How America’s Corporations Lost their Public Purpose, and How it Might be (Partially) Restored

Table of Contents

1. Introduction

2. Origin of the Species

3. The Neoliberal Corporation

4. From Affirmative Duty to a Zone of Liberty

5. The Rise of Vampire Management

6. Restoring the Corporation’s Public Purpose

7. Conclusion

8. References

The Corporate Issue: A Tribute to Lynn Stout

1. Why Lynn Stout Took Up the Sword Against Share Value Maximization, by Margaret Blair, https://doi.org/10.1515/ael-2020-0083.

2. Beating Shareholder Activism at Its Own Game, by Margaret Blair, https://doi.org/10.1515/ael-2019-0040.

3. Ownership (Lost) and Corporate Control: An Enterprise Entity Perspective, by Yuri Biondi, https://doi.org/10.1515/ael-2019-0025.

4. The Shareholder Value Mess, by Jean-Philippe Robé, https://doi.org/10.1515/ael-2019-0039.

5. Executive Pay and Labor’s Shares: Unions and Corporate Governance from Enron to Dodd-Frank, by Sanford M. Jacoby, https://doi.org/10.1515/ael-2019-0073.

6. How America’s Corporations Lost Their Public Purpose, and How it Might be (Partially) Restored, by David Ciepley, https://doi.org/10.1515/ael-2019-0088.

7. The Contest on Corporate Purpose: Why Lynn Stout was Right and Milton Friedman was Wrong, by Thomas Clarke, https://doi.org/10.1515/ael-2020-0145.

8. Lynn Stout, Pro-sociality, and the Campaign for Corporate Enlightenment, by Donald Langevoort, https://doi.org/10.1515/ael-2020-0067.

1 Introduction

Leading up to the coronavirus crash, America’s corporate economy appeared to be in fantastic shape. The stock markets were at record highs. Profits were soaring. Financing was cheap. The corporate tax rate had been cut. And the unemployment rate was near a fifty-year low, with little inflation.^[1]

But for those who troubled to look under the hood, it could be seen that all was not well. Those profits owed little to increased productivity; productivity growth has been down (Federal Reserve, 2018). That cheap financing seldom went to investment; despite the record profits and unusually favorable terms for borrowers, the rate of corporate investment has been down—by historical standards for such conditions, way down (Fitzpayne & Pollack, 2017, p.2; Lazonick, 2014). Those stock prices thus had little, if anything, to do with underlying value creation. Meanwhile, wages, adjusted for inflation, have remained largely flat since the 1970s, despite all of labor’s subsequent productivity gains (Lazonick, 2014). As a proportion of corporate income, wage expenditure today is at a historic low, even with profits at or near historic highs.

Source: U.S. Bureau of Economic Analysis, Compensation of Employees: Wages and Salary Accruals [WASCUR] and Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=2Xa, on April 22, 2020.

Profits that used to be allocated to wage increases, training, research, expansion, and reserves have instead been disgorged to stockholders in the form of increased dividends and stock buybacks (which helps explain those rising stock prices) (Lazonick, 2014). The windfall from the 2017 corporate tax cut went almost entirely to such buybacks, not wages, or investments, or reserves (Ghilarducci, 2018).

For a generation, the stockholder^[2] has been kept fat and happy feeding off the corporate body. Yet the feast was never going to last. There is only so much dining to be done on a host that is not allowed to feed itself. Indicative is that the number of listed companies has actually been declining, in part because entrepreneurs who wish to grow their companies dare not place them under Wall Street’s care, to be bled out for the pleasure of today’s short-term–focused stockholders (Stout, 2012, p.54–5).

Figure 1:

Worker pay declining as a percentage of GDP.

The stock market crash has helped surface the underlying weakness in corporate America. The airlines industry is an illustrative case. The industry is notorious for losses and bankruptcies during economic downturns. And yet, over the past 10 years, the industry, rather than build up its reserves (or invest in itself or its workers), has collectively spent 96% of its free cash flow on stock buybacks, at a total cost of $47 billion. The industry is now seeking a $50 billion bailout from the government (Van Doorn, 2020). The case is illustrative, not exceptional. The rampant stock repurchasing made with the corporate tax cut windfall came on the heels of 15 years in which S&P 500 companies had already sent over 90% of their profits to stockholders in the form of dividends and buybacks (up from under 40% in the 1950s (Jacobs, 2001)). And those buybacks were made not when the stock was inexpensive, for the prudent purpose of reducing liabilities, but when the stock was at a peak, weakening the corporate balance sheets for the sake of pushing the price higher before executives unloaded the stock and stock options (Lazonick, 2014). And rather than use some of the remaining 10% of profits for savings, American corporations have instead taken on unprecedented levels of debt, sometimes for the purpose of sending out even more money to stockholders. Now, the high levels of corporate debt and shaky corporate finances have pushed the Federal Reserve to participate in the short term lending market (the market in “commercial paper” that covers short term corporate financing needs, such as making payroll) and to take the unprecented step of buying corporate bonds to maintain market liquidity and corporate solvency (Vardi, 2020). Having “disgorged” its free cash flow to stockholders instead of building a broad and sustainable prosperity, corporations are now begging for a massive bailout, which, while necessary under the circumstances, could, barring reform, henceforth create the same kind of moral hazard for non-financial corporations that incentivizes too-big-to-fail banks to overleverage, knowing the government will bail them out if a downturn sends them towards collapse (Poole, 2009; Stern et al., 2004).

How has the corporation’s vision become so foreshortened? Its largess so narrowly bestowed? Its malfeasance so widespread? Viewed from the perspective of history, the American business corporation has lost its way.

Lynn Stout did more than any other scholar to make the case, in original, accessible, and compelling terms, that managerial fixation on “shareholder value”—championed by Chicago School finance and law-and-economics and adopted by Wall Street as its mantra—has been causing great harm to innovation and wealth creation, to workers, to the environment, and even to ordinary investors, who are in the market for long-term not short-term returns, which is what today’s large investors demand (Stout, 2012). More, she emphasized that this was neither normal nor necessary. In fact, it was a complete perversion of the design principle of the corporation. The signal advantage of the corporate form, Stout observed, which brought it into widespread use, is that it dedicates property to long-term purposes, projecting values—especially pro-social ones—far into the future. She loved referencing the example of the cathedral of Milan, the construction of which has been going on across 30 generations thanks to its property and contracts being held by a corporate entity, and the example of New College Oxford, the replacement roof of which could be planned 450 years in advance (with purchase of a woodlot) thanks to its perpetuity as a corporation (Stout, 2015). And she was interested in innovative new applications. Early in her final year she was slated to be the keynote speaker at, and did manage at least to participate remotely in, a conference in New Zealand focusing on New Zealand’s incorporation of pieces of nature—a forest and a river—in order to preserve them for future generations.^[3] She was in discussions with Sergio Gramitto-Ricci about the idea of incorporating works of art to preserve them. And, of course, her final book, discussed by Margaret Blair in this issue (Blair, 2019), proposed a universal stock fund so as to more broadly share corporate wealth creation (Stout, 2019)

In honor of Lynn Stout’s efforts to better suit the business corporation for the pursuit of long-term, publicly-beneficial purposes, the present essay reviews critically the historical process by which the corporation’s tie to public purposes—a precondition of the earliest grants of corporate powers—was slowly severed. And it explores a form of corporate control, once widespread in the U.S. and easily revivable, that could partially restore corporate emphasis on public benefits—the foundation-controlled corporation.

2 Origin of the Species

The business corporation got its real start in the 16th and 17th centuries and came fully into its own in the nineteenth century. It was the offspring of collaboration between government and a growing class of enterprising individuals. On the one side, the government would see something that it wanted done because of a perceived benefit to itself or to the public—for example, the opening of trade with distant lands, the construction and maintenance of a road or canal, or the provision of insurance. But the government would decline to do it itself, for lack of financial resources, administrative capacity, or will. On the other side, private businessmen would see the revenue potential in the activity, but would also decline to undertake it, whether alone or in partnership, perhaps because of insufficient resources or capacity, or the poor prospects of reasonable risk-adjusted returns.

The corporate form of business enterprise was a legal and institutional innovation designed to bridge this gap between public need and private risk (Handlin & Handlin, 1969, p. 98–9). As Henry Carter Adams explained in his 1896 presidential address to the American Economic Association, “A corporation…may be defined in the light of history as a body created by law for the purpose of attaining public ends through an appeal to private interests” (Adams, 1897, p.16). Both sides of this formulation are worth underscoring. First, the purpose of a corporation was not to maximize the returns to its stockholders, but to attain some specific public end. Arranging for stockholder returns was just the means to get this public purpose financed, and these returns generally took a back seat until the purpose was being met. Second, attainment of the public end did not rely on public-spiritedness on the part of the investors, or even of the managers. It was assumed that most members of both groups would be driven primarily, or even solely, by private interest. This is a sobering fact for those who today call for “corporate social responsibility” while expecting this to come solely, or at least primarily, from investor and managerial commitment. Originally, what was expected to secure these public ends—what would turn private vices into public benefits—was neither investor and managerial intent nor the invisible hand of the market. Rather, it was the visible hand of the corporate charter.

Receipt of a charter is prerequisite to forming a corporate firm. Until the mid-nineteenth century, a British corporate charter could be had only directly from the Crown or, after 1688, from Parliament. In the United States, only a state legislature or Congress can grant a charter. And historically, a charter would be granted only if the proposed corporation’s activity was of clear benefit to the public. Adam Smith himself recommended being even more stringent. Aware that incorporation was a legal privilege, and doubtful that corporations were as diligently managed as partnerships, he advised granting charters only for undertakings that (1) required capital outlays beyond the reach of partnerships, (2) could be reduced to “routine,” and (3) would, on the “clearest evidence,” bring public benefits beyond the ordinary. In his view, only banking, insurance, canals, and waterworks satisfied all three criteria (Smith, 1904, p.246–7).

The corporation’s beneficial purpose was written into its charter, and to this purpose it had to stick. If a corporation failed to fulfill its purpose—for example, if after several years it had yet to start work on a bridge it was chartered to construct—it was dissolved by the state (in a quo warranto proceeding). Furthermore, activities unrelated to this purpose (or outside other charter restrictions) were subject to being struck down by the courts as ultra vires (“beyond powers” of the corporation). Finally, if the purpose were consummated—say, the bridge was completed—the corporation would be dissolved. Each corporation was tailored to advance a specific public end, and this end alone.^[4]

And what did the incorporators get in return? The benefits of incorporation. Incorporation bestows a bundle of legal privileges that, although originally designed to improve the governance of non-profit associations (especially towns), proved of great benefit also to for-profit enterprises.

The most central of the privileges incident to incorporation is the charter’s creation ex nihilo of a new legal entity—the “juridical person” that is the corporation in law. This legal entity owns all of the firm’s assets, is the contracting party in all firm contracts, and sues and is sued in court. It also bears all of the liabilities of the firm. The notion that stockholders have “limited” liability is a misnomer descending from an earlier age—they actually bear no liability, whether of corporate debts, torts, or even crimes (unless they are a large, controlling stockholder). The expression ‘limited liability’ relates to the limited financial risk stockholders took through the equity they committed to the business venture at its foundation.

Of course, the corporate entity, being a mere legal posit, cannot itself act, but relies on a board or other human agent to act on its behalf. In the language of the medieval jurists, the corporation is a “perpetual minor,” or ward, and the board its guardian, with a fiduciary duty to use the property and personnel of the corporation to advance the corporation’s authorized purposes (Kantorowicz, 1957, p.374–8). This in effect makes the company a special form of “sole proprietorship,” with the corporation (the legal entity) as proprietor and management as its agent. What stockholders own is a financial instrument—which, for historical reasons, is still called (misleadingly) a share of “stock”—which the corporation is privileged to issue and possibly sell to them to finance the firm.^[5]

Having all property owned by the corporation (the legal entity) provides the enterprise with two extraordinary benefits: what I call “asset lock-in,” which prevents investors from pulling out assets from the firm; and “entity shielding,” which prevents the personal creditors of the investors from pulling out assets (to settle investor debts). In other words, they secure for the firm a perpetual body of assets—impervious to the deaths, departures, and bankruptcies of shareholding investors—that can be accumulated across generations unless the board initiates liquidation and the general assembly of stockholders approves it. This increases the firm’s realizable scale and longevity. What is more, because the assets cannot be withdrawn by the investors, they can be hyper-specialized to the firm’s production process—turned into unique pieces of equipment with little resale value but enhanced performance—and the workers can in turn be specialized to them. Both increase firm productivity. At the same time, the firm’s cost of capital is reduced. Investors and creditors don’t have to worry about assets disappearing with departing or insolvent investors, so feel more secure handing over their money. For the same reason, the character and creditworthiness of individual investors ceases to have any impact on the firm or on the other investors. One can multiply investors willy-nilly—large and small, rich and poor, old and young—greatly increasing one’s financing. And all the “shares” that the firm sells can be allowed to trade freely to any purchaser, returning liquidity to the investors and therefore increasing the appeal of the investment and lowering the firm’s cost of capital yet more. In short, the corporate form is ideal for business undertakings requiring large amounts of specialized assets dedicated long-term (Blair, 2003; Ciepley, 2013, p.143–5; Hansmann et al., 2006, p.1337–54).

It is important to note that this separate legal entity is not something that individuals can create for themselves through private contract in the US common law regime (Hansmann et al., 2006, p.1340–43). It requires the sovereign’s legal fiat along with the sovereign’s willingness, as vouchsafed by the charter, to recognize this artificial person in court and enforce its property and contract claims. This explains why every single business corporation has been chartered or gone through some equivalent statutory process. To be sure, this sovereign act has been routinized through time and become a formality, but it is still a sovereign act which is required to incorporate a legal entity as a corporation capable of holding legal title to property and making contracts.

The corporation enjoys other privileges as well, beyond legal personhood, perpetuity, and the right to issue shares. Managers and investors are exempted from liability for company debts (which for historical reasons we continue to call “limited liability,” although it really means “no liability”). Corporations are also granted the privilege of centralized management—for example, a board operating by majority vote—which allows for decisions to be made expeditiously without need for unanimity (as classically needed in general partnerships). Finally, every corporation is granted “jurisdictional authority” to enact rules beyond the law of the land, so long as not “repugnant” to the law of the land (for example, the by-laws and work rules of business corporations). In other words, every corporation is a little government with legislative and executive powers. The corporation is in effect a “replicant” of the state—a Leviathan on a leash, with juridical personhood and jurisdictional authority (like a state), franchised by the state to manage undertakings that, as noted, the government would like done but cannot or will not do itself.^[6]

All of these corporate privileges are good for business, with the result that, in a broad range of circumstances, corporate firms operate at a significant competitive advantage to natural persons, whether sole proprietors or partners. For this reason, issuing a corporate charter was long considered justifiable only if there were some noteworthy public benefit to justify the advantage. Otherwise, it amounted to little more than the state using its public authority to provide private rents to favorites.

3 The Neoliberal Corporation

Today, the scene is much changed. Astonishingly, the most basic feature of the corporate firm—the state-ordained legal entity at its heart, owner of the firm’s property and party to all its contracts—has vanished from common understandings of the corporation, along with any sense that the corporation has a public purpose. Instead, for two generations the reigning wisdom has been that the business corporation is a private contractual association (a mere “nexus of contracts”) to be run in the interest of its stockholders alone—in accordance with a doctrine known as “shareholder primacy.” In other words, the corporate firm is viewed as a glorified private partnership, with the stockholders as the partners. The stockholders, it is said, “own” the corporation, either literally or at least in the minimalist sense that they are its “residual claimants,” receiving what remains from corporate earnings after all contractual obligations of the firm—to employees, suppliers, bankers, and bondholders—have been met.^[7] It is thus right, and efficient, that management work for them.

This view has been propagated especially by “Chicago school” neoliberal theorists in economics, law, and finance, who have been anxious to square the corporation with free-market principles of private property, private contract, and private profit. As Milton Friedman put the point in an infamous 1970 polemic, “The Social Responsibility of Business Is to Increase Its Profits”:

In a free-enterprise, private-property system a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society (Friedman, 1970).

By “owners,” Friedman meant “stockholders.” As a matter of legal fact, this description of the corporate firm is way off the mark (see also Robe, 2019, this volume):

1. Stockholders own stock, not corporate assets. The latter are owned by the legal entity—this being the main point of incorporating.

2. Nor are stockholders the residual claimants of the firm. The corporation is the residual claimant. A portion of this residual may be passed on from the legal entity to the shareholders in the form of dividends, and indirectly through stock buy-backs (which increases the stock price), but this is entirely at the discretion of management (as Apple shareholders long rued (Gosh, 2012; Ghilarducci, 2018)).

3. Nor do stockholders relate to the board as principals to agents. The charter grants the board original jurisdiction over the firm’s property and personnel. Stockholders elect the board’s members, but this does not establish an agency relationship. The stockholders cannot dismiss the board prior to the next shareholder meeting; nor can they override its decisions or sue it for failure to follow instructions, as true principals could. Management is the legal agent of the corporation, not of the stockholders.

Yet while neither law nor history supports the neoliberal construction of the corporation, it has nonetheless gained wide currency and even significant institutionalization through the support of business opinion and legislation. How has this come to pass? And with what consequences?

4 From Affirmative Duty to a Zone of Liberty

At the time of the American founding, the public dimension of corporate bodies remained universally acknowledged. Accordingly, incorporation was granted strictly for business activities with a clear public benefit such as road and bridge construction, banking, and insurance, the objective being to erect the physical and financial infrastructure of civil society. Corporations were indirect arms of the US states, chartered as part of public programs for economic and societal development, with public monies often invested to kickstart particular ventures.

But over the course of the nineteenth century, as liberal economics seeped in (Hovenkamp, 1991), a number of changes occurred that obscured the corporation’s public provenance. One significant development followed from the fateful decision at the American founding to leave chartering to the individual states. It was thought that this would subject corporations to closer monitoring. Instead, competition among the states to attract corporations and collect franchising fees induced a “race to the bottom” in charter leniency, eliminating the restrictions and watering down the public benefit requirements that had set corporations operationally apart from ordinary businesses. Corporations were allowed into ever more business lines, of decreasingly clear public benefit, until their range of activity was indistinguishable from that of private businesses. In a further move toward normalization, the purpose clauses of charters were opened up to include long lists of allowable activities, rather than one specific public end, transforming the purpose clause from a statement of affirmative duty into a zone of liberty. One of the most important additions to that list has been the right to own shares in other incorporate entities, paving the way to the development of corporate groups (see https://doi.org/10.2202/2152-2820.1000).

The most important change of all, however, was the shift from individual chartering by the legislature to chartering by the secretary of state under general incorporation laws. This opening of access did much to undo the notion that incorporation was a “special privilege,” and thereby helped square the corporation, at least in the classical legal mind, with the liberal commitment to an economy based on private property and contract with minimal state interference (Hovenkamp, 1991, p.36–8; North et al., 2009, p.239). In reality, however, this didn’t decrease corporations’ dependence on government one whit: receiving one’s charter and “personhood” and jurisdictional authority from a secretary of state on authority of the legislature is no less of a government intervention than receiving it from the legislature directly. Incorporation remained and remains a government program for economic development. Nevertheless, the change in procedure changed the optics, and it became possible to imagine the corporation as a fully private entity that merely “registered” itself with the government.^[8]

On the back of these changes, prominent corporate lawyer Victor Morawetz advanced the view, in what became a popular legal treatise (published in 1882), that corporations “are formed by the voluntary association of their members…. Although a corporation is frequently spoken of as a person or unit…the existence of a corporation as an entity, independently of its members, is a fiction…the rights and duties of an incorporated association are in reality the rights and duties of the persons who compose it, and not of an imaginary being” (Morawetz, 1882, p.2). Of course, it is very hard to explain the liability exemption of shareholders if this account is correct. Nevertheless, before the decade was out, the Supreme Court was granting constitutional rights to corporations, on precisely this ground.^[9] It rapidly became commonplace, if not universal, to think of corporations as private associations not so different from partnerships or private trusts, with the shareholders as their owners and principals and the board as the shareholders’ agent (Mitchell, 2009, p.81).

Equally important is that this “privatization” of the corporation was accompanied by a corresponding shift in the courts’ interpretation of the corporation’s purpose, from the public purpose enunciated in the charter to the shareholder’s purpose of money making—and thus a shift in the courts’ understanding of the fiduciary duty of directors, from a duty to the corporation’s public purpose to a duty to its shareholders.

A good illustration of this comes from a Michigan case widely cited in its day, Miner v. Belle Isle Ice Co. (1892). The court begins with well-established doctrine. “[W]hen it turns out that the purposes for which a corporation was formed cannot be attained, it is the duty of the company to wind up its affairs.” This rule followed naturally from the directors’ duty to the corporation’s chartered purpose. The end of the purpose triggers the end of the corporation. But with the corporation now understood as a private association, a very different purpose interposes itself. In the next sentence of its summary, the court gives no attention to the corporation’s chartered purpose—providing ice to the public, which it continued to do on a break-even basis—but shifts attention to the purpose of the shareholders in investing in it. “[T]he ultimate object of every ordinary trading corporation is the pecuniary gain of its shareholders; that it is for this purpose, and no other, that the capital has been advanced; and if circumstances have rendered it impossible to continue to carry out the purpose for which it was formed with profit to its shareholders, it is the duty of its managing agents to wind up its affairs.” The summary then returns incongruously to the traditional line of reasoning for dissolving a corporation, that the corporation was operating ultra vires—beyond the powers authorized by its charter—as if its chartered purpose were to make shareholder profits rather than ice. “To continue the business of the company under such circumstances would involve both an unauthorized exercise of the corporate franchises and a breach of the charter contract” (p.223). Siding with the stockholders who brought the suit, the court ordered the company liquidated with proceeds divided among the stockholders.

This view did not go unchallenged. The “great merger movement” at century’s end, which created monopolistic behemoths in industry after industry, led Progressive Era scholars to rethink the “privateness” of the corporation. In 1932, Adolph Berle and Gardiner Means published The Modern Corporation and Private Property, a kind of culmination of the new thinking and a “Bible” of the early New Deal, with Berle serving in Roosevelt’s “Brains Trust.” Publicly-traded corporations, the authors argued, had become semi-sovereign entities, with power comparable to that of national states. This made them “quasi-public.” Yet just when responsible control of them was most needed, shareholders, now numerous and dispersed, had lost the ability to exercise effective control. They had become passive owners—mere rentiers, free from liability and exercising no responsibility. The social costs of this were too high to be tolerated. “[B]y surrendering control and responsibility over the active property, shareholders [have] released the community from the obligation fully to protect their property rights and cleared the way for placing the community in a position to demand that the modern corporation serve not [only] the owners or the control [group] but all society” (Berle & Means, 1932, p.305, 312). By the 1930s, the dominant view in legal circles was that directors were trustees for the corporation, but also for the community at large (Mitchell, 2009, p.87–8). Corporations had a social responsibility to the public.

This remained the dominant view for several decades. And it corresponded with an interval of great corporate success. Indeed, the period from the end of World War II through the 1970s is widely regarded by corporate scholars to represent the zenith of the American corporation—a period of high innovation and productivity in which, it should be noted, managers enjoyed freedom from stockholder pressure, the Business Roundtable subscribed to the notion of corporate social responsibility (with a helpful nudge from organizations such as unions and consumer groups), and corporate executives were compensated not with stock but with relatively modest salaries (Jacobs, 2001, p.1646).

The view that corporations have a “social responsibility” is precisely what, starting with Friedman’s salvo, the Chicago School neoliberals attacked, seeing it as a stalking horse for increased state intervention in the economy, which they in turn saw as a slippery slope to totalitarianism. And because progressives had failed to shed the dogma that stockholders “own” the corporation, with “property rights” in it, the door was left open for Chicago neoliberals to reassert the partnership conception of the corporation, as we have seen, and also to reverse the progressives’ prescription. What the corporate economy really needed, the neoliberals argued, was for stockholders to be re-empowered, their “control and responsibility” reinvigorated (Ciepley, 2020a).

The “shareholder primacy” norm gradually gained ground, propelled by neoliberal salesmanship, managerial fear of hostile takeover, and the rise of the big institutional investors (mutual funds, pension funds, insurance companies and private equity firms)—investors powerful enough to apply pressure in the boardroom. Eventually, the Business Roundtable signed on (partially in 1990 and fully in 1997), as did the courts, with Delaware judges specifically reverting to the notion that the fiduciary duty of directors is to stockholders (although, in an unworkable qualification, they aver that this includes a duty to future stockholders as well, despite their being unknown and unknowable) (for example, Strine, 2015; for critique, Stout, 2012).

5 The Rise of Vampire Management

Although shareholder primacy is not new, its neoliberal institutionalization is especially toxic, for two reasons. First, the character of the typical stockholder in the publicly traded corporation has changed. Institutional investors now own around 70 percent of US stocks traded on Wall Street. And they are active traders. Between the decreasing cost of trades and the rise of the institutional investors, the average time that stock is held has plummeted, from six years in the postwar decades to four months today (Stout, 2012). Such stockholders don’t behave like responsible owners, making improvements for long-term returns, but like renters—or worse, renters with insurance (limited liability)—quickly squeezing what they can out of the company before offloading it. To empower such stockholders—as has been done, for example, by mandating that they vote their shares, allowing them to nominate alternative directors on the proxy ballot, and eliminating staggered boards—is to invigorate irresponsibility.

Second, Chicago school neoliberals read their assumptions about human psychology into the firm. Namely, they hypothesized that executives are moved by pecuniary interests, not fiduciary duty or other motives, and prescribe the firm’s reconstruction on this basis. From this thinking has followed the leading neoliberal reform of the corporation—shifting executive pay from salary to stock (or other performance-based schemes tied to share prices or earnings per share) (Jensen and Murphy, 1990), in effect bribing CEOs to pursue stockholder enrichment in the near term regardless of its damage over the long term. Over the past 15 years, S&P 500 companies have, on the direction of their CEOs, paid out to stockholders (including to the CEOs themselves) on average more than 90 percent of their earnings, in the form of dividends and buybacks (Lazonick, 2014). From mid-2015 to mid-2016, it was 128 percent. How is this possible? By dipping into reserves, borrowing, or selling off assets.

The great advantage of the corporate form is that it allows for assets to be accumulated and specialized to the production process. Neoliberalism undoes this, decapitalizing the corporation for the sake of enriching the rentier. It is vampire management—or cannibalism, with stockholders consuming the corporate body. It robs the future to pay off the present, and reflects a massive reallocation of corporate revenues, with much of what used to be shared with workers, or reinvested in the firm, now disgorged to stockholders, executives included (Ciepley, 2020a).

One consequence is slowed economic growth, as stockholder payouts bring corresponding cuts to research and development, plant expansion, and worker training, whose contributions to stock price are not immediate. In the 1950s, for example, 60 percent of US corporate earnings were retained for R&D and expansion. This was down to 3 percent by 2003, and remains under 10 percent today (the rest, more than 90 percent of earnings, going to stockholders) (Jacobs, 2001).^[10] Significantly, expenditure on R&D by otherwise identical but privately held firms is three to four times higher (Asker et al., 2011, p.1), suggesting the problem lies not with the investing environment but with shareholder primacy.

The imbalance brings the investment practices of American corporations closer to those of Britain, where stockholders are even more empowered than in the United States and where a similar disparity exists between the investment rates of publicly traded and privately held firms. This does not augur well. Outside of banking (where large capital investment is not needed) and oil (built on monopolistic concessions), there just are not many world-class British corporations operating in competitive international markets (Stout, 2012, 26).

Another consequence is rapidly widening inequality, made all the more grating by the disproportionate pieces being cut out of a more slowly growing pie. Over the last 40 years, US corporate profits as a percentage of Gross Domestic Product have almost doubled, from an average of 5–6 percent to an average of 10 percent (Worstall, 2013), and stockholders, including executives, are receiving almost all of them (see above). The ratio of CEO pay to average nonmanagerial pay has risen from 20 to 1 in 1965 to nearly 900 to 1 today (Hopkins and Lazonick, 2016).

The corporate economy began as a public program for state and national economic development, with corporations tied to public purposes. Neoliberal ideology has put this into reverse, transforming the corporation into an inequality machine focused less on value creation than value extraction (Lazonick, 2014). The result is a slow-growth, high-inequality domestic economy that sends significant portions of its productive capital abroad. Meanwhile, cuts to the tax rate of corporations and the wealthy have left government with limited resources to soften the blow to those left behind, or to fund the education, training, and infrastructure demanded by the new economic landscape.

6 Restoring the Corporation’s Public Purpose

Despite common opinion to the contrary, there is not today, nor has there ever been, any legal obstacle preventing corporations from pursuing public ends. In particular, the idea that any legal precedent or statute mandates the maximization of returns to current stockholders, to the exclusion of other constituencies, or the public, is a myth (Stout, 2012). By far the most important jurisdiction for corporations is the state of Delaware, where the majority of US corporations are chartered. The furthest the Delaware Supreme Court has gone is to hold that, other than at the time of dissolution or sale, the fiduciary duty of a corporate board is not to current stockholders but to the stockholders as a class, including future stockholders (Revlon v. Macandrews & Forbes Holdings, 1986). When combined with the “business judgment rule,” under which courts refrain from second-guessing management decisions, this interpretation gives corporations the widest latitude to undertake activities, whether profitable, unprofitable, or purely charitable, that build “good will” and are thus colorable as having a potential benefit, to future stockholders, however remote. Corporate charters are similarly accommodating. Since the 1970s, incorporators have been allowed to, and today almost always do, fill in the purpose clause of their charters with “any legal purpose,” thus completing the long history of diluting the public purpose requirement of corporations to the point of abandonment. Bare lawfulness encompasses much that is not of clear benefit to the public and is even harmful to it; but activities benefiting the public are surely included as well.

That is the good news. The bad news is that, owing to how executives today are trained and recruited, few believe it part of their brief to pursue public ends—or even to provide above-minimum terms of employment, environmental stewardship, or community support. Further, even if more did believe this, the pressure of market competition (against competitors differently inclined) and the pressure applied by short-term institutional investors make it very unlikely that we will see widespread voluntary adoption of a public benefit agenda by publicly traded corporations, at least as currently structured. And in the individual cases in which we do see it, it is very unlikely to be sustained across generations, there being almost no successful examples of this.

What if providing public benefits were not voluntary but mandatory, as it was for corporations originally? Unfortunately, there is no simple or obvious path to restoring the public purpose of the corporation as a legal requirement.

For example, Ralph Nader, among others, has long advocated the national chartering of corporations as a way to preempt the race to the bottom and raise standards (Nader et al., 1976). There was a time when this might have had a meaningful impact, including enabling a return to restrictive purpose clauses. But the World Trade Organization and similar “trade” agreements allow the corporations of any signatory state to operate in any other signatory state on the same terms as its domestic corporations. In other words, corporations can charter wherever charter standards are most lenient and operate almost anywhere. The “race to the bottom” in chartering standards is thus now international in scope. Only a herculean effort at international cooperation, or (even less plausible) a sole international chartering agency, could halt it. In short, so long as such agreements are in force, the charter is dead as a regulatory device.

The new option, available in many US states, of incorporating as a “benefit corporation,” or “B Corp,” is unfortunately not an exception to this rule. The intent of the form is to make it legally allowable for a corporation to pursue publicly beneficial activities free of any requirement to maximize stockholder payouts. This is a good intent, and the form may be of use to companies as a signal to their customers. But three cautions are in order. First, there are no legal consequences for a B Corp if it fails to provide public benefits. Its charter merely gives it license to do so. Second, the B Corp is arguably solving an imaginary problem, because there is no requirement to maximize stockholder payouts even for a conventional corporation, or “C Corp,” except at sale. There is nothing that the benefit corporation legally allows that is not already allowed to conventional corporations. Third, as a perverse consequence, it has led commentators, including the then-sitting chief justice of the Delaware Supreme Court, to cite the advent of the benefit corporation as support for the notion that the purpose of the conventional corporation is to provide stockholder benefits rather than public benefits. Otherwise, the reasoning goes, why was the former introduced (Strine, 2015)? The sad irony is that the benefit corporation, while not guaranteeing public benefits from the companies that use it, may further entrench the norm of shareholder primacy among the many more that don’t use it.

What of the more minimalist strategy of rigorously regulating and prosecuting corporations so that, even if not geared toward public benefits, they are at least deterred from causing public harms? While this would be an improvement over what we currently see, it would only go so far. Corporations are so structured that it is difficult to deter them from misconduct using external sanctions alone, whether one goes after the entity, the human instrument, or both (Ciepley, 2019; Coffee, 1981). Further progress on this front will require sanctions to be paired with a reconstruction of the corporation’s current internal norms and governance, so that management is less inclined to engage in misconduct in the first place.

The crucial preliminary step, both for reducing corporate misconduct and for reorienting the corporation to public purposes is the normative one of overthrowing the baleful notion, currently regnant in law schools, business schools, the business press, and even the courts (at least in non-binding dicta), that corporations are purely private associations and that their shareholders are their “members,” “owners,” and “principals”—the ideological props of shareholder primacy.^[11] Norms matter, both for orienting actors and for directing the course of institutional development. Dispelling the shareholder primacy norm is thus the key precondition for reaffirming the public purpose of the corporation and infusing management with a sense of public stewardship.

Following from this should be the dismantling of the body of rules and practices implemented to support shareholder primacy, and the enactment of rules to discourage it. Preeminently, this would include reversing the change in how executives are paid, eliminating or at least drastically curtailing stock-based pay. It should also include banning, or at least severely constraining, stock buybacks—which until a generation ago were illegal. By and large, they are a waste of corporate resources, used by executives to manipulate stock prices upward right before they sell their shares (Lazonick, 2014). The rule mandating that institutional investors vote in board elections should also be repealed, and the manner in which their portfolio managers are compensated should be reformed to discourage short-termism (Robe, 2019; Schwartz, 2009).

With respect to the reconstruction of corporate governance, it is the power and privilege of the stockholder that most need reconsideration. The stockholder-centric corporation of the Anglophone world is far from universal. In Germany, for example, 50 percent of the supervisory board must consist of worker representatives. The Anglo model—in which stockholders elect the board, can call special meetings, and must approve major decisions—gelled in the seventeenth century and solidified in the early nineteenth century. That was a time when capital was scarce, when investments were long-term and illiquid, when major stockholders were familiar with the business, often assuming managerial roles, and when limitation of stockholder liability was the exception rather than the rule. Under such circumstances, it made sense to provide stockholders, whose capital was desperately needed, with extensive control rights, as a form of protection.

In today’s world, all of this has been turned upside down. Thanks to developments in modern banking and finance, we live in an era of investment capital glut, not scarcity (Hockett and Omarova, 2017). Companies “go public” so that entrepreneurs can cash out, not because they need the capital infusion. Indeed, corporations in aggregate are buying back more stock than they are issuing. Who really needs the stockholder today? The instances are few.

What is more, the stockholder has been transmogrified—now oriented to the short term, highly liquid, ignorant of the business, and exempt from liability for corporate debts, torts, and crimes. We call them “investors,” but they are the most uninvested, irresponsible parties involved. Indeed, most have never contributed a dime to the corporations we say they “own,” because they bought their shares from some previous stockholder on the secondary market. What they are really doing is speculating in the stock market. In sum, the stockholders of today’s publicly traded corporations are typically ignorant of the business, are not liable for its actions, and have contributed nothing to it. Yet we have re-engineered the corporation so that it attends to their pecuniary interests above all—over the well-being of workers, customers, the community, the environment, or even the long-term well-being of the company itself—empowering them to push management to maximize payouts today, and incentivizing management to comply.

No rational person, sitting down to design a governance structure for the modern corporation, would come up with the system we have. Yet the ideological baggage of corporate “privateness” and shareholder “ownership” prevents us from even considering a public remodel. We need to get past that. The legitimate financial interest of stockholders is today well protected by a host of laws and legal actions absent in the corporation’s founding era—such as derivative and class-action suits, and laws against director self-dealing, negligence, and insider trading. Giving stockholders control rights on top of this is gratuitous. Overwhelmingly, today’s stockholders are outside speculators, not insiders. Owning stock is thus not unlike owning a painting. If the artist continues to do good work, its value goes up. If she falters, its value goes down. That is the chance the investor takes. But no one ever thought of giving art collectors control over the artist’s studio. Similarly, it is time to rethink the control group and control structure of the business corporation, in a way that turns it in a more public direction.

One possibility for gradually reorienting our current corporate governance system in a more public direction would require little more than the repeal of an obscure provision in the Tax Reform Act of 1969 that bars nonprofit foundations from owning more than 20 percent of the shares of a for-profit corporation. In Denmark today, 70 percent of the value of the stock market is held by nonprofit foundations, or “industrial foundations,” which, by owning all, or at least a majority, of a corporation’s voting shares, control its board membership. Novo Nordisk and Carlsberg Group (the beer company) are just two examples of prominent companies so controlled, the latter since 1887. Such structures used to be common in the United States as well, before the 1969 legislation was passed.

In the typical case, a company founder who lacks interested or capable heirs establishes the foundation to continue the business, and the founder’s vision for the business, after the founder is gone. To ensure that this occurs, a specific purpose is typically written into the foundation charter, and the company stock is then placed with the foundation, indirectly placing the company back under the strictures of a purpose clause. Members of the foundation board, who are initially appointed, generally elect their own replacements, eliminating any pressure from outside stockholders (if there even are any), and, by law, they are compensated strictly in salary, which eliminates all personal interest in short-term stock price improvements. The board is thus freed to fulfill its fiduciary duty to the foundation purpose without distraction, and to direct the board of the operating company to make the investments in research, plant, and personnel that will advance the corporation’s purpose for the long term. The success of such companies strongly suggests that this fiduciary duty is faithfully discharged (Hansmann and Thomsen, 2013).

The profits of the operating company continue to be taxed as normal, so there is no substantial loss to the public treasury. The one exception is that the dividends that go to the non-profit foundation are not taxed; however, there is little demand for the company to issue dividends, since neither the foundation board members (paid in salary alone) nor any other natural persons can appropriate them. In general, all revenues are plowed back into the company (solving the problem of underinvestment) unless, as is very often the case, the founder additionally designates a charity to which unneeded earnings are to go. This restores the public benefit function of the corporation, even in cases in which the business purpose has no other strong association with public ends. Finally, foundation-controlled companies account for almost all the examples of progressive management practices—with respect to workers, the environment, and the community—being preserved across generations (Ciepley, 2019; Mayer, 2015).^[12] As I have suggested, this is a gradual way to turn a corporate economy back to public purposes. Stronger medicine than this will be required to expedite the process, especially for the many firms that have already passed outside the control of a founder. Reconsideration of the power and privileges of stockholders must remain on the agenda. Nonetheless, given its long-term benefits and the ease with which it might be done, repealing the 20 percent rule should be a priority, perhaps with other incentives added to encourage placement of corporations under foundation control.

7 Conclusion

Business corporations began their career in the United States as accessories to the democratically elected state governments that chartered them. They were themselves little legally-subordinate governments—although not democratic but authoritarian, exercising quite extensive “arbitrary” authority over their workers.^[13] Nonetheless, they were chartered to advance the public weal, chained to it through a fiduciary obligation to their specific, government-sanctioned purposes. With time, corporations broke this chain, even as they swelled to rival the governments that had chartered them—in income, employment, and capabilities. These leviathans now straddle the globe as multinational enterprises—congeries of multiple national corporations unified into structures of subsidiarity through intercorporate stockownership, which was not even allowed prior to the end of the nineteenth century. We face the paradox of liberal democratic governments chartering rafts of massive, for-profit authoritarian corporate ‘governments’, which lash themselves together across national boundaries and shift capital and operations from one country to the other, wherever they are offered the most favorable terms. This is a “race to the top” for corporate profits by way of a “race to the bottom” for wage rates, environmental protections, workplace regulations, and corporate tax rates. In short, not only have corporations shed their obligation to advance the public weal, but they increasingly undermine the ability of their chartering governments to do so, by undermining legislation that protects the public and reducing the tax base that finances public goods. It is a complete inversion of the relation that justified the chartering of corporations in the first place. And in the backlash, democracy itself is imperiled. Realigning corporations with the public interest has become imperative not only for economic welfare, but for the very survival of self-government. In the area of corporate reform, it will be important not to let the current crisis to go to waste.