The Purpose of the Corporation

1
Chapter 2

• The Purpose of the Corporation

2
Stockholders Versus Stakeholders

• Milton Friedman
• The Social Responsibility of Business Is to
  Increase Its Profits
• This theory (known as the classical U.S. view)
  asserts a corporation's primary and perhaps sole
  purpose is to maximize profits for the
  stockholder.
• A business does not have responsibilities, each
  individual does.

3
Friedmans 2 Main Arguments

• Property
• Stockholders are the owners of the
  corporation,so corporate profits belong to them.
• Contracts
• Stockholders are entitled to their profits as a
  result of a contract among the corporate
  stakeholders.

4
Friedmans Property Arg.

• Stockholders own the corporation.
• Corporate executives are the stockholder's
  agents,so they must operate in the interests of
  their principle (stockholders).
• Managers cant make donations to charity by the
  corporation (corporate executives) because the
  income doesnt belong to them, it belongs to the
  stockholders.
• If an individual stockholder wishes to spend
  their dividends for charity, that is their option
  since the dividend is their money.
• If corporate executives wish to spend their own
  money and time for charitable purposes that is
  acceptable as long this does not take away from
  their duties to the stockholders.

5
Proprietors vs. Managers

• Individual proprietors are different in that if
  they choose to spend the income generated by
  their business they are spending their own money,
  not the money of other people.

6
Friedmans Contract Arg.

• A stakeholder in this context refers to
  employees, managers, customers, suppliers, the
  local community, and the stockholders.
• Each stakeholder group has a contractual
  relationship with the firm, since they receive
  the remuneration to which they freely agreed in a
  pre-established agreement (contract).

7
Stakeholder Contracts

• Employees and managers are paid wages to produce
  the product or service of the corporation.
• The local community is paid in the form of taxes.
  
• Suppliers provide raw materials to the
  corporation in exchange for money.
• Stockholders receive any funds that remain after
  all stakeholders have been remunerated. They are
  contractually entitled to these profits based on
  the risks they incur.

8
Stockholders Versus Stakeholders

• R. Edward Freeman
• Says both stockholders and stakeholders have a
  vested stake in the corporation.
• So both stockholders and stakeholders have a
  right to demand certain actions from management
  because all.

9
Freeman Theses Principles

• Businesses should be managed so as to create
  value for customers, suppliers, employees,
  communities, and financiers.
• The Separation Fallacy It is useful to believe
  that sentences like x is a business decision
  have no ethical content or any implicit ethical
  point of view. And, it is useful to believe that
  sentences like x is an ethical decision have no
  business content.
• The Integration Thesis Most business decisions
  have some ethical content, or implicit ethical
  view. Most have ethical decisions, business
  content, or an implicit view about business.
• The Responsibility Principle Most people, most
  of the time, want to, actually do, and should
  accept responsibility for the defects of their
  actions on others.

10
Freeman Defining Stakeholders

• Defining Stakeholder
• Wide definition A stakeholder includes any group
  or individual who can affect or is affected by
  the corporation.
• Narrow definition A stakeholder includes those
  groups who are vital to the survival and success
  of the organization.
• Returns are paid to the owners (stockholders,
  bondholders, etc.), NOT because they own the
  corporation
• Returns are paid to the owners because their
  financial support is necessary for the survival
  of the corporation and that they have a
  legitimate claim on the firm.

11
Freemans Stakeholder Roles

• The owners have a financial stake in the
  corporation and expect a return on their
  investment.
• The employees have their jobs and usually their
  livelihoods at stake.
• The suppliers are vital to the corporation for
  the raw materials they provide. In turn, the
  corporation is a customer of the supplier and is
  therefore vital to the supplier's success.
• The customer exchanges resources for the products
  or services of the firm and in return receives
  the benefits of the products or services.
• The local community grants the corporation the
  right to build facilities in their area in turn,
  the community benefits from the tax base and
  economic contributions of the corporation.
• Management (corporate executives) must look after
  the health of the corporation and carefully
  balance the conflicting claims of all
  stakeholders.

12
Freemans Stakeholder View

• Theoretical Foundations
• The argument from consequences Results in
  economic, social, and environmental benefits.
• The argument from rights Helps to ensure that
  property rights and human rights are protected.
• The argument from character Helps ensure that
  virtues, such as efficiency, fairness, respect,
  and integrity are enacted by managers.
• The Pragmatists argument Because we want
  humane social institutions, businesses should be
  regarded as a social practice governed by the
  norms common to all social practices.

13
Freemans Stakeholder View

• Practical Implications
• Stakeholder interests should be regarded as
  joint.
• Stakeholder interests may be prioritized by
  different companies in different ways.
• Businesses must have a clearly defined purpose.

14
Freeman Recommends.(in a different article)

• Corporation law reform principles
• Stakeholder Enabling Principle - Corporations
  shall be managed in the interests of their
  stakeholders, defined as employees, financiers,
  customers, and communities.
• Stakeholder board of directors
• Principle of Director Responsibility - Directors
  of the corporation shall have a duty of care to
  use reasonable judgment to define and direct the
  affairs of the corporation in accordance with the
  Stakeholder Enabling Principle.
• Principle of Stakeholder Recourse - Stakeholders
  may bring an action against the directors for
  failure to perform the required duty of care.

15
Integrating Stakes in Management(back to our
class reading)

• Types of Questions Managers should ask
• If this decision is made, for whom is value
  created and destroyed?
• Who bears the burden on this choice? Who gets the
  benefit? Are these fair?
• Who is harmed and/or benefited by this decision?
• Whose rights are enabled and whose values are
  realized by this decision (and whose are not)?
• What kind of company will we become if we make
  this decision?

16
Summary thus Far

• Friedman
• Corporate responsibility the responsibility of
  individual managers
• Individual managers are agents who are
  responsible for pursuing the interests of the
  principle party.
• Stockholders are the principles, and they are
  interested in profits
• Stockholders own the company, which gives them a
  property right to the profits.
• Stockholders have a contract that gives them
  corporate profits

17
Summary thus Far

• Freeman
• Corporate responsibility the responsibility of
  individual managers
• Managers must balance the claims of all
  stakeholders
• Managers must use due care in determining and
  pursuing the interests of all stakeholders
• Any stakeholder group can bring suit against the
  managers for failing the duty of care

18
Boatright

• What is so special about stockholders?
• Nothing really, at least theyre not at all like
  traditional owners
• No strong ownership rights of shareholders
• No real contractual relationship between
  management and the shareholders
• No true agency relationship exists

19
Boatright Basic Ideas

• Boatright appeals to transaction-cost economics
  to defend the stockholder model of the
  corporation and to criticize the stakeholder
  model.
• Advocates of stakeholder management get one point
  right the modern for-profit corporation should
  serve the interests of all stakeholder groups.
• Where stakeholder theory goes wrong is in
  thinking that managing for the interests of all
  stockholders (shareholders) is not in the
  interest of all shareholders.
• Managers ought not be tasked with managing for
  the interests of all since the market will ensure
  that the interests of all are taken into account.

20
Boatright Setting the Stage

• Two Forms of Stakeholder Management.
• Instrumental stakeholder theory holds that it is
  in the interest of shareholders for managers to
  attend to all stakeholder groups in their
  operations. This view is compatible with the
  prevailing stockholder (shareholder) theory of
  the firm.
• Normative stakeholder theory holds that (1)
  stakeholders have a right to participate in
  decisions that affect them (2) that managers
  have fiduciary duties to serve all stakeholders
  and (3) the objective of the firm ought to be the
  promotion of all interests and not shareholders
  alone.

21
Boatright Firms coordinate benefits

• An Economic Approach to the Purpose of the Firm
  The stockholder model of corporate governance is,
  or should be, grounded in the transaction cost
  theory of the firm as articulated by Coase
  (1937).
• On this theory, the purpose of the firm is to
  enable individuals with economic assets to
  realize the full benefits of joint production.
• Every stakeholder group benefits from such
  production.
• Employees, suppliers, and investors cooperate to
  produce greater returns than they could achieve
  on their own.

22
Boatright Governance Control

• Governance may be understood as the contractual
  agreement and legal rules that secure the
  interests of each input group.
• Shareholders govern corporations because control
  is the most suitable protection for the capital
  they contribute to the firm.
• Their interest is future profits, which is
  secured by governing control
• Having shareholders in control is also in the
  best interest of other stakeholder groups
  because
• All benefit from maximizing profits
• Shareholders assume most of the risk

23
Boatright Control Best Protects Stockholders

• Protecting stakeholder interests is best
  accomplished by the shareholder model of
  management since
• Legal protection is to be preferred to managerial
  good will.
• Corporate decision-making is more efficient when
  management has a single goal and this benefits
  all stakeholders.

24
Boatright How To Manage

• Just because all stakeholders should benefit from
  the operation of the firm does not mean that it
  is the job of managers to achieve that end.
• Fairness is partly secured by managers
  recognizing their basic ethical obligations to
  all parties, in addition to their legal
  obligations. Three further points
• Contractual agreements and legal rules help
  secure fairness.
• Governments, and not managers, are best
  positioned to ensure a fair distribution of
  wealth.
• Governments, and not corporate governance
  structures are best suited to ensure a fair
  distribution of wealth.

25
Wal-Mart or Cost-Co

• Cascio compares two big companies with divergent
  models for managing stakeholders
• Cascio argues that Costco is more profitable than
  Wal-Mart and treats its stakeholders better.
• This article compares the labor practices and
  Wal-Marts Sams Club with Costco.
• Sams Club secures low prices by insisting on low
  costs from suppliers and paying workers low wages
  with few benefits.
• Costco emphasizes its Code of Ethics in its
  everyday business operations including respect
  for suppliers and employees.

26
Facts about Sams Club

• Average hourly wage 10.11
• Poor benefits
• Does not permit unions
• Turnover 44 per year
• Stock value over 5 years minus 10

27
Facts about Costco

• Average hourly wage 17
• Substantial benefits
• Permits unions
• Turnover 17 per year
• Stock value over 5 years plus 55

28
Court Rulings

• Dodge v Ford Motor Co.
• The court ruled that the benefits of higher
  salaries for Ford workers and the benefits of
  lower auto prices to consumers must not take
  priority over stockholder interests.
• The stockholder interests come first.
• Smith Manufacturing Co. v. Barlow
• Managers can donate money, even if it lowers
  stockholders profit-margin
• The stockholder interests do NOT come first.

29
Dodge v. Ford Motor Co.

• Nature and Structure of Company
• Ford had a general idea to spread benefits of
  industrial system.
• Primary purpose of the company was to benefit
  mankind
• Semi-eleemosynary
• Stockholders got nice dividends, and should be
  content with what Mr. Ford doled out.
• Mr. Ford can chose various ways to pursue profit
• Mr. Ford cannot decide to change the whole
  purpose of the business!

30
Smith Manufacturing Co. v. Barlow

• Ordinary Business Operation
• Mgmt may coordinate many interests, including
  promotion of free vigorous private education
• Donation was not indiscriminate, nor to a pet
  charity
• Aid public welfare advance corp. interests
• Does not affect the nature character of the
  corp. or its overall goal of sustainable profit.