Chapter 1
Lost Opportunity
HOW DO SOCIETIES DECIDE WHO GETS WHAT and what gets done? Most people pondering this question think of two controlling forces: free markets and government. Together they seem to rule our lives, determining how we live (For example, have I saved enough to buy a house? Are the neighborhood schools good here?); what we do (Can I afford a vacation? Whatâs the speed limit here?), and what we consume (Can I pay for a new smartphone? Do I need a prescription to buy that drug?). In general, liberals tend to favor relying on government to solve social problems, while conservatives often prefer relying on the market. But whatever our political leanings, most of us think of governments and markets as the two options for solving problems and allocating resources.
Beyond Governments and Markets
Thereâs a third force, however, that also governs us: private ordering. Academics use private ordering to describe institutions and organizations that exercise control over peopleâs lives yet are created through the voluntary actions of private individuals coming together of their own free will. Just as governments and markets have existed for thousands of years, so too have powerful private organizations. Many of our greatest universities are private organizations, including Princeton, Yale, Harvard, Stanford, Cambridge, and Oxford. The Sierra Club (three million members),1 the AARP (thirty-eight million members),2 National Public Radio (thirty-five million weekly listeners),3 the New York Stock Exchange, and the Smithsonian Institution (approximately thirty million annual visitors)4 are all private organizations. So, too, are the residential co-ops and condominium associations in which millions of Americans live today.5
What makes privately ordered organizations different from markets and governments? First, unlike an open marketplace, where the only âlawâ is that you must be willing and able to pay for something, privately ordered organizations impose and enforce detailed rules of behavior on the people inside them. Students must follow the honor code or be sanctioned. Employees must be present during work hours unless excused. Companies must meet certain qualifications or the NYSE will refuse to list them. Moreover, private organizations often make decisions and act through a complex process that involves many different individuals and groups, and they may use governance techniques like voting, delegation of authority, higher-level review, and checks and balances that resemble those we see in political systems. As a result, very large private organizations look a lot like governments and can even be described as quasi-governments.
But thereâs a key difference between privately ordered organizations and the state: unlike government regulations, the regulations of private organizations can be avoided simply by choosing not to deal with the organization. You can choose to ride with Lyft, with Uber, or not at all. You can choose not to apply to a particular university. You can choose not to list a company on the NYSE. But you canât choose not to pay taxesâat least, not without going to jail or paying a large fine. A private organizationâs internal rules donât apply to anyone who doesnât want to deal with the organization. If, however, you want to do business/deal with such an organization, you must follow the rules, and the punishment for violations is typically exclusion from the benefits provided by the organizationâwhether it be a club, a university, or a business corporation.
Enter the Business Corporation
The most powerful of our private institutionsâthe Leviathans swimming in our economic seasâare business corporations. To get a sense of just how powerful and pervasive this third force truly is, itâs worth comparing corporate power and influence with that of the federal government. In 2016, the federal government took in $3.3 trillion in revenues.6 The Global 500âthe worldâs biggest five hundred companies by revenue according to Fortune magazineâs rankingâbrought in nearly ten times as much, $27 trillion.7 The federal government has 2.25 million civilian employees.8 Walmart alone has moreâ2.3 million.9
Like other privately ordered organizations, business corporations are formed through the voluntary actions of free individuals. Yet collectively, in many ways they dictate the structure and content of our lives. Modern life makes it nearly impossible to escape dealing with business corporations. While you might be able to escape dealing with private clubs, universities, or religious groups, imagine how difficult your life would be if you tried to avoid interacting with corporations. They affect what we can and cannot do, what we do or do not have, how we spend our days, and evenâin the case of the health insurance industryâhow we choose our doctors and make decisions that could affect our health.
If you think of your typical day, perhaps you rise in the morning and learn whatâs happened in the world from Facebook, Twitter, Fox News, CNN, or the New York Times. You drink coffee from Starbucks or tea from Lipton. You take Lyft to work or drive a Toyota. At some point before reaching work you check your emails and texts (hopefully not while driving) on your Samsung or Apple smartphone, over a network powered by Verizon, AT&T, or T-Mobile. Once at work, your workplace itself may be a corporationâUPS, Walmart, IBM, or Citibank. In the evening you get groceries from Whole Foods or Kroger, or a burger from Sonic, Shake Shack, or McDonaldâs. That night you watch Netflix or Hulu, or search YouTube, or do a little online shopping with Amazon. Maybe you check how your IRA is doing (if you are lucky enough to have one) at Charles Schwab or Fidelity. A life without interfacing with corporations would mean you would have no cell phone, no means to get around outside the city center, no retirement investment fund, and very possibly no shelter or food beyond what you could build, grow, or scavenge yourself. (And even the few individuals who manage to live âoff the gridâ are affected when corporations dirty the air, pollute the waters, or change the climate.)
Where Corporations Go Right
Luckily, while corporations pervade our lives, they also provide us with a lot of very useful inventions and social contributions. In the nineteenth century, corporations built the railroads, steel mills, and factories that powered the Industrial Revolution and tremendously improved most peopleâs standard of living. In the early twentieth century, General Electric and Consolidated Edison built the electrical grid, while Otis Elevator Company developed and produced the electric elevators that made high-rise buildings and modern cities possible. In the late twentieth century, IBM created personal computers, and Google developed the search engines that allowed easy access to information on the internet. Today, Tesla and Alphabet are working on self-driving cars, while Pfizer and AstraZeneca seek cures for cancer.
In the process of creating and producing critical new technologies, corporations give us a cornucopia of other benefits: salaries and jobs training for workers, dividends and interest payments for investors, quality goods and services for consumers, tax payments for governments, infrastructure and philanthropic donations for communities. Consider the example of Corning Incorporated, a Fortune 500 company headquartered in New York Stateâs Southern Tier region, between the authorsâ hometowns of Ithaca and Brooklyn. Corning has an enviable record of innovation, having developed the glass used in Thomas Edisonâs light bulbs, the fiber optic cables that underlie the modern telecommunications system, and the tough âgorilla glassâ that covers most smartphones today. These inventions are wonderful social contributions.
But Corning does much more. It employs more than forty thousand people.10 In 2016, it paid its shareholders $645 million in dividends, while authorizing more than $4 billion to repurchase some of its shares from investors.11 Moreover, the Corning Incorporated Foundation makes millions of dollars of grants to local and regional educational, cultural, volunteer, and human services programs.12
Where Corporations Go Wrong
Corning might have a less impressive record, however, when it comes to contributing its share to the public treasury. Reportedly, by stashing more than $10 billion in offshore tax havens, it was able to pay no federal income taxes at all between 2008 and 2012.13 And when Corning doesnât pay taxes, the rest of us have to pay more.
As Corningâs tax strategy demonstrates, while corporations provide us with a number of essential benefits, they could do better. There are many critical human problems our corporations have failed to solveâin some cases, failed to even seriously address. These include the scourges of poverty, disease, pollution, and climate change.
Let us consider the case of climate change. Climate change is already bringing us droughts, floods, heat waves, shrinking glaciers, rising sea levels, invasive pests, dying coral reefs, infectious diseases, and extreme weather events that threaten our infrastructure, agriculture, fisheries, and many industriesâas well as our health and our ecosystem. Its costs have been estimated at more than $240 billion over the past ten years in the United States alone and can only be expected to rise in the future.14 Of course, most of us have contributed our share of carbon to the atmosphere. But we have few attractive alternatives; fossil fuels remain our cheapest and most readily available source of energy. The fossil fuel industry has played a major role in ensuring they remain so, devoting enormous resources to lobbying against a carbon tax, funding scientists who question climate change, and developing environmentally destructive, energy-intensive fuel extraction technologies like fracking.15
The same is true for many other difficult problems we face today, including poverty, crumbling infrastructure, chronic and acute disease, and our nationâs need to protect and preserve an accurate, informed, effective, and untainted mass media. Too many companies neglect such issues to focus instead on goals like cutting costs or raising revenuesâno matter the cost to employees, consumers, taxpayers, or the integrity of our political system.
Corporations contain both yin and yang. In the process of producing desirable things, corporations can produce less desirable things as well. Uber makes local travel cheaper, but its business model is destroying a taxi industry that arguably provided more secure jobs for drivers. Facebook and Twitter have allowed us to connect and communicate online with many more people, but they may be making our relationships shallower and promoting narcissism and loneliness.16 The fossil fuel industryâs fracking technologies have reduced energy costs while threatening our water supply and contributing to climate change. Meanwhile, the finance and tech industries have contributed to growing economic inequality and the rise of an ultrawealthy elite with outsized wealth, power, and influence, while doing disproportionately less to address concerns at the bottom of the pyramid. As we discuss below, the mistaken mantra of shareholder value is often used as the main justification for why corporations do not extend their capacities to addressing social concerns.
The Mistaken Mantra of Shareholder Value
One obstacle to better corporations is the commonâbut erroneousâbelief that corporations must maximize âshareholder value.â In her 2012 book, The Shareholder Value Myth: How Putting Shareholders First Harms Companies, Investors, and the Public,17 author Lynn Stout explains at length why this is false. Interested readers can learn more there, but the bottom line is easily summarized.
The idea that corporations should maximize shareholder value draws most of its power from the arguments of late twentieth-century âChicago Schoolâ economists like Milton Friedman. In reality, US corporate law is quite flexible about what goals corporations must pursue. Corporate law is mostly state law, and state codes explicitly allow corporations to be formed âfor any lawful purpose.â Virtually all corporate charters describe the companyâs purpose in similar language (the authors have never seen a charter listing a companyâs purpose as âmaximizing shareholder valueâ). Meanwhile, judges deciding corporate law cases religiously apply a doctrine called the business judgment rule to protect disinterested directors from liability for failing to maximize profits or stock price. Occasionally, a judge trained during the height of the Chicago Schoolâs influenceâjudges are as vulnerable to culture as anyone elseâmay vaguely suggest in an opinion that corporate directors have an amorphous, and never actually enforced, duty to maximize profits. Such musings, however, are mere âdictaâ that other judges are free to ignore. And plenty of contrary dicta can be found. Consider US Supreme Court justice Samuel Alitoâs recent statement in Burwell v. Hobby Lobby Stores that âmodern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not do so.â18
Second, trying to âmaximize shareholder valueâ is not only not a legal requirement, it is often a bad business idea, especially in the long run. Long-term investors donât care much about todayâs stock price; they care about the companyâs future performance. Unfortunately, without a crystal ball, it is impossible to quantify future performance in a fashion everyone can agree with. This means that attempts to increase shareholder value in a way that can be measured today inevitably translate into attempts to raise short-term metrics like stock price or current earningsâmetrics that can be gamed by selling off assets, taking on debt, or cutting âexpensesâ such as payroll or research and development. As Larry Fink, famed CEO of BlackRock mutual funds, publicly complained in his 2016 annual letter to CEOs, such a focus on short-term results harms long-term shareholders, who would prefer companies devote their attention to developing new products and markets.19
Meanwhile, chasing shareholder value not only hurts long-term corporate results, it also harms shareholdersâ broader interests as diversified investors, employees, consumers, taxpayers, and organisms that must live in the environment. When company after company relentlessly lays off employees to boost the bottom line, overall unemployment rises, consumer demand falls, and eventually corporate profits suffer. Similarly, when fossil fuel companies seek profits from fracking instead of developing cleaner energy technologies, what we gain as investors is more than wiped out by what we lose from dealing with hurricanes, heat waves, tainted water supplies, droughts, floods, new tropical diseases, or climate changeâdriven political instability.
Nor are we the only ones who lose. For example, climate change not only imposes enormous costs on the current generation; it also harms future generations, other species, and the planet.
Another fatal flaw in the âshareholder valueâ mantra is that it ignores the reality that most people would prefer their companies not make profits by breaking the law, abusing employees, defrauding consumers, polluting the environment, corrupting the political system, or impoverishing future generations. Science supports this view; hundreds of experiments have demonstrated that the vast maj...