Markets and firms
Adolf Berle (1895–1971)
Gardiner Means (1896–1988)
1602 The Dutch East India Company is the first joint-stock company to issue shares and begins trading on the Amsterdam Stock Exchange.
1929 The Dow Jones loses 50 percent of its value in one day, Black Thursday, kick-starting the Great Depression.
1983 US economists Eugene Fama and Michael Jensen publish The Separation of Ownership and Control, viewing the company as a series of contracts.
2002 The Sarbanes-Oxley Act becomes law in the US, laying down stricter standards for US boardrooms.
Most people assume that the basic principle of a free market economy is that companies are run by management in the best interests of the shareholders. According to the US economists Adolf Berle and Gardiner Means, this view is entirely wrong. Their 1932 book, The Modern Corporation and Private Property, shined a light on corporate governance and showed how the balance of power had swung from the owners of a company toward the management.
Berle and Means claimed that the dominance of management began during the Industrial Revolution with the emergence of the factory system. An increasing number of workers came together under one roof, where they handed their labor over to management in exchange for a wage. Modern corporations bring together the wealth of innumerable individuals (the shareholders). They hand control of it to a small management group, this time in return for a dividend. Both result in a powerful management answerable to no one.
Berle and Means identified modern shareholders as passive owners. These owners surrender their wealth to the governance of the company and no longer make decisions about how to “look after” their investments—they have passed that responsibility, and that power, to management. The apathy of small-time shareholders results in them either merely maintaining the status quo or failing to exercise their voting options. This may be beyond their grasp in any case—if they really wished to change things, they would have to hold a larger shareholding or galvanize a sufficient number of shareholders to force through a change. As a result, the owners of companies have a smaller and smaller influence in the running of their companies. This is not a problem when management interests coincide with those of the shareholders. However, if we assume that management are acting in a self-interested way and seeking their own personal profit, their interests will be very different from those of the owners.
Berle and Means argued for a change in corporate law that would return power to shareholders over the corporations. They insisted that shareholders should be given rights to hire and fire management and to hold regular general meetings. When their book was first published, US corporate law did not generally include such measures, and Berle and Means were instrumental in the founding of the modern corporate legal system.
Today, the failure of corporate governance is the focus of popular discontent with capitalism. Since taxpayers have become majority owners in some large corporations, corporate leadership is in the spotlight, revealing the self-interest of some chief executives who are awarded ever increasing pay and bonuses. Many feel that shareholders remain powerless in the face of the corporate machine.
The failure of corporate governance became a big issue in 2008 when many felt that the pay of top executives rose out of proportion to their company’s results and falling share prices.
Today, a merry-go-round of remuneration committee members sets corporate pay. Legislation that would allow shareholders a voice in these committees seems likely.
Berle and Means warned of the dangers of self-interested executives in 1932, but some people argue that the problem has become worse in the US and Europe in the last 20 years. Shareholders vote to choose the board of directors, but executive pay is set by a remuneration committee composed of other high-earners. They keep pay high to enforce a “market rate,” and they can then look forward to receiving a large pay raise due to “market forces.” Shareholders have the power to dismiss the board, but this would not be well received by the markets—which, in turn, could cause share prices to fall.
The problem is worsened by the fact that many shares are held by hedge funds (speculative investment firms) with no long-term interest in the company. Fund managers aim to receive large pay increases in line with chief executive officers (CEOs), so it is not in their interest to vote against high remuneration packages.