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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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If money is an instrument of control, then financial markets are a lot more than the institutional matchmakers for saving and investmentGovernance If money is an instrument of control, then financial markets are a lot more than the institutional matchmakers for saving and investment. You can see that clearly by looking at how an owning classs power is asserted over corporations and governments through financial mechanisms. governing corporations [T]he modern corporation may be regarded not simply as one form of social organization but potentially (if not yet actually) as the dominant institution of the modern world. Where its own interests are concerned, it even attempts to dominate the state. Adolph A. Berle and Gardiner C. Means, The Modern Corporation and Private Property was right; the separation of the unitary capitalist into the rentier and manager was an important innovation in the history of capitalism. Surprisingly few economists since have given the matter much thought. Given the vast powers of big business, how firms are run is of great interest to almost everyone. But in American public speech, consideration of the firm and how its run is confined to a fairly narrow circle of specialists in the professional and businesses press.1 So restricted, the debate takes on the quality of a family fight within capital. For example, writing in the Harvard Business Review, a place where academic theory meets real business practice, one of the gurus in the field, John Pound (1995), identified the three critical constituencies of a firm: managers, shareholders, and the board of directors. Ordinary workers, customers, suppliers, and communities arent included. One reason the governance issue is interesting is that its an implicit admission that markets do not regulate themselves as perfectly as were told. If the competitive market system worked as well as its adherents say, then there would be little need for shareholders to worry about how their corporations are run; reward and punishment would be administered by the market, with minimal conscious intervention. The same could be said about the stock market; if it really did discipline ineffective managers and reward good ones, then the governance debate would be pretty small beer. But obviously neither the product nor stock markets work as advertised. That means that capital is admitting that corporations must be subject to some kind of outside oversight. If thats the case, then the question becomes oversight by whom, in what form, and in whose interest. Few economists pay much attention to corporations, or how theyre owned and run. As Eugene Fama (1991) noted, many of the corporatecontrol studies appear in finance journals, but the work goes to the heart of issues in industrial organization, law and economics, and labor economics. He might have added politics and culture, since these too shape and are shaped by big business. Corporate governance is too important a matter to be left to finance theorists. Economists often analyze financial structures, if they look at them at all, in a fairly mechanistic fashion. Changes in corporate investment are treated as almost hydraulically influenced by changes in interest rates or stock prices.2 They pay much less attention to financial structures as institutions of legal and social control. Take, for example, the difference between debt and equity. Modigliani and Miller famously said there was none of any significance. But as Oliver E. Williamson (1988; 1993) noted, there are great qualitative differences between them. According to Williamson, the appropriate form of finance varies with the nature of the underlying corporate assets. Debt is appropriate if the proceeds are used to fund highly redeployable assets; if the borrower gets in trouble, the debt-financed assets could be sold, and the debts repaid. To finance more specialized investments, which depend on a specific firm or a narrow market for their value, equity is more appropriate, since equity gives the suppliers of funds the right to supervise managers and replace them, should things go wrong. In practice, however, shareholder supervision isnt as easy as that sounds, as well see in a bit. The relations between financial and governance structures have become clearer in recent years, as increasing attention has been paid to international differences in corporate ownership and control and their possible influence on economic performance. Broadly speaking, the U.S. and Britain share a structure characterized by widely dispersed ownership and loose external controls, while Japan and Germany exhibit much more concentrated ownership and tighter external control. Of course, such an extreme characterization does violence to the particulars, and especially so since the systems in all four countries have been changing in recent years, but its still a useful place to start. The fundamental issues are these: stockholders want high stock prices, bondholders and other creditors want their interest paid regularly and their principal eventually returned, and managers want a peaceful life with high salaries and minimal external intrusion. (In most mainstream theories, what workers want is of no matter; the only theoretical problem is how to get the most effort out of them for the least pay and with the least supervisory exertion.) Often these goals collide. High-risk strategies that might pay off in a big gain in a firms stock price may strike creditors as putting the security of their payment stream at risk. Stockholders may resent the conservative influence of creditors on corporate strategies. Both sets of outside interests may resent managerial perks and complacency, while managers might try to mislead outsiders into thinking the corporation is doing better than it really is. When a firm gets into trouble, stockholders are likely to favor indulgence (that is, some degree of debt forgiveness), while creditors are often happy to see stockholders wiped out and the firm wholly or partly liquidated to satisfy their claims. Further, different classes of creditors theres usually a hierarchy, with some more senior than others may have different interests in a bankruptcy. Managers, however, are often tied to a firm, either through habit, or convenience, or what economists call firm-specific human capital (which means that skills honed over the years in a particular corporate environment may be near-worthless in another), and reluctant to see it liquidated. transactional analysis In much received economic theory, the firm is a simple black box, with no conflicts among managers, workers, creditors, and owners (stockholders).3 The firm simply applies raw materials to its stock of machines and labor, creates a product that it costlessly and unproblematically sells, and earns profits for its shareholders. Later, Modigliani and Miller would show that it didnt matter where the capital came from, so external finance too became just another input, like labor and raw materials, of no great theoretical or practical interest. In a famous paper that was largely responsible for his winning of the 1991 Nobel Prize in Economics, Ronald H. Coase (1937) challenged this orthodoxy. Coase posed the question, largely unasked in classical economics, of why firms exist. Coase quoted this aphorism from Sir Arthur Salter as embodying the classic (and classical) mode of thought a view that was to become the routine punditry of the 1990s: The normal economic system works itself. That is, supply and demand, production and consumption, are equilibrated by the self-regulating mechanism of the price system. Of course, individuals plan for themselves within this selfregulating miracle, but no coordinating institution beyond that is required. But, Coase countered, Salters view does not obtain within the firm at all. If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so. Firms, in a formulation of D.H. Robertson that Coase quoted approvingly, are islands of conscious power in this ocean of unconscious cooperation like lumps of butter coagulating in a pail of buttermilk (as if the butterlumps thought themselves into existence). Not every aspect of economic activity can be encompassed by the price system. The costs of negotiating contracts for everything would be prohibitive; were a boss to take bids and write a contract for every letter she needs typed, nothing would ever get done. In Coasian language, the transactions costs would exceed its return. Further, contracts cannot be written to cover every eventuality; every spill cant be anticipated, so it pays to have a janitor on hand to deploy whenever an unexpected disaster presents itself. In such cases, the price system hardly enters the picture. Or, in Coases concise definition, the distinguishing mark of the firm is the supersession of the price mechanism. But under capitalism, the scope of conscious planning rarely extends beyond a firms boundaries; the price system is the normal governor of relations among firms and between firms and final consumers. Conventional economics still treats the market as essentially self-regulating: the system, outside the firm, still works itself. But in reality there are substantial costs of time and money devoted to making the system work. Sellers must seek buyers, and buyers must weigh the competence and honesty of sellers. Transactions costs are far from trivial as much as half U.S. GDP, according to one estimate cited by Coase (quoted in Williamson and Winter 1993, p. 63). Though Coase didnt make the point, the transaction cost argument for the existence of the firm can be applied to the provision of capital. Conventional theory assumes that entrepreneurs can raise capital for their projects effortlessly and costlessly, when in fact they cannot; even the most seasoned corporation has to pay commissions to the bankers underwriting its paper, and for less established and virginal ventures, capital can be expensive to raise, if its available at all. Established firms economize on such costs by tapping their own in-house sources of capital profits. As the figures cited in Chapter 2 on the cost of finance show, these transaction costs are quite stiff, making internal finance quite attractive. By introducing the firm as an institution and the transaction as a unit of analysis, Coase did help bring economics into closer engagement with the real world though as he noted in 1970, the paper was much cited and little used (quoted in Williamson and Winter 1993, p. 61). Mainstream economics remained largely indifferent to the costs of the price system, at least until the 1970s ironically, as the supposedly costless magic of the marketplace was about to score great political triumphs. But in some ways, Coase simply exchanged one black box for another. While his firm was exposed to the competitive price system on the outside, the firm itself was a conflictless hierarchy that worked itself. The workman told to move from Y to X did as he was told, and there was no conflict between managers and owners, or creditors and stockholders. And aside from the rigors of competition, his model of transactions was also rather pacific. There was no stark conflict between producer and consumer, worker and boss. While his intellectual heirs have introduced some aspects of these conflicts into their analysis, they tend to use the ideologically neutered language of transactions, contracts, and information, rather than the more blooded language of conflict and struggle.4 The rediscovery of Coase in the 1970s led to a school of transactions costs economics, Oliver Williamson prominent among its practitioners, who use the theory to explain much of social life. Any organization can be seen as existing to economize on costs. While its refreshing to see mainstream economists take some notice of institutions, their assumptions are still deeply individualistic. Their basic unit of analysis is the transaction; all the social mechanisms that precede and surround the transaction are elided. The firm or nonprofit organization, government, or even family is seen as a web of individual contracts, not a social organism with a life of its own. Politics and power largely disappear in whats called the new institutional economics. Radical institutionalists look to Veblen for a sharper view (Knoedler 1995). Veblen noted that many transactions are undertaken not for efficiency, but for reasons of power to undermine competitors or secure monopoly position. He emphasized that businesses wanted to make money, not run the best industrial system imaginable. The difference in emphasis is important, because the Coasian view sees the corporations role as maximizing efficiency, not profit, which is another matter entirely. Advertising, planned obsolescence, predatory pricing, and spurious innovation are partly or wholly socially useless, even malignant, activities, but they are profit-maximizing. Veblen also argued that an industrial system run for social efficiency rather than maximum profit might see more internalized and fewer market transactions. Sometimes profit-maximizing will lead to socially beneficial combination and coordination, but sometimes it wont. Janet Knoedler (1995) argued, for example, that GMs integration with its suppliers (like Fisher auto body) had less to do with economizing on costs than with simplifying the annual style change, a marketing rather than an industrial consideration. But that is getting political, which is something most economists never do. theorizing corporations |
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