Corporate Purpose and Corporate Competition

Mark J. Roe is David Berg Professor of Business Law at Harvard Law School. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

The large American corporation faces ever-rising pressure to pursue a purpose that is more than just for shareholder profit. This rising pressure interacts with sharp changes in industrial organization in a way that ought to be further analyzed and considered: at the same time that purpose pressure has been increasing, firms’ capacity to accommodate pressure for a wider purpose is rising as well.

I begin this paper by contrasting classical corporate purpose—shareholder primacy—with the wider purpose sought today. I then ask: In principle, is purpose pressure more likely to succeed in a competitive industry or a non-competitive one?

Once we see that accommodating a nonprofitable purpose in a competitive market faces more hurdles than in a noncompetitive one, I then explore the extent to which the facts-on-the-ground match the expected relationship. I start with the evidence of decreasing competition and then turn to the evidence that stakeholders do better in markets where competition is weak. More profitable firms share profits with stakeholders and are more socially responsible than less profitable firms.

However, the view that competition has decreased in the United States is far from unanimous. The alternative view is not that competition is as it has always been and that rents—the supracompetitive profits that some firms obtain, classically from weak competition—have not risen. The other explanations lie in increased economies of scale (which propels us to have larger firms), more network monopolies, and the dominance of superstar firms that emerge from winner-take-all contests of skill, foresight, and industry.

Does the paper’s thesis stand or fall with which view of changing industrial organization better describes the real trends? It doesn’t, because each alternate avenue of industrial change also frees benefiting firms (at least for a time) from that intense competition that impedes firms from accommodating corporate purpose pressures. Skill, foresight, and industry monopolies are, in important analyses, the result of ferocious competition. But those end-result firms also no longer need to respond immediately and strongly to competitive pressures. There is good reason, and important data, indicating that this avenue is more substantial than a competitive decline. But for this paper’s thesis, we need not arbitrate the disagreement. Corporate purpose pressure to redivide the “good” monopolist’s profits is as compatible with the paper’s core thesis as pressure to redivide the “bad” monopolist’s profits.

Then I show the consistency between the new horizontal shareholding analysis and the paper’s thesis. In otherwise competitive industries, those seeking expanded but expensive purpose cannot readily succeed when they pressure a single firm. The purpose people must instead bear down on the entire industry. For the pressure to succeed, it must resemble a tax, paid by all. Or the purpose pressure must be managed by a cartel, either agreed to by the firms themselves or organized by an outside ringmaster, such as institutional investors that own part of every firm in the industry. Recent scholarship has shown conceptually how, and brought forth evidence that, this new horizontal shareholding across an industry can affect prices and competition. (And this view, and the underlying empirics, are strongly contested.) This shareholding structure can in parallel fashion facilitate firms’ decisions to broaden purpose. That is, horizontal shareholding can stifle competition on price and quality—the dominant focus of the academic inquiry. But it can also facilitate weakening competition to avoid costly purpose—thus far a secondary aspect of the academic inquiry on horizontal shareholding. Cartelization allows the firms to escape the competitive forces that bar them from adopting wider purpose.

Each channel for industrial change—decreased competition or an altered nature of competition—can better accommodate the new purpose pressure than classic multi-firm competition. Thus I push forward a “supply-side” perspective for corporate purpose analysis; to fully understand the phenomenon, we need to understand not just the rising demand for wider purpose but the extent to which firms can accommodate that rising demand.

Then, I extend the analysis. First, I note normative implications. Shareholder primacy is more likely to bake the biggest economic pie in highly competitive industries than in noncompetitive ones. Declining competitive zeal does not reverse all rationales for shareholder primacy but it weakens one.

Second, I consider the mechanisms how purpose pressure can be greater for firms with rents than firms in highly competitive markets. Large firms attract political attention. Large firms with visible rents attract even more political attention. And firms with large rents have more reason to dodge political animosity because they want to retain those rents, which the polity could confiscate or reallocate. The firm that does more CSR and more strongly supports ESG efforts can reduce one big source of political animosity. The firm can give up some rent if doing so sufficiently increases the probability it will retain the rest of that rent. But it is the rent that motivates and facilitates the action.

A third way ESG and CSR pressure becomes important needs further analysis. Many analysts indicate that in the end most ESG/CSR is just cheap talk; executives and boards will only do ESG and CSR if it is profitable. I agree that much purpose pressure in the end must be profitable to succeed widely. But that determination is dynamic, not static. Effective purpose pressure changes the profit calculation of the firm, its executives, and its shareholders. I show how this process can work and why it is more effective when brought to bear on firms, or industries, with rents: by affecting the public’s opinion of the firm, by altering the morale and motivation of the employees, by striking at executives’ conscience, and by upping the chance of congressional action that redistributes the rents away from executives and shareholders.

The fourth extension is to link purpose to rising contemporary political tension: if corporate profit becomes a major distributional battlefield inside the corporation, that conflict would contribute to the increasing instability and tension in the polity. Corporate governance institutions—like board elections, capital structure, and shareholder activism—have long tied executives and boards more tightly to shareholder-profit goals. Some thought tightening was needed for managerial accountability; some thought accountability was already too tight and managers needed more autonomy. But now the contest is shifting to include these social purpose values. Institutions that once were solely or primarily thought of as means to mitigate managerial slack are becoming suffused with social considerations. This concept resonates and parallels with classic conceptualizations of the costs of monopoly pushed formed by Richard Posner and Gordon Tullock.

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Ideas—like a more benign corporate purpose than raw shareholder primacy—may succeed because they are persuasive and fair. They can succeed when they fit the interests of those with votes and power. And—the thesis of this paper—they can succeed more easily when market structure makes them easier to implement. The new corporate purpose pressures’ origins lie primarily outside industrial organization—mostly in frustration with weak government responses to systemic problems and in a sense that big social problems like climate change are getting bigger—but it has more potential to disturb the profit-focused public corporation today than it could have had decades ago. This difference in susceptibility is due to markets and industrial change yielding higher rents. The new industrial organization makes more firms able to respond positively to stakeholder pressure without cutting into their competitive profits.

Rising social pressure on the corporation should be seen as not just a set of changing mores, but as a new struggle to divide up the large firm’s supra-competitive profits. A rise in supra-competitive profits fits with a rise of pressure on the firm to distribute those extra profits to more than just shareholders. The pressure both reflects and fosters the increasing polarization and instability of the polity.

The complete paper is available for download here.

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