For Shareholder Wealth Maximization, Against Corporate Purpose

In “The Future of Shareholder Wealth Maximization,” George Mocsary undertakes two important tasks. The first is to establish that, notwithstanding claims to the contrary advanced by some corporate law scholars,[1] the shareholder wealth maximization norm is and remains a bedrock principle of corporate law. The second is to establish that, on broadly libertarian grounds, the for-profit corporation having as its purpose the maximization of shareholder returns is among the permissible vehicles by which people may pursue their ends in a libertarian social order.

Though a philosopher by training and a business ethicist by vocation, to the extent I understand corporate law, Mocsary’s account of the shareholder wealth maximization norm in it appears sound. He exposes a number of misapprehensions that, though embraced by a minority of corporate law scholars, are mainstream and even majority positions within the academic business ethics field. In distinguishing the shareholder wealth maximization norm as a standard of conduct from the business judgment rule as a standard of review, for example, Mocsary’s analysis reveals a conflation of the two lying at the heart of at least one frequently-cited contribution to the corporate governance debate in the business ethics literature. [2] My colleagues in business ethics would do well to read Mocsary as he exposes these common misapprehensions.

Mocsary thereafter turns from the role of the shareholder wealth maximization norm in corporate law to addressing the notion of (libertarian) corporate purpose. Here, however, I believe another conflation is at work. The conflation is due less to the peculiarities of Mocsary’s essay than to unresolved tensions between the evolved corporate law and the evolving theory of the firm. Shareholder wealth maximization, as a duty owed by corporate managers to shareholders, is conflated with the idea that there exists an overarching corporate purpose, to maximize shareholder wealth. My aim in what follows is not to argue that the firm has some other purpose instead of shareholder wealth maximization, but that it has no purpose. What is more, this is a conclusion that should be welcome both to adherents of the nexus of contracts theory of the firm and to classical liberals.

The Firm as a Nexus of Contracts

Informing our understanding of the firm at least since Jensen and Meckling [3] is the idea that the firm is (or is illuminatingly understood as) a nexus of contracts. On the nexus of contracts theory of the firm, the firm is a kind of Lockean substratum. [4] Just as, for Locke, the substratum supports or holds together the qualities of objects (e.g., the sweetness, acidity, texture, weight, etc., of an orange), for nexus-of-contracts theorists the firm supports or holds together all of the contracts that compose it. According to the nexus of contracts theory, people make agreements with other people; the firm is a Schelling point around which these agreements are made.

The nexus of contracts theory has both descriptive and normative aspects. Descriptively, the nexus of contracts theory highlights salient features of firms that help to understand both why they exist (an account having its roots in Coase [5]) and why they face the problems they do (e.g., agency theory). Normatively, the nexus contracts theory implies that because the firm is the sum of the agreements composing it, everyone ought to get out of their agreements what they were promised in their agreements.

In its normative aspect, the nexus of contracts theory implies that no agreement is antecedently more important than any other agreement. To the extent that the firm can be said to have a “purpose,” it would seem to be to make good on the contracts composing it. Shareholders bear a peculiar relationship to the firm not because they (or the value of their investments) are special but because what they have contracted for is special. As Jonathan Macey notes:

What distinguishes shareholders is that they are the only claimants to the cash flows of the firm whose only economic interests in the firm are residual. [6]

By virtue of that fact, shareholders contract for the only thing that makes sensible holding a solely residual claim on the firm—fiduciary care from managers. Although this is a strange contractual arrangement, especially when taken against the contractual arrangements made by other constituencies of the firm, it is hard to see within the nexus of contracts theory how this contract invests the firm with a purpose any more than, say, a supply contract does.

A Brief Detour Through Oakeshott: From Enterprise Association to Civil Association

The 20th Century political philosopher Michael Oakeshott [7] makes a celebrated distinction between two forms of human association that, as models of political order, he sees competing within European political thought. These he calls enterprise association and civil association.

For Oakeshott, an enterprise association is one in which its participants are united by a common aim or goal. The satisfaction of that aim or reaching that goal is the enterprise in which the participants are associated. A military force is an archetypal example of an enterprise association. Its members are associated in the common enterprise of vanquishing the opposing forces.

In a civil association, by contrast, participants are not associated by way of a common aim or goal, but by their commitment to observe certain adverbial rules of conduct as they pursue their diverging and, sometimes, conflicting aims or goals. Thus, the rules of a game – say, chess – would be an example of a civil association. Chess players are united not in their aims, but in their joint observance of chess rules as each seeks to secure victory over the other at the board.

Oakeshott thought civil association the more civilized conception of the role of the state and the one compatible with liberal social order. However, my purpose in adverting to Oakeshott’s distinction is not to weigh in on the relative merits of each kind of human association (or on the role of the state). Instead, I wish to address what kind of association the corporation is.

Is the Corporation an Enterprise or a Civil Association?

If we think of the corporation as a “business enterprise,” then it seems clear that, like a military force, the corporation is an enterprise association. However, recall that under the nexus of contracts theory of the firm, the firm is constituted by its contracts. Writes Macey:

[C]orporations are not only organized around the idea of contract, they are most accurately described as contracts. … [T]he corporation is best conceptualized not as an entity but as a complex web or nexus of contractual relationships. … Once these contractual relationships are unbundled from the corporation, there is nothing left. [8]

If the corporation is a contract (or web or nexus of contracts), this seems to undermine the idea that there can be a corporate purpose. This is so for the simple reason that contracts have no overarching purpose. You have your purpose for entering into a contract with me and I have my purpose for entering into it with you. What unites us in contract is not a common purpose (or enterprise), but our common observance of certain rules of conduct (the contractual terms, the law of contract) as we pursue our different ends in and through the contract. Put differently, contract is a kind of civil association. If corporations, per Macey, are contracts and contracts are civil associations, it follows that corporations are civil associations. As civil associations, they have no corporate purpose.

A Farewell to Corporate Purpose

The argument above may convince you, as an adherent of the nexus of contracts theory of the firm, that corporations have no purpose. Alternatively, the argument may convince you, as an adherent of the view that there exists a corporate purpose, that the nexus of contracts theory of the firm is false. As philosophers like to say, one man’s modus ponens is another man’s modus tollens.[9]

Mocsary observes that there has been a debate reignited at twenty-year intervals over the proper purpose of the corporation. Keeping the debate alive are less the points of disagreement among the contestants than one, major point of agreement: that the corporation has a purpose. Berle and Means [10] launched the spectacle by insisting that the emergence of the corporate form had “split the atom of property” and created a form of economic ordering unlike anything we had ever seen before.

Classical liberals should embrace the conclusion that there is no corporate purpose. For by eliminating the idea that there is a corporate purpose we further – and, perhaps, finally – demystify the corporation. We call shenanigans on those who insist that the corporation is too different, too important, or too powerful to be left to the voluntary interactions of those who organize or contract with it. Just as contractarian moral and political theorists say their theory means “there is no justice, there’s ‘just us’,” so may classically liberal contractarian corporate theorists say of the corporation, “a contract by any other name is just a contract.”

[1] See, e.g., Lynn A. Stout, Why We Should Stop Teaching Dodge v. Ford, 3 Va. L. Bus. Rev. 163 (2008).

[2] Richard Marens & Andrew Wicks, Getting Real:

Stakeholder Theory, Managerial Practice, and the General Irrelevance of Fiduciary Duties Owed to Shareholders, 9 Bus. Ethics Q. 273 (1999). In the article, Marens and Wicks treat the business judgment rule as a standard of conduct.

[3] Michael C. Jensen & William H. Meckling, The Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J. Fin. Econ. 305 (1976).

[4] John Locke, Essay Concerning Human Understanding (1690), Book II, chapter xxiii.

[5] Ronald Coase, The Nature of the Firm, 4 Economica 386 (1937).

[6] Jonathan R. Macey, A Close Read of an Excellent Commentary on Dodge v. Ford, 3 Va. L. Bus. Rev. 177 (2008), 186 (emphasis in the original).

[7] Michael Oakeshott, On Human Conduct (1975).

[8] Jonathan R. Macey, Corporate Governance: Promises Kept, Promises Broken (2008), 20 (emphasis mine).

[9] Modus ponens: If p, then q; p; therefore, q. Modus tollens: If p, then q; not-q; therefore, not-p.

[10] Adolf Berle and Gardiner Means, The Modern Corporation and Private Property (1932).