Corporate Governance: Background

Observers of the corporate scene have long struggled with the dilemma of corporate control. It was originally expressed in terms of the strain between diffuse ownership and management. It has subsequently been enlarged to consider the problems of creating a mechanism to ensure that corporate management does right by “labor, suppliers, customers, and owners while simultaneously serving the public interests” (Mason, 1958, p. 7).

Large corporate size was mainly responsible for Berle and Means’s (1932) challenge to the view that the shareholders controlled the modem corporation. Since the large size of modem firms often resulted in diffuse ownership, management purportedly assumed effective control. Berle and Means thus inquired whether, under those circumstances, there was “any justification for assuming that those in control of a modem corporation will also choose to operate it in the interests of the owners” (1932, p. 121). The possibility that management might operate the corporation in its own interests could scarcely be dismissed.

Other scholars broadened the inquiry and examined the role of other constituencies. Their views sometimes reflect political preferences, pure and simple. They are often buttressed, however, by implicit or explicit reference to market failure. Thus although the stockholders may at one time have had defensible exclusive claims on the board of directors, that has since become an anachronism—all the more so as markets in modem economies progressively deviate from the neoclassical ideal. Since imperfect markets afford very unsatisfactory relief against corporate malfunctions, all constituencies require direct access to corporate governance lest their legitimate interests be ignored or abused.

The market failure view of corporate governance has been elaborated by reference to the efficacy of stock markets as compared with factor markets. Thus E.C. B. Gower observes that “the workers form an integral part of the company,” and laments that this condition is ignored by company law in Bntain (1969, p. 10). He contends that a master-servant fiction is maintained by legal theory and that this “is unreal, in that it ignores the undoubted fact that the employees are members of the company for which they work to a far greater extent than are the shareholders whom the law persists in regarding as its proprietors’(Gower, 1969, p.11). Masahiko Aoki similarly observes that the association of individual shareholders . . . may not be enduring” and concurs that the “employees form an integral part of the firm for which they work to a far greater extent than” most shareholders (1983, p. 5). Summers concurs:

If the corporation is conceived … as an operating institution combining all factors of production to conduct an on-going business, then the employees who provide the labor are as much members of that enterprise as the shareholders who provide the capital. Indeed, the employees may have made a much greater investment in the enterprise by their years of service, may have much less ability to withdraw, and may have a greater stake in the future of the enterprise than many of the stockholders. In a corporation, so conceived, employee directors have no more conflict of interest than shareholder directors. [1982, p. 170]

Application of that logic suggests that other constituencies with a longterm stake in the enterprise also deserve representation on the board of directors. This would go beyond E. Merrick Dodd’s (1932) proposal that the directors of a corporation should serve as trustees for all the constituencies    shareholders, customers, suppliers, community—that have a stake in the corporation. What Robert Dahl has referred to as “interest group management” would expressly apportion seats on the board of directors to corporate constituencies: “Thus the board of directors might consist of one-third repre- sentatives elected by employees, one-third consumer representatives, one- third delegates of federal, state and local governments” (Dahl, 1970, p. 20). Shareholders are conspicuously omitted from the proposal.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.

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