Academic journal article Economic Inquiry

Corporate Control and Performance in the 1930s

Academic journal article Economic Inquiry

Corporate Control and Performance in the 1930s

Article excerpt


A fundamental assumption of mainstream microeconomics holds that firms strive to maximize economic profits. Beginning with the work of Berle and Means |1932~, however, researchers have seriously questioned if profit maximization is the sole objective for the large modern corporation given various circumstances. In particular, Berle and Means |1932, 69~ contend that "as the ownership of corporate wealth has become more widely dispersed, ownership of that wealth and control over it have come to lie less and less in the same hands." They argue that the main beneficiaries of this transfer of control ultimately have been the managers because it has put them in the position to pursue their own interests at the expense of profits.

Modern managerialist/neoclassical theory suggests that corporate managers must be exempt from a number of behavioral constraints to successfully deviate from profit maximization and pursue the five P's of increased pay, prerequisites, power, prestige and patronage. First, as Berle and Means note, the executives must be free of a stockholder constraint. Some slack typically exists in this constraint when stock ownership is widely dispersed because an agency problem results from the asymmetry of information regarding true managerial behavior and performance. Simply put, when an individual holds a relatively small percentage of the firm's outstanding stocks, there exists little, if any, willingness (in terms of a financial incentive) to monitor true performance and ability (with regards to corporate power) to either actually or potentially discipline management. Thus, the severity of the stockholder constraint generally depends on the percentage of the firm's outstanding stock held by the dominant stockholder.

Second, according to Williamson |1963~, the product market constraint cannot be fully binding since discretionary expenditures require excess profits. In a competitive market, managers are forced to minimize costs or the firm fails to survive in the marketplace. As a result, the firm must possess some degree of market power for managers to successfully pursue other goals besides profit maximization. Third, some imperfections must exist in the capital markets. Otherwise, any inefficient behavior on the part of management increases the likelihood of a corporate takeover. In some cases, as Marris |1964~ notes, the mere threat of a takeover might sufficiently discipline management. Smiley |1976~ points out, however, that the transaction costs of a takeover gives management some room to exercise discretionary behavior before the risk of a takeover becomes intolerably high.

Fourth, Fama |1980~ argues that imperfections must also exist in the external and internal labor markets. Otherwise, job mobility, within and among firms, creates an incentive for managers to behave efficiently. In addition, better jobs and rewards in the future mean better job performance today. Finally, Jensen and Meckling |1976~ show that managers must be awarded an incomplete incentive contract. If executive compensation completely depends on performance, less inefficient behavior results.

Despite the fact that managers must be, at least, partially free of all five constraints to successfully deviate from profit maximization, a surprisingly large number of researchers, including Larner |1970~, Palmer |1973~, McEachern |1975~ and Neun and Santerre |1986~, has found evidence linking unconstrained managers with lower levels of corporate performance in more modern times.(1) These studies typically focus on the consequence of a loosening of the stockholder constraint on profitability. Researchers either explicitly or implicitly control for the severity of the product market constraint and some slack is assumed in the other three constraints on managerial behavior.(2) With the exception of Neun and Santerre |1986~, however, these studies use a dichotomous measure of stockholder control which is based upon arbitrary and subjective criteria. …

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