“In a free-enterprise, private-property system,” the article states flatly at the outset as an obvious truth requiring no justification or proof, “a corporate executive is an employee of the owners of the business,” namely the shareholders.
If anyone familiar with even the rudiments of the law were to be asked whether a corporate executive is an employee of the shareholders, the answer would be: clearly not. The executive is an employee of the corporation.
An organization is a mere legal fiction
So if the organisation is a legal fiction the executive can't really work for it. He can't be responsible to something that doesn't really exist, because a nonexistant thing cannot hold power over a real thing. The executive works for the shareholders because they are the ones whose money he is recieving, they are the ones whose benefit he is supposed to work for. To say that he is doing something for the good of the corporation, but not the good of the shareholders is meaningless. The corporations only has meaning as a collection of the interests of the shareholders.
"The executive “has direct responsibility to his employers.” i.e. the shareholders."
Who else is he responsible to? How is this not undeniable?
"What’s interesting is that while the article jettisons one legal reality—the corporation—as a mere legal fiction,"
The corporation IS a legal fiction.
"it rests its entire argument on another legal reality—the law of agency—as the foundation for the conclusions. "
Well yes, because that reality is actually a reality. It is possible to make someone your agent, and that's not a "legal fiction" they really are your agent, you really have authorized them to make contracts and do other things on your behalf.
"The choice depends on the predetermined conclusion that is sought to be proved."
No it depends on what is actually a legal fiction and what is not.
"How did the corporation’s money somehow become the shareholder’s money? "
It was always the shareholders money. All money and assets the corporation has were either to the corporation on the understanding that the resultant returns would be given to the shareholders, or they are the resultant returns that should be given to the shareholders.
"That is the article’s starting assumption. "
No it's the stated fact in the companies own documents.
"The article goes on: “Insofar as his actions raise the price to customers, he is spending the customers’ money.” One moment ago, the organization’s money was the stockholder’s money. "
Yes but now we're talking about the money paid by the customers, which is NOT the organisation's money. It's the customer's money, and they're paying more because of the executives actions.
"With another wave of Professor Friedman’s conceptual wand, the customers have acquired a notional “right” to a product at a certain price "
No he hasn't said they have a right to the product at a certain price. What he has said is that the ill-effects of the executive spending money other than on production can impact customers, and he has no right to negatively affect them. Why should they pay because he thinks money should be spent on something?
"Now suddenly, the organization’s money has become, not the stockholder’s money or the customers’ money, but the employees’ money."
But again, this is not the organisation's money, it's the employees. If he causes them to lose wages then he is causing them to lose THEIR money, not the corporation's.
"One might think that intellectual nonsense of this sort would have been quickly spotted and denounced as absurd. And perhaps if the article had been written by someone other than the leader of the Chicago school of economics and a front-runner for the Nobel Prize in Economics that was to come in 1976, that would have been the article’s fate. "
Right because nobody ever dispute anything Friedman said. Practically everything he said was attacked by someone. The problem is that his logic is flawless.
"The success of the article was not because the arguments were sound or powerful, but rather because people desperately wanted to believe. "
But almost nobody wanted to believe this. Most people wanted corporations to act like nice guys, or they thought they did.
"Underneath impenetrable jargon and abstruse mathematics is the reality that whole intellectual edifice of the famous article rests on the same false assumption as Professor Friedman’s article, namely, that an organization is a legal fiction which doesn’t exist "
That's not an assumption it's a clear fact. A corporation does not have a physical existance.
"and that the organization’s money is owned by the stockholders."
Ok firstly that's two things, and secondly neither is an assumption. Both are clearly true for the reasons I've shown.
"In this way, the alleged tendency of executives to feather their own nests would be mobilized in the interests of the shareholders."
Alleged tendencies? I'm sorry was there anyone anywhere who didn't know that executives feathered their own nests?
"So for a time, it looked as though the magic of shareholder value was working. But once the financial tricks that were used to support it were uncovered, the underlying reality became apparent. "
So the problem isn't with shareholder value, but that executives FAKED shareholder value. Great I hope that means you'll stop trashing the concept.
"The rate of return on assets and on invested capital of US firms declined from 1965 to 2009 by three-quarters, as shown by the Shift Index, a study of 20,000 US firms.
"The shareholder value theory thus failed even on its own narrow terms: making money. "
Ah yes, the post hoc, promptier hoc fallacy. Hello my old friend.
"Yet, precisely the opposite occurred. In the period of shareholder capitalism since 1976, executive compensation has exploded while corporate performance declined."
Which suggests that executives HAVEN'T been prioritizing shareholder value have they?
"”. It turned out that the fabulous returns of GE during the Welch era were obtained in part by the risky financial leverage of GE Capital, which would have collapsed in 2008 if it had not been for a government bailout."
So in other words Welch wasn't maximising shareholder value, he was just maximising what the value appeared to be if you didn't look at the risks. So again this has nothing to do with what Friedman said.
"Jack Welch... said“On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy..." "
Yes and it's the result you're trying for. Friedman didn't say that it was a strategy. He said it was a GOAL, and the only legitimate one.
Welsh continues "...your main constituencies are your employees, your customers and your products."
This is literally insane. Does he honestly think that his products voted for him? Or that they should? Good thing he didn't manage a piggery. As for employees being your constituents, no. They did not hire you, they cannot fire you, they don't pay you and you're not responsible to them. That this even needs to be said is astounding. Customers at least could be argued to be paying executives, but they are not doing this because they control the executives or have rights over the executives, other than not being defrauded by them. The purpose of serving the customers is to serve the employer. That is true for the lowliest fast food worker to the highest executive.
"Managers and investors should not set share price increases as their overarching goal"
And Friedman didn't say they should He did not mention share price but the VALUE of the company. It's possible that this whole article is the result of this moronic misunderstanding. Price is not value.
"… Short-term profits should be allied with an increase in the long-term value of a company.”
Note that Friedman said nothing about the timeframe that value should be assessed in or how it should be discounted for time. He never said that short term profits should be earned at the expense of long-term value. In fact considering his other statements he would probably have considered the question unanswerable except by those whose money it was.
"In an effort to win, they go up to the very edge of illegality"
Yes they should, that's why it's the edge of illegality, because they shouldn't go beyond it but it's OK to go right up to it. If you're trying to say that firms have an ethical duty to stay away from these edges you're going to have to make the case.
" or if they go over the line, get off with civil penalties that appear large in absolute terms but meager in relation to the illicit gains that are made."
Ok let's suppose that the penalty for a "crime" (whether it's actually a bad thing or not) is $1M. That is effectively the price that government has put on doing that thing (or at least being caught at it). Now either that price is too low to compensate for the damage to society from breaking the law or it isn't.
If it isn't if the fine completely compensates for the damage to society then if the profit from crime exceeds the fine they should do it. The shareholder benefits, the public in the form of the taxpayers benefit and since there's nobody else involved, society in general benefit. The exception is if the benefits form the fine don't go to the people who suffered costs from the crime. But that's hardly the companies or the executive's fault.
If the fine doesn't completely compensate for the damage to society, this is STILL not the company or the executives fault. It is not their job to correctly set incentives for corporate behaviour, but to recognise and act on those incentives. Just like the worker isn't obliged to tell his employer how to operate more profitably by firing him. Just like the customer isn't obliged to tell the seller how to get more money out of him. It makes no sense to impose a duty on executives that they have no expertise in, that is difficult or impossible to measure and that frankly nobody is paying them to do.
"In such a world, it is therefore hardly surprising, says Roger Martin in his book, Fixing the Game, that the corporate world is plagued by continuing scandals, such as the accounting scandals in 2001-2002 with Enron, WorldCom, Tyco International, Global Crossing, and Adelphia, "
None of which were about maximising shareholder value, but faking it.
"subprime meltdown of 2007-2008"
First of all there was a general meltdown in mortgages, not one specifically in subprime mortgages. But the meltdown was caused by government interference in the market, and people ignoring shareholder value for quick paper profits.
"Martin writes: “It isn’t just about the money for shareholders, or even the dubious CEO behavior that our theories encourage. It’s much bigger than that. Our theories of shareholder value maximization and stock-based compensation have the ability to destroy our economy and rot out the core of American capitalism"
Yet not a single one of these abuses relates to what Friedman said. He never justified fraud in the pursuit of shareholder value. He never justified lying to the shareholders to pretend value was greater than it was.
"Peter Drucker made a sustained argument against shareholder value in his classic book, Management. In his view, “There is only one valid definition of business purpose: to create a customer. . . . It is the customer who determines what a business is. It is the customer alone whose willingness to pay for a good or for a service converts economic resources into wealth, things into goods. . . . The customer is the foundation of a business and keeps it in existence.” "
And if that doesn't result in benefit for the business owners, usually in the form of profit, how is that an overall good thing? The customer is a means to an end, not an end in itself. There are of course businesses where the customer is an end in themselves, formed by customers to serve them. These are called buyers cooperatives. That most businesses are not organised in this way shows that Drucker is clearly wrong.
"Similarly in 1979, Quaker Oats president Kenneth Mason, writing in Business Week, declared Friedman’s profits-are-everything philosophy “a dreary and demeaning view of the role of business and business leaders in our society… Making a profit is no more the purpose of a corporation than getting enough to eat is the purpose of life. Getting enough to eat is a requirement of life; life’s purpose, one would hope, is somewhat broader and more challenging. Likewise with business and profit.” "
The difference is that it's your life but not your business. If you consider creating profit to be too "dreary" then by all means quit and pursue something more meaninful. Personally I would consider making the shareholders richer so that they can pursue their life goals more successfully to be pretty meaningful, but maybe I just care more about other people than him.
"Power in the marketplace shifted from seller to buyer. "
When you see a buyer and a seller interacting, who is usually being nicer to the other? Who acts as though they are the supplicant, and the other guy has their fate in their hands? It's almost always the buyer that has the power and it always has been So the claim that the power "shifted" to buyers is questionable at best, bizarre at worst. True there are MORE options for consumers, but they always had multiple options in any free or near-free market.
"A whole set of organizations responded by doing things differently and focusing on delighting customers profitably, rather than a sole focus on shareholder value. "
As though these were opposing goals.
"In effect, shareholder value is obsolete. What we are seeing is a paradigm shift in management, in the strict sense laid down by Thomas Kuhn: a different mental model of how the world works."
And note that not one difference in how firms actually operate is listed, nor how that way would be inconsistent with shareholder value. So we can assume Denning is just lying here.