Date: 2024-12-10 Page is: DBtxt003.php txt00005616 | |||||||||
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Burgess COMMENTARY | |||||||||
The Myth of Shareholder Capitalism When Kraft took over Cadbury in January, the deal was viewed as a victory of shareholder capitalism. The acquired company’s deeply English roots were no match for the wealth shareholders could gain by selling out to what one Cadbury family member called “a company that makes cheese to go on hamburgers.” Cadbury chairman Roger Carr said, “The reality is we are part of a global business.” Did Carr have a choice? Was he truly beholden to his shareholders’ desire to take the deal? If not, how can directors act against the wishes of shareholders to preserve value for other stakeholders—value that is often less easily measured than a buyout price? In the wake of the scandals that caused the recession, the management world has been immersed in trying to answer such questions. Oddly, no previous management research has looked at what the legal literature says about the topic, so we conducted a systematic analysis of a century’s worth of legal theory and precedent. It turns out that the law provides a surprisingly clear answer: Shareholders do not own the corporation, which is an autonomous legal person. What’s more, when directors go against shareholder wishes—even when a loss in value is documented—courts side with directors the vast majority of the time. Shareholders seem to get this. They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times. In short, directors are to a great extent autonomous. And yet, in an important 2007 article in the Journal of Business Ethics, 31 of 34 directors surveyed (each of whom served on an average of six Fortune 200 boards) said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximize shareholder wealth, they believed it was their duty to do. Why are directors so convinced of their obligation that they’d make decisions with such damaging results? If the law clearly doesn’t call for all the kowtowing, couldn’t Cadbury’s Carr have assumed a more defiant stance against a takeover? The problem, we believe, is that managers and lawyers have failed to meaningfully collaborate on defining directors’ role. That lack of communication has led to the election of directors who, frankly, don’t know what their legal duties are. Indeed, they’re being taught the wrong things. The case still most often used in law schools to illustrate a director’s obligation is Dodge v. Ford Motor (1919)—even though an important 2008 paper by Lynn A. Stout explains that it’s bad law, now largely ignored by the courts. It has been cited in only one decision by Delaware courts in the past 30 years. Collaboration between legal and management entities should start at the MBA and executive-education level, to change the way directors are trained and developed. But it should also shape director selection, a process where trustworthiness and independence from all stakeholders, not just from managers, is critical. The impact on directors’ decision making could be significant. The Cadburys of the future may not end up selling out just because it looks like a good deal for the shareholders. Loizos Heracleous is a professor of strategy and organization at the University of Warwick. Luh Luh Lan is an associate professor of law at the National University of Singapore. Showing 6 comments PeterBurgess I have been concerned for a very long time that there is systemic dysfunction in the modern economic system, and very little being done at high levels of academia, business, finance or politics to understand the issues and do something significant to address them. The purpose of economic activity at its core is to satisfy the needs of people. It is widely accepted (in the West) that a capitalist market economy is the most efficient way for economic activity to be optimized for efficiency. The proxy for efficiency in this economic model is profit and stock value. I think this is simplistic, and essentially wrong. Adam Smith did a deep analysis of the economy of his day, and came to some important conclusions. I like to think that there have been some significant changes in the structure of the economy since his time, not to mention the productivity of economic activity. Some of these changes include: (1) Many modern business organizations are now bigger than countries; (2) productivity is amazing, and labor is no longer a constraint on aggregate production; and (3) capital markets are only weakly linked to real markets for goods and services. I also argue that rule of law is dangerously compromised by its loopholes that benefit the rich and powerful at the expense of society as a whole. Rule of law often works for some ... the rich and powerful ... at the expense of those that have nothing, notably indigenous peoples and the poor at the bottom of the pyramid. Where profit is king and nothing else counts, economic activity that serves important humanitarian needs can never be funded. With somewhere between 1 billion and 3 billion people on the planet in this situation, the world cannot function in a way that makes any sense ... that will be sustainable and secure. As a starting point for the future, there needs to be better more meaningful metrics about things that matter. Peter Burgess TrueValueMetrics. show less Edit Reply 1 month ago 1 Like guest So true. We are hampered by the disproportionate definition of the corporation as crafted 'legal personhood' while true personhood has much broader ethical responsibilities. Until legislation, courts, and markets incorporate the value of ethics and sustainability we're destined to skewed results. Like Reply 9 hours ago in reply to PeterBurgess Jam Garciax Perfect example of directors losing sight of the original purpose the corporation, despite the current paradigm of maximize shareholder profits, corporations have more responsibilities than that. Even though the establishment of a corporation is for the purpose of conducting business activities, managers and directors alike have lost sight of their ETHICAL duties. Corporations are not independent of the environments in which they operate and it is sad to see the poll sighted in this article. Profit maximization is not the only way to run a corporation. Like Reply 1 year ago 1 Like Bjmb500 Can the director's real (rather than ideal) autonomy be defined in legal terms at all? Even if that were possible, would the power of shareholders still not be stronger, faster and more efficient? Namely, by simply controlling the flow of financial resources rather than arguing in legal terms for or against whatever value of a director's decision. Thus, basing director's autonomy on the (yet interesting) fact that they have barely ever been unseated by shareholders does not seem a strong argument to me. If, however, the role and importance of leadership and responsibility was more accurately communicated and legally founded, shareholders' control of financial resources could be put into a wider perspective which may benefit society more than it has in the last years. Like Reply 3 years ago 3 Likes Charles H. Green, co-author The Trusted Advisor, author Trust-based Selling, founder Trusted Advisor Associates. It's a shame this article has gotten exactly zero comments in nearly two months; it's a vital issue. The largest single explanation I hear for the epidemic of short-term thinking in business is 'the need to show quarterly earnings increases.' This is used to justify all manner of short-term, short-sighted, value-destroying behaviors. And it's used by CEOs as well as their underlings. I think it comes down to the same issue. If managers, CEOs and shareholders can't be trusted to operate corporate entities in the long-term interest of all parties, then whose job is it? The job of director is at least one plausible answer. Except that, if they too mistakenly think they are beholden to someone else's view of ownership and value, then we have lost an important role in the chain of corporate governance. I think this is about more than ecologically or ethically bad decisions (not that there's anything right with that); it's also about the fundamental soundness of basic economic decision-making. Like Reply 3 years ago 9 Likes Dmitry Zhukov Collapse Indeed. Until a recent HBR podcast on the same subject I was not even aware of it. A very valuable piece of research worthy of much further elaboration. Like Reply 1 year ago in reply to Cha |