The law giveth,
And the law taketh away.
Debt to debt,
Assets to assets.
Law is in general important but in the case of the corporation it is defining. Corporate law creates the corporation. It would not exist without corporate law because the corporation is a product of the law. It is a legal fiction whose presence is defined, determined, and dependent on the law. Few other parts of the law have such powers of creation.1
That power of creation makes corporate law a remarkable tool of influence. Since, as has been described previously, the corporation is one of the most important institutions in our lives, touching on virtually every aspect of them, the way in which the law influences this creature, which is of its own making, is of profound significance. It has the power to let a genie out of the bottle that can be our guardian angel or our malevolent destructor. As described in Chapter 1, it is currently poised somewhere between the two. To ensure that it delivers us from evil into ecstasy, we need to understand its basic function.
Company law is regarded as being the source of rights and rules imposed on its constituent members. It defines the basis on which the legal entity is established and the obligations on those who comprise it. It is a set of rules that define how the corporation is structured and conducts its affairs. As such it is like a toolkit that defines the framework around which the corporation is constructed.
The traditional view of corporate governance described in Chapter 5 mirrored this notion of corporate law. It saw the governance of the company as delivering on the framework established by law in promoting the interests of the company for the benefit of its members. The law defines the rules, and corporate governance adopts them. It is the basis of the plethora of regulatory rules that will be discussed in Chapter 8 and the conventional delineation between the state and business—the former sets the rules by which the latter plays for gains.
This book argues that this conception of the corporation and its relation with society is incorrect and that the conventional separation between state and firm has been damaging and unrealistic. This is reflected in a misconception of the nature and role of corporate law. It should not simply be considered as a set of rules that define rights and responsibilities and what firms can and should do, but instead as a way of allowing different parties to commit to the common purposes that the corporation promotes. The remarkable contribution of corporate law has been to provide commitment devices that bind people and organizations together in such a way that they fulfil purposes that would otherwise be infeasible.
Commitment is a complex concept in regard to individuals but it is largely absent from a corporate context. Contracts, control, incentives, and fiduciary duties feature prominently, but commitment does not. The reason is straightforward: it is not thought to be credible. It is not credible to think of commercially oriented institutions sustaining relations of trust. We would be remarkably foolish to commit something or someone to the care of an individual let alone a corporation whose sole interest is focused on enhancing its own well-being. We would be naïve to entrust our property or possessions let alone ourselves without watertight contracts or strong incentives that aligned the interests of the corporation with our own.2 But that is precisely what nearly all commercial transactions and relations rely on, and until we have conceived, created, and confirmed the concept of corporate commitment we will not understand the functioning of corporations or the economies within which they operate.
Corporations are not first and foremost mechanisms for enforcing contracts or imposing incentives but vehicles for upholding commitments.3 The law plays a critical role in this by allowing companies to make and sustain commitments through the types of ownership and governance arrangements that were described in Chapters 4 and 5. This chapter will describe how the law does this by conceptualizing what is meant by corporate commitments, and considering how corporations create and consolidate them through their ownership and governance arrangements. It will distinguish between laws that enable, empower, and enforce conduct that is consistent with commitment and those that require, restrain, and restore it. It will contrast forms of commitment that are self-regarding in furthering the success of the company itself4 and those that have a wider social purpose in promoting the interests of communities and societies beyond the firm.
Consider these statements by some US corporations of their ‘corporate commitments’:
As a responsible global citizen, Formica Group has established numerous programmes of environmental management reflecting our belief that significant action must follow good intentions and ambitious goals.
We continually develop strategies that enable us to move toward sustainability with efforts to:
• reduce energy use throughout the life of our products;
• reduce carbon emissions by developing renewable energy sources, waste-to-energy technologies and fuel-efficient freight activities;
• work with suppliers to increase recycled and eco-friendly content in our raw materials, making mandatory the use of fibres from sustainable forests.
Formica Group
At Columbia Group our customers’ success drives our success. We promise to provide the right resources with unrivalled expertise and the personal commitment to deliver superior solutions and facilitate your mission.
Columbia Group
By building an inclusive work environment, we help ensure that Lockheed Martin is able to attract, develop, and retain a diverse workforce that has the opportunity to showcase and develop their skills and abilities. We believe that all employees should have a safe and inclusive work environment––one in which everyone is treated fairly, with the highest standards of professionalism, ethical conduct, and full compliance with the law. From the CEO down, we are actively committed to promoting diversity and inclusion throughout our Corporation.
Lockheed Martin
At Northrop Grumman, we look at diversity and inclusion as being integrated into all our business practices. We take pride in creating a working environment where diversity and inclusion is valued and leveraged to foster creativity and innovation, thereby allowing us to meet the business challenges of tomorrow.
Northrop Grumman
Happy? Reassured? Our corporations are committed to looking after our environment, customers, and employees. Others are committed to looking after communities, suppliers, investors, the elderly, and the vulnerable. ‘From the CEO down’, they are committed to you, your families, and your descendants because we live in a world of committed caring corporations.
Well, we would be happy, if we had one iota of confidence in these statements. Our scepticism derives from the fact that we know full well that ‘from the CEO down’ what they are really committed to is their own and their owners’ interests, and ours and our societies’ only feature to the extent that they are consistent with theirs. Where they diverge then we know who will come off the better, and we do not expect it to be us.
Our scepticism derives from the fact that these are not in practice commitments in the conventional sense. Contracts are obligations to abide by statements, written or verbal, which are enforceable by law. Commitment is an obligation to abide by statements, principles, or values stated or presumed that are not enforceable by law. Corporate commitment is an obligation on the part of the corporation so to abide.
Commitment can be self-regarding, communal, and social. Self-regarding commitment benefits the provider by giving the recipient sufficient assurance of its irreversibility to encourage them to do things and in particular make investments that otherwise they would be reluctant to undertake. For example, they encourage employees to make firm specific human-capital investments in education and training that they cannot readily transfer to another corporation. They induce customers to make purchases from suppliers on whom they are then dependent for after-sales service. They are self-regarding in so far as they are reflected in the benefits, either priced or reciprocal, that the provider derives. In other words, they are consistent with, not divergent from profit maximization in improving the terms on which the corporation can trade by lowering its cost of employment, purchases, and capital and raising the prices it charges its customers.
Communal commitments confer benefits on the communities of which the provider is a part, the employees who work for it, the suppliers to and purchasers from it, and the locality in which it operates. Communal commitments may not confer direct pecuniary benefits on the corporation but they may derive non-pecuniary benefits of status and prestige, which at least in part convert them into being self-regarding. A corporation that is committed to socially responsible investing cares for its employees and protects the environment and is a respected organization for which employees are proud to work, with which customers and suppliers are keen to be associated, and which governments and nations respect. This may in part be reflected in a willingness of employees to work for lower wages, of customers to pay higher prices, and of governments to engage in greater procurement, but not all of the benefits will necessarily be reflected in enhanced profitability; some will remain external.
Social commitments extend beyond the provider’s community to society and nations more generally. There may not be any benefit that a corporation derives from adopting a policy of no corruption throughout the organization. On the contrary, it might forgo many commercial opportunities from so doing and derive little non-pecuniary benefit because its adoption is not widely appreciated. Its reason for implementing such a policy beyond its legal obligations may be because it believes it to be right or proper and for it to be inappropriate to do otherwise. Alternatively, social norms may encourage it to act in this way or there may be inducements that come from the provision of subsidies and taxes.
Commitments therefore relate to those components of obligations that are not enforceable by contract. Some of them are promoted by an alignment of incentives between the recipient and provider and some by more general forms of well-being that the provider might derive. In some cases, they reflect broader principles for which there may not be a direct profit motive.
Why are they needed? The significance of commitments derives from the fact that they are opportunity enhancing. In their absence the range of relations that can be sustained is constrained by those that are enforceable by contract or promoted by incentives. Most relations cannot be sustained in this way because they are dependent on the trustworthiness of the individuals and institutions involved and the trust that others have in them.
Many of the limitations on contracts and incentives come from conventional explanations—costs of writing and enforcing contracts, the impossibility of identifying all possible contingencies, and problems of what are termed the ‘observability and verifiability’ of outcomes by third parties, by which is meant the ability of disputes to be resolved in courts of law.5 Some of the limitations of contracts are more fundamental, for example, the inability of future generations to negotiate on contractual terms about activities that impinge on them.
The result is that contractual protection is imperfect, incomplete, and often altogether absent, leaving exposed those who do not have rights of contract or ownership. Instead, those parties depend on the trustworthiness of corporations acting with integrity, principles, and compassion in upholding their interests as well as those of the corporation. But what justifies that conviction?
This goes to the central proposition of this chapter that a combination of the ownership and governance of the corporation and the legal environment within which it operates determines both the ability of the corporation to commit to its stated purposes and the degree to which it credibly can do so. Furthermore, the combination of ownership, governance, and law allows the corporation to provide degrees of commitment beyond those of which individuals are capable.
At a personal level, the ability of individuals to commit derives from a combination of aretaic (virtue), deontic (obligations), and consequential considerations.6 It reflects character, rules, and outcomes. We infer the credibility of the commitments of others from their personality, family, upbringing, education, social background, and conduct. The problem this presents is that it is frequently difficult to evaluate these criteria and it takes a long time to do so. Only immediate family members may feel able to evaluate the character of their relations and the obligations that derive from being a part of the family. Even they may find it hard and slow to do so and still harder to establish how resilient their assessments are to adverse circumstances, such as the financial or personal stress of their relations.
As a consequence, the reliance that they or anyone else can place on their ability to evaluate the trustworthiness and commitment of others is very limited and they in turn respond by limiting the extent to which they are willing to trust and commit. To express this in more conventional terms, reputations take years to establish and seconds to destroy, and our inherent reluctance to engage in relationships therefore takes years to overcome and seconds to justify.7
The commitment capability of the corporation derives from the fusion of finance and administration that was the innovation in the evolution of the corporation from the guilds in Britain and the partnerships (societas) in Continental Europe described in Chapter 3.8 The presence of the owners provides a constraint on the administration—the management—and the management limits the latitude of the owners. What this does is to allow the corporation to provide checks on the conduct of individuals to ensure that they abide by their statements, principles, and values. That is what ownership and corporate governance are concerned with or rather should be concerned with but that is not how they are currently conceived.
At present, ownership and corporate governance are perceived as being about aligning the interests of management with those of shareholders and the exercise of control by shareholders to do so.9 Shareholders are the owners of the corporation and those entrusted with running it therefore owe the shareholders a duty to act in their interests and maximize the returns on their investments. They have a fiduciary responsibility to act with care, diligence, honesty, and loyalty at all times to their shareholders. Corporate governance is about ensuring that they do so through the accountability of management to shareholders, the information that is provided to shareholders for them to monitor the performance of the firm, the incentives that align the interests of management with those of shareholders, and the control that shareholders can exert to ensure that their interests are upheld.
What is wrong with this is the premise. As discussed in Chapter 5, corporate governance is not about aligning the interests of management with shareholders. It is about ensuring that the corporation abides by its stated purposes, values, and principles at all times. It is about confirming the basis on which the corporation can credibly commit to other parties in the delivery of its purpose.
It might be thought that promoting shareholder interests and establishing corporate commitments are equivalent if the commitments of the corporation are solely designed to enhance shareholder value, i.e. they are purely self-regarding. But even this would be incorrect for several reasons. First, corporate governance as currently conceived is not about the creation of commitments. It is about the rights of shareholders and the responsibilities of directors to act in their interests, not about the self-imposed restraint that both may have to demonstrate to create credible commitments to each other. In particular, restraints on the activities of shareholders have not been a focus of the corporate governance literature to date. Second, theories of corporate governance that emphasize shareholder interests fail to recognize the diversity of shareholders reported in Chapter 4. It is only comparatively recently that the divergence of interests between block holders and minority shareholders has been appreciated and still more recently that the potential conflicts between short- and long-term shareholders have been acknowledged.
Self-regarding commitments raise questions about whose self we are regarding—block holders or minority, short-term or long-term shareholders? More generally, they suggest the inclusion of other parties, such as employees, suppliers, distributors, and customers. The justification for this is not some normative argument about enhancing the welfare of others but a pure economic efficiency one that, in the absence of broader commitments, the relations that the corporation can sustain are restricted and its efficiency constrained. For example, employees that do not trust their employers, suppliers who do not trust their customers, and customers who do not trust their suppliers withhold their labour, supplies, and custom. In the absence of credible commitments to protect them, they restrict their participation in commercial transactions below the level at which they would be willing to engage with trustworthy firms.
Companies that are incapable of sustaining credible commitments to their vulnerable counterparties are impoverished in relation to those that can. Put simply, in a world in which contracts are incomplete, unenforceable, or infeasible, then the ability to commit and sustain relations of trust is critical to the scope of economic activity. We should encourage commitments to engagements that extend beyond the purely self-regarding because they are enriching in every sense of the word.
The corporation’s existence derives from the law. The law establishes the corporation as an entity that is distinct from its individuals. It defines the various manifestations of the corporation and the boundaries within which it operates.10 Corporate, securities, competition, commercial, and public law all contribute to the identification of the corporation.11
In creating the corporation, the law determines its characteristics. It does this by defining the permissible forms it can take: who owns, who controls, the responsibilities of different parties to each other, the information that they have to provide, and the powers that they can exert. Together these determine the nature of the corporation. They are the corporate genome from which the genetic make-up of a particular corporation, as reflected in its ownership and governance, is derived. One of the characteristics of the corporation that the law, ownership, and governance determine is its ability to commit to its corporate purpose. To date, corporate law and governance have failed to recognize their significance in this regard, and the next section attempts to rectify this by describing how they achieve it.
The way in which the law impinges on commitment is in establishing the range of relations a corporation can sustain. If the law states that the only obligations of class X of individuals can be to class Y of individuals then the range of relations that can be sustained is restricted to these two sets of individuals. It makes precise the nature of permissible relations of the corporation. Another society that permits the relations of class X of individuals to be with class Z as well as Y is potentially a richer one in a literal as well as metaphorical sense of sustaining a broader set of relations than that of the first society. However, by restricting permissible relations to a more narrowly defined class, the first society might assist its corporations in committing to a more restricted set of relations and, in so doing, may enhance not diminish its economic efficiency relative to the second society.
For example, if corporate law states that the responsibilities of the directors is solely to their shareholders then this prevents a broader range of stakeholders from exerting influence over them. This might be deleterious in preventing the executives from being accountable to their creditors, customers, employees, or suppliers, but it might be advantageous in making precise their obligations and preventing the executives from switching their allegiance at a future date from one party, such as the shareholders, to another, such as the employees. It is not therefore possible to determine a priori whether an exclusive or inclusive corporate form is preferred.
Enabling legislation is permissive in allowing corporations to adopt a range of different forms. It provides a broad framework within which corporations are free to select a particular structure that is suited to their activities. In particular, it allows corporations to define the ownership and governance arrangements that establish the degrees of commitment that they provide to different parties. The recent introduction of the benefit corporation is an illustration of a legislative innovation that permits of a greater variation in corporate form than previously existed.12 The creation of limited liability partnerships at the beginning of the 1990s is another example.13
Chapter 5 described how the UK Companies Act privileges shareholders over other parties to the firm notwithstanding its reference in s.172 to the obligations on directors to take other party and long-term interests of the company into account. In practice, directors to date have paid scant attention to those other interests on the presumption that the force of the law favoured shareholders. The existing law could encompass more diverse forms by describing alternative models, for example, stakeholder participation models that grant rights of information and representation to employees and other stakeholders, or shareholder privilege models that confer greater control rights on long-term and engaged owners.14
Legislation enables corporations to empower different parties. Traditionally the two groups who are empowered are the shareholders and the directors of a corporation. Their spheres of influence are different, relating respectively to the property rights that are associated with the ownership of shares and the duties of administration of the employment of that property. However, entitlement need not be restricted to shareholders and directors, and could be extended to other parties such as employees, customers, and communities. They too could be granted access to information about the performance of the corporation in regard to their interests and rights of representation in relevant decision-making processes.
Associated with the allocation of rights are the liabilities arising out of them. The responsibility of the corporation to different parties creates obligations that in turn establish liabilities for actions taken or intended.15 With the attribution of claims comes access to information about the status of the claims and the liabilities arising out of those claims. For example, if employees are empowered to have influence over corporate decisions then they should be party to relevant information on the performance of the corporation and their claims on the organization arising out of it.
As described in Chapter 6, accounting conventions and measures of performance should reflect the stated objectives of the corporation, and the commitments to employees, customers, or communities should be reflected in associated liabilities in income and balance-sheet statements. Different parties to the corporation should therefore have the information on which to judge whether it is abiding by its stated purposes and values. For example, benefit corporations are required to provide precise information on how they contribute to their social as well as private purpose.
Once endowed with rights, the relevant parties should have powers to enforce them. These powers may derive from voting within their particular class, voting corporately in conjunction with other classes, initiating class actions, or publicizing the opinions of members of the class in social media. Where the directors of a corporation fail to uphold the interests of the relevant party then it should have the right to have the deficiency remedied and compensated. Such remedies may result from enforcement through the courts, the ballot box, and the media.
In sum, there are three forms of legislation that facilitate the provision of corporate commitments: enabling, empowering, and enforcing legislation. Together these define available corporate arrangements and forms of corporate commitment. However, legislation may not only be permissive in facilitating the establishment of different corporate structures, but also prescriptive or restrictive in requiring corporations to abide by particular conventions.16
To date we have presumed that commitments are voluntarily entered into to enhance the value of the corporation for self-regarding reasons. The question is whether there should be obligations beyond those to which parties voluntarily agree to abide. The answer is yes if corporations do not address communal and social commitments adequately and thereby fail to internalize externalities that more socially oriented corporations would internalize.
In particular, the requirements of corporations will relate to their provision of human, intellectual, natural, and social as well as financial and material capital. There may be obligations to enhance human, intellectual, natural, and social capital beyond the levels that organizations would voluntarily choose. Corporations should be required to refrain from pursuing purposes and engaging in activities that could be detrimental to the maintenance of these forms of capital and to invest in those that would benefit from enhancement. There should be a requirement to make good failures and restore detriments where damage has been done.
In other words, there are three forms of legislation that regulate corporations: requiring, refraining, and restoring legislation. Together with those that establish corporations—enabling, empowering, and enforcing legislation—they provide the legislative framework within which corporations can determine their particular structures and processes. Legislation and governance together, then, define the nature of the corporation and its ability to commit.
The transformation of what is possible into what is realized is achieved through the ownership and governance of the corporation as described in Chapters 4 and 5.17 The ability of the corporation to display self-regarding commitment derives from its ownership. Long-term owners endure the consequences of their actions; short-term owners may not, particularly if the consequences of them are not fully evident before the disposal of their shares. Long-term owners are therefore able to provide a menu of credible commitments that short-term owners cannot.
Neither is capable of offering commitments that extend beyond self-regarding ones without further assistance. That assistance comes from the governance of the corporation. There are three components to corporate governance: the articulation of values and principles; accountability and accounting for liabilities attributable to the values and principles; and attribution of responsibility for attainment of the values and principles and adjudication over their allocation between different parties. The combination of articulation, accountability, and attribution allows for communal as well as self-regarding commitments. This can be illustrated in the context of the corporate commitment statements quoted at the start of this chapter.
This was Formica Group’s statement about sustainability:
These statements raise three questions. Question 1: does this statement by Formica mean continuously reducing the use of the volume of all forms of energy used in all of its products? Question 2: what has been the substitution between conventional and renewable energy sources and the overall level of carbon emissions? Question 3: what are the target levels of increase of recycled content in raw materials and what precisely is meant by eco-friendly content? In other words, values and principles need to be specific and have measurable goals and targets for them to carry conviction and content. The values and principles by which the corporation will abide need to be clearly and precisely stated. By their articulation and specification they should create obligations and responsibilities on corporations that are persuasive and precise.
To illustrate accountability, consider the statement by Lockheed Martin: ‘Lockheed Martin is able to attract, develop, and retain a diverse workforce that has the opportunity to showcase and develop their skills and abilities.’ Northrop Grumman made a similar statement about diversity. How should diversity be measured and what are its target levels in regard to new recruitment and retention of existing employees? What are the financial liabilities associated with these diversity targets and how are they reflected in Lockheed Martin and Northrop Grumman’s accounts? Arising from the stated purposes and values, there should be associated liabilities that are reflected in corporate accounts. As suggested in Chapter 6, the content of corporate accounts should correspond with the purposes of corporations and be tailored to their particular needs. Accounting statements should be consistent with corporate purpose statements.
Finally on attribution, consider the next part of Lockheed Martin’s statement: ‘We believe that all employees should have a safe and inclusive work environment––one in which everyone is treated fairly, with the highest standards of professionalism, ethical conduct, and full compliance with the law.’ Who is responsible for ensuring safety? Who adjudicates on the fair treatment of employees and the resolution of disputes between employees and between employees and their employers? There should be a group of individuals in Lockheed Martin who take responsibility for these statements, bear the consequence for upholding them, and arbitrate disputes between different interested parties.
In other words, what converts these assertions, to which at present we attribute little significance or credibility, into credible commitments of substance is precision in their articulation, accounting for their implementation, and allocation of responsibility for upholding them and bearing the consequences of a failure to do so. Without that precision, measurement, and responsibility, the statements are vacuous; with them, they are powerful assertions of binding commitments that have consequences for the corporation in terms of its profitability and for individuals within it in relation to their careers and reputation for a failure to deliver.
By articulating clearly in whose interest the corporation is run, making the corporation explicitly liable to those parties, accounting for those liabilities in a transparent way, and making someone specifically responsible for ensuring that the corporation does not deviate from its stated purposes, it is able to offer credible commitments to other parties. By empowering other parties, allowing them to enforce their rights, and making individuals within the organization accountable for this, the corporation can extend its commitments beyond the self-regarding interests of its owners to those of other members of its community. The scope of self-regarding commitment has been broadened by making other groups parties to the corporation and conferring rights on them that are analogous to those of shareholders. In other words it has converted them into meaningful ‘stakeholders’. The mere act of requiring companies to articulate their purposes and demonstrate a credible commitment to their delivery will, in and of itself, be transformational in reforming the corporate landscape.
Nevertheless, the domain of commitment remains within the confines of those that the corporation embraces as part of its community through empowering them with rights as stakeholders. It does not extend to society at large whose members do not have a specific claim or right of enforcement on the corporation. To protect them, the corporation will have to act in trust in promising to uphold their interests. In so doing, the owners of the corporation will have to relinquish control rights to others, such as a board of trustees, whose responsibility is to third-party members of society.18 So while Lockheed Martin and Northrop Grumman can credibly uphold the commitments to their employees by empowering and conferring appropriate rights of enforcement on them, the Formica Group can only deliver on its promised environmental protection by holding those promises in trust for society at large. To be able to do that then there will have to be individuals in the corporation endowed with the necessary authority to act as trustees for society at large.
This is an effective way in which corporations can commit. By creating a board of trustees, the owners of a corporation relinquish control and confer it on a board of directors responsible for upholding the values of the corporation. It is the responsibility of the trustees to ensure that the interests of those parties for whose benefit the corporation is run are respected.19 On appointment, the trustees become the guardians of the values of the corporation. It is so powerful a form of commitment that it should be applied with caution because in the process of disenfranchising the owners, it places immense reliance on a board of trustees to provide effective governance of a corporation with little or no accountability for their actions.
As described in Chapter 1, it is a technique that has been used very effectively in industrial foundations which some of the most successful European corporations, such as Bertelsmann, the media company, Robert Bosch, the automotive supply company, Carlsberg, the brewery, Ikea, the furniture retailer, and Velux, the window manufacturer, have adopted.20 It is also the organizational form of the Indian conglomerate, Tata and the US chocolate manufacturer, Hershey. These corporations are controlled by boards of foundations that are responsible for ensuring that they abide by the principles and values of the foundations. In many cases, the foundations have a charitable purpose. They were often created by founders of the companies who were concerned about succession and sought to avoid problems of inheritance by transferring control from their heirs to a body with a philanthropic and public purpose. Below the boards of the foundations, the corporations have operating boards that are responsible for formulation of corporate strategy and below these are executive boards that oversee its implementation.
Notwithstanding the fact that the industrial foundations are in essence ownerless corporations with self-appointing boards that are not externally accountable, and that the corporations are insulated from the discipline of markets for corporate control, their performance has been strikingly good. There are many possible explanations for this but the most compelling is the value that all employees from the board of directors downwards place on contributing to an organization that has public and social as well as private purposes. In other words, industrial foundations are able to command the trust and respect of their stakeholders through abiding by social as well as self-regarding and communal commitments.
The power of the corporation to commit therefore derives from its ownership and governance and its ability to align these with its commitments. Short-term owners can avoid commitments of any form. There may be drawbacks as well as advantages associated with commitments in imposing obligations on corporations which they would wish to avoid, and short-term ownership allows the corporation to do that. Long-term owners can sustain self-regarding commitments. Empowering stakeholders allows corporations to provide commitments to their broader communities. Separating ownership and control by creating a board of trustees allows the corporation to provide social as well as communal commitments.
The flexibility of the corporation to commit reflects two features of it. The first is its ability to assign responsibility to directors to act as agents of shareholders alone, as agents of stakeholders as well as shareholders, or as trustees of society at large as well as shareholders and stakeholders. The second is its ability to allocate property rights equally and proportionally to all shareholders or to concentrate them in the hands of certain classes of, for example, long-term shareowners as against short-term shareholders. The first feature of the corporation’s governance determines the cross-sectional breadth of its commitment to different parties, namely whether it is self-regarding, communal, or social. The second feature of the corporation’s ownership affects the inter-temporal length of its commitment horizon, namely whether it is of long or short duration. Together with the depth of capital committed, the product of the length, breadth, and depth establishes the volume of committed capital.
The degree of trust that the corporation’s communities and societies place in it is a function of its volume of committed capital.21 In the absence of full protection from complete and binding contracts, it determines the terms on which different parties (customers, employees, investors, and suppliers) are willing to trade and invest in it. The volume of committed capital therefore affects the prices the corporation can charge its customers and its cost of capital, labour, and material inputs. It therefore influences the corporation’s capital structure, employment, and investment, and it bears critically on its performance measured in both conventional profitability and broader stakeholder and social terms.
In essence, what commitment and the structures associated with it do is to place the corporation in a social and political context. The corporation can be the narrow self-regarding instrument with which economics and finance traditionally associate it, concerned with the interests of its owners and its executives alone. Alternatively, through relevant legal, ownership, and governance forms it can extend its obligations to other parties in the corporation such as its employees, suppliers, and local communities, or it can go beyond that in creating responsibilities to societies and the public at large. The corporation should therefore be regarded in a system as well as an individual entity context, and sociology and politics bear on it not just through the duties that society and nations impose on it but through the commitments that it makes to them.
The structure of ownership and governance gives the corporation a ‘personality’. As described in Chapter 2, this has normative virtues associated with it that derive from the purposes and values of the corporation. These in turn establish internal norms and rules, which together with those externally imposed by society through regulation create obligations that constrain the behaviour and conduct of the corporation.
What makes the ethical basis of the corporation and its power to commit potentially stronger than that of individuals is the juxtaposition of its ownership with the control exercised through its board of directors and the public manner in which its purposes and values are stated. These make the character of the corporation transparent in a way in which it remains opaque for individuals, and allows the corporation to provide commitments that are more credible than those of individuals. In the terms of Chapter 2, they allow our individual mintegrity to be converted into a corporate maxtegrity. Whereas economics typically places welfare analysis in a consequential framework, its basis in the corporation can equally be a reflection of virtues and obligations.
Europe provides illustrations of all these forms of corporations and corporate commitments. The United Kingdom, in particular, with its dispersed ownership is dominated by short-term shareholders rather than long-term shareowners, and is therefore a low commitment economy. UK corporations can avoid the commitments that constrain their counterparts elsewhere and thereby demonstrate a greater degree of flexibility to changing circumstances. Nordic countries confer control on long-term owners, in particular families, who are actively engaged in the oversight of corporations. These long-term owners are able to uphold self-regarding commitments. Central European countries, such as Austria and Germany, confer control rights on stakeholders, in particular employees, as well as shareholders through workers councils and co-determination on supervisory boards. These allow Austrian and German corporations to offer credible communal commitments beyond those that are self-regarding. In the industrial foundations of, in particular, Denmark, founders of corporations relinquish control rights to a board that is responsible for ensuring that the corporations act in trust for the philanthropic benefit of other members of society. The foundations are therefore able to offer social as well as communal and self-regarding commitments.
The combination of enabling legislation, ownership, and corporate governance allows corporations to fulfil a range of communal and social as well as self-regarding functions. Where corporations do not or are unable to offer the level of commitments that society demands of them then it resorts to prescriptive regulation in place of permissive enabling legislation. In other words if corporations do not demonstrate the levels of commitment that society requires of them then they sacrifice their powers of self-determination to externally imposed restrictions on their activities. It may therefore be in the interests of corporations that they provide the forms of ownership and governance that allow them to offer the levels of commitment which communities and societies demand of them.
The attainment of particular levels of communal and social engagement would require high levels of regulation in the United Kingdom to compensate for its low levels of corporate commitment, modest levels of regulation associated with industrial foundations that sustain high levels of social commitment, and intermediate levels in Central European countries where corporations provide commitments to stakeholders but not society more generally. However, nations are constrained in terms of the regulations that they can impose to correct for deficient corporate commitment by the impact that these have on the efficiency and commercial performance of their corporations. So, marked variations in levels of trust across countries persist, with consequences for the nature of both corporations and the societies within which they operate.
Ownership and governance determine the balance between permissive, establishing and restrictive, regulating legislation. The longer the controlling ownership of the corporation, the broader the scope of corporate values and principles, the greater the accountability of the corporation to its stakeholders and the clearer the attribution of responsibilities for upholding values and principles, the less the need for regulation and the greater the potential diversity of corporate forms and commitments. The advantage of this is that it allows for a richer set of commercial arrangements that in turn promotes economic efficiency and well-being.
In contrast to the enriching nature of enabling legislation, the drawback of regulation is that it is essentially retrospective and restraining in limiting potential commercial arrangements. Therefore, if corporations can themselves demonstrate a credible ability to commit then legislation will be available to provide the framework within which corporations have the latitude to do this. If, on the other hand, the willingness of corporations to commit is weak then legislation will have to fill the gaps through the imposition of regulatory rules.
This chapter has pointed to the centrality of commitment in the functioning of corporations and economies. Why have we failed to recognize corporate commitment to date? The answer is that we have not always failed to recognize it. As described in Chapter 2, charters originally endowed corporations with public purposes. At that stage commitments were intrinsic to the corporation. With freedom of incorporation the intrinsic commitments were relinquished. Nonetheless, so long as the corporation remained in family ownership then commitments were synonymous with the values of the families. As ownership became more dispersed it was the board that could commit, safe in the knowledge that the degree of control that shareholders would in practice exercise was limited. However, in an attempt to address the resulting agency problem through markets for corporate control, discretion of management became progressively more constrained to a point at which it was subsumed in shareholder-value maximization. Furthermore, the horizon of shareholders diminished with the shortening duration of shareholdings and, in the process, the latitude to commit was extinguished.
The consequence has been a futile attempt to rectify this by seeking ever more extensive contractual arrangements and imposing tougher regulatory requirements that constrain the commercial potential of the corporation. We need to break out of this destructive spiral of declining commitment and intensifying regulation by conceiving what corporate commitment is capable of achieving and creating the context within which it can realize its full potential to perform communal and social as well as self-regarding purposes. Otherwise, as Chapter 8 will reveal, regulations that not only distort but also threaten greater financial instability than the crisis of 2008 will inevitably intensify.