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07/24/2005

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Bernard Yomtov

Matt,

"Are managers allowd to kill in the pursuit of profits if shareholders don't object?"

Doesn't my earlier response cover this? A manager that breaches the values of his shareholders isn't going to be employed by them. And you are ignoring other constraints on company behavior.

I don't think your earlier response does cover this. The shareholders may well not object to the manager's behavior. Oh sure, they'd object if he pulled out a gun and started shooting, but if he dumps crap in the water that increases cancer incidence and damages food supplies, say, they may very well not object. Or they may very well be unaware of the action and its consequences.

Net social benefit of pollution can be measured.

Sometimes, to a reasonable approximation. But not always and certainly not easily, if at all, in underdeveloped areas. If it were as easy as you say, even in the US, why are there so many political and legal disputes about it?

I certainly do not claim the only question is legality.

No, you don't. You argued that one factor mitigating pollution is that sometimes it can be efficient. But earlier you did not state that as a requirement for you to consider it acceptable. So I was just trying to say that the question of social efficiency of pollution is not part of your basic argument.

There isn't a part of your 1:45pm response I agree with.

Do you really think shareholders can easily vote out board member when they dislike company policies?

Underpinning your response is a view that shareholders' ethics are wrong and somebody else's (yours?) are right. Please justify this.

No. Underpinning my argument is the view that acting in the financial interests, or even the broader interests, of the shareholders does not justify behavior that is plainly unethical or immoral on other grounds. This is what anonymous says in his point #2.

Anonymous,

I understand your point, but it is not clear to me whether you are talking about economic profits or accounting profits. Yes, the SR firm will earn less than the appropriate risk-adjusted return on its capital, hence will not make a "profit," using the word as I think you are using it when you call profit an anomaly. But that does not mean it does not earn an accounting profit, does not have positive cash flow, and cannot survive. I agree that it wouldn't be easy.

BB

The question of what responsibility corporations owe the societies that permit their charters is not avoided by arguing that management should act only to increase shareholder value to the extent possible within the law.


If we follow Becker, the question is simply shifted onto the electorate. What benefits should we demand of corporations through laws and regulations in exchange for the privileges we extend them?


The rightists will say as little as possible in order to maximize efficiency and attract capital. But isn't it time we reevaluated profit and growth as ipso facto social goods?

What values might the people place above profit? We might value sustainability--clean air and water and renewable resources. We might value self-sufficiency and make corporations which do business abroad bear more of the cost of keeping the world safe for international trade. We might value fairness for corporate stakeholders and require workers' wages to be based on value-added (as shareholder and management wages are) and not merely on their replacement cost.


I agree with Becker that the way to make corporations responsible is through the law, but I question what laws and regulations Becker and Posner are ready to support.

Matt Burgess

Bernard

"Underpinning my argument is the view that acting in the financial interests, or even the broader interests, of the shareholders does not justify behavior that is plainly unethical or immoral on other grounds."

Earlier, you used the word "allowed" rather than "justify" and I think that caused confusion. I now see what you are getting at.

I agree with you. But I do not think your point is especially useful because, firstly, nobody including Becker and Posner are actually arguing the pursuit of profits justifies plainly unethical behavior, and secondly nobody can agree what unethical or even "plainly unethical" means. We can probably agree wanton murder qualifies, but what about paying $2/hour for labor or a decision to pollute a waterway? We can agree with your statement without being any closer to understanding it's implications.

Claiming that maximizing shareholder value is the appropriate objective is not the same as saying any unethical behavior in pursuit of that is justified. There is no contradiction in tying constraints to an objective. Those constraints will reflect the sensbilities of shareholders.

the living ham

"But isn't it time we reevaluated profit and growth as ipso facto social goods?"

Not ipso facto, Brute.

Profit and growth are the sine qua non of social good.

Matt Burgess

Anonymous,

I think point 1), notwithstanding control issues, is true by definition. And, as I mentioned in my post back to Bernard, we can agree with point 2) without really saying anything of consequence. 2)'s implications turn on what you define is moral. Has a firm that acts in a way that is consistent with shareholders' and officers' morality but contrary to yours been immoral?

Bernard Yomtov

Matt,

Obviously, defining precisely what is ethical or unethical, at the border, is difficult, and there is plenty of room for reasonable people to disagree.

My understanding of Becker's position, which I understand you to endorse, is that it is the obligation of corporate management to maximize shareholders' wellbeing, constrained only by the law and contractual obligations, implicit or explicit.

I disagree with this. I think situations may arise in which maximizing shareholder wellbeing subject only to these constraints is immoral. I recognize that it is hard to produce a general rule, but the very fact that we can agree on extreme cases - homicide, for example - suggests that the "Becker rule," while a decent guideline, is not a firm principle.

Part of your argument is that it is hard to know when the Becker rule should be ignored. Yes it is. But I do not think that moral principles which cannot be simply stated do not exist. I am confident that there are cases where the rule should be ignored, and that there would be substantial agreement on many of them. If some are reasonably debatable, so be it. That's what our brains are for.

MikeTheBear

"For example, while it is not illegal to promote the use of baby formula to mothers in the third world, using sophisticated marketing techniques that do not include false advertising, it is morally reprehensible when the promoters know that mother's milk is the best way to feed a baby, all else being equal, and that the water that is likely to be used to mix the formula is contaminated with disease, leading to the deaths and injury of babies as a result of promoting that product."

Perhaps it's mean to point out flaws in logic, but then again, the point of this blog is to learn, so I'll try to be kind and gentle. This argument suffers from a causation problem. It's the contaminated water that would be responsible for causing sickness in infants, not formuala. While it is true that "but for" the formula mixed with water, some infants may be spared, but the underlying cause is still the water. Chances are that if the water is contaminated in a certain area, the standard of living there is not very high, which means that the adults probably experience some malnutrition. A malnourished mother would not produce good quality breast milk; the infants would probably be better off with pre-mixed formula.

As for the poster who asked whether it was morally responsible for a corporation to lobby against laws that would add to the cost of doing business but may benefit society as a whole. The question I have is who is the truly committing the wrong here: is it the corporation lobbying and throwing money at politicians or the politicians who accept the money and eventually vote against the law?

BB

Paul Krugman's op-ed in today's NYT is on topic.

Palooka

I think the guiding principle should be the fudiciary duty. A commenter pointed out, in response to me, that it is the interests (and not necessarily just the interest of maximizing shareholder value) of the stockholders which management must further. While I think it is usually prudent to construe these interests narrowly--the interest in maximizing shareholder value should usually take precedence--I do believe when there is near univeral agreement among shareholders on an issue of "social responsibility" it's appropriate to act accordingly. On issues which do not share near clear super majority support, I think it is best to construe shareholders interest narrowly. The reason I do not require a mere majority is that I do not believe corporations are suited to be sort of mini-democracies, where a majority can essentially tax the minority in support of the majority's views. That seems to me a scenario that we want to avoid.

99.99% of shareholders do not want to be part of a company which profits from slavery (even it is legal where it's practiced), so I think it's properly understood that being involved in those activities would be a violation of management's responsibilities, even if it increased profitability.

This rule should apply more to actions than omissions, however (for exmaple, I think charitable donations should be left to the individual). But the issue of "social responsibility" is much greater than just the issue of charitable donations, and I think where there is overwhelming shareholder disapprobation of a practice, management can and should refrain from engaging in that practice.

Further, I am not certain it is legal for an American company to engage in such practices, even if they're on foreign soil. And if it is legal, then it would certainly be possible to sanction those companies that do in engange in aboherent practices like slavery, even if offshore. That seems more sensible than using the extreme case of legalized offshore slavery as justification for the generally unjustifiable concept of corporate "social responsibility." Nevertheless, I concede that reducing shareholder value in order to act morally is sometimes consistent with management's fudiciary duty. But, as the saying goes, the exception proves the rule.

Ben M

Prof. Becker, one aspect that you didn't touch on is the corporattion's ability to influence the law. For example, it would clearly be unethical for a gold mine to violate a law requiring its tailing pile to be expensively cleaned, whether or not the penalties are larger than the compliance costs. As you observe, there's a democratic process that could pull the penalties up appropriately.

However, the companies have a voice in the very democratic process that's supposed to restrict them. There are many reported examples of industry a) commissioning flawed scientific studies to cover up risks, b) lobbying against the passage of environmental laws, and c) lobbying against the enforcement of environmental laws. Those activities are entirely legal, so your description of corporate ethics does not proscribe them. I would say that heavy lobbying itself is unethical, as it prevents the ideal solution, the limit on externalities for the public good, from being reached.

mw

I recognize that the question posed for criticism aims toward profundity, but I must unfortunately answer it in a quite quotidian way. Corporations are state-created legal entities that states may fashion into whatever shape they please. Corporations as a result have whatever obligations toward the wider community, the public interest, public health, or society-at-large that their states of incorporation demand of them. It is a very simple matter, then. Vote for a legislator who will enact legislation that obligates corporations to do xyz if you believe that corporations should do xyz.

John V

This is lengthy. Humor me.

Poor children do not perform as well on standardized tests as do the children of the rich, which stunts their social mobility. Wait. Am I saying that poor kids are dumb?

It is not so difficult a gap to bridge. I think we all understand that money can be exchanged for goods, and that acquiring greater amounts of money, up to a certain point, grants us greater access to goods. If the good at issue is a tutor, and the tutor costs $500, someone with $500 can afford the tutor, whereas someone with $300 cannot. A tutor, clearly, can help one pass a test. One might reasonably call Princeton Review and Bar/Bri tutoring services.

Another way to think about how poverty impacts test scores is to consider how standard of living intersects with language. If all of my friends are rich and we yacht on the weekends, chances are we are all familiar with the word "keel". "Keel" is not a particularly difficult word, like, say, tenesmus. Because tenesmus is obscure and technical, a question requiring knowledge of this word is apt to flunk almost all test-takers. By contrast, a question employing the word "keel" will flunk only those test-takers unfamiliar with the word. Because all of my rich friends and I are familiar with the word, due entirely to our standard of living, the test has given an advantage to the rich.

So: while I agree that poverty does not cause stupidity, poverty does entail exclusion from certain social circles, which means the ignorance of certain parlance that middle-class exam-makers may employ in drafting a biased exam. It also increases the likelihood that one has been less adequately prepared, in comparison to richer students, for the exam.

One must also consider the causes of poverty. Poverty is often caused by divorce. A child in a single-parent family not only has a lower standard of living, but also has a decreased likelihood of being imparted secondhand knowledge. A family with a mother who is a doctor and a father who is a janitor offers a child a greater opportunity to receive competent help with his mathematics homework than a family consisting of only a father who is a janitor. Note that in the foregoing example even if the disappearing mother were the janitor, the father, as a single-parent doctor, would have greater responsibilty (indeed, the burdens of two parents), and thus less quality time to spend with the child. It is also that case that even in intact families, poor families are poor because their wage-earners have not attained advanced degrees. In general, a family comprised of two MIT microbiologists will offer an evironment more conducive to scholastic achievement than one comprised of a daylaborer and a hot dog vendor. While this is not true in every case, as poor families often transmit concrete values, such as a strong work ethic, to their children, it is undeniably the general rule.

Lest any reader suspect I am calling for any radical political regime, let me assuage your fears. All I suggest is the following: bias should be eliminated from exams, strong families and marriages should be encouraged and promoted by the state, quick and easy divorce should be discouraged by the state, and private tutoring courses should be compelled to admit some percentage of poorer students who cannot afford their exam preparation services, in exchange for a voucher.

Corporations should be compelled to provide these vouchers; to subsidize the intellectual accomplishment of the poor. Promote marriage and aid the poor: since when did the core of most of the world's major religions become a radical notion?

tm

Death is always in the wings: every "cost" is a little death, every "benefit" is a spark of new or extended life. Wages are new blood; pollution will kill or shorten lives. No corporate endeavor can avoid doing both.

The concept that a corporation can add much death to society and also can add much life to society is extremely relevant. Forget philanthropy. Each enterprise has an overarching
responsibility to grow, enhance, and support life at the least cost to itself, to its workers and to the human race. Finding out how to do this is our responsibility, and our corporations' responsibility.

Mr. Becker is not wrong; however, I urge him, and Matt, and some others, to define
"profit" in the manner, and according to the spirit, of what insight led Ford to pay his workers enough to buy the cars they built, or Nike to offer Thai girls an alternative to forced prostitution: a clear picture of what it is to be human and to be empowered with new choices.

Economic growth is about empowerment; that someone could profit from manufacturing 'Xyklon B', or from excreting untreated waste downstream, or from slave labor,
nevertheless has very little real profit involved. Instead, we are speaking of a transfer
of costs, so that what results in a profit for one party is completely at the cost of someone else. In a real sense, there is no economic "profit" involved whatsoever; instead, the activity may be a zero-sum or negative-sum activity in total. To say that extracting a profit 100% as the result of costs incurred but
not paid is ibn a "profit" truly trivializes and marginalizes the value of real economic profit
to society.
The social costs of opium in 19th
Century China, cigarettes in 20th Century America, and so on, created enormous profits by transferring the costs of addiction from the
substance manufacturers and purveyors to the users and to families and Governments. It is not
at all an issue of whether these products killed people or not; it was that the time lags created the appearance of non-lethal relationships, allowing for the profits to be banked and used for charity and so on, long before anyone even began to try to count the real costs.

This does not make the British opium merchants and the American tobacco companies truly profitable corporate enterprises. They were schemes for the transfer of costs from the
suppliers to the consumers and to society at large.

So, my simple rule is, if the enterprise actually profits -- is a positive-sum
corporate undertaking -- then, real shareholder value is very, very likely to be created.

Death and life will always be supported by corporate activity. The only question is, what will the balance be ?

tm

Sam

MikeTheBear points out a putative logical flaw in Marcin's baby formula example when he writes: "This argument suffers from a causation problem. It's the contaminated water that would be responsible for causing sickness in infants, not formuala. A malnourished mother would not produce good quality breast milk; the infants would probably be better off with pre-mixed formula."

MikeTheBear's first assumption is false. In Marcin's example, it is not only the contaminated water that would be causing sickness, it is also the absence of colostrum in formula that causes sickness.

Morbidity and mortality rates are demonstrably lower for breast-fed infants compared with formula-fed infants even when the breast-feeding mothers are themselves malnourished. This is particularly true if the local water supply is contaminated. Except in the case that the mother will directly transmit a disease to her infant (e.g., HIV), it is better for an infant to be breast-fed by a malnourished mother who is drinking contaminated water than for that infant to drink formula prepared with the same contaminated water.

There is no logical flaw in Marcin's argument. A corporation would only under extremely rare circumstances be justified in promoting the use of formula instead of breastfeeding, even if it would be maximally profitable for the company to sell more formula.

ben

Jeremy

I suppose I should commend you for introducing some technical terms to the discussion, but I won't because you have used them inappropriately.

Information asymmetries and market failure are red herrings. Board members almost always come with reputations and an interest to protect them. Board decisions are usually transparent on hiring and compensation decisions. The hiring decision is reversible. And investors can take their money elsewhere. Co-ordinated action is also a red herring: all shareholders whatever their size do not want to be ripped off; their private and co-ordinated incentives are aligned.

This alignment of interests is precisely why boards are so careful in who they hire and what they pay for a CEO. Far from looking after a CEOs interests ahead of their shareholders, boards have a record of being meticulous in determining CEO compensation. Boards frequently benchmark candidates using consultants, their explicit aim being to ensure they get value for their shareholders' money (or to say they made every effort to). Boards also fire CEOs, strongly indicating no special treatment on salary.

Your prisoner's dilemma is not a prisoner's dilemma. It also does not explain why wages continue spiraling beyond the CEO's value to the firm. I will ignore your vague psychological theories on the basis that a) shareholder's preferences are what they are and b) I think you just made that up.

It appears I have trodden on some religious feelings. You have no doubt that CEOs do not justify their wages and you have no plausible reasons to back it up. To be fair, your mission is not easy. You must demonstrate that millions of shareholders around the world own firms that overpay their CEOs but in all other respects add value. Rather than take the difficulty in justifying this as a sign the theory is wrong, you have joined the procession in proposing ever more outlandish explanations.

Let me bring the following facts to the anti-corporate altar. One, there is competition. If CEOs are being overpaid, then every shareholder on earth has an incentive to fix the problem. Once a mechanism is found, companies that do not adopt it cannot compete and eventually go out of business. Competition for funds ensures that. There is also competition from other forms of business organization e.g. cooperatives. Two, boards are replaced, there are takeovers, and CEOs are fired. So your theory that shareholders find it hard to discipline their agents looks a bit thin. Three, shareholders and their boards succeed. They manage to hire people to undertake complex activities like R&D, distribution, marketing and production and do so in a cost-effective manner. Yet according to you they are unable to cap the earnings of their highest profile employee. Four, suitably qualified CEOs are rare and valuable. This explains why boards go to the trouble and expense of a global search for their next leader. Five, CEO is a risky position and failure can literally end a career. Competition requires that risk be rewarded.

I can't help thinking the religious ferment that seems to underlie the view that CEOs are overpaid also underpins the view that corporations should be charitable. If you want to add one and one to get three, go ahead, but you do so at the expense of reason.

Apologies for the length.

Anonymous

A business is not a social service enterprise. The purpose of a business is to make money for its owners. The obvious constraint is the legal one. Make all the money you can, as long as you stay within the law.

If corporations pay "exorbitant" salaries to CEOs, give to symphonies and operas, and adopt anti-pollution policies, it's because these corporations believe such actions will pay off on the bottom line.

Demosophist

I apologize for not reading all the comments before drafting a reply, so it's possible that someone has lready brought this up. The broader question is whether anyone has an obligation called "social responsibility" of the sort that is implied. For instance, how does one manage a commons without such a sense of constitutional obligation, and if it exists for individual actors then it's just as valid for incorporated actors. The same goes for social obligations such as patriotism if the corporate entity is coherently "national" in character and history. And even if it's not... then it must bear some such obligation to a world community rather than a single nationa-state. That is, the simple fact that a corporation establishes itself as a global entity with no ties of allegience to a nation, doesn't mean that it escapes such an obligation simply because it transcends the nation-state tutelage into the lawless condition of a non-sovereign world non-order. If it's a law unto itself then it's also no longer under the protection of the law. It's fair game..

I don't think these social obligations extend to charity any more for corporations than for individuals, however. To that extent I agree with Posner and Becker. To put it as simply as poossible, the social obligation born by an actor, whether individal or incorporated, depends upon which "tribe" or coalition of tribes it belongs to... because its onthe tribe that its claim on sovereignty rests (whether the tribe is local or universal).

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