I could really sue real people for it, but I cannot, and when their shield breaks from being beaten, there’s really nothing more for me to do. I mean, let’s just say it: if it were about real people, then there’s no need for the fiction, and we wouldn’t have corporations.
Right.
Right. And I find this to be fundamentally improper. An investor should care about more than profit. Perhaps some investors do, and select investments based on additional reasons. But to me the only way to get the incentives right is to tie their risk to the real events their money is enabling. If I give money to terrorists, it would be highly suspect to suggest I have no culpability in the acts they commit. Why are investors so lucky to limit their responsibility?
My example is meant to illustrate that they do not stand to lose the most. This is precisely the problem. (I think there are other problems, too, but I’d like to stick to this one.)
Yes, I have investments, and no, I’m not pushing myself to minimize my risk. The incentives to do so aren’t right, so why would I bother? But even so, I don’t want to suggest that any particular investor, by virtue of investing $1, is potentially on the hook for millions. I don’t think that is the right incentive, either. Honestly, I just don’t know what the right incentive is, but I feel strongly that this is not it.
But there are limits and there are limits. Right now $1 risks exactly the loss of $1, but the potential for gain is unlimited (not infinite). This is so obviously improper to me that I’m not even sure how anyone can make sense of it. I don’t know what to do to make it better. I do know that investors are the ones who stand to make a profit but they do not bear all the risk, and this is a problem.
I am absolutely certain the benefits are worth the cost. I am quite skeptical that the same people reaping benefits are the ones bearing the costs.
I talk a mean talk but I’m quite mild. We could probably attempt to correct the issues I’m raising without a wholesale banishment of the corporation. But if we do, the tools we’re using to analyze it have to extend beyond the analysis that corporations represent shareholders–if this is all it were, we wouldn’t have corporations.
I understand your point( and it seems we disagree about little)—I understand the distortion, but as I pointed out in my first post, the things that are distortative are necessary to allow investment.
Well, first of all, who would you sue in a public corporation? Either the answer is directors, or it’s some individual shareholder-and then I would ask which one, why that one, and whether that’s fair to the rest?
IANAL, but as I understand it, limited liability protects shareholders, not directors (my understanding is that they have other things that protect them)–as its canonical definition is that your liability is limited to what you invest (and they’re not first and foremost shareholders)
I also disagree about the purpose of the fiction-inasmuch as it is to allow real people to invest, and to do so without incurring either management responsibility or liability. The reason we have limited liability is that real people like me want to invest, and wouldn’t do it without these protections.
I understand that you want to resolve incentives-and first I’ll note that I can’t think of any reason that you couldn’t create a corporation that had a purpose of public service/caring about employees-and the fact that we don’t says a lot.
Well, why limit it to investors? Why shouldn’t a lender be liable if it lends money to a bad corporation? As it is these days, a lot of shareholders don’t have any control over a corporation’s acts. I would argue it would be hard for them to have knowledge over the corporation’s acts to the depth necessary to find even casually concealed wrongdoing. (and let me pose that to you-what would you argue we ought to do when shareholders are deceived that a corporation isn’t doing wrong? If we put the burden of ensuring the corporation’s doing good on shareholders, why should we limit it to obvious wrongdoing (if we did, the rule would be effectively meaningless for reasons I’m sure you can see))
I don’t disagree that investors should care about more than profit. I think it’s hard to do so when you’re a small investor, and the only information you have is from the WSJ.
I think changing the things investors care about is only possible through re-education or a fundamental change in how corporations function. And as I will hope to show now, I think the change you propose is a lot more damaging than you think it is.
Well, but my point was really trying to show both that conscientious people who think we should care more about those things don’t, but that it just isn’t practically possible for one ordinary shareholder to do the kind of analysis you demand, even if she wanted to. I couldn’t do that for one big-ish corporation without having it be an undue burden on my day job-and I have some business skill and some education. Try doing it for ten, or twenty. Try doing it if you’re a factory worker who gets some compensation in stock. I just don’t think it’s possible
However, I think this leads to the best argument I have, and the most important benefit of limited liability-it allows transferability of shares. The principal reason I think it would be utterly impossible to create any shareholder liability above their investment would be that doing so would end the easy transferability of shares, and that would be catastrophic.
What happens if an investor for $1 could be liable for $2? (or any sum over $1?)
It suddenly starts to really matter who those investors are. One of the key benefits of limited liability is that I don’t care about the solvency of other shareholders. I don’t need to look at every share sale with care.
If there’s any possibility at all that I am held liable for more than my investment, then the problem is that it suddenly matters that I can cover such a judgment. Let’s imagine shareholder X has invested for $1, and is held liable for $2. If he can’t pay, who do we put the burden on? Presumably, the other shareholders.
Hence, if I’m one of those other shareholders, X’s solvency dramatically changes the risk I’m taking. Further, when X sells to Y, I’d suddenly need to figure out if Y was solvent to the extent of any potential judgment, and would want some way to avoid buying in when X was a shareholder, and having my risk increased when X sells to Y. (and similarly, it would be a lot harder for me to sell out-as it would matter who I was selling to, and presumably, the other shareholders would want to stop me from selling out to someone who couldn’t cover any liability over his investment).
That would shut down the system of stock ownership and sale overnight. One of the biggest benefits of limited liability is transferability of that stock.
Well, I do appreciate vigorous debate–but I think that the analysis has to be that way, at least on a level of liability for no other reason than practicality. If we want better governance oversight, or to require corporations take account of (say) employees, we should make the directors responsible for it-not the shareholders.
) pet peeves, is these adverts that try and convince us that big multi-national company puts the well-being of their community, customers, environment, fluffy kittens, etc. first, and aren’t just out to make a buck, whereas if that WAS in fact the case, their shareholders could sue their ass.