Myth #2: Companies compete by trying to best respond to the needs of society
In March 2019, almost exactly six years after Rana Plaza, I found myself in a room full of rebels planning peaceful acts of civil disobedience. The objective of the meeting was to force political action on climate change.1 This was not a ragtag pack of rabble-rousers, these were my peers: philanthropists, scientists, lawyers, politicians, students, and one sixteen-year-old girl, busy with exams and teenage life, who told us about how one day she was so overcome with grief for the fate of her generation that she sat down in the street and wept.
The degradation of the planet is proceeding at a devastating pace, with the impact of human activities driving each one of the planet’s vital ecological systems, from the climate to the freshwater cycle, to the brink of catastrophic failure. It could be five, ten or twenty years until we face social and environmental collapse, depending on your levels of optimism.2 By some estimates, the temperature of the planet is set to rise by almost 5°C by the end of the century, bringing with it floods, droughts, storms and a rise in sea levels that will jeopardize all life on Earth.3 We have over-exploited the agricultural land, the water and the fisheries, as well as using them as dumping grounds for waste and plastic. The list goes on.
Accepting the reality of climate change invites cognitive dissonance: companies compete by trying to best serve our needs, driving forward innovation and allocating resources in the economy in just the best possible way – how can this have led to ruin? The existential threat faced by our species, after decades of careless disregard for the natural systems on which we depend, is as stark an example as can be found of our supposedly rational, just, innovative and generous economic system being anything but. An efficient and desirable system does not destroy itself with its own emissions, and it would not harm the most vulnerable and marginalized first.
We have had plenty of warning that the profit-is-everything way of doing business might be our undoing. On the night of 20 April 2010, in the Gulf of Mexico, there was an almighty explosion at the Deepwater Horizon oil rig, operated on behalf of oil giant BP.4 Highly combustible gas flooded the rig, coating the crew from head to toe as they ran for cover from shrapnel and debris. Those who could, piled into the lifeboats as the smoke and heat began to overwhelm the workers stuck on the rig’s deck. Some jumped the sixty feet into the water and swam for their lives. The rig began to leak what would end up being 4.9 million barrels of petroleum into the ocean. This was the largest marine oil spill in history, which would take eighty-seven days to get under control. The disaster killed eleven people, hundreds of dolphins, over 100,000 birds and billions of fish. The environmental damage was catastrophic.
The cause? Running weeks behind schedule and tens of millions of dollars over budget, BP and its contractors implemented dangerous cost-cutting measures in the construction of the well. Eager to close up what was known as ‘the well from hell’, as the project neared its end, the crew were encouraged to drill fast and get out of there. Meanwhile, despite daily safety briefings, the crew had not been trained for the worst.
The Deepwater Horizon oil spill is a poignant example of one way in which the free market logic can come unstuck, when a steely-eyed focus on profits and nothing else causes a company to make decisions that clearly do not serve the public good, and in fact are not even in the company’s own best interests. BP had to pay out $65 billion in compensation. The planet picked up the rest of the bill.
The myth of efficient and competitive free markets relies on another myth: the myth of the efficient company. The economics of free market competition assume that firms will seek to maximize profits, and that this is what drives efficiency. Capital will never rest, it will constantly search for a better investment, a better return, and, in the meantime, consumers benefit from cheap goods whilst their every priceable need is met. Owners of capital will receive some profit, enough to make a living, to compensate them for putting their money to work instead of spending it on themselves. Since companies are so miraculously efficient, and creative, and innovative, and since this means we will get the most economic output and the best allocation of resources we could hope for as a society through corporate self-interest, this myth leaves us so very grateful to the investors that make this sacrifice to finance our corporations and therefore our society.
But companies can choose how they make their profits – how to pursue power and returns for shareholders ‒ within what the law will allow, and the law currently allows the expulsion of many costs from the corporate balance sheet over to the societal balance sheet, all under the principle of ‘shareholder value’. Antitrust does not consider this unfair competition and does not recognize this sort of power.
The protection of shareholder interests, in and of itself, is a sensible idea. Shareholders invest their money, they do not always get to control how it is managed, and the law of corporate governance is partly there to make sure that unwitting investors are not taken advantage of by lazy or wasteful executives. Shareholders accept the risk that they may receive no return for their investment, may even lose their original contribution, but they do so on the back of the enticing promise that they have some claim over the company’s gains, and it therefore makes sense that they would want the managers of the company to work towards securing those gains. But taken to the extreme, as it has been by modern economists, legal scholars and business people themselves, ‘shareholder value’ creates a duty not just to consider shareholder interests but to prioritize them above all others, to equate shareholder ‘interests’ with financial returns only, and not just to deliver such returns but to ensure their maximization.
Shareholder value took hold as a business strategy in the 1970s. How did companies lose all sense of responsibility other than to shareholders? How did the principle of shareholder value become entrenched? And why do we continue to assume that this lack of responsibility will somehow serve the public interest?
The most famous, or indeed infamous, defender of shareholder value was Milton Friedman. Friedman and I have two things in common: we are connected via my husband’s grandfather, who was one of his PhD students at Chicago, and we are both five foot two. He was known to be loud and argumentative (okay, maybe that’s three things we have in common) and he was obsessed with free markets ‒ he even made a TV show about it.
Neoliberal thinking on corporate governance took shape in the context of the post-war economy in which the future of the free market stood imperilled. This spurred Milton Friedman, Friedrich Hayek and other disgruntled economists to form a free marketeers club – the Mont Pelerin Society – founded to save market liberalism. Their campaign to rehabilitate free market capitalism, and to protect the freedom of capital from state control, was astonishingly successful, and Friedman himself, through his single-minded and relentless focus, had a huge impact on economic policy and the business world. Most importantly for our inquiry, he lent intellectual rigour to the concept of shareholder value.
One of his most influential pieces of work was, in fact, not a peer-reviewed journal article or his Nobel-winning research. It was an op-ed piece in the New York Times Magazine, published in 1970. Titled ‘The Social Responsibility of Business is to Increase its Profits’, it is often cited as the seminal pronouncement on shareholder value.
Shocking readers at the time, Friedman argued that it is the only proper goal of business, and indeed its social responsibility, to maximize profits for the benefit of shareholders.5 Managers should not get distracted by trying to use private money for public good. In fact, this would imperil the efficiency of the company. Instead, companies should be run on behalf of their shareholders only. In a free market, so the mantra goes, the rest will take care of itself.
What Friedman was fighting against at the time was what he, and others in the Chicago School, perceived to be the ‘already too prevalent view’ that the ‘pursuit of profits is wicked and immoral and must be curbed and controlled’.6 The profit motive is so universal now that it can be hard to remember a time when it was thought of as abhorrent, but when Friedman started waging his campaign, just after the Great Depression, unregulated capitalism lay manifestly discredited.
According to Friedman, though, shareholders should be free to make money through corporations, and express themselves as consumers and investors through the markets. The highest possible good would flow from this self-interest. The opposite view – that business should take on broader responsibilities – was, for Friedman, one step removed from communism. It was as bad, possibly worse, than government itself intervening in markets. Writing in the midst of the Cold War, he argued that businessmen who say that business should not ‘merely’ be focused on profit, but should be concerned with providing employment, eliminating discrimination, or avoiding pollution ‘are ‒ or would be if they or anyone else took them seriously ‒ preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.’7 In promoting shareholder value, neoliberal thinkers like Friedman felt themselves to be ‘foot-soldiers in the fight against communism’.8 Accommodating social responsibility within the corporation, he thought, would push free market America ever closer towards Soviet collectivism and totalitarianism.
There was a time when doing business did not necessarily mean operating a company. Before corporations, if you wanted to join assets or resources with someone else, you had to come up with a complex contract to set out all the terms and distribute all the financial risks, and you had to do that every time. Economist Ronald Coase took this inefficient system as a basis for why the business firm must exist. Coase’s insight was that forming a company would have a distinct advantage over repeated, ad hoc interactions between individuals operating in the market: it would limit the ‘transaction costs’ of entering into new contracts every time you wanted to get something done.9 What had to be done through contracting on the market could be smoothly achieved with a kind of command and control in the hierarchy of a company.
In the 1930s, Coase, then a young socialist, visited Detroit and pondered how people could be so opposed to communist economic planning when the Ford Motor Company, a large and vertically integrated firm, was in essence a privately owned, planned bureaucracy, not unlike the Soviet Union. For Coase, the difference between the two was efficiency: the firm would limit its scale, the boundaries of its domain and its extent of integration with competitors and suppliers, to that which was most efficient. The communist state could not be relied upon to do the same.
This view came to be highly influential in the Chicago School approach towards companies, and big companies in particular. But what Coase’s theory failed to acknowledge was that there may be a difference between efficiency-enhancing profit maximization on the one hand and spillover-inducing shareholder wealth maximization on the other, which can transform a company from a vessel for consumer welfare into a vehicle for power and externalities. Indeed, the firm’s boundaries are determined by what the market and the law will allow, not by efficiency. If pushing those boundaries allows for a greater financial return for investors, the shareholder value company will happily encroach on the public sphere to satisfy the need for profits. Efficiency poses no restraint when the costs are not fully counted.
Viewing shareholder value as a mechanism for value extraction casts corporate activities in a different light. Gone is the myth of earnest companies competing to meet our needs. Instead, if bewitched by the spell of shareholder value, companies will do whatever it takes to get to our wallets, hoovering up cash for the benefit of shareholders only. It is what the shareholder value imperative demands; it is what companies have been designed to do.
Even though economic theory touts consumer welfare as the windfall of competitive markets, companies are busy trying to limit consumer welfare and channel it into producer profits wherever possible. This is the essence of much management training and business education: lessons in how to evade competitive pressure. According to Michael Porter’s ‘Five Forces’ model, for example, the least attractive industry for investment and enterprise will be one in which profitability is systematically eroded by the Five Forces of competition:
Antitrust law, in theory, tries to dial up the intensity of each of these forces, or prevent any barriers from arising that would mitigate their effects. But, of course, avoiding competition is precisely what the business executive is trying to achieve.
For example, instead of competing with their rivals, which destroys corporate value, companies can attempt to collude. As a junior lawyer, when I was tasked with poring over thousands of emails amassed as potential evidence of a collusive conspiracy, I was generally struck by the observation that they were not the obviously conniving communications of evil conspirators. The emails told funny, sad and ultimately human stories of health problems, divorce, children’s birthdays and weddings. They also documented the intense pressure piled on to mid-level managers in rival companies to deliver financial results. It seemed that it was precisely the pressure of competition that drove those managers to fix prices or to agree to stay out of each other’s sales territory.
One of the most famous cartel cases of recent decades was what the FBI dubbed the case of the ‘Harvest King’. The FBI became involved because the conspiracy to increase prices in the market for a product called lysine ‒ a growth-enhancing additive fed to animals to fatten them up for human consumption ‒ was uncovered with the help of an informant. Mark Whitacre, played by Matt Damon in the Hollywood adaptation of this remarkable story, The Informant!, was a PhD biochemist working for Archer Daniels Midland, an agrochemical company operating out of the fertile lands of Decatur, Illinois. Whitacre, a rising star in the company, was embezzling money from ADM ‒ he would eventually steal at least $9 million by submitting phony invoices for work done by contractors, and funnelling the proceeds into offshore and Swiss bank accounts. He unwittingly involved the FBI in his attempt to cover his own tracks when he accused a competitor of industrial sabotage. He realized that the FBI would soon figure out what he had been up to so he confessed and agreed to help the authorities crack down on the global lysine cartel.
The court documents revealed the spirit of the conspiracy. ADM President James Randall had baldly proclaimed that: ‘Our competitors are our friends. Our customers are the enemy.’ Such pronouncements were not unusual in the 1990s, but this statement belies the true lengths to which a company will go to secure a profit. The lysine competitors spied on each other, fabricated aliases, lied, cheated, extorted, obstructed justice, and hired prostitutes to gather information from competitors (that is how they treated their ‘friends’!). They also formed a fake trade association as a cover for their cartel meetings. In one such meeting, secretly filmed by Whitacre, the participants joked about the FBI and antitrust authorities finding out about what they were doing. They knew full well it was illegal, but the risk was well worth it.
ADM is a public company, listed on the New York Stock Exchange, and at the time it had $14 billion in global sales and 23,000 employees. At trial, the US Court of Appeals for the Seventh Circuit described ‘an inexplicable lack of business ethics and an atmosphere of general lawlessness that infected the very heart of one of America’s leading corporate citizens’.10 But, in fact, it is not inexplicable. It can be easily explained by the relentless driver of shareholder value and the search for market power, however it may be achieved. Efficient? Companies are certainly efficient at generating schemes to make money – it is another question whether the public at large benefits.
If a company cannot join with a competitor, though – through collusion or merger – then it can seek to destroy them. What happens when you start carrying shareholder value and market power around with you in your pocket? Facebook has a track record of using dubious methods to establish its market position. Confidential documents seized by the UK Parliament showed that Facebook was ruthless in cutting off access to its services for apps like Vine, a video-sharing app, created by Twitter and subsequently shut down. Facebook used an app called Onavo to monitor users without their knowledge, including to identify frequently used rival apps, which helped them to decide which apps to buy and which to try to shut down or clone.11 The evidence showed that whilst the antitrust authorities were unable to identify the competitive threat that WhatsApp posed to Facebook, perfunctorily rubber-stamping the merger, the company itself knew precisely how much the rival app was being used and therefore the upside of eliminating that competition.
A single-minded focus on profits forces companies to pursue all available means of obtaining power and lowering costs. The DuPont case shows how generating social harm can be a perfectly rational business strategy ‒ perhaps especially for big firms, for whom the potentially enormous litigation costs and fines are not critical.12 C8 is a chemical that DuPont used in the making of Teflon in its West Virginia plant. At least since 1984, DuPont knew that C8 is toxic, does not break down in the environment, accumulates in human blood, travels from pregnant mothers to their babies, and seeps into local drinking water supplies. But, after a careful cost‒benefit analysis, and ignoring the recommendations of their legal and medical departments, DuPont decided to continue with, and even scale up, C8 emissions.
Internal documents show that polluting was a rational decision for DuPont: under reasonable probabilities of detection, choosing to pollute was an optimal strategy from the company’s perspective, even if the cost of preventing pollution was lower than the cost of the health damages produced. The debacle cost the company close to $1 billion, so you might ask how can that be good for shareholders? But the company was able to use its informational advantage over regulators to hide the true costs of C8 for decades, which meant that the company could earn profits in the meantime but the litigation and regulatory costs would not catch up with them until years later. And even then, payment of compensation could be delayed or paid in instalments.
Companies can also compete by cutting costs we would rather not have them cut. Amazon’s low prices to consumers may be subsidized by high fees to merchants and may be motivated by a desire to dominate not just one market but all the markets. BP can cut costs in building a well but the result is the Deepwater Horizon disaster. In the case of the 1990s ‘banana wars’, UK supermarkets were able to cut the price of bananas because suppliers were willing to reduce costs. Fair trade groups documented that in 1999 Del Monte sacked all 4,300 of its workers on one of its biggest plantations in Costa Rica, and then rehired them on wages that were cut by half, with longer hours and fewer benefits.13 Cost cutting puts pressure on production, including on the real human beings doing the work, who must tolerate longer working days or lower wages, and deliver higher productivity.
Competition is a race to monopoly as firms elbow each other out of the way to get to higher profits. And things can get ugly. As recently as 2004, a popular business book encouraged companies to pursue shareholder value to ‘win’ in the marketplace.14 These firms should be ‘willing to hurt their rivals’, to be ‘ruthless’ and ‘mean’, and ‘enjoy watching their competitors squirm’. They should do whatever it takes to win, going up to the very edge of illegality. And if they go over the line then the penalties, even if big, will be nothing in relation to the winnings. When audit firm Ernst & Young surveyed nearly 400 chief financial officers, it found that a worryingly high percentage, 13 per cent, would be willing to make cash payments to win or retain business.15
People point to the landmark antitrust case against Microsoft in the 1990s as releasing the computer market from Bill Gates’ grip and paving the way for new technologies and platforms. They use it as a reason to break up Facebook and Google ‒ look, the world didn’t crumble, in fact it thrived. But clipping Microsoft’s wings gave only a brief reprieve, because the new competitors were competing to be exactly like Microsoft had been, and Microsoft is still a substantial force in technology. Like the many-headed Hydra of Greek mythology, cutting down one power-hungry company spawns five others in its wake. Seeking market dominance is a reliable way to guarantee shareholder returns, and history shows us that creating more competition is only ever a temporary measure. AT&T made way for Microsoft; Microsoft made way for Google ‒ the demolition of one monopoly merely readies the field for another to take its place or, more usually, to amble alongside it. Breaking up companies is not enough.
Companies competing to maximize profits will always be devising ways to do so at public expense – either by avoiding competition in order to increase prices, or by shifting costs on to society in the form of negative spillovers. Stronger enforcement against monopolies would help. But whilst making markets more competitive may lead to lower prices for consumers, we must ask how long it will last, and how are those low prices achieved? Without addressing the fundamental driver within the company to pursue profits at any cost, it is like trying to hold back the tide with our bare hands.
Myth #2: Companies compete by trying to best respond to the needs of society.
Reality: Companies compete for power, for the benefit of their shareholders, in ways that harm society.