“Show me the incentives and I will show you the outcome.”
The goal of corporations is to maximise profits for investors. This concept has directed and justified the behaviour of corporations for centuries. But is it sensible, is it right, is it useful?
Profit is a holy cow of the Capitalist economic system. It is the fuel that drives the market engine.
Capitalism focuses on the creation and accumulation of capital through profits derived from trade. The free market system focuses on the freedom of individuals to trade with each other. Both favour private property, open competition, and minimal regulation, and rely on the price mechanism.
Profits provide the incentive for investment. Non-shareholders are specifically excluded from a share of profits. Shareholders control corporations. They have a perverse incentive to maximise the profits which accrue only to them, through the appointment of managers whose main aim is to maximise profits. Not surprisingly, these perverse incentives may lead to perverse outcomes.
The 21st century has seen the rise of several mega-corporations with unprecedented control over health, energy, the flow of information, money and goods. These corporations have been very profitable, and have made many investors stupendously rich. They tend to make large annual profits. But have they increased the sum total of human prosperity? In their quest for profit, do they undertake evil acts to the detriment of society? How do you reconcile the freedom to trade with accountability for the consequences of that trade?
Merck discouraged the use of Ivermectin, an effective treatment for Covid but no longer profitable to Merck, in favour of high profit drugs such as Molnupiravir and Remdesivir, with known serious side-effects. Pfizer aggressively promoted their highly profitable mRNA vaccine, despite dangerous reports from their testing process. There are thousands of similar stories.
Most companies and corporations do not make high profits. The average profit margin for American corporations is around 5%, for those that make any profit at all. Corporations making low profits may be even more desperate to increase profits than wealthier ones. However, I would contend that companies make high profits mostly because of 3 factors
- Reduced competition, possibly through monopolistic practices (Banks, oil companies).
- Regulatory capture - they manipulate politicians and legislatures to their advantage (Pharmaceutical companies).
- Better products and processes (Tesla and Apple).
What can be done to reduce the perverse incentives of shareholder profit?
In most countries high wealth is heavily taxed, but the richest are the most adept at avoiding taxes.
In many countries, the rich provide considerable philanthropy, mostly aimed at the poor of third world countries.
Wealth tends to be distributed and reduced across generations of the same family, but not if the family is careful.
I have no quarrel with the acquisition of wealth through legal means, only with the perverse incentives that the profit motive gives rise to.
I propose a new goal for corporations. The goal of corporations is to maximise shareholders
Annual profits above a specific percentage (say 10%) would be used to buy and distribute shares to stakeholders in the corporation. Stakeholders are individuals whose actions contribute to the corporate profit, but do not receive that profit. This would be employees, suppliers, customers, agents, retirees, charities.
A company would establish a register of stakeholders, just like the shareholders register. Each year an allocation of shares would be made to these stakeholders funded by the profit in excess of 10%. Various criteria for allocation would be established, such as years of service, previous receipts, age, etc.
I believe that the incentive to accumulate excessive profit for the benefit of just a few would be diluted by this approach. I believe that an increase in shareholders amongst stakeholders would be beneficial to the corporation, as more individuals would be motivated by the success of the corporation. I believe this would be beneficial to the prosperity of the community in which the corporation operates. Like Maggie Thatcher, I believe a share-owning population is superior to a population dependent on government largesse.
How would this new goal be implemented? While some may feel tempted to enact laws to enforce this approach, I believe that would be counter-productive. Let individual corporations freely choose to adopt this approach because it is the right thing to do, because it may result in increased revenue, and because of peer pressure from the public. For example, many corporations adopt counter-productive policies for the alleviation of global warming, because of the public pressure to do so.
Our goal should be increased prosperity for all, through voluntary means, rather than just profits for some.