I’m at the Tokyo Foundation office in Toranomon, Tokyo reading this article by Masahiko Aoki and Gregory Jackson entitled “Understanding an emergent diversity of corporate governance and organizational architecture: an essentiality-based analysis”. Aoki and Jackson propose that the view (currently ascendent in financial economics) of the firm as the private property of the shareholders can be understood as a special case of a more general game-theoretical model of corporate governance. Moreover, when employees and managers can create value by exerting control over the production process, circumscribing the control rights of shareholders may be desirable. Aoki and Jackson argue:
An enforceable legal framework for worker participation may be a necessary prerequisite to focus managers and workers on the potential positive-sum gains of cooperation by constraining the potential for short-term gains from non-cooperation that may exist under liberal and purely contractual regimes
As Mary O’Sullivan argues in her book Contests for Corporate Control, insider (manager and employee) control is essential to innovation. Thus, in a world where competitive advantage increasingly derives from dynamic capabilities, learning, and innovation, it seems reasonable to expect that forms of corporate governance that limit the control rights of shareholders will exhibit better performance.
This work is thus broadly consistent with my research on Public Interest Capitalism, which advocates redesigning capitalist institutions (“rules of the game”) in order to encourage more equitable, sustainable, and innovative economic activity. Along these lines, I favor a rule requiring employee approval in the case of hostile takeovers, since the possibility of a hostile takeover impedes the creation of implicit contracts between managers and employees, among other stakeholders.
The article also includes an interesting empirical analysis of the institutional clusters emerging in the Japanese economy.
Over the last several decades, maximizing shareholder value has become widely accepted as the duty and legitimate purpose of business managers. Many scholars propounded this ideology, and probably none more forcefully than Milton Friedman. In a well-known article in the New York Times Magazine in 1970, he argued that “The Social Responsibility of Business is to Increase its Profits“. In his book From Higher Aims to Hired Hands, Harvard Business School professor Rakesh Khurana describes how this view replaced a conception of the business manager as a steward of the public interest responsible for skillfully balancing the interests of corporate stakeholders to sustain the enterprise and create value for society. William Lazonick and Mary O’Sullivan provide a complementary perspective.
Unfortunately, while maximizing shareholder value squares nicely with neoclassical economic theory, it can cause serious problems in practice. In my research project on Public Interest Capitalism, we link shareholder value maximization to inequity, short-termism and underinvestment, and deterioration of social capital. In a nutshell, there are three fundamental problems with relying on shareholder value maximization as the criterion for corporate management. First, market incentives (hence profit) may correlate only slightly or even negatively with social welfare (on this point, see David Grewal’s book Network Power). Second, markets can impede innovation (Mary O’Sullivan provides the details in Contests for Corporate Control). Third, by reducing the purpose of the company to generating as much profit as possible for a diffuse external constituency, shareholder value maximization decrease the identification of employees to organizational goals, thereby hindering learning and efficient operation. For a different but complementary perspective, see Simons, Mintzberg and Basu’s “Memo to: CEOs“.