Thursday, September 17, 2020

Doyle, Watson, and the Purpose of the Corporation

Sherlock Holmes aficionados distinguish between literary criticism that is “Watsonian” in perspective, and criticism that is “Doylist.”  As any fan knows, the stories were written by Arthur Conan Doyle as a first-person narrative; they purport to be the work of John Watson, who is recounting the exploits of his brilliant friend and sometime-roommate, Sherlock Holmes.  Fans who analyze the stories, then, have a choice: They can take an “outsider” perspective and discuss them as works of fiction authored by the real-life person Arthur Conan Doyle, or they can take an “in-universe” perspective and discuss them as the actual literary product of John Watson, unreliable narrator.  Depending on which viewpoint you adopt, you may end up in strikingly different conversations.  For example, a Doylist might look at inconsistencies in how Watson’s wife is described throughout the series, and attribute them to the multi-year period over which the stories were published; a Watsonian might argue that Watson was covering for a gay relationship with Holmes and couldn’t keep his lies straight.  Neither viewpoint is incorrect, but the two fans are talking past each other; in order to communicate, they have to define the relevant playing field.

That’s how I feel about a lot of the conversations currently surrounding corporate purpose, especially the ones you see in popular media. 

We’ve had a lot of soul-searching recently about whether corporations should be run to benefit society overall, or whether they should be run to benefit their shareholders alone.  But that conversation is incoherent unless you first clarify your perspective.  Are you looking at things from outside the corporation, in terms of structuring our overall legal and societal institutions?  Or are you looking at things from inside the corporation, in terms of how corporate managers should understand their jobs and their own roles?

From a societal, or Doylist, perspective, I don’t think there’s any dispute that corporations exist to serve the community as a whole.  We charter corporations, we create rules for their operation, we develop infrastructure to facilitate investing, all because we believe that on balance, corporations are (or can be) a net good.  They are an efficient way of doing business, which means they contribute to innovation and economic development, provide necessary (or even just enjoyable) goods and services, generate wealth not only for investors, but also for workers and governments (through tax payments).  They can provide outlets for creativity and generally contribute to human flourishing.  That is the social purpose of a corporation.

But corporations harness and coordinate labor and capital on a potentially global scale, and thus are very powerful tools.  Any form of power can be misused.  Corporations might exploit and injure workers, or consumers, or the environment, perhaps to the point where the benefits are not worth the costs.  Thus, we need to arrange our societal institutions to minimize these harms, and maximize the benefits.

Corporate purpose debates are not about those principles – on which, I suspect, everyone agrees.  The debate about corporate purpose is a debate about method.  If we agree that corporations exist to benefit society, and if we agree that we need some kind of legal and/or market structure to ensure this occurs, what does that structure look like?

And this is when we switch to the Watsonian perspective, from within the corporation itself.  And here, the question is, is it better that corporate managers understand themselves to be servants of society, and manage the corporation to effectuate that purpose?  Or is it better if managers understand themselves to be serving investors, while other societal institutions – regulation, contract law, and the like – protect the rest of society?

This is a point I’ve made repeatedly, most recently in Beyond Internal and External, but also in Not Everything is About Investors, and I’m hardly the first to do so.  For example, though Henry Hansmann’s & Reinier Kraakman’s essay, The End of History for Corporate Law, has received its share of ribbing for being a bit premature, it lays out this framework very neatly, while arguing that society overall benefits if managers focus on investors, while we reserve other types of regulation to protect non-investor constituencies. 

Unless these premises are understood by everyone in the conversation, it devolves into the same incoherence one would expect from a Doylist discussing Watson’s marriages with a Watsonian.  So, for example, the New York Times recently published a retrospective on Milton Friedman, with soundbites from assorted businesspeople and academics.  You will, I’m sure, be shocked to learn that every business person included argues that corporations should be run to benefit all stakeholders.

Now, there’s a certain banality to this exercise – what CEO is going to say “screw my customers, I’m all about the stock price”? – but more importantly, there is no dispute that corporations should operate to benefit all stakeholders; the issue is how do we make that happen. One method – and only one method – is to rely on managerial largesse to distribute surplus to shareholders and stakeholders alike. (We’ll call this the “Martin Lipton” method*)  But there are other mechanisms to constrain corporate behavior besides managerial largesse, and it’s impossible to talk about the merits of such largesse without acknowledging those mechanisms and discussing how they function.  The question, properly framed, isn’t whether CEOs should consciously operate their companies to serve society, but what are the options we have for making sure they do so, and which mechanisms are more effective than others, and why?  If CEO altruism is one of our options, is it better or worse than other possibilities, and if we are going to rely on altruism, what institutions do we need to generate that altruism and channel it appropriately?

Which is why I find the NYT piece so frustrating, because it’s got the Doylists and the Watsonians all mixed together as though they’re talking about the same thing.  Many of the academics are Doylistically describing the types of societal structures we need to corral corporate power and ensure that capitalism benefits everyone.  Meanwhile, Starbucks’s Howard Schultz, Home Depot’s Ken Langone, J&J’s Alex Gorsky, and BlackRock’s Larry Fink, among others, take the Watsonian view, which is to say, they argue what all businesspeople argue: CEOs should run the company with a view toward serving shareholders because you cannot serve shareholders without serving the rest of society.  From Watson’s perspective, if the CEO is focused on maximizing profits, s/he will make good products that consumers want to buy, and create good jobs that attract high-quality employees, which satisfies Doyle’s desire for a better society overall. 

But by focusing on the Watsionian viewpoint and eliding the Doylist challenge of the academics, these businesspeople avoid any test of the very specific factual claim that undergirds their argument: that the interests of shareholders and the interests of other stakeholders are aligned.  And in order for that to be true – that shareholders cannot profit unless the rest of society benefits – nonshareholder constituencies must be sufficiently powerful Doylistically to extract a price for corporate malfeasance.  They must have, in Galbraith’s words, countervailing power, from labor unions, a strong regulatory system, consumer advocacy groups, and so forth. 

That line of thinking yields two possibilities: We can maximize the benefits provided by corporations, and minimize their harms, by strengthening these countervailing institutions, or we can do it by weakening corporations. The latter, for example, was long the goal of antitrust law, and it’s why there’s so much advocacy around limiting corporate political donations.

Which brings me to Jens Dammann and Horst Eidenmueller, who have written a pair of papers that arguing that co-determination (whereby employees, as well as shareholders, get to vote for corporate directors) may not strengthen corporate functioning but instead weaken it, by creating a type of separation of powers within the corporate form, and that itself may be net beneficial to society.  I made a similar point in Beyond Internal and External, where I argued that the regulatory system shapes shareholders to have divergent preferences in a manner akin to the separation of powers.  The separation of powers has two Watsonian functions.  The first is that it encourages a variety of incentives and goals among corporate managers, which encourages a broader perspective in corporate decisionmaking.  The second is that it impedes any kind of corporate action in the first place, by making it more difficult for corporations to reach a consensus.  In that vein, certain kinds of corporate governance reforms – elimination of dual-class stock, separating chair and CEO roles, and so forth – seem less about ensuring good (profit-maximizing) governance than creating friction in governance, because by impeding the corporation’s ability to act, we necessarily strengthen other constituencies. 

Okay, yeah, so just imagine I have a pithy conclusion here.  Whatever, it’s a blog post.

*no relation

Ann Lipton | Permalink


Thank you for sharing these insights. I have yet to weigh in on this scholarly discourse, but will do so in the future. Briefly, I want to note that there is a moral dimension to this dialogue that is important to wrestle with, particularly as it relates to how we define "benefit" and who is included in the "who" that are deemed within our scope of reference.

When we adopt the economic (neoclassical) language of utility maximization (minimizing costs and maximizing benefits), we risk obscuring the practical dimensions of "sacrifice" that undergird the everyday functionings of political economy. Put another way, how does one conceptualize "benefit" on moral grounds in a market economy that legitimates the exploitation of some (more often than not, the poor and "Black"/"Brown") as low-wage workers for the benefit of a few (more often than not, the wealthy and "White") as elite high-paid executives of high-powered corporations?

The influence of neoliberal politics at the hands of such corporate actors further obscures the notion of public benefit (notwithstanding the problematic public/private distinction that itself legitimates the normative dimensions of status quo market functionings). Even more, the commonplace notion of "shareholder benefit" relies upon problematic normative/moral principles of individualism (to sustain an ethic of American exceptionalism amidst a vicious legacy of white supremacy) that neglect the relational dimensions of political economy; which is to say, how can profit maximization be deemed a private benefit when it relies upon the systematic exploitation of low-wage workers, in so many instances?

To suggest that one benefits privately from the political (viewing economic exploitation as a kind of political inequality) subordination of fellow citizens publicly not only ignores the moral dimensions of market activity, it also - and here I would engage a Critical Race Theory lens - obscures the way such market structures shelter white supremacist ideology in the clothing of "neutral" and "competitive" market logic.

Thus, I am very skeptical of the notion of shareholder benefit, generally speaking, as presently conceived. To put it in layman's terms, its sad to me that we view Amazon shareholders (as but one example) as "benefiting" from the sacrifice of low-wage workers in packaging factories crammed in unjust conditions and rendered susceptible to COVID-19. To me, that's not private benefit; that's simply cultural blindness.

Posted by: Etienne Toussaint | Sep 18, 2020 10:18:08 AM

Hi, Etienne - thanks for your comments! And I agree, you could take a point of view that stands outside the capitalist system (meta Doyle!) but I admit, that's less my area - I was trying to to clarify a point of confusion in the current conversations that continually bother me. But if you plan to write on this subject, I look forward to seeing what you come up with!

Posted by: Ann Lipton | Sep 18, 2020 10:55:57 AM

Hi, Ann. I’m struck by the "Doylist" claim that “corporations exist to serve the community as a whole.” That strikes me as a remnant of the 19th century idea that corporations had to be specially chartered by legislatures for some public purpose, like a bridge or a canal. Today, anybody with a computer and a credit card can create a corporation for “transacting any and all lawful business” in five minutes.

Individuals do not exist to serve the community. Ordinarily we get to choose whether we want to serve "the community" (better, “those who make decisions on behalf of the community”) or not. If two of us join together, we still get to define our own purpose and our own rights to pursue “happiness” as we choose. Thus, if my friend and I start a partnership, I assume we are free to pursue our own aims exclusively.

If that's the case, what changes when we file a form with the Secretary of State’s office? Whether we organize as an LLP, LLC, or a corporation, our business will be identical and we will have the same limited liability. Would checking the “corporation” box rather than the “LLP” box require us to change our very reason for existence? No one ever mentions that obligation on state incorporation web sites, and I'm not aware of any statutes that so provide. It would seem irrational if it did, because the business is identical regardless of form. OTOH, if LLPs, LLCs, Massachusetts business trusts and Swiss vereins owe the same duty, then every business would seem to owe that duty and talking about "corporations" is redundant.

I think much of the enthusiasm for requiring corporations to pursue interests other than their own is based on the idea that large entities—most of which are corporations—ought to be regulated by courts and trial lawyers in addition to legislatures and regulatory bodies. Even if that’s true, I see no rational basis for saying that Pratt Industries, Inc., of Conyers, GA (revenues $3.2 billion) “exists to serve the community as a whole” but that Kirkland & Ellis LLP (revenues $3.2 billion) does not. Again, if they both in fact exist for the benefit of the community, then limiting this to “corporations” seems odd.

Posted by: Frank Snyder | Sep 19, 2020 7:11:26 AM

Hi, Frank. I'd say you're confusing the Doylist and Watsonian perspectives again. From a Doylist perspective, the issue isn't "what is the purpose stated in the charter?" It's, why do states authorize corporations at all? And that's because they believe, on balance, corporations will help the state - and that can be for a variety of reasons, from the value of human freedom to start a business to the goods and services corporations can provide.

But from a Watsonian perspective, then yes, you might say, an individual, having formed the corporation, may run it to benefit himself.

Posted by: Ann Lipton | Sep 19, 2020 7:26:01 AM

There is also a sense in which this dialogue engages the liberty-equality ideals that underscore liberal democratic governments. If equality is achieved by provided legal structures to enable private business endeavors for anyone who sees fit to do so, does the state need to impose certain regulations to ensure that the actions of one business entity does not infringe on the liberty interests of another business entity?

One could argue that (at a minimum) the "purpose" of the business entity is to not infringe upon the continued existence of a system of business entities that facilitates the individual pursuit of happiness. Yet, necessarily, government must regulate the individual "purpose" of such business entities to ensure that their discrete business activities do not harm other citizens (unfair labor practices, worker exploitation, harmful business practices, etc.) and thereby infringe on the marketplace for the free and equal operation of business activities.

So, the private order must, in some ways, have a public purpose, if but for nothing else than to ensure it do not infringe on the fairness of the marketplace for private ordering.

Posted by: Etienne Toussaint | Sep 19, 2020 9:28:20 AM

Hi, Etienne, I'd say that's a pretty distinctive Doylist argument. I.e., the state charters corporations to achieve a common good - equality - and then we need to worry about how the state develops structures surrounding the corporation to make sure that actually happens. It still doesn't tell us whether from a Watsonian viewpoint, individuals may act to pursue only their own benefit, or not, once having formed the business - that depends on what kinds of structures the state puts in place to accomplish the higher order goal.

Posted by: Ann Lipton | Sep 19, 2020 11:46:14 AM

Fantastic and thought-provoking post. Thanks so much for writing.

Posted by: Emilie Aguirre | Sep 21, 2020 10:50:06 PM

You wrote, “From a societal, or Doylist, perspective, I don’t think there’s any dispute that corporations exist to serve the community as a whole.” I was using your terminology, and was responding to the italicized language. I think there is actually quite a dispute about whether corporations “exist” to serve any interest except their own.

My position may be based on a fundamental disagreement. The idea that the state “create” corporations today is a myth. The Walt Disney Company existed well before a piece of paper was filed in an office in Sacramento in 1928 (Mickey Mouse had already made his public debut in Steamboat Willie), and more than sixty years before it was “created” again by Delaware in 1995. It would continue to exist even if both states were to repeal their corporate statutes entirely. To say that either state “created” Disney is like saying that the Social Security Administration “created” me when it issued me a social security card. An SS card, like a corporate charter, is merely a document that grants rights or privileges to the recipient.

It is fair to say that California had a public purpose in letting businesses like Disney get shareholder immunity, or that the SSA had a public purpose in giving me a number that allows me to be employed. But that’s a very different argument. It also has a public purpose in granting building permits.

I’ll reiterate that no one seems to claim that New York “created” Cravath, Swaine & Moore when it granted LLP status, yet Delaware is said to have “created” Disney because Disney picked a different form.

Posted by: Frank Snyder | Sep 22, 2020 7:38:59 AM

I am confused. Walt Disney as a business may have existed before it was chartered - I don't know the history - but are you saying it was a corporation before the charter was filed? How are you defining corporation for the purpose of this conversation?

Posted by: Ann Lipton | Sep 22, 2020 8:17:03 AM

"Corporation," today at least, is a designation applied to one type of limited liability entity. There is nothing special or unique about it, any more than there is for the LP, LLP, or LLC. Disney is a firm, and a firm exists independent of the particular form it selects to secure its limited liability. The piece of paper creates Disney to the same extent that a Federal patent "creates" a new pharmaceutical. All it does is grant the owners a particular benefit.

The idea of "the corporation" as a thing that "exists" is simple reification. It's a legal status, not a thing in esse.

Posted by: Frank Snyder | Sep 22, 2020 1:29:37 PM

Okay, legal status as a corporation. So there wasn't a corporation, though, until the state granted that status - and as we know, historically, the state can be more or less restrictive in its willingness to grant that status. Doing so includes legal recognition as an entity rather than a collection of specific natural persons, the right to make contracts in its own name, sue and be sued, own property, borrow money, have rights in intellectual property, asset partitioning that keeps its assets separate from those of its owners, indefinite life independent of the lives of its members. As I said in my post, "We charter corporations, we create rules for their operation, we develop infrastructure to facilitate investing, all because we believe that on balance, corporations are (or can be) a net good." Which includes all those features that come from recognition of the entity as having an independent legal existence.

Posted by: Ann Lipton | Sep 22, 2020 1:41:48 PM

To dumb-down considerably the comment-mediated discourse, your conclusion is a pragmatic masterwork; the asterisked footnote merely a joy, whatever the philosophical tradition.

Posted by: Kyle Wagner Compton | Sep 23, 2020 6:18:54 AM

Hah, thanks, Kyle - it's what I have to tell my students when we get to Unocal and Revlon!

Posted by: Ann Lipton | Sep 23, 2020 6:50:18 AM

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