The Curse Of The Corporation...Aaaaah

The corporation brought about a curse on society... can we survive it? 

Utopian objectives

A world where companies focus on long term growth, not short term profit

Stakeholders are not the victims of brutal cost cutting 

The Key To Modern Capitalism

Often, very small and insignificant things have enabled humans to make great progress. For example, technological progress has allowed us to increase the productivity of workers. But another not so obvious example is: limited liability.

That small Ltd, PLC, or LLP symbolises limited liability 

In the past, someone starting a company risked everything, their wealth, property and even personal freedom. This was because owners were personally responsible for the companies debts. Anyone who was unable to pay off their companies debts could end up in a debtors' prison.

Limited liability changed all this; if a limited liability company was sued, then the plaintiffs are suing the company and not the owners or investors. Other than the value of their investment, investors are not personally liable for the companies debts.

An early steel factory - Limited liability made such investments

less risky

This concept was responsible for the industrialisation of countries. With its gradual introduction in the US and Europe over the 19th century, risk became more affordable. This led to increased investment and the emergence of large scale industries like railways, steel, chemicals and factories, all of which were the building stones of modern society. This way, limited liability is the key to modern capitalism.

The 1st Transcontinental Railway - After limited liability was
introduced, many such investments were made possible

 

Manager vs Investor Incentives

You would think that the idea of limited liability, considering its benefits would be embraced immediately. However, for many hundred years, limited liability companies have been viewed suspiciously. In fact, Adam Smith, the father of modern economics criticised the idea. Why?

In the past, company owner often used to run companies and factories on their own. But as limited liability became more widespread, it led to the separation of management and ownership. Many people, including Adam Smith, then asked the question: how can managers be trusted to handle others (investors) money?

As companies grew in size, and it became increasingly difficult for one person to own a substantial part of the company, this question was once again raised. It was argued that company managers would not work for owners but for themselves. Instead of increasing profits, managers would focus to increase sales (and thus their own prestige) and their own perks; managers would focus on large prestige projects which does not add much to the company's profit and value. Finally, in the 1980s, a solution was found.

The Dumbest Idea In The World

 

The solution was called shareholder value maximisation. Since previously manager and investor interests conflicted, the idea aimed to bring them on the same side. Under the new idea, professional managers would be rewarded based on how much money they returned to their shareholders.

This idea was first introduced by Jack Welch. And at first, it seemed to work. The amount of money returned to shareholders by companies increased rapidly.

 Value Maximisation has increased the amount of money returned to shareholders



However, the way this was achieved is a different story. There are two ways to achieve higher profits: one is to cut costs which is a short term solution and the other is to grow profits.

This increase in dividends was achieved by ruthlessly cutting jobs and holding back on investment. Increase in wages were suppressed with the threat of outsourcing and governments were forced to lower tax rates under the threat of companies relocating to other countries.

In fact, shareholder value maximisation often harms a companies long term prospects. In the past, companies spent most of their profits reinvesting and growing the company. Now, most of their profits are spent in share buybacks and dividends. And why don't the shareholders care about their own company. The truth is, even though shareholders are the owners of the company, they are least committed to the long term growth of companies.

Companies spend most of their companies on dividends and buybacks

  

Impact On Economy

 

Investment by firms have fallen in many countries

Since companies spend an insane proportion of their profits on share buybacks and dividends, investment and growth rates have fallen.

In fact, S&P 500 companies, the 500 largest companies based on market capitalisation, spent nearly $914 billion ($914,000,000,000) on share buybacks/dividends this year. This is about 95% of their earnings. Instead, this money could have been used to build factories, research new products, employee retraining or other ways that will benefit the company in the long run.

 It is however important to notice that this has happened mostly in the US and UK. Jack Welch, the one who came up with the term 'shareholder value maximisation' later called it 'the dumbest idea in the world'. In short, it has failed to do what it was suppose to help: make money.

 

Alternatives - The Google Way 

 

Many governments outside the Anglo-American companies have tried to reduce the impact of shareholders. But there is one example which really stands out to me: Google.

Before Google went private, it's founders Larry Page and Sergey Brin worried about their company losing focus on innovation and falling into the same trap as other large corporation. So they decided to retain control over their company by issuing three different types of shares: class A for regular investors and carry 1 vote each, class B shares for themselves which carry 10 votes per share and class C shares which do not carry any votes.

Nowadays, we see how Google still manages to maintain it's focus and invests in a wide range of projects, from self driving cars to wearable glasses. The company has been growing. Not only that, its shareholders have also benefited from an increase in their share value.

One of Google's current research involves self driving cars..

Many more, like Groupon, Facebook and other tech companies have also opted for dual class shares because of its benefit.

Google glasses have been called the Best Inventions Of The Year

This is only one way, there are many others like cross-shareholding, Corporate Social Responsibility etc.  But one thing is for sure...we need to replace Shareholder Value Maximisation. It will benefit employees, corporations, the economy and even shareholders. Because there is more to a company than just this: shareholders trading in stocking exchanges trying to make money as soon as possible.

What is important to them is not necessarily important to Microsoft or

it's employees

Shareholders are not interested in company's growth. Shareholder Value Maximisation harms growth, reduces long term potential and hurts stakeholders like employees and suppliers the most.

Is this really what is important for everyone?