20040312_austrian_economics_and_business_ethics

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THE CORPORATION

The corporation, especially in its multinational form, has been a particular target of business ethics. The power it wields apparently belies the idealistic model of capitalism where every participant is subject to competitive pressure, others can enter the market at will and individuals are free, responsible agents who must bear the costs of their own actions. Instead, the corporation is now seen as, if not a monopoly, considerably protected from the competition described in orthodox neoclassical theory. Indeed, there is no room for the corporation in that purely individualistic model. The firm itself, in whatever form it takes, is something of a departure from theoretical market economics. In its pristine form 'business' is characterised as a series of contracts between economic transactors who obviously enjoy the maximum feasible economic freedom. But once a person joins the corporation he gives up some of that liberty. Obviously, he is free to leave the corporation but once he makes the bilateral contract he is under its authority and must do as he is told. Of course, the immense transactions [25] costs of the pure market model made it inevitable that the corporation would develop for efficiency reason. Indeed, it has been responsible for the progress of market economies through the raising of capital and the flexibility brought about by the easy exchange of shares; but it is something of a departure from the pure market model.

For a long time it has been argued that the existence of the limited liability corporation erodes proper ownership. For the nominal owners, the shareholders, do not exercise proper control. That has been ceded to the managers who constitute a new elite immune not only from the competitive pressures of the market but also from the authority of the owners. Adam Smith himself was critical of the joint stock company because he thought that efficiency could only brought about by the owner-managed enterprise. Employees of the joint stock company would exploit the owners. As we shall see, the relationship between the agents, the contracted employees, and the principals, owners, is the permanent problem of capitalism and it turns up in a dramatic form every generation. We are going through particularly lurid examples of it now with managers exploiting stockholders on the grand scale.

There are two principled arguments that are relevant to this theme. First, how did the corporation develop and does its existence prove that not all efficient institutions are a product of the spontaneity of the market? Second, if the necessary features of the corporation are the product of statute law does that not validate a much wider range of corporate responsibilities than those implied in contract? In other words, are not corporations and their personnel responsible to society as well as their nominal owners?

It is the alleged privileges of the corporation that cause the controversy. It is a collective body (and this is a departure from market individualism) that can sue and be sued in court, it has a life that goes beyond the lives of its individual members and, most important, it has limited liability for debt and for torts; the owners only have their investment in the corporation exposed, not their private assets. It is argued that these 'privileges' did not evolve spontaneously but had to be a grant of society or the state. And the recipients of such advantages are under a moral duty to 'earn' them: hence the social responsibility of the corporation. Austrians did not write about institutional economics and never noticed the difficulties the existence of firms and corporations might have for their market theories but it is possible to reconstruct their views from the main tenets of their political economy.

It can easily be shown that the corporation emerged spontaneously through the law of contract and it had existed long before regulation by statute. Although in all capitalist countries corporations are licensed and heavily regulated by legislation, this need not be the case. We have to use money issued by the state but this does not mean that private money cannot exist; and although corporations are now governed by statute this does not mean that they could not emerge from common law. Under analysis, the 'privileges' of the corporation turn out to be not originally a product of the state; they are not special to that institution but arise out of the rights of private persons. The corporation is not a kind of entity.

A corporate body emerges when number of private persons agree to pool their assets and create an artificial body with specific purposes determined by its charter. The corporation takes on burdens shared by its individual members and the owners of the enterprise so created are entitled to the residual (profit). It appoints managers who have a fiduciary duty to act on behalf of the owners of the enterprise. If it is big enough the corporation can get a stock exchange listing and its shares become publicly traded. But this makes no difference to its logic. Size does not make the managers responsible to society, they still owe duties to the owners. The purposes of a corporation are determined exclusively by its owners. They might want to do good for society but if this were the case they would not have formed a business but a charity. Fiduciary duty of employees to owners is crucially important here for despite all the depredations that capitalism has suffered from the state and statutory law it still remains as the fundamental feature of business in common law countries. The recent business scandals have involved clear breaches of fiduciary duties: Enron, Tyco and WorldCom clear cases of the exploitation of stockholders by managers; breaches of their fiduciary duties.

Limited liability emerged spontaneously through contract and no one is obliged to trade with a body that claims it. Indeed, even in the business world today commercial contracts are sometime made in which its extent is reduced and transactors become personally liable. Everybody dealing with a company is perfectly aware of the fact that he won't get all of his money back if things go wrong. There is some difficulty, however, with limited liability for torts for it is most unlikely that anybody would willingly sign a contract that allowed him to be harmed with no possibility of redress. It seemed to have emerged in American common law because of the difficulty of extending the notion of vicarious liability (whereby the master is liable for the wrongful acts of his servant) and is a regrettable consequence of the entity concept of the corporation; as if it were something separate from its owners. It led to the creation of one man corporations, by which individuals can escape liability. Limited liability for torts, partly because of the evasion of personal responsibility that it invites, is not consistent with minimalist business ethics or Austrian economics. It is not actually required for a market society; big companies could afford to pay damages and small ones could insure.

Although the personnel of the company may change over time and it might sometimes be difficult to identify individual wrongdoers in the case of corporate malfeasance, none of this is dilutes the individualistic foundations of the corporation. As Robert Hessen wrote: '(A)t every stage of its development (it) is a voluntary association based exclusively on contract'. [26] It follows from this that the recent invention of 'corporate crime' is just that, an invention. It is a collectivist departure from the ethical convention of personal responsibility for action.

Perhaps the most insidious modern concept derived from anti-capitalist business ethics is the idea of the 'stakeholder corporation'. This began as the rather mild advice to companies that they should involve all employees more fully in the running of the organisation and the stakeholders were specifically confined to those who had a clearly definable role in it. But when modern corporations make pious references to their concern for all stakeholders in their annual reports, something different is meant. It has developed in such a way that, if all the injunctions of business ethics were to be taken seriously, the property rights of the company would be irreparably undermined. For the new stakeholders have become as important as formal owners. We are told by prominent business ethicists, W. Evans and R. Freeman, that: 'The very purpose of the firm is to serve as a vehicle for stakeholder interests'. [27] The shareholders, instead of being decisive, are simply one of the groups that are to have an influence over such things as investment policy, takeovers, plant location and remuneration. Those who risk their capital in the company are to have no greater say than trade unions, suppliers and local residents.

Presumably policy will not be decided by managers responsible to the shareholders but by all affected parties sitting and voting in a company 'parliament'. But this will be disruptive of efficient management for a number of groups with divergent goals will be influential in decision-making. In fact, no decisions will be made at all for very soon an 'Arrow problem' will emerge. This, named after economist Kenneth Arrow, shows the impossibility of decisions by majority rule if there are at least three possible decisions and three groups of voters. If votes are taken separately there will simply be cyclical majorities and no clear winner. [28] Under present company law, decisions are ultimately made by shareholders who can be assumed to have only one goal - the maximisation of shareholder value. There is then none of the problems involved with stakeholder capitalism. The answer to the difficulty of conflicting stakeholder groups given by stakeholder theorists, Evan and Freeman, is laughable. They are Kantians, not interested in the firm's profit and therefore blithely recommend the appointment of a 'metaphysical director' to reconcile the differing stakeholder groups. However, the person appointed to this exalted position would simply prolong the disputes up to the point at which the viability of the firm is threatened. Everybody is a self-interested utility maximiser, and philosophers are not exempt from this realistic description of human behaviour.

All of the ethical problems of corporations can be handled by conventional ethics and law. The imposition of supererogatory duties on corporations has no basis in business practice or in the individualism that powers Anglo-American capitalism. In fact, the emphasis on the higher duties has distracted corporate executive from the much more compelling basic moral duties. All of the persons involved in the business scandals of recent years had very high moral profiles, they gave to charity (often with company money) and were visible churchgoers. But they were lax in the elementary fiduciary duty of responsibility to shareholders. [29]

footnotes

[25] . R. H. Coase, 'The Nature of the Firm', Economica, vol. 4 (1937), pp. 386-405.

[26] . Robert Hessen, In Defense of the Corporation, Stanford, Hoover Institution, 1979, p. 43.

[27] . W. Evan and R. Freeman, 'A Stakeholder Theory of the Corporation', in T. Beauchamp and N. Bowie, Ethical Theory and Business, Englewood Cliffs, Prentice Hall, 1993, p. 82.

[28] . Norman Barry, 'The Stakeholder Concept of the Corporation is Illogical and Impractical', The Independent Review, vol. 6 (2002, pp. 541-55.

[29] . 'A Stakeholder Theory of the Corporation', p. 82.

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