Large corporations rival nation states in power. EXXON's revenues in 2007 were $373 billion, which is about the size of GDP in Saudi Arabia. The Blackwater corporation does much of the work for the US military in the Mid-East. Its reserve army is larger than that of Australia. They have also provided many of the social benefit programs for the employees that are usually provided by nation states in Europe. The corporation may exceed the state as the dominant form of social organization in the world. Some politicians would like to model the organization of the state after that of the corporation. Some politicians claim that experience as a corporate manager is an essential ingredient for success as a government leader. Therefore it is important to understand how the mission and structure of the corporation has changed over time. Gerald Davis, who is an endowed professor in the University of Michigan's Ross School of Business, wrote an informative book on this subject (Managed By The Markets) which describes how the corporation has been reshaped by the financial industry. I have summarized his description of managerial capitalism, and how it evolved into shareholder capitalism below.
Managerial capitalism was described in a seminal book by Berle and Means in 1932 (The Modern Corporation And Private Property). The ownership of the corporation was in the hands of numerous and dispersed shareholders. Control of the corporation resided in the hands of professional managers. They believed that the professionalization of management would create a commitment of the corporation, as an institution, to employees, customers, communities, and other stakeholders, including shareholders. Some economists referred to this development as a departure from the older form or capitalism in which property owners, or capitalists, controlled the means of productions by virtue of their ownership of the means of production. Shareholders were important stakeholders but the CEO of General Electric stated that the shareholders were only entitled to a return that was equivalent to a risk premium over an investment in a risk free treasury. The remaining profit would stay in the enterprise and be paid out in higher wages, or lower prices to consumers which would make the enterprise more competitive.
One of the features of managerial capitalism was that the corporation assumed many of the social welfare functions of the state. They provided pension plans, healthcare insurance and a well defined career path within the corporation for their employees. The state provided most of these benefits in Europe because the states were relatively mature as the corporate structure was developing in Europe. The state was relatively immature in the US as the corporate structure developed. Consequently, the corporation assumed many of the roles of the mature state. It was also a good way for the corporation to ward off the socialist movements that were underway in Europe.
The era of managerial capitalism lasted until around 1980 in the US. Many large US corporations were unable to compete with international competitors. They lost market share, and profits were more difficult to maintain as the cost of energy skyrocketed due to the operation of the oil cartel centered in the Mid-East. Double digit inflation in the US also created a problem. The Fed raised interest rates in response to inflation, and this led to an appreciation of the dollar relative to foreign currencies. This made US exports more expensive, and imports became less expensive for consumers in the US. Many corporations attempted to grow by acquiring companies in unrelated businesses. The era of corporate conglomerates was short lived. The conglomerates were inefficient and unprofitable. Their share prices fell and they were attacked by corporate raiders who realized that their assets were worth more than their market capitalization. New sources of capital were made available to the corporate raiders by developments on Wall Street. The raiders were able to fund their takeovers by issuing junk bonds that paid high yields to investors. A market for managerial control of the corporation emerged which managers had to defend against. They were vulnerable to attack as long as their market capitalization was below the value of their marketable assets.
It didn't take long for corporations to restate their mission. They no longer had an obligation to multiple stakeholders. Their primary mission was to maximize profits and to increase shareholder value. Executive compensation was aligned with their new mission. Stock options were awarded for achieving financial objectives. Managers had the same goal as their shareholders. They did whatever they could to increase the stock price. In essence, the stock price served as the measure of corporate efficiency. The financial market was the best judge of a corporations worth. The CEO of Sara Lee argued that Wall Street set the rules by which his performance would be judged. The market places a higher value on corporations that produce the most profits with the least assets. He divested most his manufacturing facilities to external suppliers, and he put his focus on brand management. Nike followed a similar strategy. Hewlett Packard outsourced the manufacturing of its PC because consumers care more about the brand than they do about who manufactures the product. HP owns the intellectual property and that is their real asset. Jack Welch, the widely admired CEO of GE, made it clear that GE did not have a lifelong commitment to its employees. He cut 100,000 jobs between 1981 and 1985. The shareholder was king to Jack Welch and GE was rewarded with higher stock prices under his leadership. The market decided that GE stock was worth over $60 per share during his reign. Today its stock price is under $30 per share. Apparently, the market is not always efficient at setting the price for a business. Nevertheless, the assumption that market is efficient some of the time underlies the edifice of shareholder capitalism. Managing the stock price requires actions that please Wall Street.
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