John Quiggin of Crooked Timber:
The creative capitalism blog has been set up to examine the idea that corporations could do a job of promoting social goals like improving health in poor countries (that is, better than they do now and better, in at least some ways, than governments or NGOs). Richard Posner objects to this on the ground that corporate managers have a fiduciary obligation to maximise profits. I don?t find this convincing (reposted over the fold).
... I somehow doubt that, if US law were changed to remove any obligation to maximize profits, or even to create a positive obligation to pursue broader social goals, Posner?s objections to creative capitalism would be resolved.
It's an interesting post. What it ignores, I think, is that shareholders will view a director preference for other constituencies as a risk demanding compensatory returns. First, absent the shareholder wealth maximization norm, the board would lack a determinate metric for assessing options. Because stakeholder decisionmaking models necessarily create a two masters problem, such models inevitably lead to indeterminate results. Recall the XYZ hypothetical from the preceding section, in which the board of directors is considering closing an obsolete plant. Assume the closing will harm the plant?s workers and the local community, but will benefit shareholders, creditors, employees at a more modern plant to which the work previously performed at the old plant is transferred, and communities around the modern plant. Further assume that the latter groups cannot gain except at the former groups? expense. By what standard should the board make the decision? Shareholder wealth maximization provides a clear answer?close the plant. Once the directors are allowed to deviate from shareholder wealth maximization, however, they must inevitably turn to indeterminate balancing standards.
Second, any legal standards developed to review such decisions would operate mostly by virtue of hindsight. Such rules deprive directors of the critical ability to determine ex ante whether their behavior comports with the law?s demands, raising the transaction costs of corporate governance. The conflict of interest rules governing the legal profession provide a useful analogy. Despite many years of refinement, these rules are still widely viewed as inadequate, vague, and inconsistent?hardly the stuff of which certainty and predictability are made.
Finally, absent clear standards, directors will be tempted to pursue their own self-interest. One may celebrate the virtues of granting directors largely unfettered discretion to manage the business enterprise, as we have done throughout this text, without having to ignore the agency costs associated with such discretion. Discretion should not be allowed to camouflage self-interest.
Directors who are responsible to everyone are accountable to no one. In the foregoing hypothetical, for example, if the board?s interests favor keeping the plant open, we can expect the board to at least lean in that direction. The plant likely will stay open, with the decision being justified by reference to the impact of a closing on the plant?s workers and the local community. In contrast, if directors? interests are served by closing the plant, the plant will likely close, with the decision being justified by concern for the firm?s shareholders, creditors, and other benefited constituencies.
At best, stakeholder models give directors a license to reallocate wealth from shareholders to nonshareholder constituencies. Would investors be willing to invest their retirement savings in corporate stock if that approach became law? hence, there are good reasons to think that the shareholder wealth maximization norm is the appropriate standard of corporate decisionmaking.
Timberite Daniel picks up where John leaves off with the following comments:
I have a real bee in my bonnet about the claim made by Richard Posner that ? The managers of corporations have a fiduciary duty to maximize corporate profits?. It raises a whole load of topics relevant to plenty of my favourite economic hobby-horses as soon as you start to look remotely critically at what the seemingly simple phrase ?maximise corporate profits? actually means anyway.
Pretending not to understand the meanings of common English phrases is a stock tactic for creating the impression of profundity (cf philosophers, who are always pretending not to understand the meaning of words like ?is?, ?would? and ?must?). But sometimes you have to do it ? my view is that in any view of the world more complicated than a very elementary blackboard model, the phrase ?maximise profits? can?t be unpacked into a coherent decision rule which rules out any of the things which Posner talks as if it does.
Go read the whole thing.
My take on the definitional question is premised on the notion that boards of directors sometimes face decisions in which it is possible to make at least one corporate constituent better off without leaving any constituency worse off. In economic terms, such a decision is Pareto efficient?it moves the firm from a Pareto inferior position to the Pareto frontier. Other times, however, they face a decision that makes at least one constituency better off but leaves at least one worse off. The familiar concept of zero sum games is just the worst-case variation on this theme. Imagine a decision with a pay-off for one constituency of $150 that leaves another constituency worse off by $100. As a whole, the organization is better off by $50. In economic terms, this decision is Kaldor-Hicks efficient. With this background in mind, the shareholder wealth maximization norm can be described as a bargained-for term of the board-shareholder contract by which the directors agree not to make Kaldor-Hicks efficient decisions that leave shareholders worse-off.
A commonly used justification for adopting Kaldor-Hicks efficiency as a decisionmaking norm is the claim that everything comes out in the wash. With respect to one decision, you may be in the constituency that loses, but next time you will be in the constituency that gains. If the decisionmaking apparatus is systematically biased against a particular constituency, however, that justification fails. If shareholders suspect that their constituency would be systematically saddled with losses, they will insist on contract terms precluding directors from making Kaldor-Hicks decisions that leave shareholders worse off. As explained in the next section, shareholders in fact are the constituency most vulnerable to board misconduct and, by extension, to being on the losing end of Kaldor-Hicks efficient decisions. Hence, they predictably will bargain for something like the shareholder wealth maximization norm.