Corporations and the 99%: Team Production Revisited

Shlomit Azgad-Tromer is a researcher at Tel Aviv University—Buchmann Faculty of Law. This post is based on the article Corporations and the 99%: Team Production Revisited. Related research from the Program on Corporate Governance includes The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein, and The CEO Pay Slice by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

“We Are the 99%” is a political slogan used by the Occupy Wall Street movement, referring to the prevailing wealth and income inequality, and claiming a divergence of corporate America from the public. The article explores the interaction between the general public and the public corporation, and its legal manifestation.

Stakeholder theory portrays the corporation as a sphere of cooperation between all stakeholder constituencies, including the general public. Revisiting team production analysis, the article argues that while several constituencies indeed form part of the corporate team, others are exogenous to the corporate enterprise. Employees, suppliers and financiers contribute together to the common corporate enterprise, enjoying a long-term relational contract with the corporation, while retail consumers contract with the corporation at arm’s length, and other people living alongside the corporation do not contract with it at all. Under this organizational model, the general public may participate in the team forming the corporate enterprise by providing public financing. Indeed, corporate law was developed to protect public investors.

However, evidence shows that most of the listed equity is no longer held by the general public directly. The new shareholders are institutional investors. The article analyses the impact of institutionalization on the interaction of corporations with the general public, outlining three main differences between retail and institutional investors.

First, not all institutional investors are investing on behalf of the public. While some institutional investors are providing professional asset management services to the general public and investing on its behalf, other institutional investors are obliged towards their consumers, but invest to their own accounts. Banks and insurance companies, for example, contract with the general public to repay a loan under a contract or to pay a sum upon an insurance event under the policy. The duties of banks and of insurance companies towards the general public are in its consumer constituency. In addition, institutional activism is often mobilized by hedge funds, exclusively representing the wealthiest 1%.

Second, when shareholders are mostly institutional investors, the likelihood of distributional conflicts between various stakeholder groups is higher, because the institutional thought and decision making patterns do not match those of the general public. The institutional objectives of investment are significantly narrower than, and potentially divergent from, those of the general public. Institutional investors are bound to enhance financial value: only a minority of institutional investors are socially-responsible funds that cater to investors who have social objectives other than profit-making, such as fair labor practices, environmental sustainability and the promotion of moral values. Moreover, institutional investors are more likely than retail investors to act as rational agents and to collect and analyze the full information provided in order to support the investment allocation decisions. While corporate law and securities regulation continue to protect the bounded rationality of retail investors, empirical evidence suggests that institutional investors professionally collect all the required information for a thorough analysis and investment allocation even in the absence of mandatory disclosure platforms.

Third, the institutional trading methodologies of algo-trading are technologically inaccessible to individuals, potentially imposing negative externalities on retail investors.

Institutionalization may render retail investors significantly disadvantaged, as much of the impact and voice given by the empowerment platforms are utilized by institutional investors and intermediaries who are not legally bound by the general public’s interests. Shareholder empowerment does not empower all shareholders equally. It may often be the case that the institutional interest aligns with that of the general public, but the law does not necessitate it.

There are also, however, converse trends towards convergence. Investment paradigms putting social progress as a consideration in forming the asset portfolio, such as impact investments and socially responsible investments, serve to converge the public corporation with the public. The corporate social responsibility movement and sustainability reporting, are commitments imposing duties towards the general public. The growing interest of public corporations in the voice of the general public is also apparent in the impact of customer voice, which, due to the social media and websites providing accumulated customer reviews such as Yelp, has grown immensely in recent years, providing considerable incentives for corporations to listen. The essay analyses these trends and raises policy implications.

Corporate law is to face the challenge of aligning the interests of shareholders with those of the general public. The implications of institutionalization suggest that protecting investors may not always serve as a good heuristic for aggregate social welfare. In addition, to reach the general public, the platform and audience for sustainability reporting should not be restricted to the public’s investor capacity in public corporations; rather, it should apply to corporations with strong public interaction in other stakeholder constituencies, serving public roles or providing public services, even when funded privately.

The full paper is available for download here.

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