Shareholder Wealth Maximization: A Response to Cynthia Williams

Prof. Cynthia Williams raises some of the standard arguments against the shareholder wealth maximization norm. Most of her arguments are addressed in my original essay,[1] and restating what is written there would not add to the conversation. On other points, which can be boiled down to problems with short-termism in its myriad manifestations, we obviously agree (whether we like it or not, though I happen to find satisfaction in finding common ground). Reiterating these would likewise not be productive.[2] A few of Prof. Williams’ thoughts, however, deserve further elaboration.

She observes that Ford Motor Company, in its actions surrounding the Dodge v. Ford[3] case, pursued the long-term strategy of “paying employees well so they could buy more cars.” Ford certainly wanted to keep employees happy, but not merely so that they could buy more cars, but so that they would produce more cars. When Henry Ford doubled wages from $2.50 to $5.00 per day, he was in the process of attempting to perfect the assembly line. His company was experiencing high absenteeism and very high turnover, both of which were calamitous to assembly-line production. After wages were doubled, there was a long waiting list for Ford jobs, turnover dropped to less than one twentieth of its pre-increase level, from 370 percent to 16 percent, and productivity increased by 50 percent. Said Henry Ford: “I have a thousand men who if I say ‘Be at the northeast corner of the building at four a.m.’ will be there at four a.m.”[4] Thus, although doubled wages and assembly lines meant that employees could buy more cars at a lower price, it was long-term profit that motivated Ford’s wage decisions.

Prof. Williams also mentions with dismay that in eBay v. Newmark[5] the court did not allow two of Craigslist’s original owners to run the company for a purpose other than the maximization of shareholder wealth despite their belief that “craigslist should not be about the business of stockholder wealth maximization.”[6] I share Prof. Williams’ consternation. I believe (as my essay argues) that the two founders should have been afforded the freedom to form Craigslist for whatever purpose they desired. The eBay court also noted that the two founders could have run the company any way they wanted had they been the only shareholders.[7] Had the law allowed Craigslist’s founders to establish a firm that pursued any lawful purpose, and had they included their nonprofit purpose in the company’s certificate of incorporation (or, perhaps, provided other suitable notice to future shareholders [8]), their ability to eschew shareholder wealth maximization would have been secure.

Finally, Prof. Williams expresses concern that the fruits of economic output should be fairly shared so as to fuel the consumption that drives the U.S. economy. Although I agree, I believe that it is unfair to say that a long-term-shareholder-wealth-maximization purpose cannot accomplish this goal. Even Prof. Williams implicitly acknowledges that Henry Ford’s profit-driven doubling of his workers’ wages was good for the workers because it allowed them to buy more cars (or whatever else they wanted). Further, the value created by public companies—with respect to which the concerns relating to the wealth-maximization norm are most acute—is already being shared by nearly every income level, including the laboring class: pension funds have demonstrated their ability and willingness to share in corporate profits and influence firm behavior through their massive stock holdings.[9] Public companies are, by definition, open for investment by everyone.[10]

Ultimately, it appears that the point on which Prof. Williams and I truly disagree is whether a corporation’s founders should have the option to create a firm for the sole purpose of maximizing their wealth, in the long term and within the bounds of the law. Ignoring liberty concerns,[11] one’s answer to this question should depend on whether one believes that disallowing wealth maximization as a corporate purpose would lead to decreased economic investment, causing a decrease in the size of the nation’s economic pie. For my part, I believe that it would. We decrease the size of the pie at our peril.[12]

[1] For example, she argues that Dodge v. Ford, 170 N.W. 668 (Mich. 1919) is misunderstood as requiring shareholder wealth maximization, and that cases like Air Prods. & Chems. v. Airgas, 16 A.3d 48 (Del. Ch. 2011), Paramount Communications v. Time, 571 A.2d 1140 (Del. 1989), and, presumably, other Delaware Supreme Court cases like Paramount Communications v. QVC Network, 637 A.2d 34 (Del. 1993) and Unocal v. Mesa Petroleum, 493 A.2d 946 (Del. 1985), allow corporate boards not to strive to maximize long-term shareholder wealth.

[2]Compare, e.g., George A. Mocsary, The Future of Shareholder Wealth Maximization, Libr. L. & Liberty, Liberty Forum ¶ 14-15 (Dec. 2, 2013), http://www.libertylawsite.org/liberty-forum/the-future-of-shareholder-wealth-maximization/ (discussing the benefits to all constituencies of managing forms for the long- rather than today’s stock price) with Cynthia Williams, The Future of Shareholder Wealth Maximization:A Response to George Mocsary, Libr. L. & Liberty, Liberty Forum ¶ 11-12 (Dec. 23, 2013), http://www.libertylawsite.org/liberty-forum/the-future-of-shareholder-wealth-maximization-a-response-to-george-mocsary/ (same).

Prof. Williams implies that implementing long-termism is difficult because few shareholders have long-term interests in companies. Id. ¶¶ 9-10. To the extent that (1) loose distribution requirements that allow easy extraction of money from firms, and (2) owners of large blocks of shares can influence firm behavior to their short-term benefit, I agree. Recall, however, that each seller of shares must find a buyer for the shares being sold. Neither the seller nor buyer may withdraw the original investment associated with the transferred shares on a whim, and all withdrawals must be on a pro-rata basis with other shareholders. Further, I disagree that a symptom of long-termism is the fact that “most funding of corporate enterprise comes from retained earnings.” Id. ¶ 10. As well it should. Only a healthy corporation, whose operations are value producing, is able to support itself via earnings. A firm that requires continual capital investment is one that is unable to generate earnings and is, consequently, value destroying. Investors do not put their money into a firm so that they can keep putting more money into it. Indeed, it is all but axiomatic that only a self-supporting corporation can hope for a long-term existence.

[3] 170 N.W. 668.

[4]See Gary J. Miller, Managerial Dilemmas: The Political Economy of Hierarchy 65-71 (1992).

[5] 16 A.3d 1 (Del. Ch. 2010).

[6]Id. at 34.

[7] Viewed differently, this is an admonition by the court that the two founders should have ensured either that their third cofounder shared their views or that they should have protected themselves from unwanted sales by the third founder by contract.

[8] Although the eBay court does not address the matter, its opinion recounts a number of facts, most or all of which would ordinarily have come to light after the completion of basic due diligence, that should have put eBay on notice that Craigslist was not a profit-oriented company. eBay, 16 A.3d at 8-9. As Prof. Williams’ apt quote suggests, the court apparently did not feel the need to explore the notice question. Id. at 34; Williams, supra note 2, ¶6. This is understandable, but unfortunate, in an environment where the corporate purpose must be the maximization of shareholder wealth.

[9]See, e.g., Simon Archer, Pension funds as owners and as financial intermediaries: a review of recent Canadian experience, in The Embedded Firm: Corporate Governance, Labor, and Finance Capitalism 177, 177-204 (Cynthia A. Williams & Peer Zumbansen eds. 2011); Sanford M. Jacoby, Labor and finance in the United States, in Williams & Zumbansen, supra, at 277, 304-09; Keith L. Johnson & Frank Jan De Graaf, Modernizing pension fund legal standards for the twenty-first century (quoting Chairman Alan Greenspan), in Williams & Zumbansen, supra, 459, 459-66.

[10]Cf. Vera C. Smith, The Rationale of Central Banking and the Free Banking Alternative 89 (1936) (Liberty Press 1990) (Stating, referring to banking firms, that “before the advent of the joint stock company the firms had always consisted of a large number of known and wealthy men.”)

[11] Of course, making policy decisions without considering their effects on individual freedom is itself a bad idea.

[12] Maximizing economic production is especially important in a world experiencing “the pressures of population growth,” Williams, supra note 2, ¶12—at the most basic level, people must eat. Greater value creation is therefore essential. Although economic inequality does raise concerns, it is more important to encourage an economic system wherein everyone’s wealth (and corresponding standard of living) increases rather than one that limits the relative increases of participants (at the cost of reducing everyone’s standard of living) for the sake of more equality. Stated differently, those at the bottom of the economic ladder care more about (1) climbing the ladder than about making the ladder shorter, and (2) the height of their bottom rung than the height of someone else’s top rung.