Prosperity (part 3)

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Here I will summarize Colin Mayer’s ideas about the relationship between the corporation and the government.

Law

The idea that a corporation is more than a profit-making machine requires a new way of thinking about corporate law.

It should not simply be considered as a set of rules that define rights and responsibilities and what firms can and should do, but instead as a way of allowing different parties to commit to the common purposes that the corporation promotes. The remarkable contribution of corporate law has been to provide commitment devices that bind people and organizations together in such a way that they fulfill purposes that would otherwise be infeasible.

The commitments Mayer is talking about are more than contractual obligations. They are “self-imposed restraints” that build trust in such relationships as employer-employee or supplier-customer.

Corporate law affects commitments by “establishing the range of relations a corporation can sustain.” It:

  • Enables corporations to adopt a range of forms for different purposes
  • Empowers various parties, no longer just corporate directors and shareholders
  • Enforces the rights of different parties through such means as “voting within their particular class, voting corporately in conjunction with other classes, initiating class actions, or publicizing the opinions of members of the class in social media.”

If this seems rather abstract, that is typical of the book, which is stronger on general principles than on practical examples. An example of at least the first point is the innovation of the “benefit corporation,” which is allowed by the laws of thirty-five states and the District of Columbia. This B-corporation is similar to a C-corporation, except that it requires its directors to consider the impact of its activities on employees, customers, the community and/or the environment.

Regulation

Mayer sees an inverse relationship between the level of commitment and trust in the economy, and the need for government regulation. The UK, described previously as an economy dominated by widely dispersed corporate owners, is a low-commitment economy. Many other countries, on the other hand, have various ways of building commitment:

Nordic countries confer control on long-term owners, in particular families, who are actively engaged in the oversight of corporations. These long-term owners are able to uphold self-regarding commitments. Central European countries, such as Austria and Germany, confer control rights on stakeholders, in particular employees, as well as shareholders through workers councils and co-determination on supervisory boards. These allow Austrian and German corporations to offer credible communal commitments beyond those that are self-regarding. In the industrial foundations of, in particular, Denmark, founders of corporations relinquish control rights to a board that is responsible for ensuring that the corporations act in trust for the philanthropic benefit of other members of society. The foundations are therefore able to offer social as well as communal and self-regarding commitments.

Where the Friedman doctrine is most influential, in the UK and US, it has tended to erode social commitments and encourage calls for government regulation.

We need to break out of this destructive spiral of declining commitment and intensifying regulation by conceiving what corporate commitment is capable of achieving and creating the context within which it can realize its full potential to perform communal and social as well as self-regarding purposes.

Government regulation is no substitute for corporate cultures with pro-social purposes, self-imposed constraint and trust. External regulation without internal commitment leads corporations to find ways of evading the laws. For example, banking regulations have fostered the rise of financial institutions that perform banking functions without being classified as banks because they don’t take a traditional form (with depositors).

Mayer suggests that regulations be based more on function than on form. Institutions performing similar functions should be regulated in similar ways, or else activities will move from a regulated sector to an informal unregulated sector, like “shadow banking.” “This will potentially be a cause of a systems-wide financial failure that will be more serious than the financial crisis of 2008.”

A second principle is that regulations be based on a clearly defined public purpose. An emerging purpose today is verifying the security of data storage systems.

A third principle is that regulations must address past failures, such as the failure to recognize and manage the risks of highly leveraged hedge funds, or derivative securities like collateralized debt obligations.

Partnership

Conflicts between the private and public sector have gotten in the way of providing many public goods, such as adequate infrastructure. “There is a chronic under-provision of it around the world,” including in some of the wealthiest countries.

Part of the problem, noted in the last post, is an accounting system that excludes many social costs from private accounting, while excluding many social benefits from public accounting, thus exaggerating both private profits and public deficits.

When the public sector relies on private companies to help provide public goods, the two sectors have a conflict of interest: “Governments and regulators want maximum quality at lowest prices for the largest number of, in particular disadvantaged, consumers. Companies want the highest revenues from the provision of the lowest-cost projects and services.”

Mayer recommends that public obligations be specified in company articles of association, somewhat as they were when monarchs and parliaments granted charters to build canals or railroads. Complete freedom to incorporate and operate “may or may not have been appropriate for private companies that were not supplying public goods, [but] it is most certainly not right for the provision of infrastructure.”

For its part, government needs to engage the private sector in the design and regulation of infrastructure services. Corporate responsibility cuts both ways, conferring some legitimacy as well as obligation.

As I noted in the first post, the Friedman doctrine seems to be based on the assumption that the pursuit of private interest ultimately serves the public interest through the miracle of free-market competition. Mayer views this as naive, overlooking the enormous power of the corporation to enrich its shareholders at the expense of the public good. The profit-making machine rolls on, increasingly out of control, while the democratic state struggles to remain viable. The times require a thorough rethinking of the corporation, so that private gain may be reconciled with the well-being of society and nature.

The corporation is a conscious entity that has values. But when its sphere of operation is public not private, when it interacts with others in fulfilling its function, and when it is collectively part of a bigger whole, its consciousness has to embrace its environment, not just itself. That is the challenge of the twenty-first-century corporation, government, and world, and it is what will make the subject of the corporation one of the most fascinating for many years to come. We await the coming of the [next] age of the corporation as the trusted corporation.

 

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