Profit-maximization as the sole goal of a corporation - Creative Capitalism

Summary:
Martin Wolf on the nature of the firm. "What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy?" Important distinction between the role of the firm and its goal. Role is to provide valuable goods and services, whereas its goal is to maximize profit. Different views of the firm: as a bundle of contracts, as a social organism, as having culture and history, and as having/offering meaning. Big differences between Anglo-American capitalism and capitalism in rest of the world. Differences focus on the nature of ownership of the firm, the existence of a market for corporate control, and whether or not a firm can be bought and sold. Implications for relationship with employees, efficiency and creativity. Room for enduring divergence in the forms of capitalism is bigger than those working in the Anglo-American intellectual tradition appreciate. Evidence on the (in)effectiveness of takeovers and the recent sad experiences in financial markets rather suggests Anglo-American capitalism may be on the way out. (Published: 17/08/08)

Notes:

• What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy?

• distinction between goal of the firm and its role
• role of companies: to provide valuable goods and services
  
• i.e. outputs worth more than their inputs
• great insight of market economics is that they will do this job best if they are subject to competition
• goal of the firm: profit-maximization
• or shareholder value maximization
• its more sophisticated modern equivalent
• goal of profit-maximization drives the firm to fulfill its role

• market in corporate control
  
• competitive market for corporate control forces companies to maximize shareholder value
• or at least behave in ways that the market believes will lead them to do so
• if companies fail to oblige, the company will be put “into play."
  
• thus, in Anglo-American shareholder-driven capitalism, maximization of shareholder value (as perceived by the market) must perforce be the goal of the company
• not the case in countries where a market in corporate control does not exist
• in such countries, companies must earn a high enough return on capital to survive
• but this need not be a shareholder value-maximizing return

• views of the firm
  
• company as a bundle of contracts
• Anglo-American view of the company
• contracts between the company, its employees and, quite often, its suppliers and even distributors
• many contracts relational
• cannot be written down in any precise form
• companies are hierarchies in which people engage voluntarily
• they necessarily work on the basis of trust in what is often a very long-term relationship:
  
• "I work extra hard to meet a deadline now, in return for consideration when I need to look after my elderly mother later on."
  
• for many companies, trustworthiness is an essential ingredient in their long-term success.
• company as social organism
  
• companies are social organisms created by a highly gregarious mammalian species with a unique capacity for large-scale co-operation over time and space
• companies have cultures and histories
• companies have/offer meaning
• for many of those most closely associated with them
• committed workers in successful companies do not work in order to maximize shareholder value or even to earn the largest possible living
• indeed, it is impossible to direct most companies solely by the goal of profit-maximization
• they have to be aimed at the intermediate goal of producing and developing goods and services that people want to buy and are worth more in the market than they cost to produce
• company is an entity that can be freely bought and sold
• Anglo-Saxon view
• not shared by rest of the world
• for many cultures, a company is viewed as being an enduring social entity
• e.g. for many Japanese, one can no more sell a company over the heads of its workers than one can sell one’s grandmother
• in this view, goods and services can be bought and sold.
  
• companies, like countries (or, as we all now agree, people), must not be
• if companies can be freely bought and sold, relational contracts are hardly worth the paper they are (not) written on
• relational contracts depend on continuing interaction among specific people inside the business
• rational employees will act opportunistically
  
• because they will always expect their company to do the same
• the longer and more reliable relationships are expected to be, the less likely such opportunistic behaviour is to emerge
• not necessarily the case that companies which operate under the assumption that they can be bought and sold (like GM) will operate more successfully in terms of maximizing shareholder value than those which do not
• e.g. Toyota is a better car company than GM in almost all dimensions.
  
• the failure of Japanese capitalism to achieve the highest level of productivity and sustained dynamism may have far more to with
  
• repression of domestic competition in many markets for goods and,
  
• above all, services, rather than with the absence of an active market for corporate control.
• ownership of the firm
  
• Anglo-Saxon view: shareholders are the owners
  
• rest of the world: core workers are the owners
  
• shareholders are not genuine owners
• they are merely an (ever-shifting) group of people with a claim to the residual incomes
• contribute nothing of value to the competitive strengths of the firm
• enjoy the benefits of limited liability
• are well able to diversify the risks they run
• core workers have the biggest (undiversifiable) investment in the firm
• and thus the greatest exposure to firm-specific risks
• the interests of the core workers are, therefore, paramount
• capital-market arrangements (and associated views of the firm) that enforce shareholder value maximization may make companies work less efficiently than otherwise, in terms of their primary role, by precluding a range of potentially valuable relational contracts inside the firm
• such restrictions may have powerful effects on comparative advantage
• by shifting countries away from those activities in which companies that benefit from long-term relational contracts are likely to be most effective
• room for enduring divergence in the forms of capitalism is bigger than those working in the Anglo-American intellectual tradition appreciate
• without an active market for corporate control, managements rule companies
• they also acts as a trustee for a range of stakeholders, of which core workers are the most important
• Anglo-American capitalism gives primary direction of companies to capital markets
• because these companies cannot be forced to maximize shareholder value, they can indeed undertake a range of costly “charitable”activities
• provided they do not threaten the company’s ability to survive
• one of the most interesting questions over the next generation is whether the Anglo-American form of capitalism will flourish and expand, or not
• some of the evidence on the (in)effectiveness of takeovers and the recent sad experiences in financial markets rather suggests not
• but: active financial markets do bring big benefits
• particularly in financing new companies and enforcing greater discipline on badly run businesses
• the more “Anglo-American” capitalism becomes and so the more shareholder driven
• the less “creative” it is likely to be
• the less concerned with wider social results it is likely to be