Volume 2, Issue 2 - Ownership and the Business Firm: Implications for Corporate Governance and Social Responsibility

This fable was published for the first time in 1668 in the collected "Fables" by Jean de la Fontaine (Book I, No. 6). It was inspired by a fable by Phaedrus (Book I, No. 5). From this fable comes the French proverbial expression, “la part du lion,” and its English equivalent, the “lion's share.”

Over the last thirty years, the shareholder conception of corporate governance has established itself as the foundation of the power structure and management principles of the corporation. It is based on a specific theorization of the firm: agency theory. Our aim is to explain the full significance of this theorization, by considering the context in which it was developed and the project – of a fundamentally political nature – that it conveys. For that purpose, we return to the questions raised during the first half of the twentieth century, in the seminal book of Berle and Means and in subsequent works by Berle; questions of a much broader scope that the relationship between shareholders and managers. We will show that agency theory can be considered a response to the most important ideas advanced by Berle and Means, and then by Berle (and others), after the New Deal and the Second World War. Comparison of these two themes of reflection leads us to identify two theorizations, and two radically different conceptions of the firm and the corporation. To address these issues, we start by considering the questions raised in the early twentieth century about the nature of the corporation and the status of managers; and how, in response to these questions, Berle constructed a certain conceptualization of the corporation and of managerial capitalism; we shall then revisit the contract-based approach of Jensen and Meckling, to assess the theoretical and ideological content and show how it was actually strongly opposed to Berle’s vision. Lastly, by way of conclusion, we shall endeavor to show how the opposition between these two theorizations should be seen, above all, as an opposition between two theories that are both “performative” rather than positive, and that the apparent success of agency theory and the dominance of shareholder primacy in corporate governance can only be understood in an institutional and political perspective.

In an article of just under 3,000 words, published on September 19, 1970 in The New York Times under the title The Social Responsibility of Business is to Increase its Profits, Milton Friedman strongly expressed a simple idea, summarized in its title, which quickly took off as a statement of the obvious.This article has achieved the wonder of making appear as obviously true inferences about the role of the firm and its executives which, in fact, are based on erroneous assertions. Friedman’s argument, in particular, is based on the claim that shareholders own the firm. This is totally false, as our article will show. But based on this assertion, the argument has been built that corporate executives are the shareholders’ agents, that they must maximize the shareholders’ interests -equated with a maximization of the profits- and that they should not pay attention to anything else and especially not to the impact the pursuit of this goal may have on other contributors to the firm or on its social and natural environments.

By the beginning of the twenty-first century, many observers had come to believe that U.S. corporate law should, and does, embrace a “shareholder primacy” rule that requires corporate directors to maximize shareholder wealth as measured by share price. This Essay argues that such a view is mistaken.As a positive matter, U.S. corporate law and practice does not require directors to maximize “shareholder value” but instead grants them a wide range of discretion, constrained only at the margin by market forces, to sacrifice shareholder wealth in order to benefit other constituencies and the firm itself. Although recent “reforms” designed to promote greater shareholder power have begun to limit this discretion, U.S. corporate governance remains director-centric.As a normative matter, several lines of theory have emerged in modern corporate scholarship that independently explain why director governance of public firms is desirable from shareholders’ own perspective. These theories suggest that if we want to protect the interests of shareholders as a class over time—rather than the interest of a single shareholder in today’s stock price—conventional shareholder primacy thinking is counterproductive. The Essay reviews five of these lines of theory and explores why each gives us reason to believe that shareholder primacy rules in public companies in fact disadvantage shareholders. It concludes that shareholder primacy thinking in its conventional form is on the brink of intellectual collapse, and will be replaced by more sophisticated and nuanced theories of corporate structure and purpose.

In the last three decades, corporate governance and reporting have been confronted to a drift toward shareholders’ primacy and value, and the revival of old-fashioned proprietary views against entity views on the business firm. This paper develops an accounting perspective of the relationship between shareholding and the inner congeries of the enterprise entity. These congeries require an accounting system, instead of a market price system, to deal with. Theoretical insights and improved accounting reporting methods are then presented to better represent and control the relationship between shareholding and the business firm, based upon the distinction between shareholders’ income and equity from income and equity to the enterprise entity. This distinction is especially important in case of goodwill, asset revaluations and share buybacks, as well as share issuance (use) for employee benefits and business combination considerations. Absent this distinction, accounting systems might enable corporate Ponzi schemes (through the corporate shield) by insiders (either executive management or controlling blockholders) to the detriment of other stakeholders, including outsider shareholders, and the continuity of the business enterprise over time.

In this paper we investigate the link between stock ownership, political beliefs, and party identification. Stock ownership significantly increased the likelihood of voters identifying with the Republican Party between 2000 and 2004 – a period when that party offered tax cuts and proposed an overhaul of Social Security which directly appealed to shareholders. Yet in the period leading up to the 2008 election, the financial crisis cast doubt on the idea that a Republican administration would best represent stockholder interests. We find that while there was a small backlash, stockholders largely remained committed to the party in high numbers. But these effects vary depending on the ideological orientation of stockholders: In 2004, those stockowners with the most ideologically conflicted views were most receptive to recruitment by the Republican Party, and stock ownership continued to increase Republicanism among those in 2008 who were more ideologically liberal on economic issues. These results suggest that party identification may be less about pure economic interests than about identity, especially for those whose ideological beliefs do not map cleanly onto the liberal/conservative continuum, and that psychological mechanisms such as cognitive dissonance and identity conflict are important drivers of political behavior.

I have never met Lynn Stout. Of course, just like any person even remotely interested in corporate governance and US corporate law, I know her insightful writings. But I do not know her personally. I know for a fact, however, that Lynn Stout is a nice person. And an excessively nice person she must be. Her paper on New Thinking on “Shareholder Primacy” talks about the surge of a new paradigm in corporate law. This is an excessively generous thesis. For we are not witnessing the takeover of an old science by a new one explaining facts better than the old stuff. We are witnessing the surge of a scientific analysis of the legal structure of the firm -and of the role of corporations to structure firms- which is replacing an ideology; not a science. This comment will comment on this ideology and the insightful critique developed by Lynn Stout in her paper.