IN 2000 two American law professors, Henry Hansmann of Yale University and Reinier Kraakman of Harva...

1. Schumpeter: The business of business
IN 2000 two American law professors, Henry Hansmann of Yale University and Reinier Kraakman of
Harvard, pronounced that the most hotly-contested debate in corporate law had been resolved. For
decades conservatives and progressives had argued over whether the purpose of a company is to
maximise shareholder value or pursue broader social ends. Now, the conservatives had won. Anglo-
Saxon capitalism was sweeping all before it. And the world's legal systems were converging on the
shareholder-value model. The duo could hardly have been more unlucky in their timing. Not long
after their article was published, several companies that proudly practised shareholder-value
maximisation went up in flames: Enron, Arthur Andersen and WorldCom, among others. Six years
later the collapse of Lehman Brothers triggered a global crisis. Jack Welch, GE's former boss and a
poster boy of the conservative school, said pursuing shareholder value as a strategy was "the
dumbest idea ever".
Defenders of the model might retort that a few bad apples don't spoil the bunch. These have now
been dealt with and the laws strengthened. But the shareholder-value model has conceptual as well
as practical problems. Its proponents argue that companies are owned by shareholders, when in fact
they are "legal persons" that own themselves. Shareholders just own shares--that is, bundles of
entitlements such as the right to receive dividends and to vote on certain issues. Corporate
personhood gives shareholders the benefit of limited liability: creditors can only enforce their claims
against the firm's assets rather than against the shareholder's assets. It also gives companies the
benefit of capital "lock-in", so they can pursue long-term projects: if shareholders want their money
back they have to sell their shares.
Shareholder-value arguments are often used
to press a company to do something that
would create a short-term profit for
shareholders, such as accepting a takeover
bid. However, in America most legal
jurisdictions have some version of the
"business judgment rule" which gives
directors discretion to act in the long-term
interests of the company even if this means
sacrificing short-term gains. In practice, of
course, shareholders are often not a
homogeneous block with a collective
interest: traders who buy on the whiff of a
bid may have a different perspective from
investors who have held the shares for
decades.

2. With conservatives on the defensive, progressives are now pressing their advantage. In a new book,
"How Good We Can Be", Will Hutton, a British newspaper columnist, calls for a "Companies Act for
the 21st century": firms should be required to declare on incorporation their intention "to deliver
particular goods and services that serve a societal or economic need". In a recent lecture to the
British Academy, Colin Mayer, a management professor at Oxford University, called for companies
to be required to "articulate their purposes". Directors should be held to account for the delivery of
these stated purposes. Controlling ownership should be in the hands of people who can ensure that
directors discharge their responsibilities. Mr Mayer says a striking number of what he sees as the
world's best firms, such as Bosch, Carlsberg, Bertelsmann and Tata, are owned by foundations that
are pledged to pursue the public good. Darrell West of the Brookings Institution in Washington, DC,
notes the decline of the idea that companies are creatures of the state, given the privilege of
incorporation in return for pursuing a broad public purpose.
This all sounds very enlightened. But who will decide whether new companies are likely to serve the
public good? Will a committee of the great and the good interrogate young app designers about the
social benefits of their inventions? Will foreign competitors who are not required to pass a public-
interest test be barred from the market? Or domestic entrepreneurs who choose to incorporate
abroad?

3. Nor are foundations the paragons that Sir Colin imagines: they are frequently created to reduce
corporate tax burdens and invariably hand power to a select group of insiders. Carlsberg is
struggling, after going heavily into the Russian market, and recently replaced its CEO. Bertelsmann
remains highly dependent on its German television stations despite repeated attempts to join the
digital revolution. Tata has lots of underperforming businesses as well as some excellent ones. As for
Mr West and the supposed virtues of companies as creatures of the state, the one-word response to
that is: Petrobras.
...is business
The secret of the modern company's success is precisely that it is such an open-ended organisation.
Until the 19th century companies had to pursue a public purpose (imperial domination, usually) in
return for limited liability. But various governments, starting in Britain and America, swept away
these restrictions and let companies form for no other purpose than to engage in business. This
simple act of liberalisation did as much as anything to create the modern economy. Open-endedness
lets companies evolve: startups have very different purposes to mature businesses.
Open-endedness reflects the realities of corporate life: far from being slaves to the share price, as
progressives imagine, most companies are engaged in a constant process of negotiation between
managers and investors over their strategy and time horizons. Mature companies such as Shell, Intel
and Nestlé often invest for the long term without a squeak from fund managers. New-economy
companies such as Google, Facebook and, particularly, Amazon have had no difficulty in persuading
investors to sacrifice short-term returns (and indeed any control whatsoever) in return for long-term
rewards.
That businesses do not have to declare a lofty purpose so as to enjoy the privilege of incorporation is
not a bug but a feature. Indeed, it is the defining feature of the modern corporation. Change it and
you wreck the entire machine.
http://www.economist.com/news/business/21646742-old-debate-about-what-companies-are-has-been-
revived-business-business