ABSTRACT: This study examines whether corporations should operate solely to maximize shareholder value or to serve a more broadly defined, diverse set of social interests. This paper reviews how American public policy toward corporations has rested upon different answers to this question, from colonial times to the twenty-first century.
This study offers a strikingly new diagnosis of the corporate governance, and lessons to be learned for global corporations.
Introduction
Across the nation and around the globe, Chief Executive Officers (CEOs) are feeling pressure to deliver consistent improvement in earnings growth regardless of the economic environment in which they are working. This pressure is exerted by their companies' shareholders and boards of directors. This study examines whether corporations should operate solely to maximize shareholder value or to serve a more broadly defined, diverse set of social interests. This paper reviews how American public policy toward corporations has rested upon different answers to this question, from colonial times to the twenty-first century. It does so in order to provide a historical context in which to view the social and ethical issues that underlie recent corporate scandals. In the last several years, powerful CEO's have been forced out by the board members, employees, shareholders, and the government for poor performance or ethical improprieties. Boardroom scandals and corruption of companies during periods of crisis (Murray, 2007) have created a sense of paranoia and a zero-tolerance atmosphere.
As Public corporations are in the midst of radical change due to governmental oversight and the role of the CEO may be greatly diminished as a result. American corporate finance and law has been shaped by the failures of bold, visionary speculators whose reckless gambles invariably attempted a bridge too far and inflicted great damage on others when they collapsed. In turn, their debacles spurred the reforms of the New Deal and the Sarbanes-Oxley Act. Compounding the scandals is an ongoing cat-and-mouse game between regulators efforts to police the factors that lead to failures and efforts by corporate America (Skeel, 2005) to evade the current regulation in the name of efficiency and flexibility. But there is also a silver lining to the stunning failures: the outrage they provoke galvanizes public opinion in favor of corporate reform. This study offers a strikingly new diagnosis of the influence of public policy on corporate governance. Particularly in the context of recent corporate scandals that raise ethical questions related to the duties and obligations of corporate directors and officers, and the role of shareholders as stakeholders and lessons to be learned for global corporations.
Literature Review
When companies are followed closely by institutional investors and market analysts, the pressure on CEO's intensifies as the focus shifts from basic performance to the expected rate of increase in revenues and earnings. A select group of CEOs has been successful in addressing this demand head-on. They improved their bottom line while satisfying customers and empowering employees-a true win-win for all. CEOs also have a positive, direct, and long-term impact on how firms detect, develop, and deploy new technologies over time (Yadav, et al., 2007).
American corporations since the colonial era quickly transformed themselves to serve a range of public policy objectives set by the colonists, from advancing democracy to building public infrastructure. Private gain on the part of the investors was necessary to attract capital, but the primary purposes of those institutions were public undertakings that included objectives that went beyond maximizing shareholder returns. Following the industrial revolution and the subsequent growth of national markets, American corporations focused more upon private interests instead of public purposes. Much of this occurred as the largest U.S. businesses chose to operate as corporations rather than partnerships, decisions influenced by public policy changes and an evolving economic environment. How did this affect the social and political consensus regarding the purpose of the corporation? Whose interests should the corporation serve particularly shareholders and stakeholders? The answers to these questions have varied significantly during the American experience with the corporation as an economic and social enterprise. Furthermore, as the primary role of American corporations changed from public purpose entities to private business institutions from the 19th century into early 20th Century, conflicts between corporate constituencies became significant(Boedecker and Morgan, 2008).
The interests of corporate shareholders, directors, officers, other employees began to diverge. Government policies towards corporations also underwent changes as the economy proceeded with industrialization. Recent events have again Recent events have again underscored the extent to which these conflicts exist and importance of maintaining a public policy that resolves them to the benefit of our social, political and economic systems. In particular, current corporate scandals can be better understood in terms of the historical development of corporate theory and the underlying social and public policy assumptions that they reflect(Boedecker and Morgan, 2008).
During the depression of the 1930's, Adolf A Berle (1932) and E. Merrick Dodd (1932) famously debated the question of whether corporations should operate solely to maximize shareholder value or serve a more broadly defined, diverse set of social interests. That issue has relevance today in terms of the transparency and accountability of corporate directors' decision-making, its impact upon investor confidence, and how it affects investment markets. It also lies at the core of the question regarding the nature of the corporation. Is that institution public or private? To whom and for what should it be held accountable? Berle maintained that corporate directors, officers and managers should operate solely in the interests of shareholders, specifically to maximize the return on their invested capital(Boedecker and Morgan, 2008). On the other hand, Dodd claimed that the corporation amounted to more than an aggregation of shareholders and therefore had social obligations that went beyond duties to shareholders.
A more recent version of that controversy involved the contrasting views of Milton Friedman and R. Edward Freeman. Friedman (1970) posits that corporate directors should act to maximize the value of shareholders' stock, while Freeman(i994) maintains that their decisions should take into account the interests of all stakeholders, a considerably broader group than shareholders, whom it also includes. Thus, Friedman's views largely conform to those of Berle, while Freeman offers a more detailed exposition of Dodd's perspective. This analysis considers corporate governance in the context of recent corporate scandals that raise ethical questions related to the duties and obligations of corporate directors and officers and the role of shareholders as stakeholders(Boedecker and Morgan, 2008).
Analysis
The changing views regarding the purposes of corporations, their creation, and the restrictions imposed in their charters reflected changes in underlying assumptions about the nature of a corporation. To what extent were they creations of the state and, therefore, ultimately obligated to serve public purposes as defined by the sovereign? To what extent did they enjoy private property rights based upon their capitalization by private individuals? These and related questions were commonly addressed as "theories of the corporation." Consideration of alternative theories of the corporation can help inform the Berle-Dodd debate over what interests the corporation should serve. Thus, this section briefly describes the major theories that underlie that controversy. Grant/Concession Theory(Boedecker and Morgan, 2008). The grant or concession theory rests upon the fact that corporations first came into existence upon recognition by a political or religious authority.
Beginning in the 16th century, European sovereigns primarily used the grant of a corporate charter as a means of pursuing mercantilist economic policies. In return for taking the risks associated with opening new trade routes or establishing new colonies that would generate additional trade for the mother country, kings and queens would guarantee the exclusive rights to conduct that trade as part of the charter, or concession. Those individuals who invested in the corporation were assured by the terms of the charter that the corporation would use its capital for those purposes only(Boedecker and Morgan, 2008). A corporation chartered for a single ocean voyage would dissolve upon its completion and the distribution of profits to investors. If the voyage were to fail, investors' losses would be limited to the capital that they originally provided.
Thus, a corporation could come into existence only by act of a sovereign to serve a public purpose (e.g., promoting trade or providing infrastructure-building roads, harbor improvements, wharfs), and under specific restrictions upon operations, capitalization and even duration (Gevurtz, 2004; Padfield, 2004).
Findings
The demise of the grant theory and the ascendance of the entity view of the corporation did not resolve a fundamental question about corporate purpose: what interests should the organization serve? If the power over corporate assets and how to deploy them lay with directors, what principles should they follow when making decisions on behalf of shareholders and stakeholders? Were corporate directors bound to act solely to maximize shareholder gain or did they owe obligations to other constituencies, both internal and external, as well?(Boedecker and Morgan, 2008).
In the early part of the 20th century, American courts continued to adhere to the shareholder primacy view of the corporation. This shareholder primary view of the corporate purpose began to erode during subsequent decades, however. A. A. Berle attributed this development to the fact that as corporations grew in size and scope, and public trading of shares on stock exchanges increased, shareholders no longer served entrepreneurial or proprietary roles(Boedecker and Morgan, 2008). For the largest corporations, widely dispersed shareholders had become passive investors rather than "handson" owners. As such, they had passed managerial power to directors, who in turn often delegated authority to hired managers. Berle had stated that corporate directors, officers and managers held their powers in trust for the sole benefit of shareholders (Berle 1931, p. 1049). The latter had entrusted their private property (in the form of capital) to those who ran the corporation and therefore had every legal right to expect that corporate managers and decisionmakers would endeavor to maximize returns on that investment.
Berle based this view of "corporate activity as the pursuit of business objectives by individual property owners acting through fiduciaries" (Mill�n 1990, pp. 224-225) upon an aggregation theory of the corporation, namely that the corporation embodied the private property rights of its individual investors, apart from any grant by a sovereign. These shareholders entrusted their private property to the corporate directors for the latter to use in their interests. Thus, the principles of property and trust law constrained directors and managers to operate exclusively in the interests of shareholder gain (Mill�n 1990, pp. 223).
In response, E. Merrick Dodd saw the corporation as an entity that was more than an aggregation of shareholders and therefore directors and managers had obligations beyond those to shareholders. As a natural entity that enjoyed rights and protections under the law, it had obligations of citizenship in much the same way as an individual under traditional social contract theory. Some of those corporate obligations might supersede the financial interests of shareholders. Thus, Dodd asserted (Mill�n 1990, footnote 72): That [the corporate] purpose, both factually and legally, is maximum stockholder profit has commonly been assumed by lawyers. That such is factually the purpose of the stockholders in creating the association may be granted.
Nevertheless, the association, once it becomes a going concern, takes its place in a business world with certain ethical standards which appear to be developing in the direction of increased social responsibility(Boedecker and Morgan, 2008). If we think of it as an institution which differs in the nature of things from the individuals who compose it, we may then readily conceive of it as a person, which, like other persons engaged in business, is affected not only by the laws which regulate business but [also] by the attitude of the public and business opinion as to the social obligations of business.
Under this view of the corporation as an entity that owed duties to society arising from its status as a "person engaged in business," directors and managers were no longer constrained by concerns about how their use of corporate resources would affect profitability(Boedecker and Morgan, 2008). They could legally justify the use of corporate assets for the benefit of employees, consumers or society at large in the form of such actions as making charitable contributions, underwriting arts organizations, or giving money to educational institutions.
In light of these and many similar holdings, Berle publicly conceded in 1954 that Dodd's view had prevailed (Berle 1954, p. 169). At its core, this debate focused upon the legally permissible range of managerial discretion in the use of corporate assets and the extent to which managerial performance should be assessed by calculating the return on invested capital. This is a variation on the questions posed earlier: Who or what is the corporation? Whose interests should it serve? To whom should directors be held accountable - shareholders and stakeholders?(Boedecker and Morgan, 2008).
Discussion: Limitations and Implications for Practice
The Berle-Dodd debate, as restated and extended by Friedman and Freeman, identifies competing goals for the corporate enterprise: maximizing shareholder value on the one hand versus balancing multiples stakeholders' interests on the other. Management scholars arguing for the latter position identify competing interests among which the corporation navigates as it pursues financial goals. Notwithstanding this debate, corporate directors occupy positions of power fraught with opportunities to exercise or even abuse their authority(Boedecker and Morgan, 2008). Enabling this situation are information asymmetries favoring directors and top management relative to shareholders and stakeholders, a feature of most organizations where ownership and control are vested in different groups (see, e.g., Stiglitz 2004).
Whether corporate directors can legally put the interests of other corporate constituencies above those of shareholders depends upon which theory of the corporation a court assumes, either implicitly or explicitly. The Berle-Dodd debate brought this fact into sharper focus by inquiring into what purpose the corporation should serve and in whose interests the directors should act. Widely reported incidents of corporate misconduct, including allegations against corporate directors and officers as well as the organizations themselves, underscore the continuing relevance of these questions raised in the Berle-Dodd debate(Boedecker and Morgan, 2008). The directors' duties of loyalty and the business judgment rule could be used to deal with Berle's concerns about the separation of ownership from control in the widely held corporation. Doing so would require that courts construe them to compel corporate decision makers to operate in the best interests of the shareholders, whose property is entrusted to hired managers.
Several cases and the actions of many state legislatures during the last decades of the 20th century have taken corporate law in the opposite direction, however. The net impact has been to bolster the entity theory of the corporation by granting directors very broad discretion to use corporate resources in what they alone deem the best interests of the corporation, notwithstanding any negative effects upon the shareholders. The current state of American corporate law suggests that the corporation exists as an entity, with control resting in the hands of its directors. Absent gross negligence or fraud, they have little, if any, accountability to shareholders for the use of corporate assets. Reports of incidents where corporate officers and directors have pursued individual gain at the expense of shareholders will force courts to reconsider these aspects of corporate law as shareholders proceed with litigation that challenges some of those directors' actions(Boedecker and Morgan, 2008).
In a current globalize world, the fundamental flaws in the corporate world of excessive risk-taking, competition, and the increasing size and complexity of corporations will be fixed if, and only if, there is an effort towards continued reform, regulation, and a concerted social action to challenge the corporations that now govern our lives(Boedecker and Morgan, 2008). Important avenues for further research remain particularly - can a corporation reconcile the needs of its shareholders as stakeholders when adopting principles designed to promote corporate social responsibility (CSR)?
References
Berle, Adolf A., Jr., "Corporate Powers as Powers in Trust," Harvard Law Review, 44 (May), 1049-1074, 1931.
Berle, Adolf A., Jr., "For Whom Corporate Are Managers Trustees: A Note," Harvard Law Review, 45 (8), 1365-1372, 1932.
Berle, Adolf A., Jr., The 20th Century Capitalist Revolution, New York: Harcourt, Brace, 1954
Boedecker, Karl., Morgan, Fred.A, "A Legal Review of Corporate Purpose", American Marketing Association Annual Summer Educator's Conference, 2008.
Dodd, E. Merrick, "For Whom Are Corporate Managers Trustees?" Harvard Law Review, 45 (7), 1145-1163, 1932.
Freeman, R. Edward, "The Politics of Stakeholder Theory: Some Future Directions," Business Ethics Quarterly, 4 (October), 409-421, 1994.
Friedman, Milton, "The Social Responsibility of Business Is to Increase Its Profits," New York Times Magazine, (September 13), 30-35, 1970.
Gevurtz, Franklin A., Corporation Law, St. Paul, MN: West Group, 2000.
Millon, David , "Frontiers of Legal Thought I: Theories of the Corporation," Duke Law Journal, (April), 201- 262, 1990.
Murray, Alan. Revolt in the boardroom: The new rules of power in Corporate America, Collins; 1 edition, 2007.
Padfield, Stefan J. , "In Search of a Higher Standard: Rethinking Fiduciary Duties ofDirectors of Wholly- Owned Subsidiaries," Fordham Journal of Corporate & Financial Law, 10, 79-128, 2004.
Skeel, David A. Icarus In The Boardroom: The Fundamental Flaws In Corporate America And Where They Came From, Oxford University Press, 2005.
Stiglitz, Joseph E. "Information and the Change in the Paradigm in Economics, Part 2, "American Economist, 48 (Spring), 17-49, 2004
Yadav.,et al., "Managing the Future: CEO Attention and Innovation Outcomes". Journal of Marketing, 71(4), 84, 2007.
About Author:
Dr.Mohammed NADEEM is an Associate Professor (Marketing), and Program Lead (Marketing) at the School of Business, National University, San Jose, CA. Professor Nadeem has also taught at DeVry University, and Grand Canyon University. He received his PhD (Concentration: Marketing) from the Union Institute & University, Cincinnati, Ohio.
Dr. Nadeem has received his MS in eBusiness in San Jose, and his undergraduate degree from India. His teaching interests include Internet Marketing, Marketing Management, Consumer Behavior, and Market Research. His research interests include Customer Choice and Post-Purchase Evaluation, Customer Satisfaction and Value, Customer Relationship and Brands, Customer Ethical and societal Policies.
Dr. Nadeem has over ten years of marketing leadership experience from Lockheed Martin Corporation, and Western Digital Corporation in Silicon Valley, California. Professor Nadeem served as a Vice-Chair, Senator, Faculty Senate, National University, and Civil Services Commissioner, City of Santa Clara. Dr. Nadeem is married with children and lives in Santa Clara, CA
Copyright: Journal of Global Business Issues, Spring 2008.
Provided by ProQuest Information and Learning Company. All rights Reserved.
http://findarticles.com/p/articles/mi_hb6054/is_200804/ai_n32279838/?tag=content;col1
|
