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Corporations Must Maximize Profit

by rdf Wed May 13th, 2009 at 07:07:47 PM EST

There is much discussion going on these days over the idea that corporations must maximize profit in order to satisfy their stockholders. Many take the position that this isn't even a choice, but that firms are required to do so by the terms of their incorporation. To do less would be to fail to properly represent the interests of the investors.

Along with this idea there has arisen a discussion of what flexibility firms have when spending money. For example, is it proper for a firm to invest in "green" technology, which may be more expensive, but which benefits society at large? Similarly can firms donate money to charitable causes or provide services (pro bono) for free?

Those who support both the charitable actions and the assumption over maximizing earnings turn to convoluted arguments to bolster their ideas. So, for example, charity can add to a firm's "good will" and make customers more likely to want to deal with it in the future. Similarly "green" investment can make a firm more appealing to customers. Certainly firms buy into this logic as can be seen by the amount of green-washing going on as polluting firms try to improve their image.

All of this misses a key point. Firms operate as state-sanctioned entities. The rules that they must follow come from laws and regulations. It is within this framework that they are allowed to maximize profit. A firm must, for example, pay minimum wage and provide for a safe and healthy workplace. There are limits on hours worked and the age of employees. There are limits on how waste can be dealt with and one sort of damage can be done in extracting raw materials. Products must meet certain safety and efficacy standards as well. There is no such thing as maximizing profit in the abstract.

So such discussions are not really about maximizing profit, but rather are about what are the limits that government can impose. Firms use spurious arguments about fiduciary responsibility rather than say that they want a license to pollute or abuse workers. It is somewhat ironic that firms spend so much time opposing regulation, since most of it actually benefits them. Without regulations firms that engage in illegal activity would have an edge over ethical firms. Who would make more profit, a firm selling a well-tested drug or one selling a counterfeit? Who would make more profit, a firm employing skilled workers or one using slaves (or illegal immigrants)? Many of the big failures in finance over the past several decades have involved firms engaged in fraud forcing other firms to try to compete so as not to lose business. Enron was such an example as was Madoff's Ponzi scheme. How can a real investment firm compete with a firm that is just a shell?

Firms benefit from a level playing field. It means the ones which are the best managed and the most innovative will prosper. Many firms, which know they are poorly run, deliberately try to get special favors from government to compensate. This frequently takes the form of seeking tax advantages or restrictions on offerings from competitors, i.e. protectionism.

One should be very wary of firms which ask for such favors. If they can't make a profit without government help then why have they been granted the benefits that accrue to limited liability corporations? Firms which are expected to be uneconomic are generally set up as non-profits, such as hospitals and educational institutions. They get the protection of limited liability and the tax benefits so that they can perform inherently unprofitable activities for the public good.

Maximizing profit is, thus, a false justification for seeking competitive advantage over one's competitors. Such claims should be seen for what they are - special pleading.

According to Galbraith in The New Industrial State, large US corporations up to at least 1970 did not operate as if their most important concern were profit maximization but rather self-preservation of the corporation itself.

This was to the detriment of the shareholders, and with CEOs being rather obscure figures not receiving the outrageous compensations they receive nowadays.

Since 1970 we have seen the rise of a fantastically remunerated CEO class and things like fiduciary responsibility to the shareholders have become convenient ideological justifications for doing things that the CEOs want to do.

Also, since shareholder value as currently understood seems to depend less on dividends that on rising stock valuations, it is not even clear that "delivering shareholder value" requires "dividend maximization", let alone "profit maximization".

The brainless should not be in banking. — Willem Buitler

by Carrie (migeru at eurotrib dot com) on Thu May 14th, 2009 at 06:05:34 AM EST
The rise of the dominance of the financial sector has brought with it the emphasis on the investor and return on investment as the primary, and indeed sole, focus of corporate activity. As you say, the astronomically remunerated CEO is a feature of that focus - since the CEO who can keep the share price in the right (rising) bracket by producing the right (rising) quarterly results can simply dip into the pot with no opposition.
by afew (afew(a in a circle)eurotrib_dot_com) on Thu May 14th, 2009 at 07:11:02 AM EST
[ Parent ]
Firms benefit from a regulatory structure, "a level playing field", or let's say more broadly from operating under the rule of law.

They also benefit from the physical infrastructure of the country they operate in (energy, transport, communications), and more largely from its cultural infrastructure (general level of knowledge, creativity, productivity potential of the population).

Corporations could argue that, if they pay taxes (but how many seek to avoid them as yet another profit-reducing cost?), they have acquitted their debt to the State and society. Yet when they (and their licenced thinkers and pundits) maintain a continual agitation in favour of the reduction of public services and spending - when, for example, they lobby for national education systems to teach "skills" not knowledge (ie concentrate on turning out graduates ready-made for corporate jobs, so firms can cut back on training costs), they are sawing the branch they're sitting on.

by afew (afew(a in a circle)eurotrib_dot_com) on Thu May 14th, 2009 at 07:31:00 AM EST
But the mindset is: 'humans are resources - resources are to be exploited and are limitless - if we don't have them, then we must go and control them where they are'.

Capitalism is the biggest Ponzi scheme ever. It CAN keep giving profits to new investors by expanding its exploitation of resources (material or human). It's a scheme that has unfortunately worked well for at least 400 years.

But the resources are not unlimited. The planet is finite. This Cosmic Ponzi scheme will end, as it always does, in disgrace for the perpetrators and violent anger from the investors - and the investors, ultimately, are everybody else i.e. us.

It is a Ponzi scheme because it is unsustainable. But I do think we can have sustainable growth. The planet, in one way, is not resource finite, i.e: it is being hit all the time by enormous energy from the sun. That energy, and the other energy it enables e.g. the wind, is the only infinite source we have.

It all ends of course when our Sun dies - but that is another even bigger Ponzi scheme ;-)

You can't be me, I'm taken

by Sven Triloqvist on Thu May 14th, 2009 at 07:59:00 AM EST
[ Parent ]
The difference between the resource exploiters and everyone else is that they enjoy it most when it's a zero sum game.

Systemic cooperation and synergy are the modalities they hate the most.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu May 14th, 2009 at 08:24:32 AM EST
[ Parent ]
Who are "the resource exploiters"?
by Colman (colman at eurotrib.com) on Thu May 14th, 2009 at 08:28:27 AM EST
[ Parent ]
Anyone who believes that numbers on a spreadsheet or profit and loss account are more important than the human stories which created those numbers.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu May 14th, 2009 at 09:38:56 AM EST
[ Parent ]
Hmmm seems to me there is a kind of collectivisation of guilt at work too -- it's "the shareholders" who are used as the excuse for various forms of criminality, as if the "sharing" of wealth legitimised the crimes.  I once had a rather fraught argument with my own father on this topic:  it was his opinion that the various immoralities of the for-profit US medical system were actually for everyone's benefit, since -- in his view -- so many pension funds and other "ordinary people" investment instruments were based at least partly in Big Pharma and medical equipment corporations, for-profit hospital chains, etc.  People were funding their retirements, he said, on the same profit-seeking they were complaining about in the med/pharma sector.  So, since the benefits (in his view) flowed to large numbers of people, people should really accept sharp practises, exclusionary policies, toxic externalities, etc. as the cost of high profits and cushy pension plans.

My riposte at the time was that if this is truly the case -- that a public stock offering legitimises any and all shady business practise -- then all the Mafia should need to do is an IPO, in order to become perfectly ethical/legit:  surely if they return a profit to a few mio of investors, then a few tens of thousands of murders, thefts, arsons and the like are quite acceptable.  My dad said Harumph -- laughed -- and allowed as how there might just be a few commonalities of business practise between the mafia and the med/pharma complex, but he didn't think they'd be going public any time soon.  [If they did, I bet the old devil would have bought some shares.]

At any rate, the whole "maximise profit for shareholders" argument not only constitutes special pleading for corporate pseudo-persons to be allowed to break the laws of the land;  it also implicates the shareholders as accessories to and beneficiaries of lawbreaking, and (imho) assists (I think) in alienating (investment-owning) citizens from the law as well as in diluting or diverting responsibility from the decision-makers in the corporate structure who choose, daily, to flout laws, commit bribery, perjury, embezzlement, false advertising, insider trading and all the rest.  "I was only doing it for the shareholders!"  [Yet as we see, the bulk of the notional wealth concentrates in very few hands, and the ordinary "shareholders" are defrauded immediately when there is a stutter in the Ponzi scheme.]

I've often thought about that argument -- that widely dispersed investment instruments somehow "democratise" or legitimise criminal or unethical practises.  It seems a very useful one (for the criminals).  What a marvelous bait&switch it is too.

The difference between theory and practise in practise ...

by DeAnander (de_at_daclarke_dot_org) on Fri May 15th, 2009 at 03:34:16 AM EST

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