For many years after World War II, I worked for an organization of businessmen, mainly the CEOs of large corporations. These people had a constant hankering for something they called “the social responsibility of business.” What they meant by that was the responsibility of corporate officers to anyone other than their stockholders-to their workers, customers, the community or the nation. For example, the corporate officers claimed to have a responsibility for preventing inflation by holding prices down, or for cleaning up the environment, or for other things.
I was never very comfortable with these assumptions of responsibility, for several reasons: First, I doubted that many of the businessmen would actually discharge what they called their social responsibility when that conflicted with more private interests.
Second, I did not think that in most cases businessmen would know how to serve the social interest when that involved something different from the pursuit of their private interest. Pollution is one example. The problem is to make the amount of the investment worth the benefit to “society” for the clean air produced. But “society” cannot indicate how much clean air is worth by its willingness to pay a price for it, unlike the indication it gives of how much, say, automobiles are worth by the price it is willing to pay. The businessman is not able to measure the social preference for clean air. We have a mechanism for measuring that preference, which is government-imperfect though that is.
Third, I feared that if businessmen asserted their responsibility to do something other than pursue their private interests, they would invite government to force them to do it. The leading case is price control. In the 1950s and early ’60s, businessmen talked a lot about their responsibility to hold down prices-and, not surprisingly, about the responsibility of their unions to hold down wages. The logical deduction was that the prices and wages that would naturally arise in the free market, were not the “right” prices and wages. The next step, which soon followed, was government prescription of price and wage guidelines, to be “voluntarily” observed. The next step was comprehensive, mandatory wage and price controls, which followed in 1971.
The irony of this story is that for all the talk about the social responsibility of business, we are now seeing many cases of businessmen violating their most obvious private responsibility. I refer to the responsibility of corporation executives and directors to their stockholders. The most glaring of these cases, because the amounts of money at stake are large, relate to takeovers by management. Several of these episodes have been documented in reports by Benjamin Stein (my son) in Barron’s magazine.
The typical story runs like this: The management has reason to believe that the corporations’ assets could be sold for, say, $5 billion. It offers to buy the corporation from the stockholders for, say, $750 million. It obtains estimates from reputable investment bankers-who will make large fees if the deal goes through-that the corporation is worth $750 million. The management does not share with the stockholders its reasons for believing that the corporation is worth much more. The deal goes through. The management makes a lot of money, most of which belonged to the stockholders-the people to whom they had a fiduciary responsibility. It’s as if the supervisor of a plant sold scrap to his brother-in-law at less than the best prices obtainable-a practice about which the management would be irate.
I don’t know how much of this goes on. Certainly there are cases in which corporate boards handle the disposition of assets in a way that is exemplary from the standpoint of the stockholders. A corporation with which I was once connected decided to sell a subsidiary. It could have sold the subsidiary to management for a price a little above its value on the corporations’ books, making it appear that the stockholders had gained. But the directors recognized their obligation to get the maximum price for the stockholders. The decision to sell was announced, prospective purchasers were invited to inspect the physical plant and study the financial records, and the subsidiary was sold to the highest bidder. The stockholders got all they could have gotten. But enough bad cases are known to be worrisome.
A TRUST VIOLATION
The logic of the market system is that capital is attracted to uses where it is most productive because that is where capital yields the most return to the investor. The real world does not work exactly like that for various reasons-especially lack of information. It operates enough like that to make the United States and other market economies more productive than anything seen elsewhere. If, however, the management drives a wedge between what the capital produces and what investors get, the system is frustrated. The money the management extracts from the unknowing stockholders, in the kind of case I described above, is like a tax on capital income, randomly distributed among companies-a tax that the business community would properly condemn.
Aside from its inefficiency consequences, this behavior is just wrong-a violation of trust. What George Shultz said about the government is also true of the private sector: “Trust is the coin of the realm.”
The idea that corporate management and corporate stockholders act upon different interests is not new. It received a great deal of attention almost 60 years ago when A.A. Berle and Gardiner C. Means wrote The Modern Corporation and Private Property. Many people, then, during the depression, drew the lesson that since the private corporations were not working according to the economics textbook, the control of the economy should be turned over to the government. That is not the solution. The same problem, of agents and fiduciaries failing to discharge their responsibilities to those who rely upon them, is as big and serious in government as in the private sector.
A number of economists, mainly devoted to the free market, have recently been calling attention to the fact that government-elected officials and bureaucrats are not selfless servants of the public welfare. They all have interests of their own. The lesson they draw is that we should leave as little to government as possible. That may be a solution up to a point, but it does not get us very far. The irreducible amount that government must do will still be very large.
In the modern world of specialization and complex organizations, public and private, people must be able to trust each other. There is no escape from that. It is not possible for each individual to know enough about all of his transactions. He cannot know as much medicine as his doctor, as much accounting as his accountant, or as much about management as the directors and executives of the corporations whose stock he holds. He must be able to count on their behaving responsibly to him.
I am not suggesting that the world can run on love or altruism alone. Caveat emptor on the one hand and the rule of law on the other are both essential. But they are not sufficient. We need the exercise of responsibility by individuals in performing obligations that go with roles they have voluntarily assumed, like the role of chief executive or director in relation to stockholders. I believe that many businessmen understand this. It would be a good idea if they would try to instruct their fellows in the private responsibility of business. Members of the businessmen’s club learn not to kick the ball into the hole-even when no one is looking. They could learn as much about their dealings with their stockholders.
Editor’s note: This is Herbert Stein’s final column. Beginning with our January/February 1987 issue, our Comment columnist will be noted author and social critic George Gilder, whose books on social and economic issues, including Wealth and Poverty-the worldwide bestseller on supply-side economics-and The Spirit of Enterprise, have changed the terms of debate. He is also a fellow of the Manhattan Institute.
Herbert Stein is a senior fellow of the American Enterprise Institute in Washington, D.C. He served as a member of the President’s Council of Economic Advisors from 1969 to 1971 and as its chairman from 1972 to 1974 under Presidents Nixon and Ford. He is also a member of President Reagan’s Economic Policy Advisory Board.