Ralph Gomory & Richard Sylla
RALPH GOMORY, a Fellow of the American Academy since 1973, is Research Professor
at the New York University Stern School of Business.
RICHARD SYLLA, a Fellow of the American Academy since 2012, is the Henry Kaufman
Professor of the History of Financial Institutions and Markets and Professor of
Economics at the New York University Stern School of Business.
(* See endnotes for
complete contributor biographies.)
Abstract: The United States from its earliest years led the world in making the
corporate form of business organization widely available to entrepreneurs. Starting
in the 1790s, corporations became key institutions of the American economy, contributing
greatly to its remarkable growth. This essay reviews the evolution of corporations
across several eras of the country’s history. The most recent era is marked by a
shift away from a stakeholder view of corporate interests and purposes to one dominated
by profit and shareholder value maximization. We strongly question whether this shift
has been beneficial to the country as a whole. If our assessment is correct, there
is a need to find ways of inducing corporations to act in ways that produce better
societal outcomes. We therefore explore ways – including some suggested by the history
of U.S. corporations – in which corporate interests and the public interest might
become better aligned.
Great corporations exist only because they are created and safeguarded by our institutions;
and it is therefore our right and our duty to see that they work in harmony with
–Theodore Roosevelt, First Annual Message to Congress, 1901
Questions about the actions and purposes of American corporations have been with
us as long as corporations themselves. Both the questions and the answers to them
have varied widely over time. The Occupy Wall Street movement that began in New
York City in September 2011, spreading thereafter to other cities, raised or reiterated
some of the basic questions about how well these American institutions work. The
questions being raised today cover a wide range of issues.
Why, during the ongoing financial and economic crises that broke out beginning in
2007, did large financial institutions and industrial firms teetering on the brink
of failure – often because of their own misguided strategies and decisions – get bailed
out by the federal government? Why did the government seemingly do much less for
homeowners facing foreclosures on houses now worth less than the mortgage debt incurred
to buy them, perhaps because they had lost their jobs in the economic downturn and
could not afford the mortgage payments due?
Why do the profits of American corporations and the compensations of their executives
stay high and even rise in some cases while jobs disappear and both economic growth
and median family incomes stagnate? Why does the judicial branch join in to strengthen
the influence of corporations, financial and nonfinancial, as with the Supreme Court’s
Citizens United decision in 2010? That decision granted corporations relatively
unlimited free-speech rights to spend corporate funds in electoral politics.
It is not the first time in U.S. history that people have wondered whether ours is
a government of the people or a government of the corporations, by the corporations,
and for the corporations. Such fears are as old as the republic. They were present
in the 1790s, when the United States began to lead the world in the development
of the corporation as the most dynamic form of modern business enterprise. They
arose again in the financial and economic crises of the late 1830s and early 1840s,
after state legislatures had created thousands of corporations. In the decades around
the turn of the twentieth century, when many corporations became very large, the
fear of corporate power resurfaced, leading to antitrust laws and federal regulation.
The crises of the Great Depression led to further restraints on the financial and
economic powers of corporations.
If there is any surprise about the current crisis, it is not that worries about
corporate power and its abuse are once again being raised, but that so little is
being done about them in comparison with the reforms of the 1840s, the Progressive
Era, and the New Deal. Could we be witnessing the ultimate triumph of the corporation,
one in which corporate rights and privileges vastly outweigh corporate social responsibilities?
Americans have always viewed corporations with mixed feelings. On the one hand,
a corporation with limited liability and endowed with a long life is an attractive
vehicle for numerous investors to pool their individual capitals, receiving tradable
shares of the company in return. Pooling of capital makes possible large, long-term
investments that can achieve economies of scale and scope in the production and
distribution of goods and services that are beyond the capabilities of sole proprietorships
and partnerships. Indeed, one of the less appreciated reasons for the rapid rise
of the U.S. economy in the nineteenth century in comparison to other nations was
the relative ease of obtaining a corporate charter in America.
On the other hand, inherent in the corporate form are problems of conflicting goals.
Will the managers of corporations manage them in the interests of the shareholder-owners?
Or will the managers act in their self-interest? Will corporate managers take into
account the interests of employees, customers, suppliers, lenders, and the polity
that made the corporation possible?
Inevitably, these problems of corporate goals that have arisen throughout the history
of the American corporation are still with us. Our essay outlines how they have
been addressed in several distinct eras of U.S. corporate development. This history
perhaps can inform how we might deal with them now.
We conclude by strongly questioning whether today’s dominant corporate goal – profit
maximization – is beneficial to the country as a whole.
In the period from the 1790s to the 1860s, the United States led the world in modern
corporate development. Recent research provides the first comprehensive look at corporate
development, revealing that U.S. states from 1790 to 1860 chartered 22,419 business
corporations under special legislative acts and several thousand more under general
incorporation laws that were introduced mostly in the 1840s and 1850s.1 These totals
far exceed the number of corporations created in any other country (most likely
in all other countries combined) during that time. The United States thus became
what might be called the first corporation nation.
Most of the early American corporations, operating within a state or in a city or
town, were small by later standards. The largest were banks and insurance companies,
joined later in the era by railroads and manufacturers. Stockholders, often locals,
could monitor corporate operations firsthand, and they were more directly involved
in corporate affairs than would later be the case. Stockholders’ meetings were frequent
and actually provided guidance for management. Passive stockholders could keep an
eye on their investments by checking prices in securities markets and by observing
the dividends they received, which in this era accounted for the lion’s share of
corporate net earnings.
Legislative chartering meant that charters could be tailor-made for each corporation,
with its powers, responsibilities – including those to the community – and basic governance
provisions carefully specified.2 Most charters were not perpetual, but rather had
set terms of years and had to come up periodically for renewal, a constraint on
corporate malfeasance. Voting rules for shareholders in elections of directors and
other corporate matters varied. They were not always the modern norm of one vote
per share, which favors large-block shareholders. Legislative chartering could easily
be corrupted, however, with incumbent corporations using money and influence to
defeat charters for potential competitors, and would-be corporations using the same
tools to gain charters.
General incorporation laws, also a modern norm, were introduced late in the antebellum
era as a way to avoid the corruption involved in legislative chartering as well
as what was perceived as too close a relationship between corporations and the states.
Under general laws, any group of incorporators meeting the specifications of the
law could receive a charter, the granting of which became an administrative rather
than legislative function of government. Access to the corporate form became more
open – a gain for society. But state oversight of the creation and monitoring of corporations
was reduced, which had costs in terms of corporate governance.
From the 1860s to the 1930s, most corporations remained small (as is still true),
but growing numbers of them became very large and operated nationwide and even multinationally.
Large corporations required professional managers, who often had limited or no ownership
shares. These “Berle-Means” corporations, so named after the authors of a famous
1932 book, The Modern Corporation and Private Property, effectively separated ownership
(shareholders) from control (management), marginalizing the influence of owner-shareholders
in corporate affairs.
In this era, external checks on the possibility that managers would behave opportunistically
against the interests of owners and anti-socially against the larger interests of
the country came in two forms: investment bankers and government. Large corporations
often had to access capital markets by selling shares and bonds, a process in which
investment bankers served as intermediaries. These bankers had an interest in corporate
governance to assure the investors who had purchased corporate securities from them
that their investments were sound and secure. They exercised that interest by monitoring
their corporate clients, even going so far as to place bank representatives on corporate
boards. To many Americans, however, such banker influence was suspect, and charges
of banker dominance and a “money trust” caused investment bankers late in this era
to retreat from their monitoring and oversight roles in corporate affairs. That,
of course, served to increase the powers of corporate managers.
Americans’ suspicions about large banks and investment bankers were also directed
at large corporations. The Gilded Age of the late nineteenth century featured the
rise of the Robber Barons, both the business leaders who amassed great power and
wealth in the rise of mass-production and mass-distribution industries, and the
great financiers of Wall Street who collaborated with them. Popular politicos, such
as trustbusting Theodore Roosevelt, adopted ordinary Americans’ concerns about the
concentration of wealth and power, leading to the passage of antitrust laws and
corporate regulation at both the federal and state levels. The purported goal was
to prevent or rein in monopoly, but in some cases the application of antitrust laws
and regulations detracted from corporate efficiency and protected inefficient producers
from more efficient competitors. (American political economy often protects particular
competitors from competition in the name of avoiding monopoly.)
The period from the 1930s to the 1980s began with the Great Depression, which put
the financial and corporate sectors under a cloud, resulting in a host of New Deal
reforms. In finance, the Glass-Steagall Act (1933) separated investment banks and
commercial banks, ramped up federal regulation, and introduced deposit insurance.
A series of securities acts (1933, 1934, and 1940) compelled publicly traded corporations
to disclose more (and more timely) information to their stockholders and the general
public. The acts also provided regulatory oversight of securities trading and investment
Corporations recovered much of the prestige they lost during the Depression through
their contributions to the successful outcome of World War II. The lessons about
the economy learned from World War II varied with the eye of the beholder. To some,
the overwhelming factor in the U.S. contribution to the war effort was our immense
ability to manufacture. That capacity was certainly there: already by the 1920s,
the United States not only led the world in production of the key industrial products,
steel and electricity, but also led in their per-capita production. When the United
States entered the war, President Franklin Roosevelt created the War Production
Board, comprised of industry leaders. Under their command, the country moved with
incredible speed from civilian to military production. Airplanes in enormous numbers
were produced in place of cars. U.S. shipbuilding capacity produced carrier-led
fleets whose eventual scale dwarfed those of America’s enemies.
But there was another influential way of looking at the war’s outcome. This view,
popular in academic and intellectual circles, attributed the favorable outcome to
Allied scientific superiority. Radar played a key role in deflecting the German aerial
assault on Britain following the fall of France and in determining the course of
the war in the Pacific. The atomic bomb ended the war with Japan without the massive
loss of American troops that a ground assault on the Japanese home islands almost
certainly would have entailed.
Yet the wartime radar came from England, and European science underpinned the atomic
bomb. Before the war, American science was not significant on a world scale. Science
in this country, moreover, was not viewed as practical. The great productivity of
the United States had its footing in mass production technologies and mass distribution
capabilities, not in science.
The prestige of science, and the appreciation of its practicality, rose sharply
following the war. Academia and government, especially after Sputnik (1957) and
in the face of the intensifying Cold War, came together on the idea that the United
States should lead the world in science. The National Science Foundation came into
being to fund academic research in science and engineering. Cold War national defense
budgets underwrote the transfer of cutting-edge science and engineering to a cadre
of corporate military contractors. They left the more mundane area of manufacturing
to established firms using older mass production technologies. At the end of his
two terms in office (1953–1961), President Dwight Eisenhower, a military hero of
World War II, would warn the country of a rising “military-industrial complex.”
For two decades after 1945, large American corporations were subject to little international
or domestic competition because of their oligopolistic market structures. Dividend
payouts declined as corporations retained more and more of their profits to fund
much of their investment. Because of New Deal reforms and profit retention, the financial
sector, which earlier had both financed and strongly influenced corporate affairs,
was essentially reduced to advisory and service roles. Stockholders did not mind
lower dividends because prosperous times increased the value of their shares, and
regulation by the Securities and Exchange Commission increased investor confidence
that Wall Street provided a level playing field.
Managers still controlled corporations, and they exercised their power by choosing
directors. Often these included top managers themselves. Outside directors chosen
by management were obviously beholden to management. Stockholders, the putative
owners, had little say. The Berle-Means corporation remained alive and well, enjoying
its heyday in the two decades after World War II. Corporations did so well in this
period because of a strong American economy, a worldwide demand for American products
and know-how, and a lack of competition from abroad. A widespread, though not unanimous,
view was that corporate and country prosperity were closely linked. It was during
this period of prosperity in the 1950s that General Motors CEO Charles Wilson, in
hearings related to his nomination by Eisenhower to be secretary of defense, made
his famous statement that “what was good for our country was good for General Motors
and vice versa.”
In the early postwar decades, the problem of corporate goals seemed under control.
Managers in general did not feather their own nests at the expense of owners and
other stakeholders. J. K. Galbraith, a keen observer of corporate America, explained
that the system worked as well as it did because managerial power was faced by countervailing
powers in the form of big labor and big government. Unions were at their strongest
in these decades, in part because of New Deal labor reforms, and they pushed for
higher wages as well as health care and retirement benefits from corporate employers.
As for big government, federal regulatory and antitrust laws put in place from the
1880s through the 1930s remained on the books, and postwar Congresses and administrations
added a host of new laws.
The interests of managers, stockholders, workers, consumers, and society seemed
well aligned. And they needed to be. Aside from purely economic issues, the United
States and the Soviet Union were fighting a Cold War that was in significant part
a war of ideas. Communism as practiced and advocated by the U.S.S.R. asserted that
it would deliver the workers of the world from the slavery of capitalism and raise
their standard of living. Soviet ideology dominated states of Eastern Europe, engulfed
China and Cuba, and supported strong Communist parties in many parts of the world,
including important West European countries such as France and Italy.
Fortunately, the widely shared growth and prosperity in the United States supported
the idea that capitalism could be both effective and benign. Even the Soviet leader
Nikita Khrushchev, in a widely quoted remark on a visit to the United States, admitted
grudgingly that “the slaves of capitalism live well.”
For several decades, corporate leaders recognized the claims of various stakeholders.
As late as 1981, the Business Roundtable issued a statement recognizing the stewardship
obligations of corporations to society:
Corporations have a responsibility, first of all, to make available to the public
quality goods and services at fair prices, thereby earning a profit that attracts
investment to continue and enhance the enterprise, provide jobs, and build the economy.
[. . .]
That economic responsibility is by no means incompatible with other corporate responsibilities
[. . .]
The issue is one of defining, and achieving, responsible corporate management which
fully integrates into the entire corporate planning, management, and decision-making
process consideration of the impacts of all operating and policy decisions on each
of the corporation’s constituents. Responsibility to all these constituents in toto
constitutes responsibility to society. . . . Business and society have a symbiotic
relationship: The long-term viability of the corporation depends upon its responsibility
to the society of which it is a part. And the well-being of society depends upon
profitable and responsible business enterprises.3
Corporations thus for some decades after World War II were willing to accept a mix
of goals; they aimed for good products, satisfied customers, a good effect on the
community and nation, and a steady return to the shareholders. But that was about
The economies of the rest of the non-Communist world began to revive. Foreign competition
for the American market mattered more than ever because of the tremendous evolution
of seaborne commerce in the form of container ships. Goods of every size made in
one country could be shipped around the world to another nation at greatly reduced
cost. Later, airborne freight also entered the picture for goods of more value per
pound. The de facto protectionism provided by the oceans was being repealed by the
march of transport technology.
Japan in particular, by providing government support and direction, emphasized manufacturing
for export. It developed and adopted new and better manufacturing techniques, forging
rapidly ahead in key industries ranging from automobiles, once the U.S. stronghold,
to consumer electronics and, later, computer memories. American industry, used to
easy success in an environment with limited competition, was slow to respond. Rising
inflation and energy-price shocks further eroded American competitiveness. The U.S.
dollar lost value compared to other leading currencies. The stock market languished.
The easy years were over, and the 1970s saw a major slowdown in what had been steadily
rising U.S. productivity, economic growth, and prosperity. Corporate America was
The period from the 1980s to the present has been marked by a major shift away from
a broad view of stakeholder interests to an almost exclusive focus on shareholder
value. Galbraith’s countervailing powers had in fact begun to break down by the
1970s. Declining union membership gradually reduced the influence of big labor on
corporate managers. Corporations hastened the trend by closing factories in the
old manufacturing belt of the Northeast and Midwest, where unions were strong, shifting
production to Sun Belt states that had long antiunion traditions. The old manufacturing
areas became known as the Rust Belt.
Countervailing power weakened further as academics and others began to attack government
antitrust and regulatory policies as misguided. They called for deregulation and
increasingly placed government itself under scrutiny. Instead of working in the
public interest, many argued, government practiced interest-group politics. Bureaucrats
had their own interests – larger budgets, more authority, more employees – which had
little to do with the public interest. Ronald Reagan, the popular president from
1981 to 1989, epitomized this new view when he famously said government wasn’t the
solution, it was the problem.
Academics came to the rescue of corporations, or so it seemed, with new theories
of what corporate managers should do. Instead of catering to the interests of various
stakeholders, as they had done in the good old days of the postwar era, managers
would best serve owners and society in general, the academics argued, by singlemindedly
working to maximize shareholder value. The stakeholder view was complicated; actions
that are in the interests of some stakeholders may be counter to the interests of
others. Higher wages may mean lower profits, and lower wages may mean higher profits.
In contrast, shareholder value was determined daily in the stock market, which the
efficient-markets hypothesis showed to be good for measuring that value. The stock
market, academics further argued, would identify good corporate managers – those
who increased share prices – and would expose bad ones: those who didn’t. Managers
who failed to maximize shareholder value would be disciplined and even jettisoned
by the market for corporate control, which featured hostile takeovers and leveraged
buyouts financed by a rejuvenated and innovative financial sector. Society supposedly
benefited because the corporate goal was now to make the total value of the enterprise,
as measured by what it would take to buy it on the open market, as large as possible.
This academic doctrine fell on receptive ears. From a shareholder perspective, it
put their interests in the driver’s seat; the success of the company was to be measured
by their return. From the point of view of corporate management, it was a mixed
blessing. After all, corporate leadership was used to a great deal of independence,
they took pride in having good products and being respected members of the community,
and they dealt with their fellow workers and managers every day. Shareholders, in
contrast, were a distant and uninformed mass to be dealt with by dividends. But
in a world of profit maximization, profits could be measured every day and had to
be reported every quarter.
This gap in the natural orientation of shareholders and corporate managers was well
recognized in academia: it was simply the old principal-agent problem. And, the
academics argued, it was not that hard a problem to solve. The solution was to give
corporate leadership major stock options. When the stock went up, management benefited
hugely. This approach aligned the interests of managers with those of the shareholders.
The stock-options solution cost the company and its shareholders nothing if the
stock did not go up, so it was possible to vote the corporate leadership amounts
of options that overcame any hesitancy. In fact, CEO compensation soared to previously
unheard-of heights. And under many circumstances, a CEO did not have to be exceptional
to profit from stock options. In the rising stock market of the 1980s and 1990s,
compensations for all CEOs rose together. Certain practices in corporate governance
helped generate this result. CEOs sometimes served simultaneously as chairmen
of their boards. They invited other CEOs to serve on their boards and possibly chair
the compensation committee, a favor that often was returned. CEOs and boards hired
compensation consultants that, perhaps unsurprisingly, seldom if ever recommended
reducing CEO compensation.
Criticisms of CEO compensation usually elicited a response such as, “He created
$2 billion of increased value, why shouldn’t he get $100 million of it?” This attitude
implied that the efforts of an entire company, with tens of thousands of employees,
were the result of a single CEO or top-management team. John F. Welch, CEO
of General Electric from 1981 to 2001, is a prominent example. In the 1980s, Welch
was dubbed “Neutron Jack” for reducing GE employment by more than one hundred thousand
(of about four hundred thousand) and for firing each year the bottom 10 percent of
his managers. Welch also led the old manufacturing company into financial services,
which came to account for a large proportion of GE’s profits. Shareholder value
and profits soared under Welch, whose stock options made him a very wealthy man.
In 1999, Fortune magazine named him Manager of the Century. But Welch’s initiatives
would lead to problems for GE and his successor after he retired.
The principal-agent problem often did seem to be solved by the stock-option form
of remuneration. Employees, however, were not discussed in the stock-option solution
to the principal-agent problem, although they were affected by it. Wages, executive
compensation, and profits all come out of the total “value added” by a corporation.
With the extensive use of stock options, executive compensation and profit, which
is reflected in stock price, are linked together. Both improve if wages can be held
down. Thus, holding down wages became in the interest of both management and shareholders.
The path that the division of corporate value added has taken since 1980 is reflected
in data on productivity, pay, and income shares. From 1947 to 1979, productivity
rose 119 percent, average compensation of production and non-supervisory workers
(who constitute more than four-fifths of the private-sector labor force) grew 100
percent, and the share of national income received by the top 1 percent of earners
(which would include most of top corporate management) ranged from 9 to 13 percent.
From 1979 to 2009, in contrast, productivity rose 80 percent, worker compensation
rose 8 percent, and the top 1 percent of earners increased their share of national
income to more than 23 percent.4 The changes in compensation trends and top-income
shares that began in the 1980s are striking.
Equally striking is the change in tone that top corporate executives take with regard
to corporate responsibilities. In 1981, as earlier noted, the Business Roundtable
emphasized stakeholders. But by 1997, the same organization of prominent senior
[T]he principal objective of a business enterprise is to generate economic returns
to its owners. . . . [I]f the CEO and the directors are not focused on shareholder
value, it may be less likely the corporation will realize that value.5
Stock options indeed had apparently aligned the interests of management with those
Does the emphasis on maximizing shareholder value invariably lead to higher stock
prices? The evidence is mixed. Stock price indexes did trend upward from late 1982
to early 2000. But at the end of 2011 they had barely changed from the levels reached
in 2000. And even if the emphasis on stock price results in higher stock prices,
who benefits? Is maximizing shareholder value good for the country as a whole? To
answer that question, one must ask who owns the stock. If, for example, stock ownership
were spread evenly across the U.S. population, rising stock values would have a
widely beneficial effect. On the other hand, if one person were to own all stock,
it is doubtful that it would be in the national interest to have all corporations
and their employees working to make that one person even wealthier, especially if
they had to hold down wages to do it.
The actual situation is in between, but it is close enough to the second case to
be worth mentioning. The most recent (precrisis) data show that the wealthiest 1
percent of Americans own roughly one-third of the value of all shares, that the
wealthiest 5 percent hold more than two-thirds of the value of all shares, with
the other third spread over the remaining 95 percent.6 Ownership of U.S. corporations
is highly concentrated.
The preceding section traced the grand outlines of what has been happening in the
U.S. economy in recent decades. But other changes are transpiring underneath this
picture. One major change is the rise of the Asian economies, especially that of
China has experienced rapid economic growth since the late 1970s, when leaders of
the one-party Communist state turned their economy in a capitalist direction. China’s
rapid industrialization and export orientation have had a major negative impact,
via imports of Chinese goods, on U.S. productive capability, especially in the area
of manufacturing. One result is an enormous imbalance of trade, as imports from
China are not balanced by a roughly equivalent counterflow of exports from the United
States. Instead, China accumulates huge dollar balances and then lends them back
to the United States by purchasing U.S. debt securities. The trade imbalance has
led to a large increase in the availability of cheaper consumer goods. Wal-Mart,
among other retailers, is a great outlet for these Chinese goods. While this has
benefited American consumers, it has come at a high cost to parts of the American
China’s approach to trade is best described as traditional mercantilism, a pattern
of government policies aimed at advancing a nation’s industries in world trade.
China’s actions, which include mispriced currency, subsidies, and the rapid appropriation
of foreign know-how, allow many Chinese industries to compete on the world scene
with prices and capabilities that would otherwise have required decades to attain.
The effect on many American industries has been devastating. Business scholars Gary
Pisano and Willy Shih have enumerated the long list of high-tech goods no longer
made in the United States.7
Meanwhile, U.S. global corporations, in their normal pursuit of profits, are strongly
aiding the industrialization of China. They are also to a large extent using China
as a manufacturing base to supply the U.S. market. Either alone or in joint enterprises
with Chinese corporations, U.S. corporations are building plants in China that enhance
both that country’s productive abilities and its technical know-how. The goods imported
from these enterprises contribute largely to the enormous imbalance of trade. The
result is $2–3 trillion at the disposal of the Chinese government for the purchase
of more U.S. Treasury securities – or, as seems more likely in the future, for the
acquisition of American companies and their technologies. In addition, U.S. corporations
are increasingly locating their R&D in China, providing a further and direct way
for China to acquire American technologies.
Competition from China has highlighted two general attitudes toward U.S. manufacturing.
Some lament the destruction of American manufacturing, which is traditionally high
wage, R&D intensive, and the greater part of U.S. exports in international trade.
They ask where our manufactured goods will come from if we do not make them and
do not have anything on the same scale to trade for manufactured imports.
Others believe in a “new economy” in which manufacturing is off-shored. America
creates the design; those with developed manufacturing skills and perhaps lower
wages build what we design. America specializes in R&D and innovation; the duller
and older things that have become commodities are made abroad. This view is intrinsically
appealing. It is pleasant to imagine that inventive Americans will design new products
and leave the grunt work of making them to other nations. Although this view is
popular in some academic and financial circles, its quantitative underpinnings are
weak. R&D is simply too small a part of industrial activity across the board to
replace the loss of manufacturing.8
What does theory have to tell us about the overall impact of these developments?
Many economic observers believe that when you lose manufacturing, for example, it
is because your comparative advantage is somewhere else; that it is more beneficial
to let market forces move you in the direction of your comparative advantage; and
that it is a mistake in these circumstances to try to hold on to what you once had.
These views, however, follow most standard economic models in assuming that countries
have fixed capabilities. With capabilities fixed, the action of market forces will
indeed respond in the way described, and thus the free-market, free-trade result
is beneficial. But what are the effects on the home country when a trading partner
changes its capabilities? To be specific, what is the effect on the United States
when China does not hold its capabilities fixed, but instead substantially improves
Economic theory does not assert that when a trading partner improves its capabilities,
and then market forces act on these new capabilities, the new free-trade result
is better for the home country than the situation that existed before the change.
In fact, it can be harmful.9 According to standard models, a trading partner’s initial
development is good, but as that partner moves from less developed to more developed,
further development can become harmful. The result is a decrease in the home country’s
GDP.10 This theoretical result takes into account all the effects;
it includes the consumer benefits of cheaper goods from the newly developed partner
(China) as well as the negative impact of losing productive industries in the home
country (the United States).
Hence, the simple assertion that free trade is beneficial does not enable us to conclude
that China’s development is good for the United States. (And recall that China’s
current approach is more accurately described as mercantilist than as free trade.)
It is more reasonable to say that theory expects China’s development to have a negative
impact at some point. Indeed, that point has likely been reached.
We remarked earlier that U.S. global corporations are strongly aiding China’s rapid
development. We cannot, therefore, ignore the possibility that the interests of
our global corporations and the interests of our country may have diverged.
Nobel laureate Michael Spence looks beyond U.S.-China trade in particular to describe
the overall negative effect of globalization on the U.S. economy. Spence also goes
beyond the overall economic effect to describe the effects on different parts of
American society. He concludes that globalization has led to higher levels of unemployment,
particularly in manufacturing industries that compete with imports, and that it
has widened income disparities within the country.11 Spence’s analysis reminds us
to consider not only how U.S. industries and corporations are faring on the world
stage, but how well they are serving American citizens at home. To begin this discussion,
we must first ask what we as Americans want from our corporations. Only then can
we measure current circumstances against our ideals.
To do this sensibly we need a historical perspective on the corporation. It is important
to remember that from the earliest times until the middle of the nineteenth century,
most of the world’s work was done on small farms or in small shops. This traditional
world was dominated by agriculture and the need to provide food. Large organizations,
with the exception of the army, the navy, and the church, were almost nonexistent.
This was the world in which Adam Smith and David Ricardo lived and which they described
in their influential economic writings.
The industrial revolution of the late 1800s changed this world. Steel mills and
factories sprang up, and people migrated on a large scale to the new production
centers. Economic activity became increasingly the province of large organizations.
Agriculture itself gradually became more mechanized and less people-intense, and
it was organized increasingly in large corporations.
These developments have fundamentally changed our way of life. The goods we consume
today are too complex to be made at home, on a family farm, or in a small shop;
they require large organizations to create them. You cannot manufacture a car in
your garage; it takes a large-scale organization to do it. The food we eat is rarely
produced by a family on a nearby farm, but is instead made by large organizations
on highly mechanized farms with machinery produced by other large organizations,
and then is transported on highly organized networks to huge outlets. The same is
true of services; you cannot organize a telephone network on your own.
The goods and services we consume today are primarily created by organizations,
not individuals. To contribute to the economy today, an individual usually must
be part of an organization. Being part of an organization is what most people must
do in the modern world to earn a living and support themselves and their families.
Therefore, the fundamental social role of business organizations, usually corporations,
is both to produce efficiently the goods and services that are consumed in the modern
world and – equally important – to enable people to participate in that production,
so that they earn a share of the value produced for themselves and their families.
With this background in mind, we suggest that Americans can reasonably expect two
things from our corporations12:
- Productivity: Our corporations should be productive,
each contributing as much as possible to the total of goods and services produced
in the United States. It is the sum of these efforts that makes America prosperous.
- Sharing: Our corporations should provide productive and well-paying jobs so that
the value the companies create is widely shared by Americans. This widely shared
wealth gives the nation and its people economic security and political stability.
These expectations sound very different from the present goal of maximizing profit
and shareholder value. They are closer to the role that corporations played during
the prosperous 1950s and 1960s, when interests other than those of the top executives
and large shareholders were also taken into account.
If these are the goals, how well are U.S. corporations doing? They are doing well
by their own criterion of maximizing profitability and (less certainly) shareholder
value. In fact, major corporations have had record profitability in recent years,
even though the nation has been racked with declining incomes, high unemployment,
and languishing stock prices.
But corporations are not doing very well by the two criteria we list above. With
respect to the first criterion, GDP has increased more slowly in recent
years, and the most productive sectors affected by corporate globalization are no
longer the growth areas of the U.S. economy. Our high-tech and manufacturing areas
have been among the hardest hit. On the first criterion, therefore, we are hard pressed
to award a grade better than C.
On the second criterion, we have seen only small returns to most Americans over
the last thirty years, the period in which the shareholder view overtook the stakeholder
view. Almost all the gains from increased productivity, as noted earlier, have gone
to the top economic tier. The resulting concentration of wealth and its attendant
political power threatens the nature of our democracy. Three decades of this realignment
merits a low grade, charitably a D.
Currently, the dominant motivation of the American corporation is to maximize profits
and raise stock price in the interest of shareholders. While this is often regarded
as a legal requirement, it is not. Corporate directors owe their fiduciary duties
not to the shareholders, as is often thought, but to the corporation.13 Indeed,
it would be surprising if the law prescribed shareholder value as the only goal
given that the Business Roundtable, as early as its 1981 statement quoted above,
publicly urged the consideration of many other factors.
Despite its lack of legal standing, the sway of “maximizing shareholder value” appears
absolute. In today’s large corporations, shareholders are distant from the company
and their sole attachment is to the shares they hold, although they usually hold
them for only a short time. Corporate results, if the goal is shareholder value,
are easily measured; companies that do not measure up will see a change of CEO
or of the board, or possibly a hostile takeover.
If we assume that this motivation is unchangeable, then the road to better social
outcomes must lie in making these outcomes more profitable for corporations. We begin
by discussing ways to improve the performance of corporations on our first criterion,
which, in homely terms, is about making a bigger total pie (GDP) for
Americans without concern for how it is divided up.
Given the strong negative influence that Asian mercantilist policies have on our
corporations, one measure that must be considered is tariffs. Tariffs
have had a long history in this country. Although economists almost unanimously
resist the imposition of tariffs and almost automatically support free trade, no
economic theory says that persisting in free trade is the best response to mercantilism.
Modern developments in strategic trade theory in fact suggest the opposite. Nor
does the history of tariffs or other restrictive measures provide an unambiguous
guide to their usefulness or harmfulness.
The situation in which tariffs are applied as well as the form of tariff can affect
the outcome. In a 2003 Fortune article, Warren Buffett proposed what he called import
certificates.14 Buffett’s import certificates, while certainly a form of tariff or
quota, are closely connected to what economists refer to as cap and trade.
Cap and trade is familiar to economists through its application to air pollution.
In the case of air pollution, the total of allowable emissions is decided on in
advance and is called the cap. Pollution certificates are then issued, each allowing
a certain amount of pollution, with the total of the certificate amounts equal to
the cap. These certificates are then sold in an open market, and those companies
with pollution most expensive to control end up with the certificates.
Similarly, a cap can be put on imports, and permits to import can be issued and
traded. In order to balance trade, the cap (or total of import certificates issued)
is set equal to, for example, the previous year’s exports. If the U.S. government
issues the certificates, it is a source of revenue. If the certificates are instead
earned by exporters in quantities scaled to their exports, the price obtained by
selling them in an open market becomes an incentive to export. As economies adjust
to the presence of the certificates, the certificate value can be expected to move
If other countries retaliate by imposing tariffs and reducing imports from the United
States, the number of import certificates issued will automatically decrease so their
ability to export their goods to the United States is also reduced. This creates
an incentive not to impose tariffs. Alternatively, if they retaliate by adopting
a similar import certificate system of their own, the result is a world of more balanced
trade, a desirable outcome.
Another quite different but also traditional method employed in the United States
is to use the individual or corporate income tax to bias individuals or corporations
toward desired social goals. In the case of the individual, there are tax advantages
given to promote homeownership, and in the corporate case there has been a reduction
in the corporate income tax based on the company’s growth in R&D spending.
What is suggested here is to use the corporate income tax to provide direct incentives
for companies to have high value-added in the United States. While Asian countries
have provided such incentives, usually by deals with individual companies, an approach
better suited to the United States and to the capabilities of the American government
would be an across-the-board approach: reward all companies for creating high value-added
in the United States, whether they achieve that goal through R&D and advanced technology
or by finding ways to improve production of goods and services.
One form that such an incentive could take would be to lower a corporation’s income
tax in proportion to the value added per U.S. employee. Such a tax could be made
revenue neutral by having a high tax rate for unproductive companies and a low tax
rate (or even a subsidy) for productive companies. Depending on the rates, the incentive
could be strong or weak.
Many forms of this approach can be considered. An approach better suited to an economy
struggling with unemployment would be to reward companies for their total value
added in the United States rather than productivity or value added per employee.
With such an incentive in place, a company moving work overseas would suffer a tax
There are many variants of these general approaches that can be considered. We are
not alone in thinking that it is a direction worth considering. As Jeffrey Immelt,
CEO of General Electric, stated in 2007: “If the U.S. government wants
to fix the trade deficit, it’s got to be pushed; GE wants to be an exporter.
We want to be a good citizen. Do we want to make a lot of money? Sure we do. But
I think at the end of the day we’ve got to have a tax system or a set of incentives
that promote what the government wants to do.”15
Next we need to consider the second goal, which bears on who gets how much of the
bigger pie. The focus on shareholder value as the only corporate goal is a recent
development. While it has the advantage of simplicity and measurability, it also
pits wage-earners directly against those whose interest is mainly in share price:
that is, the shareholders and top executives. There is no concept of sharing or
distributing the fruits of greater productivity. Perhaps we should consider other
forms of organization. The following suggestions are intended to provoke thought,
not provide a solution. But we do think that such thought is needed.
Other forms of organization – namely, mutual corporations and cooperatives – have a
significant history in the United States. In the insurance industry, the mutual form
serves more than 135 million auto, home, and business policyholders; it accounts
for 50 percent of the automobile/ homeowners market and 31 percent of the business
insurance market. Cooperatives are more common in Europe, but in the United States
they have had a significant presence in agriculture, farm credit, federal home loan
banks, rural electric service, mutual insurance, and credit unions. There is also
a recent movement advocating so-called B corporations, which are required to create
a benefit for society as well as for shareholders.16 These corporations represent
a return to the earliest concept of the corporation in U.S. history, which was to
achieve a specific public purpose stated in the charter of incorporation.
Perhaps most interesting, however, is the possible evolution of the corporate form
itself. As we remarked above, early corporations in the United States were legislatively
chartered, with charters especially made for each corporation. Charters laid out
the corporate responsibilities and basic governance procedures; often the charter
was for a limited time, not perpetual. Such charters, whether given by states or
by the federal government, could be a way of creating corporations that do better
on the second of the two corporate goals we laid out, providing American workers
with well-paid jobs.
One form of such a corporation could be a corporation that is pledged to be value-added
maximizing rather than profit maximizing. Maximizing value added is measurable, just
as maximizing profit is. Furthermore, as it is the sum of value added by individuals
and organizations in a country that adds up to GDP, maximizing value
added makes the total economic pie as large as possible, without specifying what
share of the value added is to be wages and what is profit. This is the essence of
our first goal. If management’s compensation is tied to value added rather than profit,
all parties – wage-earners, shareholders, and management – can gain from greater value
added, and this is an incentive for them to work together to increase it.
Dividing the value added is where there is conflict, which the present profit-maximizing
arrangement settles entirely in favor of those who are compensated by profit. This
approach leaves out the wage-earners. We have seen the consequences of that division
over the past thirty years.
In a world of companies devoted to maximizing value added, there could be many ways
to divide the portion of the value added that is available for wages and profits.
Some companies will give as much as they can to profits, making them indistinguishable
from today’s profit maximizers. They may find it easier to raise money in the stock
market. Some companies may choose to give more in wages, and they may find it easier
to hire and keep good people. Some may choose to excel in being environmentally
Were such a change in the purpose of the corporation to be adopted we
might become a nation with a great variety of companies, all in their different
ways adding to the GDP and many adding to a better distribution of income, wealth,
and, in turn, political power.
Adolf Berle and Gardiner Means, in the last chapter of The Modern Corporation and
Private Property, expressed doubts about two views of the corporation.
One was the view that the corporation belonged to its shareholders and ought to
be for their sole benefit. They questioned this view because passive shareholders
had ceased to have power over, or any responsibility for, the management of corporations.
The other view was that the management that controlled a corporation, possessing
powers obtained on a quasi-contractual basis, “can operate it in their own interests,
and can divert a portion of the asset fund or income stream to their own uses.”
If these were the only two choices, Berle and Means said, “the former would appear
to be the lesser of two evils.”
But there was a third choice. Since passive shareholders had surrendered control
of, and responsibility for, corporate management, and since managements had made
no case that corporations should be operated in the interest of managers:
They have placed the community in a position to demand that the modern corporation
serve not alone the owners or the control but all society. . . . [I]f the corporate
system is to survive . . . the “control” of the great corporations should develop
into a purely neutral technocracy, balancing a variety of claims by various groups
in the community and assigning to each a portion of the income stream on the basis
of public policy rather than private cupidity.17
American corporations from the 1930s to the 1980s appeared to follow Berle and Means’s
third choice, or what might be called the stakeholder view of the corporation. That
changed when stock options came in to align the interests of shareholders and top
managers, seemingly solving the conflict of shareholder and managerial interests
that Berle and Means had exposed. With shareholders and management aligned, however,
other interests took a back seat. Perhaps it is time to consider a different problem:
how do we align the actions of corporations with the broader interests of the country?18
This is the problem we have been addressing in the last part of this essay.
The great American corporations today are doing well for their top managers and
shareholders, but this does not mean that they are doing well for the country as
a whole. The growing concentration of income and wealth threatens both the long-range
productivity of the country, through extensive off-shoring, and its long-range internal
stability, through a growing concentration of wealth that carries with it political
as well as economic dominance. These issues and what to do about them deserve more
thought from the economics profession and, indeed, from all Americans.
RICHARD SYLLA, a Fellow of the American
Academy since 2012, is the Henry Kaufman Professor of the History of Financial Institutions
and Markets and Professor of Economics at the New York University Stern School of
Business. He is chairman of the board of the Museum of American Finance. His publications
include Founding Choices: American Economic Policy in the 1790s (edited with Douglas
A. Irwin, 2011), A History of Interest Rates (with Sidney Homer; 4th ed., 2005),
and The State, the Financial System, and Economic Modernization (edited with Richard
Tilly and Gabriel Tortella, 1999).