Economic Debate

To Whom Does a Company Belong?

Fellow, RIETI

This is a debate on economics that takes place on paper by introducing two conflicting assertions regarding an economic issue, studying the points they make, and seeing whether there are any points of agreement between the two. In this column, I look at the question of to whom a company belongs, an issue that came up in the course of the battle between Livedoor Co. and Fuji Television Network Inc. for control of Nippon Broadcasting System Inc.

The purpose of a company is to maximize shareholder value

From the viewpoint of shareholders and investors, it is natural to assume that companies belong to their shareholders. Let us look at the main points of this view.

Economically speaking, companies exist to maximize profits. Furthermore, this profit, in the end, belongs to the shareholders. In short, the reason companies exist is to maximize shareholder value. In other words, a company belongs to its shareholders.

Of course, it is important for a company's employees to feel their work is worthwhile and for customers to gain a sense of satisfaction from the firm. However, the reason why employees and customers are important is because they bring profits to the company, which in turn maximizes shareholder value.

Put a different way, a company cannot care for its employees or provide customers with benefits to the extent to that such actions damage shareholder value. Such actions run counter to the purpose of a company's existence.

Also, it is the shareholders themselves who know best what serves their interests. That is why such matters as reorganization of a company's operations or restructuring of its management or employees should conform to the views of shareholders. For example, the views of new shareholders should naturally be respected to the greatest extent possible when considering the issue of reorganizing a company's operations because this maximizes the company's value. At the same time, even if shareholders do not have management expertise, they should naturally determine who manages the firm. It is the natural right of shareholders to decide whether to have the current management stay on, or to select new managers.

In the field of economics in recent years, it is generally accepted that a company should be analyzed using the "principal-agent model." This is the concept that in the basic structure of a company, management acts as the "agent" of profit-maximizing shareholders or "principals." This analysis provides unwavering support from the viewpoint of economic theory for the view that a company belongs to its shareholders.

Companies owe their existence to employees and customers

Traditional Japanese companies and employees have a totally different view from that described above. They believe it more accurate to say a company belongs to its employees and customers. The main points of this argument are as follows.

In the "real world," companies are different from the firms discussed in economics. A company begins with some business that a firm's founder or its employees want to undertake. And because they need funds to carry out their plans, they seek capital from the stock market by soliciting investment from potential shareholders. In the case where the founder is the sole shareholder, it is indeed true that the company belongs to him, but for firms that go public and whose management is composed of salaried employees, shareholders are nothing more than creditors who provide the necessary funds for the business.

Is the maximization of profit the primary reason for a company's existence?

Many companies stipulate in documents such as their statutes that the aim of their foundation is to contribute to society through their activities. This is not just a meaningless slogan. Normally, people do not work simply for monetary gain. Unless there is some public significance to a company's activities, its employees will not be motivated to do their best. The average person cannot be expected to make significant sacrifices for a company that only pursues profit.

Also, the interests of shareholders are bound to differ depending on whether the benefits they seek are short-term or long-term. From the long-term perspective, a company's value will be greater when it its activities serve to motivate employees and give a high degree of satisfaction to a large number of customers. If its actions are focused on providing shareholders with short-term profits, on the other hand, it will end up strangling them in the long run. This is why shareholders should not have their way when it comes to the minute details of company management.

Management strategies are decided based on the collective opinion of management, employees and customers. If profit is made as a result, shareholders reap the benefits as investors. In this view, shareholders are called "residual claimants." That is, they have the right to claim whatever remains from profits after wages and debts are paid. Thus, shareholders should be viewed as people who have only the right to "the leftovers."

The clash between market ethics and communal ethics

So, which argument is more convincing? If it is a question of how to distribute the pie called "the company" between shareholders and employees, the debate may boil down to six of one and half a dozen of the other. This is because from the outsider's point of view, it makes little difference whether a company's actions are initiated by shareholders or by employees.

But the issue is more profound. There are times when a company requires self-sacrifice on the part of its employees. For example, in order to handle customer complaints, there are times when employees must work overtime or on weekends. It is natural in these situations for companies to provide monetary compensation through such means as overtime pay. However, one can argue that the employees are sacrificing their families and private lives - something that cannot be made up for with money. If employees place priority on their own personal lives and do not respond to customer needs, the company will lose the trust of its customers and profits will fall. While it would be ideal for a company to run smoothly without requiring these kinds of sacrifices on the part of its employees, such companies are rare. Every company is more or less supported by the self-sacrifice of its employees. So why do employees make such sacrifices? Probably because they have a strong sense of ethics that includes loyalty to their customers and to their company, and a sense of purpose in their work. However, such loyalty and purpose belong to an ethical system that is incompatible with financial profit.

It is said that people have two ethical systems. One is the ethics of the market, which can be described by such "commercial virtues" as fulfilling the terms of a contract. However, the ultimate end of the ethics of the market is self-interest, and this does not give rise to the idea of self-sacrifice. The other ethical system is the ethics of community. This system of ethics is reflected strongly in the military and on sports teams, where it is seen as a great virtue to sacrifice yourself to save your comrades.

Even if a company pursues profit under the logic of the market externally, it needs to be managed internally by a model of communal ethics. However, once shareholders bring market ethics into a company, the latter ethical model collapses. This is why there is great revulsion toward corporate buyouts that place priority on profit. Employees feel they cannot sacrifice themselves unless their company represents some higher philosophy or ideal that goes beyond mere financial profit. Of course, this could be called a collective illusion on the part of the employees. However, a company whose employees cannot maintain this illusion cannot perform well in the end. Neither can it increase profits. On the other hand it is also true that in the market, companies are profit-pursing machines. This ambiguous reality results in an endless dispute.

>> Original text in Japanese

* This column appeared in the April 25, 2005 edition of the Asahi Shimbun.
Any reprinting of this column without the approval of the author and the Asahi Shimbun is prohibited.

April 25, 2005 Asahi Shimbun

May 19, 2005

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