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Philosophy 162F Lecture 3 Notes The Purpose of the Corporation The corporation is one way of organizing human activity. Corporations began as legal entities defined by contracts and government documents that existed for single purposes. E.g., one corporation might build a bridge, one corporation might sell a certain brand of soap, one corporation might operate a restaurant. Adam Smith argued in his work on economics that the pursuit of personal profit would turn the distribution of labour within a free market economy into the benefit of all if it could convince those with wealth to invest capital. Capital is the resources that enable labour to be productive. So capitalism and its attendant profit, as envisaged by Adam Smith, is good because it encourages people to invest their resources and goods in order to produce capital which will give return to everybody. Egoism leads to utilitarianism!   Stockholder Theory The claim of Stockholder Theory is that the management of a company should only concern itself with the interests of the stockholders. Many of the arguments in favour of the Stockholder theory assume that the capitalist system is one that produces the most good for the most people. The Stockholder theorist that we are looking at today is Milton Friedman. Friedman states the point/thesis/conclusion of his article clearly in the last sentence: "there is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud." (pg. 55). There are two main arguments that Friedman puts forward in support of Stockholder theory, the argument from ownership and the argument from strict contract. Both of these arguments assume that we are concerned with the actions of the people that run corporations, not the corporations as an entity themselves. The argument from ownership: Corporate managers are employees of the owners of the Corporation, i.e., the stockholders. Stockholders hold stock in corporations with the intention of receiving a return on their investment, i.e., the corporations' profits, and they are entitled to those profits as owners. Any profits spent by managers on social causes amounts to managers spending money that is not theirs but is instead, the rightfully owned money of the stockholders. Therefore, managers must not spend profits on social causes but instead provide the stockholders with all of the corporation's profits. The argument from strict contract: All the agents involved in a corporation have an understanding of their role and their recompense for that role. The role of the stockholder is to provide capital. Their recompense is all of the profit. The role of managers is to ensure that agents play their correct roles in a corporation and that agents receive their proper recompense. Therefore, managers must act to ensure that stockholders receive all the profit from the corporation. Friedman's personal freedom argument: Corporate Executives spending money on social causes amounts to those corporate executives imposing a tax on stockholders, along with a unilateral decision about how those tax dollars are to be spent. This is a violation of the principles of democratic freedom. (First, it violates the idea that there is to be no taxation without representation. Second, it violates the idea that decisions with respect to the spending of tax dollars are to be made by the duly elected democratic representatives of the people.)  Remember, when Friedman decries the idea of corporate social responsibility, he is not advocating that people act immorally. He simply sees the role of corporate social responsibility to be to follow its purpose, namely to make us all better off by pursuing profit.   Stakeholder Theory Stakeholder Theory holds that there are a number of groups of people that must work in concert in order to carry out business tasks and there concerns must be addressed directly. R. Edward Freeman is the Stakeholder Theorist that we are looking at today. Corporations are not profit-making legal constructs following the operation of simple and private contracts. Corporations are the dominant means by which individuals organize themselves for the purposes of economic activity. Thus corporations cannot be thought of as being responsible to only one group, but must be seen to bear responsibilities to all of the individuals their activities affect, and upon whom their existence depends. Freeman's paper has four steps in defending his presentation of a Stakeholder Theory. Show that the current legal system and dominant economic theories are both inconsistent with the view that corporations are responsible only to their stockholders. Present an outline of the Stakeholder Theory, detailing the ways in which the stakeholder groups are related to the corporation. Outline the specific implications a stakeholder theory might have for corporate managers. Present a more detailed version of a possible Stakeholder Theory, one whose rules would be determined and adopted on the grounds of a fair contract.  Step 1 The Legal system places responsibility upon corporations equivalent to and beyond that of ordinary persons. This contradicts the Stockholder Theory.  Economic theory is inconsistent with the Stockholder Theory. If Stockholder Theory followed closely it would result in problems due to moral hazards, externality and monopolies. moral hazard, the effect of insurance on the likelihood of the insured event occurring; the lack of incentive to avoid risk where there is protection against its consequences, e.g. by insurance. externality, a side-effect or consequence (of an industrial or commercial activity) which affects other parties without this being reflected in the cost of the goods or services involved; a social cost or benefit. These arguments address the practical nature of the ethical theory, but do not justify the theory. Step 2 The wide version of Stakeholder Theory maintains that corporations bear some responsibility to any person(s) that its activities affect. The narrow version of Stakeholder Theory maintains that corporations bear some responsibility to those who are engaged in a relationship with the corporation that is vital and necessary to the survival and success of the corporation. These groups would be, Stockholders Employees Suppliers Customers Local Communities Management  Step 3 Managers are more than just employees. Managers directly face the task of enacting the rules of governance of an organization. Managers need to balance between the competing interests of the many stakeholders in the corporation, because always giving priority to the interests of one group (e.g., stockholders) will ensure the corporation's demise. Stakeholder Theory is intended to provide the standards that evaluate this balance through its normative core. There are three aspects to a normative core: norms of governance, norms of management action, and background disciplines. (See pp. 61-62, especially Exhibit 1.) Norms of governance determine the principles that managers should seek to guide their decisions. Norms of management action determine the direct goal that actions should be directed towards. The background disciplines determine the methods that should be used to determine the effectiveness of particular actions.  Step 4 Freeman presents the Doctrine of Fair Contract as a normative core. This is based upon a version of pragmatic liberalism. Roughly, pragmatic liberalism is the idea that everyone should enjoy a maximal amount of freedom, limited by the fairness. This requires contracts or other organization to maximize freedom and fairness. A contract is only fair if parties would enter into the contract in ignorance of their stake in the matter. That is, either party would enter into the contract in ignorance of which side of the contract they were to be on (the Veil of Ignorance). Groundrule 1: Entry and Exit. There must be clear stipulations regarding the entry, exit and renegotiations of a contract. Groundrule 2: The Principle of Governance. Changes to the contract may only be made by unanimous consent. Groundrule 3: The Principle of Externalities. If a third party is effected by a contract, that third party has the right to become a part of that contract and the terms of the contract must be renegotiated. Groundrule 4: The Principle of Contracting Costs: All parties must share in the cost of contracting. Groundrule 5: The Agency Principle. Agents of the contract must serve the interests of all the stakeholders of the contract. Groundrule 6: The Principle of Limited Immortality. The contract shall be managed as if it can continue to serve the interests of the stakeholders through time.  These ideas lead to the following principles: The Stakeholder Enabling Principle Corporations shall be managed in the interests of its stakeholders, defined as employees, financiers, customers, employees and communities. The Principle of Director Responsibility Directors of the corporation shall have a duty of care to use reasonable judgement to define and direct the affairs of the corporation in accordance with the Stakeholder Enabling Principle. The Principle of Stakeholder Recourse Stakeholders may bring an action against the directors for failure to perform the required duty of care.  So the difference between Friedman (Stockholder) and Freeman (Stakeholder) is as follows: Friedman believes that because the purpose of the corporation is to generate profits, corporate executives have only one responsibility, i.e., to generate profit for stockholders. Freeman accepts that 'profit-generation' is one goal of the corporation, but the presence of corporations is so pervasive in today's world that they also determine economic interaction. Since economic interaction is a fundamental component of all social interactions, it follows that corporations bear some additional socially responsibility, at least toward those with whom they share a direct relationship.   Note on the Legal Cases Dodge vs. Ford Motor Co. eleemosynary, a. and n.: Of or pertaining to alms or almsgiving; charitable. eleemosynary house, corporation, one established for the distribution of alms, etc.  In this case, the court decided that the management of Ford Motor Co. could not decide to decline from the pursuit of profit in the price of their product, nor could Ford decide to reinvest profit in ways that were intended to benefit some other party at the cost of shareholder profit. The court drew a distinction between the duty of the corporation to the law and the duty of the corporation to shareholders. A. P. Smith Manufacturing Co. vs. Barlow intra vires, within the power or legal authority of an agent. In this case, the courts sided with the management that made a particular donation. It was the contention of the management that the donation was an investment in the business. Home.

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