Corporate Objectives-Maximizing Social versus Private Equity

Article excerpt

Many scholars will declare someday that 2002 was the year of the corporate scandal since it was during this time that some of the most egregious examples of executive greed in history were revealed. Because the once-respected heads of large corporations such as Merrill Lynch, Enron, and WorldCom enriched themselves at the expense of other stakeholders, the public's faith in unfettered capitalism was shaken. In response, leaders ranging from populist politicians to the president of the New York Stock Exchange demanded corporate governance reforms to restore confidence in the "free" market system.

Acting with uncharacteristic swiftness, the U.S. Congress passed and President George W. Bush signed into law the Sarbanes-Oxley Act in July 2002. Because this legislation was based on the assumption that the offending acts were isolated cases of individual deviance, the Act created a federal task force to police illegal behavior, threatened CEOs with criminal penalties, and required executives to certify their financial statements. As of late 2002, however, many of the Act's programs either had not been carried out or were inadequately funded by Congress. Even if lawmakers had been more resolute in this regard, however, its potential effectiveness is questionable.

The basis for this opinion is that the recent scandals reflect a systemic flaw in contemporary capitalism. Over the last three decades, the global economy has evolved into what Hyman Minsky (1990) called a "money-manager" form of capitalism, in which increasingly powerful institutional investors have forced executives to at least meet their quarterly earnings expectations. Moreover, because portfolio managers also encourage the use of stock options and equity-based compensation to align the interests of managers with their own, the temptation to misrepresent financial information is strong.

Thus, we have conditions today that resemble those of nearly a century ago that evoked Thorstein Veblen's (1904) observation that capitalism encouraged the pursuit of pecuniary gain at the expense of social provisioning. Not only do corporate managers attempt to please security holders by encouraging regulators to relax environmental standards and by increasing their market power, their ruthless expense cutting has, as described by Minsky and Charles Whalen (1996--97), increased economic insecurity and inequality for most working families.

Is it possible to modify corporate objectives so that activities that promote the common good also personally benefit executives and stockholders? As Rodney Stevenson (2002) observed, institutional economics is particularly well suited to addressing this type of issue because of its reliance on ethical principles in its policy prescriptions. In this spirit, this paper develops a new standard of corporate performance--social equity--that balances fairness and economic justice with traditional financial goals such as earnings per share. Not to be confused with "social capital," I use the term social equity to describe a set of corporate goals that extends beyond profits to include social and environmental standards. To provide incentives to accomplish these objectives, the paper concludes by suggesting a modification of the tax code so that a firm's income tax liability reflects its contribution to society.

Why Maximize Shareholder Wealth?

Mainstream economists generally agree that corporate decision makers should strive to maximize shareholder wealth. (1) This imperative is based upon an intertemporal version of utilitarianism in which a society's well-being increases with the quantity of goods and services it produces and consumes. (2) By targeting this objective, managers avoid having to ascertain the consumption time preferences of the firm's shareholders when they decide whether to pay out or retain current earnings. According to Irving Fisher (1930), who first developed the theoretical foundation of the share value--maximization rule, production and consumption decisions can be separated if stockholders can satisfy their own consumption preferences by lending or borrowing in perfect capital markets. …