Essential Truths
of Corporate Business

1. Corporations are not natural supporters of Capitalism. Instead, in an environment of rent-seeking politics, they are natural supporters of Mercantalism, the economic system that Adam Smith himself attacked in his Wealth of Nations [1776]. Under Mercantilism, the principle is the protection of business, and of producers, rather than consumers. This all goes back to business in the Middle Ages, when the sentiment was that no one had any right to engage in business without the permission of the government, i.e. the sovereign. A purely Feudal economy, of course, had no need of trade, money, merchants, or cities. The introduction of such things could be seen as unnecessary, or perhaps an independent source of power for the sovereign. Thus, a ruler would charter an enterprise, almost always with a monopoly of commerce. This was seen as best for the business and consequently best for the ruler, who would tax the business and benefit along with it. That the subjects in general, the consumers, would benefit from products being provided was a concern that came a distant second. After all, a great deal of trade was in expensive luxury goods, like soap or spices, and most subjects of European monarchies could not afford those things anyway. And if they began to use soap, they might begin to get above their station.

   In the modern context, businessmen may understand that they are serving a mass market of consumers; but they may also think that they are doing a good enough job, thank you, and will resent competition that drives down prices and threatens business as usual. The solution may well be selling a fairy tale to the government and getting protections -- licenses, regulations, tariffs, import quotas, legal cartels, subsidies, price supports, public contracts, mandates, etc. The purpose of such things is to impose greater costs on entry, i.e. on new competitors, or on existing competitors, or to shut out competition altogether. Thus, we have charming institutions like the California dairy cartel, which is able to do what most people probably think is universally illegal, to collude in price fixing on dairy products. Most people may not care if the prices of peanuts, or sugar, or tobacco, or even cheese are driven up by government action, but they may also find it hard to believe that the government cooperates in driving up the price of milk. Somehow, the crusading anti-capitalist press suddenly goes blind when monopolies and price-fixing are sanctioned by the government. At the same time, when something like the price of sugar is driven up, companies resort to substitutes, like corn syrup for sweetening, which drives up the price of corn. With federal mandates for the pointless (but vote winning) use of ethanol in gasoline, also manufactured from corn (which will bag Iowa), the price of corn is driven up even on the international market, resulting in food protests in Mexico City (February 2007) and elsewhere.

   Thus we begin to see all the irrationalities of a "planned" economy. But there is method behind the madness. What is irrational to the consumer may make perfect sense to the rent-seeking business (such as rent-seeking ethanol producers like the Archer Daniels Midland Company), pining for the days of chartered monopoly corporations. It is not the sense of a free market. Raised on Cargo Cult economics and anti-Capitalist propaganda, politicians and the public may not even know the difference.

2. Businesses are tax collectors, not tax payers. While politicians hand out subsidies and protections to favored businesses, they can also make political capital by attacking them in public. Nothing sounds better than raising business taxes and making those blood-sucking capitalist exploiters pay for the privilege of alienating the workers. Unfortunately, the taxes that businesses pay to the government are collected as part of the prices that they charge the consumer. In the rhetoric of class-warrior politicians (i.e. mostly Democrats and Leftists), one would think that the taxes simply come out of bloated and unnecessary profits. A profitable business, indeed, may choose to eat the costs and lose some profit in order to remain competitive. However, not all businesses are all that profitable. Many operating at the margins can simply be put in the red when an extra cost, like a tax, is imposed on them. They may have a limited time to cut costs before going bankrupt. If they fail, well, then the established and comfortably profitable businesses have lost some competitors -- they are not going to lose any sleep over that. Indeed, since higher taxes can harm the competition, maybe it will occur to the corporate fat cat (i.e. Warren Buffet or Ted Turner) to suggest to his politician friends that raising taxes on business might be a good idea. Everyone should pay their "fair share." Then, having done their good deed, they can retire to their ranches in Montana and enjoy federal subsidies for not growing food. The good works never cease. [note]

3. Corporate profits go to widows and orphans. We all know how evil corporate profits are. At least politicans and the press keep telling me that. Some guy is living on a hilltop in Beverly Hills because of corporate profits. Or maybe he is a lawyer, movie star, plastic surgeon, or professional athlete. We know they get their money honestly. On the other hand, the profits from a business are either reinvested in the business, allowing for new products, improvements, or greater productivity (reducing costs), or they are paid out in dividends to the stockholders -- after the profits are taxed by the government, which then gets to tax the dividends all over again. Who are the stockholders? In the publicly owned and traded corporation, anybody can buy stock. People invest for their old age. Pension funds invest for the old age of pensioners. The largest institutional investor in the world is the California Public Employee Retirement System (CAL PERS). If the return on investment for CAL PERS does not cover the cost of the benefits that the system pays out to retirees, then the California taxpayer gets to kick in the difference. Serves them right. After all, how can the taxpayer in good conscience avoid taxes by allowing corporate profits to pay for the retirement of selfless public servants? They better just pay their fair share and let the government take those profits to build bridges to nowhere and fund the National Trout Fishing Museum.

4. The incentive is for hired management to serve itself, not the company or the stockholders. Publicly owned corporations are going to have management which is hired by the Board of Directors and confirmed in some pro forma vote at a stockholders' meeting. When Henry Ford or John D. Rockfeller ran their companies, their interests were pretty much identical with those of the company. But for a hired management it is different. They indeed have a fiduciary responsibility, moral and legal, to honor the interests of the company and the stockholders, but this is a little different from their own personal interest, which is not necessarily tied to a company from which they might eventually be fired. As no more than hired hands, they must keep that in mind. One of the principal elements of their self-interest is to protect their own position, i.e. they want to cover their ass. This does neither the company nor the stockholders nor consumers any good. Managers have a great deal of power to accomplish their purposes, since they can control hiring, putting their own supporters in key position, and they can control a great deal of the knowledge that Directors, stockholders, and the public think that they have. In other words, Management begins to play politics with the company, regardless of the effect this may have on the quality of the company's product or service, or on the long term prospects and reputation of the company. Curiously, playing politics may include going along with political lies that are damaging to the company, to consumers, and to business in general. It may happen that Managers simply don't understand macroeconomics and politics enough to identify the lies, which means they might actually believe them, or their judgment may be that the difficulty and cost of fighting the lies, when few Managers are eloquent public spokesmen for anything, may be greater than the costs of simply going along to get along. This is not unlike the "me too" Republicans, including the Bushes, who hope to be regarded as "kinder and gentler" or "compassionate" if they go along with lesser versions of the socialism of the Democrats. Of course, they could never do enough, and the cooperation of the Bushes only earned them the contempt as well as the hatred of the forces (like W's "good friend" Ted Kennedy) they were trying to appease. For businessmen with similar attitudes, including many such Country Club Republicans, politicians may even gratefully and happily bestow mandates and protections that help the co-opted business. The Left likes to think that Corporations are then secretly buying and running the government. It is not clear that this would actually be worse than what does happen, which is a folie à deux whereby rent-seekers and politicians feed off of each other. The socialist answer of handing ownership and control of everything over to the government simply makes everyone a rent-seeker, without the possibility of an honest market exchange. As Thomas Jefferson said, "But it is not by the consolidation, or concentration of powers, but by their distribution, that good government is effected... Were we directed from Washington when to sow, and when to reap, we should soon want bread" [Autobiography]. Since something of sort was attempted in the Soviet Union, and consumers did want bread, one might think that educated American academics would know better by now. But, of course, they don't.

5. Corporate buyouts can remedy bad management. When Management fails to run a company well, and profits go down, then dividends go down, and the price of company stock goes down. The Board of Directions should fire the Management at that point, but sometimes that doesn't happen, for whatever reason. But, when the price of the stock falls far enough, it becomes possible to buy the company for less than it is worth. This is a good deal for anyone who can get the money together. Profiting from the deal, of course, depends on turning the company around enough, at least in perception -- starting with cleaning out the old Management -- that the stock can then be sold at more like the proper value. If the company is an unwieldy conglomerate, with various enterprises whose value is lost in the confusion of the combination, it may be possible to restore market values simply by breaking up the company and selling the parts separately. Either way, Managers, of course, hate the very possibility of this. One way to fight it is to go to friendly politicians and have them make buyouts more difficult, protecting Management. This can be sold by demonizing the "corporate raiders" who go looking for undervalued companies to buy. If the public thinks that such people are the Goths, and Management consists of innocent, virginal victims, then the fix is in. In the 1980's, Management propaganda was remarkably effective, as even the Press and the Hollywood Left, in their clueless ignorance, fell for the fairy tale. Thus, we have movies like Pretty Woman [1990], where Julia Roberts tells Richard Gere that buying companies, breaking them up, and selling off the constituents is like "selling parts from stolen cars" -- overlooking, apparently, the stipulation that the company, unlike the cars, has been purchased. Buying cars and selling the parts is liable to be a welcome service for the owners of old cars. We got similar follies in Barbarians at the Gate [1993 -- see, I meant it about the Goths], about a non-fictional buyout of RJR Nabisco, and Wall Street [1987], with a memorable Michael Douglas as the "greed is good" corporate raider "Gordon Gecko," who apparently loves to buy companies just to wreck them ("because it is wreckable"). The result of incompetent Executives selling themselves as the slaughtered innocents of Reagan Era Greed can be seen in a more recent movie, DodgeBall, a True Underdog Story [2004], where at the end of the movie good guy Vince Vaughn tells bad guy Ben Stiller that he has bought Stiller's company and is firing him. This cannot now happen. Vaughn would not be allowed to even begin buying stock in Stiller's company, with the intention of a buyout, without warning Management, i.e. Stiller, what he is up to. Otherwise the Securities and Exchange Commission is going to be mad, and Vaughn is liable to end up marched into a courtroom and smeared in the press as, well, a 21st century Gordan Gecko. Perhaps he and Martha Stewart can room together at Club Fed.

6. Big corporations become inefficient. Some people hear the phrase, "economies of scale," and think that it means the bigger, the better. The explains much of Stalinism, even before we hear about the Communism part. Part of that was wishful thinking. If companies get bigger and bigger, and eat all the competition, and are the last ones standing, then it is a simple and natural step to nationalize them. Nothing messy about it. Have all the public own the company rather than just some selfish stockholders. That's how we got the Tennessee Valley Authority (TVA) during the Stalinist-wanna-be New Deal. Indeed, there would be nothing more natural than such a transition, so long as bigger is better. If it isn't, this throws a different light on the matter. Big corporations do get to be rather like governments in that their internal dynamic starts to become political and bureaucratic rather than economic. Any kind of office politics is bad enough, but when such things start to determine the management of the company, disaster is likely to follow. Also, if market prices send essential signals about supply and demand, then when a company becomes large enough, it may be difficult to determine the efficiency of producing one product that simply becomes an input in another part of the company. In other words, we start getting a mini-command economy, and the other problems of Stalinism, apart from mere bigness and bureaucracy, begin to be felt. In a company of any size, various kinds of inefficiencies are likely to become a problem. The virtue of a market economy is the ultimate test of the ability of a company to deal with them, i.e. whether they can still earn a profit against their competition. If not, then they are going to be bought, reorganized, or bankrupted. The "natural" process of bigness, monopoly, and then nationalization unfortunately allows the process of inefficiency and irrationality to continue without a check. Politics and bureaucracy quickly become the dominant forces. Thus, the saying about the British National Health Service is that "useless work replaces useful work." Anyone working for a large organization will see something of the sort begin to happen eventually. In a government, it is inevitable, unless the dead weight is ruthlessly cut away with some regularity. Whether that gets done at all depends, indeed, on the politics.

Editorial Note

Several of these principles have been enunciated by the great economist Walter Williams. Also, I believe that corporate profits going to "widows and orphans" is a recollection of Ben Stein about one of his economics professors. I cannot say that giving credit to them for these ideas constitutes agreement with all they say. Walter has an embarrassing habit of defending the Confederacy, while Ben has lately jumped on the anti-Darwinian bandwagon that has become popular with a good many foolish conservatives. This simply goes to show that generally sensible people can have blind spots, or be confused in certain areas -- like Arnold Schwarzenegger becoming a Global Warming enthusiast.

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Copyright (c) 2008 Kelley L. Ross, Ph.D. All Rights Reserved

When the Clinton Administration was promoting an increase in the minimum wage, and Hillary Clinton met with a group of small business owners, one of them, who owned a pizza restaurant, complained that the increased cost might put him out of business. Clinton responded that the Administration "can't be held responsible for every undercapitalized business." It would be an interesting study in what politicians know of economics to figure out what she meant by this.

"Undercapitalized" simply means that not enough money has been invested in a business to get it up and keep it going through the period before it can turn a profit. In those terms, Clinton's answer was besides the point. With increased costs, greater capitalization would simply delay the time when the business could turn a profit, perhaps permanently, while a business already profiting at the margin could be pushed into the red and possible bankruptcy. So the problem of the business there is not undercapitalizing, it is costs imposed by government mandate.

Another way to look at this, however, is if greater capitalization increases productivity, which means that equal or greater production can be effected even with fewer workers (the dynamic that makes Say's Law possible). The "undercapitalized" business thus would be one that cannot reduce its workforce and make the productivity of the workers match the increase in wages. This interpretation of Clinton's statement would thus translate it into, "You need to invest more in your business so that you can fire people and reduce your workforce." It is unlikely to a certainty, however, that Clinton would make such a blunt statement in public. The headlines at the New York Times would scream, "Clinton Tells Business to Cut Jobs!" This is not a policy that any Administration would want to be seen promoting.

It is thus hard to say if Clinton actually understood the meaning of her own answer.

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