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10. Chapter 8--Managerialism, Irrationality and Authoritarianism.Wps Chapter Eight. Managerialism: Irrationality and Authoritarianism in the Large Organization A. The Corporate Form and Managerialism. We have already seen, in the section of Chapter Three on the corporate form, that apologists for the corporate legal form have been forced to abandon much of Mises' "entrepreneurial corporation" doctrine, and concede ground to the proponents of the managerial revolution like Berle and Means. Stephan Kinsella, for example, argued: It is bizarre that there is this notion that owners of property are automatically liable for crimes done with their property... Moreover, property just means the right to control. This right to control can be divided in varied and complex ways. If you think shareholders are "owners" of corporate property just like they own their homes or cars--well, just buy a share of Exxon stock and try to walk into the boardroom without permission. Clearly, the complex contractual arrangements divide control in various ways: the managers, etc., really have direct control; subject to oversight by the directors... etc. But even here--to get a loan, the company has to agree to various covenants w/ the bank, that condition its right to use property. Even though the law would not call the bank an "owner" praxeologically it of course has a partial right to control the property. If you have a contract allowing rentacops to patrol the building--hey, they are partial owners too. If you are leasing from a landlord--so do they. If you allow the plumber in to fix the building--he has temporary right of control too. So what?1 And in an email to the Libertarian Alliance's Sean Gabb, he "raise[d] doubts about the effective control that shareholders have over their companies, and wonder[ed] if they should not rather be placed in the same category as employees or lenders or contractors."2 He continued to develop the same argument, in his response at Mises Blog to Gabb's article on the subject: ....You conceive of a shareholder as the "natural" owner of the enterprise. I am skeptical of relying on the conceptual classifications imposed by positive law. To me a shareholder's nature or identity depends on what rights it has. What are the basic rights of a shareholder? What is he "buying" when he buys the "share"? Well, he has the right to vote--to elect directors, basically. He has the right to attend shareholder meetings. He has the right to a certain share of the net remaining assets of the company in the event it winds up or dissolves, after it pays off creditors etc. He has the right to receive a certain share of dividends paid if 1 Comment under Kevin Carson, "Corporate Personhood," Mutualist Blog, April 24, 2006 <http://mutualist.blogspot.com/2006/04/corporate-personhood.html>. 2 Sean Gabb "Thoughts on Limited Liability" Free Life Commentary, Issue Number 152, 26th September 2006 <http://www.seangabb.co.uk/flcomm/flc152.htm>. the company decides to pay dividends--that is, he has a right to be treated on some kind of equal footing with other shareholders--he has no absolute right to get a dividend (even if the company has profits), but only a conditional, relative one. He has (usually) the right to sell his shares to someone else. Why assume this bundle of rights is tantamount to "natural ownership"--of what? Of the company's assets? But he has no right to (directly) control the assets. He has no right to use the corporate jet or even enter the company's facilities, without permission of the management. Surely the right to attend meetings is not all that relevant. Nor the right to receive part of the company's assets upon winding up or upon payment of dividends--this could be characterized as the right a type of lender or creditor has.3 As I said in Chapter Three, this was a long step for Kinsella, considering that he initially argued (with Hessen) that the corporation was simply a contractual device for property owners to pool their property and appoint managers for it as they saw fit. In order to absolve shareholders of liability for the actions of their alleged "servants," he was eventually forced to concede most of the ground claimed by such theorists of the "managerial corporation" as Berle and Means. Along the same lines Alchian and Demsetz suggested (as mentioned in passing in Chapter Six) that the "ownership" role of the stockholder might be largely a myth, and that the only real difference between stockholders' ownership of equity and bondholders ownership of debt (or more specifically the difference between preferred stockholders, and common stockholders and bondholders) was one of degree. Instead of thinking of shareholders as joint owners, we can think of them as investors, like bondholders, except that the stockholders are more optimistic than bondholders about the enterprise prospects.... If we treat bondholders, preferred and convertible preferred stockholders, and common stockholders and warrant holders as simply different classes of investors... why should stockholders be regarded as "owners" in any sense distinct from the other financial investors? The identification of stock ownership with voting rights over the corporation, in fact, was far less in earlier days: Investment old timers recall a significant incidence of nonvoting common stock, now prohibited in corporations whose stock is traded on listed exchanges.... The entrepreneur in those days could hold voting shares while investors held non-voting shares, which in every other respect were identical. Nonvoting shareholders were simply investors devoid of ownership connotations.4 In our discussions of the corporation's internal calculation problem in Chapter Seven, we saw that assertions of "entrepreneurial" control of the corporation assume one of two 3 Stephan Kinsella, "Sean Gabb's Thoughts on Limited Liability," Mises Economics Blog, September 26, 2006 <http://blog.mises.org/archives/005679.asp>. 4 Armen A. Alchian and Harold Demsetz, "Production, Information Costs, and Economic Organization," The American Economic Review, p. 789n. alternative mechanisms: Mises' entrepreneur with double-entry bookkeeping, or Mises' and Manne's market for control. The interesting part is that, in addition to Mises' "entrepreneurial firm" subject to direct capitalist control, both thinkers propose a mechanism for entrepreneurial "control" short of direct control of the corporation hierarchy itself. That mechanism is the ability of the investor to shift funds in his portfolio away from firms that do not perform to his satisfaction, and to firms that maximize profits or otherwise meet his criteria for performance, in search of the investment vehicles with the highest rates of return. This last method, a version of "dollar democracy," treats the corporation largely as an autonomous, self-owned entity, with the capitalist rentier classes in the position of customers whose main instrument of control is the ability to take their business elsewhere. As we will see below, all these mechanisms are considerably less effective than their proponents believe: the "entrepreneurial" investor's direct control over the board of directors and senior management is largely a legal fiction; the threat of hostile takeover, although real at times, tends to arise at widely separated intervals and to be subject to mitigating responses by management; the threat of capital flight is limited by the corporation's reliance on retained earnings for the majority of finance and by minimal reliance on new share issues. The arguments of Kinsella, and of Alchian and Demsetz, taken together, suggest that capitalist ownership of the individual corporation is a myth, in the sense that a particular corporation is the property of its stockholders (or preferred stockholders with voting rights) in any real sense. Instead, the corporation is an agglomeration of unowned capital, under the control of a self-perpetuating managerial oligarchy. As Luigi Zingales quotes John Kay: "...if we asked a visitor from another planet to guess who were the owners of a firm... by observing behaviour rather than by reading text books in law or economics, there can be little doubt that he would point to the company's senior managers."5 This is borne out by Martin Hellwig's analysis, which shows that Manne's "market for corporate control" is more myth than reality. Hellwig argues that the concept of residual claimancy can be properly applied not so much to the shareholders as to management, which has the power "to disfranchise outside shareholders..., [and] that in all circumstances not otherwise provided for, ... has the effective power to set the rules of decision making so as to immunize itself against unwanted interference from outsiders."6 The theory that management is controlled by outside capital markets assumes a high degree of dependence on outside finance. But in fact management's first line of defense is to mimimize its reliance on outside finance. Management tends to finance new 5 John Kay, The Business of Economics (Oxford: Oxford University Press, 1996), p. 111, in Luigi Zingales, "In Search of New Foundations," The Journal of Finance, vol. lv, no. 4 (August 2000), p. 1638. 6 Martin Hellwig, "On the Economics and Politics of Corporate Finance and Corporate Control," in Xavier Vives, ed., Corporate Governance: Theoretical and Empirical Perspectives (Cambridge: Cambridge University Press, 2000), p. 98. investments as much as possible with retained earnings, followed by debt, with new issues of shares only as a last resort.7 Issues of stock are important sources of investment capital only for startups and small firms undertaking major expansions.8 Most corporations finance a majority of their new investment from retained earnings, and tend to limit investment to the highest priorities when retained earnings are scarce.9 As Doug Henwood says, in the long run "almost all corporate capital expenditures are internally financed, through profits and depreciation allowances." Between 1952 and 1995, almost 90% of investment was funded from retained earnings, while new stock issues amounted to 4% of total investment.10 The threat of shareholder intervention is diluted, likewise, by stock buy-backs.
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