The Version of Record of this manuscript has been published and is available in Business History (15 Jan 2019) http://www.tandfonline.com/doi/full/10.1080/00076791.2018.1509956.

For the past fifty years or so, the economic theory of the firm has been based on the paradigmatic model of corporate activity which perceives the firm as a nexus of contracts, its boundaries defined by the relative transaction costs of market-based and hierarchical organisation. Issues of both corporate governance and corporate management are seen as principal-agent problems, to be resolved by the establishment of appropriate incentives. This approach has had considerable influence on corporate behaviour and on public policy. Business has placed ever-greater emphasis on ‘shareholder value’ and incentive-based schemes of executive remuneration have become widespread.

In this paper, I describe the origins, development and effect of the ‘markets and hierarchies’ approach. I argue that this reductionist account fails at a political level, giving no coherent account of the legitimacy of such corporate activity – that is, no answer to the question ‘what gives them the right to do that?’ – and additionally that the model bears little relation to the reality of successful corporations. I describe an alternative tradition in the understanding of business, owing more to organisation theory, corporate strategy and business history, which treats the concept of corporate personality as more than a legal doctrine. In this view, corporations are social organisations: their competitive advantage is based on distinctive capabilities which are the product of their history, their internal architecture and organisational design, and the relationships with employers, customers, suppliers and commentators at large which arise from them. This is not just a more plausible account of what firms actually do: by recognising the social foundations of corporations, we are better placed to understand how and why corporations and their varied stakeholders succeed.

General Motors

In 1955, when Fortune prepared its first list of the world’s largest 500 corporations, General Motors led the field by some distance, with sales and profits almost twice those of its nearest rival, Standard Oil of New Jersey (now Exxon Mobil).1 It was in the context of a commercial landscape dominated by large manufacturing corporations such as GM, and a few oil companies such as Exxon, that much of the foundational literature on corporate governance, organisational theory, business history and corporate strategy and business strategy and the theory of the firm was written.2 As a result these texts all describe – implicitly or explicitly – General Motors.

The organisation that was General Motors was to a significant degree the creation of its chief executive of twenty years, Alfred Sloan. Sloan had taken control of a small bearings company with money borrowed from his family. That company benefitted from the growth of the automobile industry in the early years of the twentieth century and was acquired by the nascent General Motors. Billy Durant, the founder of GM, was a brilliant salesman and buyer of businesses, but had substantially less talent as a manager, and as a result GM was driven close to the point of collapse in the turbulent years that followed the First World War. Pierre du Pont, of the du Pont chemical family and the company’s largest shareholder, forced Durant out of the corporation. Sloan gained du Pont’s support and in 1923 became President of the company with a plan to manage Durant’s unwieldy empire. Under Sloan’s leadership, GM overtook Ford to become not only America’s leading automobile company, but the largest manufacturing corporation in the world.

Sloan’s success as a manager raised its own questions about how the firm would survive without him, and GM’s Chief Financial Officer Donaldson Brown was concerned that the whole senior management team who had created General Motors were reaching retirement. (Sloan, who had been at the helm of General Motors for 20 years, postponed his departure to assist the war effort).3 Both Brown and Sloan believed that their legacy would be better sustained if an outsider analysed and documented what they had created, and Peter Drucker was chosen to fulfill this role.4

The result was a business classic, The Concept of the Corporation, which turned Drucker from refugee Viennese intellectual into management guru. Sloan granted Drucker what business school professors today call “access”, on a scale that any modern professor could only dream of. For two years, GM paid Drucker’s salary, and allowed him to shadow Sloan. After meetings, the President of General Motors would retire with Drucker to discuss how the day had gone. Unfortunately, Sloan and his colleagues did not like the result, and did not even respond to Drucker’s book. They simply ignored it. In retirement – Sloan stepped down from his executive role in 1946 but continued as chairman of the GM board for another decade – Sloan wrote his own account. My Years at General Motors waspublished in 1964 when Sloan was 87, and only two years before his death. Drucker claims that Sloan described this work as a response to Drucker, but in keeping with Sloan’s earlier approach there is no reference whatsoever to The Concept of the Corporation in it.5

Why did Sloan dislike Drucker’s book so much? It was certainly not because it was hostile to GM: the overall tone is one of admiration for the company and respect for the men who had built it. However, Drucker raised questions that Sloan and his colleagues did not wish to discuss, and attempting to bury the book was their response to this challenge. Professional managers did not derive their power from the ownership of the means of production. So what gave legitimacy to the power that Sloan and his colleagues exercised? What was the proper scope, and necessary limits, of that authority? What defined the social role of the modern, professionally managed corporation? These were the issues which Drucker sought to open in The Concept of the Corporation; Sloan’s response was to close the book.

The Corporate Economy

But The Concept of the Corporation was nevertheless widely read. Seventy years later, Drucker’s book is still in print, and it established him as the first, and perhaps still the most insightful, of business gurus. It was studied closely by Sloan’s successor at General Motors, Charlie Wilson; the beneficiary Brown and Sloan had most in mind when they had commissioned Drucker. Nor was its impact limited to GM. When the eponymous founder of GM’s principal rival Ford died in 1946, Henry Ford II was quick to install professional management. Ford’s ‘whizz kids’ borrowed extensively from GM’s techniques and systems and enabled a revitalised Ford to contest market leadership once again.6 The most famous of the ‘whizz kids’, Robert McNamara, went on to become Kennedy’s Secretary of Defense and severely tarnished his reputation demonstrating that the systems of control and analysis which had proved so effective in Detroit failed six thousand miles away in the Mekong Delta and along the Ho Chi Minh trail.7

But McNamara was not the first automobile company chief executive to be summoned to manage the US government’s largest business. In confirmation hearings, Wilson has been widely reportedly as saying ‘what’s good for General Motors is good for America’. What he actually said was ‘I thought that what was good for America was good for General Motors, and vice versa’.8 But no matter: the distortion of the exchange exemplified the central role which the large diversified corporation had come to play in modern economic life – and the suspicion, if not outright hostility, which that role would provoke.

In the subsequent two decades, the importance of this institution came to be recognised in many different ways. Igor Ansoff and Kenneth Andrews developed the subject of corporate strategy, which became a key element in the MBA programmes of the rapidly expanding business schools. Economists were slow to come to terms with the corporation – Ansoff would justify his approach to corporate strategy by observing that microeconomics had contributed little to the subject he tried to elucidate.9 Management consultants also began to play an increasing role in the development of corporate strategy: whereas before they had been seen as men clutching stopwatches in the tradition of Frederick Taylor’s Principles of Scientific Management, now they sought to develop practical insights and create libraries of strategies to assist their clients.

The corporation was by this point sufficiently entrenched in society to be the butt of humour, as in W H Whyte’s The Organization Man or Sloan Wilson’s fictional account in The Man in the Grey Flannel Suit. Less jocular but no less (although perhaps also no more) important were the academic histories of this transformation: Chandler’s Strategy and Structure in the US; and Hannah’s Rise of the Corporate Economy in the UK. With this institutionalisation of the corporation came a belief that the modern professional executive had developed management skills and expertise that were of general application, and not necessarily rooted in the specifics of particular industries. It was this belief that provided the rationale for the construction of conglomerates such as Ling-Temco-Vought and ITT.

The empty corporation

There were critics of the growing social, political and economic power of the corporation: Eisenhower’s valedictory address on relinquishing the presidency in 1961 warned of the dangers of what he christened ‘the military-industrial complex’; JK Galbraith’s The New Industrial State in 1967 claimed that the corporation controlled its environment to such an extent that it transcended the traditional sources of ‘countervailing power’.10 As promising as these avenues of inquiry seemed, the debate on the social role of the corporation ultimately developed in a different direction. Milton Friedman’s article in the New York Times magazine in 1970 under the title ‘The Social Responsibility of Business is to Increase its Profits’ may be the most cited piece ever to appear in that newspaper. Friedman asserted, curiously, that business could not have responsibilities: only people could have responsibilities. As a result, there was no need to find a source for the legitimacy of corporate activity beyond a general assertion of the legitimacy of private property: the shareholders ‘owned’ the corporate vehicle and its executives were simply the agents of the owners as they disposed of their property in whatever manner, within the law, they thought fit.

This agency perspective was developed by financial economists Jensen and Meckling, who emphasised the need for executive incentives, such as stock options, which might align the interests of managers and shareholders.11 Legal scholars explained that the notion of corporate personality was no more than a legal fiction, a device for minimising transactions costs: the firm was a ‘nexus of contracts’.12 The broader intellectual climate was set by concepts of ‘the market for corporate control’– management teams competed through the mechanism of mergers and acquisitions for the right to deploy corporate assets, and the efficient market hypothesis governed the determination of securities prices.13

The boundaries of the firm were themselves dictated by transactions costs: where idiosyncratic investment was required, the hierarchical structures of the firm were understood as representing a more efficient organisational form than the competitive structures of the marketplace. This transactions-cost theory of the firm, which was first propounded in 1937 by Ronald Coase, became the dominant paradigm amongst economists, a development acknowledged by the award of Nobel Prizes to Coase and Williamson.

All these economists (except Williamson) were associated with the University of Chicago, and members of the ‘law and economics’ school that was initiated there: that intellectual tradition found physical embodiment at George Mason University, which was particularly devoted to the ‘law and economics’ movement. (The essential claim of that movement is that law is and should be designed and implemented to promote economic efficiency, rather than more abstract social and political goals of justice and equality).14

The ‘nexus of contracts’ approach treats the corporation as an empty shell. The managers and employees are a group of individuals, who find it convenient to do business with each other, and with customers and suppliers. There is no collective interest (and, of course, no collective responsibility), only a coincidence of individual interests. The internal organisation of the corporation – the issue which preoccupied Sloan – is reduced to a matter of command and control, to be treated as a principal-agent problem in which any information asymmetry between manager and managed (or owner and manager) is to be handled by suitable targets and incentive systems. This theme dominates Milgrom and Roberts’ classic 1992 text on the economics of industrial organisation. The external relationships of the company are defined by contract, and circumscribed by corporate law. The concept of the corporation as a social organisation operating in a wider social context, which was so emphasised by Drucker, has disappeared.

One might talk of the hollow corporation, had the term not been appropriated to describe the late twentieth century corporations which outsourced most of their supply chains; perhaps the empty corporation is an appropriate term. These businesses abandoned (as General Motors itself would do) the extensive vertical integration which had characterised the earlier generation of corporations whose rise had been chronicled by Chandler and Hannah. As I shall describe below, these developments cast doubt on the theory of the firm elaborated by Coase at precisely the time that theory commanded academic attention.

The evolution of corporations in practice

This fundamentally financially-driven view of the corporation, which linked to a new body of scholarship in finance theory and invited elaboration of principal-agent based modelling, aligned with the growing mathematicisation of economics. Such alignment to dominant paradigms within economics is one reason why Coase went on to win his Nobel Prize, whilst alternative theorists such as Penrose, who will be discussed below, did not. The theory would probably have had little impact outside the academic world, however, had its implications not been so congenial to investment bankers – and to corporate executives themselves. The representation of the corporation as a transactional rather than a social vehicle had obvious attractions for those whose livelihood was based on fees for transactions. The recharacterisation of the nature of corporate activity as financially and contractually driven became a central part of the process of financialisation which took place in western economies from the 1970s.

The phrase ‘shareholder value’ seems to have been coined by Alfred Rappaport, whose 1986 text is still the bible of the movement. But the age of the centrality of shareholder value is widely regarded as beginning with a speech by Jack Welch, newly appointed CEO of General Electric, in 1981 at the Pierre Hotel in New York. Significantly, his audience was drawn from Manhattan’s financial community. Welch did not actually use the term ‘shareholder value’ in that speech, and it would not appear in GE’s annual reports until the 1990s. Nonetheless, the speech’s emphasis on GE’s stock price was clear, and a central plank of Welch’s message was that the business would be focussed on activities in which the company held, or could rapidly establish, market leadership. Welch’s ruthless pursuit of this goal soon resulted in him acquiring the nickname ‘neutron Jack’, after the neutron bomb, which kills people but does not damage property. It was, perhaps, an appropriate title for the master of the empty corporation.

Along with the mantra of shareholder value came the role of the corporate executive as portfolio manager, juggling a collection of businesses just as a fund manager might juggle a collection of stocks. Acquisition – whether horizontal through the purchase of competitors or vertical through the purchase of suppliers or distributors – had always been part of the corporate economy, and as described above the 1960s had spawned a conglomerate movement (by the 1980s, most of these had crashed and burned), but only in the 1980s did divestments of ‘non-core’ business units become a routine practice of large corporations. Such portfolio management, through sales and purchases of businesses, led to the eventual demise of Britain’s two largest industrial companies in 1990 – ICI and GEC.15 Large-scale financial restructuring of existing businesses became commonplace – the largest was the takeover of tobacco and food giant RJR Nabisco by the private equity house KKR, famously recounted in Barbarians at the Gate.

Executives were at first slow to see the advantages to them of the reappraisal of the role of the corporation. But the principal-agent model pointed to the need for incentive schemes that motivated managers to pursue the owners’ objective of shareholder value, and share options were a mechanism, albeit asymmetric, for rewarding success in achieving that goal. As stock markets boomed in the last two decades of the twentieth century, options made many managers rich. Welch was not the first chief executive of GE to be named the most admired businessman in the United States, but he was certainly the wealthiest of the new class of professional managers produced by that firm.16

The growth of executive compensation coincided with the cult of the heroic CEO, of whom Welch was exemplar. Alfred Sloan, in common with most other business leaders of his generation, was barely known to a wider public. Walter Chrysler was Time’s man of the year in 1928, but perhaps famed as much for the iconic Chrysler Building as for the Chrysler Corporation. In the sixty years that followed, only one businessperson would garner that accolade – (surprisingly) Harlow Curtice of (unsurprisingly) General Motors, in 1955. Owen Young was the founder of RCA, but he featured more for the Young Plan for resolving postwar reparations than for his business achievements. In contrast, recent years have seen Ted Turner, Andy Grove, Jeff Bezos and Mark Zuckerberg collect the honour. And in 2016 Donald Trump was chosen as Man of the Year. Although a simple metric, this gives us an insight into the differences between Sloan, who did not devote much time to cultivating the press or stockholders, and his postwar successors, who took a very different view. The rise of business journalism led to a personalisation of the corporation – Microsoft was Bill Gates, Sandy Weill was Citigroup – and in the pages of Fortune or BusinessWeek the success or failure of these businesses was attributable to the genius, or misjudgements, of these individuals. Such a personalised approach is another facet of the empty corporation – like the nexus of contracts, it denies the reality of the corporation as social unit.

More generally, the rhetoric of shareholder value exempted senior executives from further discussion of the legitimacy of corporate organisation and the social responsibility of the corporation. Management authority was derived by delegation from the stockholders as owners of the corporation. It seemed to matter little that the ‘owners’ were in reality excluded from any meaningful control: shareholder general meetings were and generally remain little more than formalities. US corporate law was developed to entrench the position of incumbent management and the battle over ‘proxy access’ – the ability of shareholders to present their own resolutions at meetings – continues still. Incredibly, some investment banks would charge the putative owners fees for ‘corporate access’: the privilege of an audience with management.17 Analogous to the claims of Soviet leaders to represent the dictatorship of the proletariat, the rhetoric of shareholder value served to paper over the limited degree of executive accountability to anyone at all. Furthermore, in what would be in some respects the most telling paradox, the rise of remuneration schemes of ever increasing complexity, far from aligning the interests of managers and shareholders, proved in the twenty-first century to be the principal source of friction between them.

The global financial crisis of 2008 demonstrated the fundamental weakness of empty corporations. Most conspicuously, but perhaps not surprisingly, these weaknesses emerged in the financial institutions that had done most to promote the shareholder value movement. Investment banks, traditionally partnerships but transformed into corporate entities, had in these new structures little cohesion as organisations: essentially, they provided a common platform in which individuals might pursue their own self-interest.18 Levels of trust and cooperation within these institutions were low, and such reputation as the corporation itself enjoyed was to be exploited for the personal benefit of the individuals they employed. The coincidence of individual interests happened only occasionally. In the 2007-8 crisis, such businesses would be torn apart by the greed of their own employees. The business that ‘made nothing but money’ (Bear Stearns) proved in the end an ineffective vehicle even for that.19

Alternative perspectives

Corporate Strategy emerged as a subject, in business schools and consultancies, in the 1960s. One of its principal founders, Igor Ansoff, was explicit about his motivation:

‘Study of the firm has been the long-time concern of the economics profession. Unfortunately for our present purpose, the so called microeconomic theory of the firm, which occupies much of the economists’ thought and attention, sheds relatively little light on decision-making processes in a real-world firm’.20

In reflection of this observation, the discipline of corporate strategy which emerged in business schools and consultancies in the 1960s and 1970s had little regard or reference to the economic analysis of the firm. In 1979 Michael Porter literally and metaphorically crossed the Charles River from Harvard’s economics department to its business school in an attempt to bridge the gap between economics and strategy. But Porter more or less ignored the theory of the firm: instead he used the structure-conduct-performance framework which had been the guiding doctrine of the institutionally-minded industrial economics group in the Harvard economics department of the previous two decades.21 Porter’s ‘five forces’ framework is effectively a translation of the S-C-P approach into business language.

Yet the weakness of that framework as theory of the firm is immediately apparent. The strategies (conduct) of the firm are assumed to be determined by the structure: the ‘five forces’ of suppliers, customers, entrants and substantive products, mediated by competitive rivalry. There is no explanation of why different firms, facing the same five forces, perform differently.

A different view of the theory of the firm had been proposed in 1959 in Edith Penrose’s Theory of the Growth of the Firm. Penrose defined at the outset a perspective very different from what would become the transactions cost/market and hierarchies school: ‘All the evidence we have indicates that the growth of a firm is connected with attempts of a particular group of human beings to do something’.22 As noted above, Coase and Williamson were awarded Nobel Prizes for their theorising, whereas Penrose was largely neglected by subsequent generations of economists: it was in business strategy that her ideas made a real impact, although one not often acknowledged.

Penrose’s central insight was that a firm was not so much a nexus of contracts as a collection of capabilities – capabilities which might be the creation of ‘a particular group of people’ or might indeed be the ‘particular group of people, or the relations between them’. This resource-based theory of strategy, as it became known, was subsequently developed by Barney and Wernerfelt.23 Only if a firm’s capabilities were valuable, rare and inimitable, could they be a sustainable source of profit. The task of corporate strategy is to match the capabilities of the firm to its external environment. This means that the boundaries of the firm are defined less by transaction costs than by the appropriate scope of the firm’s distinctive capabilities.24

The recognition that ‘the growth of firms is connected with the attempt of a particular group of people to do something’ leads to an emphasis on stakeholders rather than the shareholders as drivers of corporate behaviour. The term ‘stakeholder’ predates the use of ‘shareholder value’. The word may have been coined in a 1963 memo at the Stanford Research Institute where, Edward Freeman claims, a stakeholder was defined as a member of ‘the groups without whose support the organisation would cease to exist’.25 Two differences from the contractarian perspective are evident immediately. The emphasis is on the individual as member of a group, rather than as autonomous agent. And the word ‘support’ entails something distinct from a contractual relationship. While the contract is essentially transactional, ‘support’ implies a social and political context and more extensive cooperation than can be written in a contract, or achieved through financial incentives.

The shareholder value approach has always been an Anglo-American phenomenon, as is evident from a 1995 survey of CEO attitudes which produced the striking result that the large majority of US and UK executives asserted shareholder primacy, whereas an even larger majority of German and Japanese CEOs believed that their responsibility was to balance the interests of all stakeholders.26 This is not, or not primarily, a legal difference: the careful legal analysis of Lynn Stout finds only lukewarm support in US law for any duty to maximise shareholder value, and the 2006 UK Companies Act lays on directors the obligation ‘to promote the success of the company for the benefit of the members’, emphasising that benefit to the members is a consequence of the success of the company rather than a measure of that success.27 Furthermore, UK law explicitly rejects the model of shareholders as owners: ‘shareholders are not, in the eyes of the law, part owners of the company’.28 What shareholders own is not the company but their shares in the company.

Thus the geographic variety of concepts of the corporation is the product of differing cultures rather than different statutory frameworks. The 2008 crisis was a challenge to the validity of the Anglo-American model and, to some degree, to capitalist organisation taken as a whole. Whilst the massive injections of government funds that followed the collapse of Lehman stabilised the financial system, the continuing revelations of corporate abuse, by no means confined to the financial sector, contributed to the wide dissatisfaction with economic performance which has only grown in the decade that followed the global financial crisis. In 2009 Jack Welch, whose Pierre Hotel speech twenty five years earlier had presaged so much, proclaimed shareholder value ‘the dumbest idea in the world’.29

Abuses in the financial system were not the result of the pursuit of shareholder value at the expense of other stakeholders. Indeed financial companies have paid out previously unimagined quantities of shareholder funds in compensation for individual wrongdoing. Hannah ended his extensive history of Barclays Bank in 1996, just as the American Bob Diamond joined the corporation and developed its investment bank, ultimately taking control of the whole institution before being removed by regulators in 2012: Barclays’ share price languishes today at roughly the levels achieved in 1996 but in the meantime Diamond and other senior employees of the bank became very rich men. The experience of investors in other financial companies has been similarly dire, and the experience of their senior executives similarly rewarding.30 Moreover, although abuse was accentuated in the financial sector, it was not confined to it. Revelations of aggressive tax avoidance by companies which in other respects appeared to serve their stakeholders well became widespread: in 2016 high-profile scandals at two retailers, BHS and Sports Direct, led in the UK to a government consultation paper on corporate governance and a commitment to rein in excessive remuneration.

Even at the height of the shareholder-value movement, there was concern for CSR, ‘corporate social responsibility’, now more often described as ‘the ESG (environmental, social, governance) agenda’. However, this approach falls far short of recognising the challenge which Drucker identified more than half a century ago: to understand the nature of the corporation as social organisation so as to define and legitimise its role in the communities in which it operates. In fact, the CSR/ESG agenda is often an attempt to answer the concerns of progressive individuals who themselves are not especially interested in business in general, and are certainly not interested in the mechanics of organising a large corporation and constructing productive corporate strategies. The result has been a proliferation of brochures printed on recycled paper and displaying pictures of smiling figures from ethnic minorities, accompanied by bland and substantially false self congratulation about making profits by doing good. This approach sidesteps the much more substantive issues of the proper role and function of the large business organisation in the global economy.

The changing concept of the corporation

GM, du Pont, Guinness and ICI were representative of the corporations whose rise Drucker, Chandler and Hannah chronicled. These large manufacturing businesses were capital intensive and their specialist plant was dedicated to its specific purpose: automobile assembly; petrochemical refining; brewing; etc. The nexus-of-contracts and shareholder-value paradigms were, in essence, an attempt to interpret the modern phenomenon of the large corporation in terms of the neo-Marxist dichotomy between capital and labour: the shareholders collectively occupied the role of the capitalist owner of the plant, to which the alienated employees delivered their homogenous labour services.

In 1946, and perhaps still for a few more years after that, it might have been possible to imagine that the General Motors of 1946 could be managed as a hierarchical structure, or group of hierarchical structures; and that within these structures, employees could either be directed by their senior managers or incentivised by principal-agent structures through provisions such as ‘piece rates’ which related wages to the volume of output. Drucker had understood – Sloan also, but perhaps less clearly – that this account did not even begin to do justice to the reality of the twentieth-century corporation. This was the reason for their collaboration. By 1980 – as the ‘nexus of contracts’ theory gained academic popularity and the shareholder value slogan came into use – General Motors was losing market share to Japanese competitors whose concept of the corporation was very different from that of a ‘nexus of contracts’. The agreements of these corporations with employees and suppliers were implicit contracts, enforced by mutual trust and expectations of continued long-term relationships. The Toyota Production System, far from insisting that the assembly line be kept running at full speed, famously gave employees access to an ‘andon’ which they could press to stop the process if they perceived defects.31

General Motors, Coase had theorised, engaged in vertical integration to control idiosyncratic supplies that required dedicated investment, and bought less heterogeneous items as cheaply as possible in competitive markets. In contrast, Toyota’s suppliers, of both specialist and homogeneous components, formed a ‘keiretsu’, an organisational form which defied this dichotomy between markets and hierarchies. The keiretsu, consisting of legally independent firms, large and small, was characterised by geographical proximity and historical continuity.

Japanese manufacturers, led by Toyota, benefitted from these arrangements through greater product reliability, the ability to adopt ‘just-in-time’ practices with minimal stock levels, and opportunities to collaborate with suppliers to shorten model cycles. Japanese practices were imitated by US corporations and in 1994 General Motors and Toyota jointly established NUMMI (New United Motor Manufacturing Inc) to implement Japanese production systems at Fremont, California. (Ironically, the NUMMI plant closed in 2010 after General Motors’ bankruptcy and is now the manufacturing facility of Tesla, Silicon Valley’s foray into the automobile industry.)

The nexus of contracts model of the corporation increasingly failed to capture the historic essence, far less the evolving nature, of the twentieth century corporation. It is in the twenty-first century, however, that its shortcomings as a description of corporate organisation have been thrown into the harshest light. At the date of writing, the largest publicly-traded corporations (by market capitalisation) in the world are Apple and Alphabet (the parent company of Google). Operating assets account for only around 5% of their value: these businesses are not capital intensive. Most of the capital resources they do use – offices, retail premises – need not be owned by the corporation that operates from them – and in fact they typically are not.

When the value of businesses such as these lies almost entirely in the expectation of future profits generated by a management team, with much of that prospective revenue stream derived from products and activities which have not yet been imagined, the relationship between investors, management and employees is necessarily one of partnership. The earlier observation of the divorce of ownership and control is superseded by a structure in which control is shared between these investors, management and employees and hence exercised by none of them.

The stakeholding corporation

Freeman has identified three central differences between the stakeholder concept of the corporation and the shareholder value, nexus-of-contracts approach. I shall follow his illuminating taxonomy. First, as Penrose had emphasised, the corporation is a social organisation, not an assemblage of agents who find it profitable (today) to do business with each other. In the successful organisation, corporate personality is a reality, not just a legal construct, and corporate culture is central to business performance. Because the corporation is a social organisation, and a continuing entity with a history and a future, it is able to operate largely on the basis of implicit contracts with employees, with suppliers and customers, and with the communities in which it operates. These implicit contracts – shared understandings rather than legal documents (although legal documents, irrelevant unless the relationship breaks down, often exist in parallel) – are enforced by their association with personal relationships and by the common intention to develop continuing economic relationships. Such agreements create the capacity to secure ‘consummate’ rather than ‘perfunctory’ cooperation – willing adherence to a common objective rather than enforced compliance with detailed rules.32

An implicit contract with the community is part of this nexus of implicit contracts. This context is sometimes described as a ‘licence to operate’, and the term is useful, although it suggests an inappropriate formality. The licence to operate is not, as sometimes suggested, a fee for the privilege of limited liability, but rather an understanding which arises from the knowledge that all property rights in a complex economy are social constructions, and regulation of such social construction is necessary to legitimate the private exercise of authority – as reflected in the considerable power held by executives of large corporations. Actions such as aggressive tax avoidance represent a breach of this implicit contract with society. The assertion that such actions are within the law simply misses the point. Repeated breaches of these implicit contracts have been central to the decline in popular perception of the legitimacy of corporate activity, evident in the critique of multinationals and the associated rejection of globalisation. There have been too many instances of violation of the reasonable expectations of employees, the trust of customers, and the exploitation of vulnerable suppliers.

Second, the corporation is necessarily a cooperative venture. If our economy could really be described by production functions in which homogenous capital and labour come together to create standardised products in competitive markets under conditions of constant returns to scale, there would be no need for the corporate economy. Corporations exist because these assumptions are not fulfilled, and the successful corporation is one which creates rents through distinctive combinations of idiosyncratic factors. This is the Penrosian model which underpins the resource-based theory of strategy, and it captures the reality of the modern corporate economy far better than the Coasian tradition. In that modern economy, as Amar Bhidé has noted, consumers as well as suppliers, employees, managers and investors – all stakeholders – play a role in the creation of these economic rents.33

The rationale of the corporation is that the value it creates is more than the sum of its parts, and a responsibility of senior executives is to determine the appropriate distribution between stakeholders of that value, bearing in mind considerations both of equity and efficiency, the contributions which different stakeholder groups have made to the creation of that value and the need to preserve that value and its sources in the future by fulfilling the expectations of different stakeholder groups. It is hard to improve on the characterisation of this issue by Freeman, Parmar and Martin: ‘There is a “jointness” to stakeholder interests. Each stakeholder contributes to the value that is created for the others… Business is fundamentally a cooperative enterprise, built to create value, trade and make ourselves, and others, better off’.34 Contrast this, as they do, with the view that ‘executives have to make tradeoffs where the value created for one shareholder reduces the value created for stakeholders’.

The management responsibility for distributing the value created by such a cooperative enterprise is necessarily a matter of fine judgement. What is certain is that the assertion that the value added created in a business is in its entirety the property of the stockholders is a position which would fundamentally undermine the factors which give rise to that value added in the first place – and in practice has. It is not, however, possible to calculate – even if it were appropriate to do so – what distribution of economic rent would maximise the net present value of current and future returns to shareholders. There is no basis for any claim that creating value for all stakeholders necessarily maximises shareholder value. It might, or it might not, and we will never know.

And third, human motivations are complex and multifaceted. There are people for whom money is an overwhelmingly dominant motivation, and who are primarily self-interested and opportunistic, but they are defective as human beings, and generally not suitable for employment in senior positions in complex organisations. As we have seen, attempts to create organisations in the financial sector designed not only to accommodate but to attract such people have been markedly unsuccessful in creating value within the organisations themselves. Most people benefit from interactions with colleagues, want to take pride in the organisation for which they work and from the jobs which they do, and there is clear evidence that job satisfaction plays a major part in what makes people happy. The economic success of the corporation is essentially bound up with its success as a social organisation; Drucker and Sloan both knew that, even if some of their successor commentators found it possible to overlook it.

Notes

Fortune, “1955 List” Berle and Means, Corporation and Property; Drucker, Concept of the Corporation; Chandler, Strategy and Structure; Ansoff, Corporate Strategy; Coase, “Nature of the Firm” Langworth, History of General Motors; Jacobs, History of General Motors Beatty, World According to Drucker; McDonald and Sloan, Years With General Motors Drucker and Kirsch, “Best Book on Management” Byrne, Whiz Kids MacNamara, Strange, and VandeMark, In Retrospect Historical Office, “Charles E. Wilson”, response to Sen. Robert Hendrickson’s question regarding conflicts of interest Ansoff, Corporate Strategy, 2-3 Galbraith, The New Industrial State, 211-3 Jensen and Meckling, “Theory of the Firm” Easterbrook and Fischel, “The Corporate Contract”, 1426 Manne, “Market for Corporate Control”; Fama, “Efficient Capital Markets” Much of this work was promoted by the Olin Foundation: Blundell, “A Gift of Freedom” See Mayo, “Explaining Some Marconi Myths” for his explanation of his role In 2008 his net wealth was reported at $720 million: Storrs, “50 Wealthiest Bostonians” Judd, “Corporate Access Shake-Up”; Teasdale, “Investor Engagement” Kay, Other People’s Money Wayne, “Dealmaker Piles Up Profits” Ansoff, Corporate Strategy, 2-3 Porter, “Competitive Forces Shape Strategy” Penrose, Growth of the Firm, 2 Barney, “Sustained Competitive Advantage”; Wernerfelt, “Resource-Based View” Kay, Foundations of Corporate Success Freeman, “Stakeholder Concept”, 31 Yoshimori, “Corporation in Japan” Stout, Shareholder Value Myth Short v. Treasury Commissioners 1948; Inland Revenue v. Laird Group 2003; Kay, “Shareholders Think They Own the Company” Welch in Guerrera, “Welch Condemns Share Price Focus” Kay, Other People’s Money, 135 Ohno, Toyota Production System A distinction introduced by Williamson, Markets and Hierarchies. See also Hart and Moore, “Contracts as Reference Points” who suggest, without further justification, that there is little additional cost to the employee in consummate cooperation. Bhidé, The Venturesome Economy Freeman, Parmar and Martin in Barton, Horváth, and Kipping, Re-imagining Capitalism

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