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Philosophy 162F

Lecture 4 Notes

The Purpose of the Corporation

Friedman Argument One:

  • 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.

 

Friedman Argument Two:

  • 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 Argument Supplement:

  • If there is any authority capable of diverting that to which an agent is entitled, it is a properly functioning, democratically elected government.
  • Managers are not democratically elected.
  • When a manager diverts profits for the purposes of the public good, they are acting as an authority capable of diverting entitlements.
  • Therefore, it is not correct for managers to divert profits, even for the public good.

 

Freeman Argument:

  • Corporations are part of the ordinary operation of our economy.
  • The actions of corporations touch on people in society whether or not they wish this interaction.
  • Freedom and personal choice are required for the creation of contracts.
  • Managers must create proper contracts with those that a corporation interacts, or else they must act as if there are proper contracts. That is, they must act in such ways such that they respect the autonomy of those who interact with the corporation that they manage.

 

John Hasnas

John Hasnas points to a particular relationship between the nature of business and any normative theory that would be applied to a business setting.

Hasnas adopts the following definition of a business from Robert Hessen's article, A New Concept of Corporations: A Contractual and Private Property Model" (See the endnotes of Hasnas' piece in the text.)

A business is, "a voluntary association of individuals, united by a network of contacts," organized to achieve a specific end. (Pg. 72)

 

For Hasnas,

  • an adequate theory does not add to the ethical commitments that one explicitly takes up as a participant in a business
  • an adequate theory takes into account all the ethical commitments that are explicit in a business

 

Note the technical definition Hasnas provides:

(Hasnas') social responsibility: those ethical obligations, if any, that businesses or business persons have to expend business resources in ways that do not promote the specific purposes for which the business is organized. (Pg. 66)

 

Hasnas definition of the Stockholder Theory:

"According to this theory, businesses are merely arrangements by which one group of people, the stockholders, advance capital to another group, the managers, to be used to realize specified ends and for which the stockholders receive an ownership interest in the venture. Under this view, the managers act as agents for the stockholders." (Pg. 66)

Hasnas' deontological argument in favour of the Stockholder theory is pretty much the strict contract argument for Stockholder Theory.

 

Claim: The public good can justify that managers divert corporate profits.

Problem One: The public good is (largely) irrelevant to the claims of Stockholder Theory.

Why: The Stockholder Theory is about duties between people; these particular duties should not be violated. One needs to argue this claim rather than simply assert the principle of utility, which rejects all such claims.

Problem Two: The claim about managers arises from a false analogy.

Why: The claim about managers arises from the analogy linking managers and their powers to those of democratic governments. Hasnas thinks that an equally good analogy can be drawn between managers who divert profits and any embezzler of funds.

 

Two core principles of Stakeholder Theory:

Principle of Corporate Legitimacy
The corporation should be managed to the benefit of and with the consent of its stakeholders.

The Stakeholder Fiduciary Principle

Managers bear a fiduciary responsibility to the stakeholders of the corporation and the corporation as an abstract entity.

Hasnas sees the argument in favour of Stakeholder theory as the following:

  • Agents should treat people with the respect due their autonomy.
  • Businesses should be held to this standard as well.
  • It is impossible for businesses to directly address the autonomy of those they effect, so it is up to managers to do the best they can to consider the interests of those that the business effects.

For Hasnas, the limit of this argument is that no person should be forced to do business with a particular company.

 

John R. Boatright

Definition time-out (from the online Oxford English Dictionary):

fiduciary: as an adjective,
Of a person: In trust of a person or thing; holding something in trust.
Of or pertaining to something held in trust.
fiduciary: as a noun,
One who holds anything in trust; a trustee.

 

Boatright's point is that we must evaluate theories of corporate governance be in terms of what is best for the public good. In this respect, shareholders are no more special than any other group important to the operation of a corporation.

 

  • Boatright assents that shareholders have rights over the overall control of a corporation (e.g., the election of the board of directors)
  • Boatright also admits that managers act as fiduciaries to management of the corporate assets.
  • But, this doesn't mean that managers should only consider shareholder profit.
  • There is a logical gap between the ownership rights of shareholders and the fiduciary duties of managers.

 

Risk argument:

  • Law and the particulars of their contract protect those who lend to a company.
  • There is nothing to prevent shareholders in the event of the failure of a business.

Equity Argument:

  • Shareholders cannot be protected by contract as other groups involved in the business because
    1. they cannot voluntarily withdraw from their relationship (they can only sell their shares),
    2. their investments are not associated with particular assets.

 

Boatright's Counter Argument One:

  • Existing shareholder rights (e.g., voting on board of directors, shareholder resolutions) offer protections other groups do not have.
  • These do not rely on the position taken in Stockholder Theory.

Boatright's Counter Argument Two:

  • Shareholders have options through the stock market that other stakeholders do not have.
  • They can dump their commitment to the company through selling their shares.
  • The stock market provides opportunities for profit outside of the traditional operation of the business.
  • Risk can be minimized through diversification.

 

Aside: What about those corporations that do not trade on the stock market?

Boatright argument against the strict contract argument

  • Shareholders rarely meet managers.
  • Often shareholders buy their stock from previous owners.
  • The information of the corporation is provided to investors it not usually specific and is viewed skeptically.
  • Shareholders do not get to negotiate the terms of their position, they either sign on as a shareholder, buying stock, or they do not.

 

Conditions for agency

  1. Consent to agency
  2. The power to act on another's behalf
  3. The element of control

Boatright sees that the law prevents these criteria from being met by managers.

  1. Managers are guided by law independent of the wishes of the shareholders.
  2. Managers cannot act in a legal sense on behalf of shareholders. The legal sense of action changes would require that the relationship of the shareholders and a third party would change. In law, a shareholder vote is required for any such change.
  3. The day-to-day (and most of the long-term) management of a corporation is wholly in the purview of managers.

 

  • Boatright is not arguing that managers have no duties to others.
  • There is a role for the current corporate structure and for the decisions of shareholders.
  • We need some restraint on the actions of managers because it is not in the public good to allow managers free reign over the corporations they control.

In Class Assignment

Get into a group of three or four. Choose one of the three cases at the end of chapter one. Discuss the case and answer three or four of the questions at the end of the case with a short answer. How many questions you answer depends on the number of people in your group. Hand in your answers, together with the names of the people in your group at the end of class.

Out of Class Assignment

Choose one of the three cases at the end of chapter one. Answer two of the questions at the end of the case with a short answer. This assignment is due Wednesday, May 18th.


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