Tuesday, June 23, 2015

Some Brief Thoughts on the Team Production Theory of the Corporation

I wanted to briefly react to Justin Fox's post on the team production theory of the firm. His contrast between the shareholder and team production view of the firm, and the recognition that the broad acceptance of the shareholder view of the firm is of recent vintage, provides a great short overview of the topic.

These are topics we spend a great deal of time on in my business ethics classes. The focus was on the stakeholder theory of the firm rather than the team production theory, but the idea that the shareholder value theory of the firm is not efficiency maximizing is a common element. There are very good reasons to think that the shareholder value theory of the firm fails to maximize value for any of the interested members of the firm, whether employees, customers, neighbors, or, at least in the very long run, shareholders.

My problem with these conceptualizations is that while the behavior of institutions like boards of directors does show that the interests of other stakeholders have some impact, this impact is generally fairly minor or lasts for only a short period. Doubtlessly, the period when norms involving strong stakeholder interests dominated in the immediate aftermath of WWII and the Great Depression involved great gains for corporations and widely held prosperity. But this period lasted for only a generation, the norms that held this consensus together quickly unraveled as those shaped by these experiences lost their influence. In the long run, formally and explicitly granted rights, such as those governing corporate control, will always win out against informal rights; no matter how effective those informal rights. Since shareholders are granted ultimate control they will always come out ahead in the long run, no matter how inefficient this outcome is.

No large organization can ever function effectively when control is vested in external elites who are not part of the day to day operation of that organization. The problem faced by business in the modern market economy has close parallels to the issues faced by aristocratic societies before democratization. When a group is run for the benefit of a few, no matter what norms seek to impose good behavior on them and how honestly they try to act for the betterment of the group, the reality is that their interests necessarily diverge from those of the other members of the organization. Elites try to make their interests appear invisible, either by claiming their interests are natural or identical to those of the organization they are influencing, but historically it has always been obvious that once their power is limited that their interests diverged sharply from the interests of others.

This is why I find the current property laws governing corporations so troubling. Similar to how aristocratic land ownership lent special privileges and influence to aristocrats under the ancien regime property rights concerning corporate property grant rights and privileges to those that own enough corporate property to exert control. They can circumvent campaign finance laws, speak with the corporations voice to claim broad support, and furthermore can protect themselves and their wealth and station through limited liability laws.

The solution to this isn't terribly difficult. It is simply to grant explicit and formal rights regarding control of the corporations they work for to labor as part of our laws governing corporations. Shareholders, can, and should, retain voting rights and rights regarding residual returns. But unless labor is granted an equal voice I do not see how any stable solution is possible to the problems of governing a corporation. While I admit this is radical the more I learn about business the more inescapable I find this conclusion; the same logic driving democratization of states ultimately holds for firms. I also see no reason to think this would deter investment, aside from an initial downward valuation as control premiums get wiped out, shareholders adjust to lower total returns, and shareholders overreact (yeah, this would be very costly short term, but so is democratization and since this is ultimately an adjustment of claims to wealth and income value is ultimately redistributed not destroyed). In the longer run, however, investors would continue to receive cash flows, incentives to create new businesses would increase since shareholder power would be diluted in more mature businesses, and incentives throughout large organizations would be improved as control comes to align more closely with the interests present in a corporation. But without this change, no matter what the normative appeal or positive benefit a different conception of the corporation has, I do not see how corporations will do anything in the long run but serve shareholder interests since their formal claims to control are given primacy and other claims have little force in law.*

* At least not beyond some minor rights at the margins. But other interests can hardly be said to have much in the way of rights governing control of a corporation in the US; other jurisdictions differ. There are also some situations where specific corporations have granted specific rights, or distributed stock in ways to give other stakeholder groups a capital stake, but these are exceptions to a general rule.


  1. So basically you are proposing a German model of governance...

    1. My view is certainly inspired by the German case as a working model. But there are other ways to do this, with more or less success, such as the Japanese or Korean models. My main point is that I think the current Anglo-Saxon model is unstable, prone to crises, and ultimately inefficient because it misallocates labor relative to capital and that we've been prone to excusing its flaws due to our other advantages that have, so far, more than compensated for our structural disadvantages. I certainly don't claim enough expertise to think that I could recommend one model of a more cooperative workplace over another, criticizing existing structures is far easier than choosing amongst alternatives.

      That said, I do think there are some distinct advantages to the Anglo-Saxon model in the early stages of the business, so ideally I'd like to see a reform movement develop that would result in a hybrid system with new businesses continuing to function about how they do now with some variant on the German system taking over as a business matures.