Friday, March 5, 2010

The Purpose of Corporations

What is the purpose of a corporation? If you said that it’s to create jobs, think again. Not only are jobs not the purpose of a corporation, they are not even the purpose of the economy. The goal of an economy (if such a thing can ever really be put forward) is to increase our standard of living. That means that our goal is to use our resources ever more efficiently in the creation of goods and services.

In a market economy, the market harmonizes the production of suppliers with the wants and desires of consumers. It does so through the price system. Prices are little packets of information that convey the relative scarcity of resources. A rising market price indicates a resource is becoming more scarce. The higher price tells entrepreneurs to use less and look for substitutes. A lower price shows that the resource is less scarce. The change in price not only tells people in which direction to move, but it also tells us by how much. If the price of a ton of steel rises by 3-cents, then it’s no big deal. However, if it rises by 300%, then more significant action is needed. The upshot of all of this is that the market coordinates the activities of producers and consumers so that we are minimizing waste. Economic profits guide entrepreneurs. Profits are the reward for correctly coordinating the economy. Losses are the result of not doing so.

Some people think that corporations are heartless and soulless entities that are only looking at the bottom line. Well, yes. While corporations on paper have the same rights as individuals, corporations are not really people. General Electric is not a real general. All too often we mix up the way we use English. We use collective nouns and then personify them. For example, you might hear on the news that “the market was feeling sluggish,” or “the EPA is regulating a new chemical,” or “General Motors is coming out with a new car.” All of these, “the market,” “the EPA,” and “General Motors,” are collective nouns. We use these phrases as shorthanded expressions, but we should not ascribe to them personal feelings and motives. Furthermore, since they are not really people, they have no morally responsibilities. The people who work within these institutions have moral responsibilities, but the organization does not.

The owners of a corporation are the shareholders. They have invested money into this form of productive organization to make a return. If the company is not making a large enough return, the shareholders sell and reinvest their funds elsewhere. Who owns stock? Most people do. Anyone who has an IRA, 401k or pension plan does. Basically, anyone who is attempting to save for retirement is a part owner of a corporation. The point is that it’s not just rich people.

The shareholders vote for a Board of Directors to oversee and supervise the operation of the company. (Usually, it is one share equals one vote.) The Board then hires a CEO for the day-to-day operations. The CEO and the rest of the management team are employees of the firm. Their job is to make as much profit as they can. That means keeping costs down while serving customers.

The CEO may be asked if he wants the corner office or a cubicle; if he wants a big mahogany desk or a small metal desk; or if he wants to schmooze clients at Waffle House or take the corporate jet to Tahiti for nine rounds of golf. When the CEO picks the expensive choice, he is taking perquisites (or perks). In other words, the CEO is spending the shareholders’ money on himself. It is the job of the Board of Directors to oversee this and attempt to curtail such practices. Clearly people get upset when they see this happening because the company’s funds are not the CEO’s personal money. In the same way, when the CEO donates corporate funds to a charity, say cancer research, he is again using someone else’s money. It’s not his to spend. It is tantamount to stealing. The corporation has no moral duty to help cancer patients and the employees of the company cannot use corporate money without breaking moral codes themselves. If the CEO feels so passionately about cancer research, let him donate his own money.

Sometimes we might see, at a little league game, players with shirts with “Joe’s Plumbing” on them. Is this also stealing? Maybe. If Joe’s Plumbing is able to generate goodwill and sales from the bestowal of the T-shirts, then that is considered good marketing. If not, then it may very well be stealing. It’s a grey area and has to be determined on a case-by-case basis. Nevertheless the bottom line is that employees should not be using company funds for their own benefit.

Thus, we have our answer: shareholders create a corporation to make profit—the bigger the profit, the better. The goal of corporate management is to increase the company’s share price. Corporations are not created for jobs, or for providing health care, or for providing a living wage, or for promoting social justice, or for any of that. It is to make profit, no more, no less. And that is a good thing.


Anonymous said...

This article states factual information throughout but then ends with a conclusion lacking justification. Why is it a good thing that the purpose of corporation is only to make a profit?? I would propose that the purpose of corporations in our capitalist society should be to spur development and growth of society - that is, to harness private interests to serve the public need. Thus, corporate profits should be suffered only to the extent necessary to serve the public need.

P F Cwik said...

My Anonymous friend is making some critical mistakes in his(?) analysis. Before we turn to that, there is a challenge about whether profit is a "good thing." I say, "Yes, it is!" because it is the "after-the-fact" signal that an entrepreneur has done something right, i.e., serve the consumer. The level of profit shows the extent that discoordination has been removed from the economy and that resources have been combined in non-wasteful ways.

The idea that investment for investment's sake spurs growth is not true. Capital is not homogeneous, and as a result, capital investments must be made through the method of economic calculation. Without economic calculation, (searching for profits) there is no manner in which we can tell if resources are being used wisely or wastefully.

Furthermore, "society" neither grows nor develops. That is falling into that "collective nouns" trap that I explained in the post. All this sort of analysis must start at the individual level and then build up.

Additionally, ALL investments that are profitable serve the public need. If people were not served by the products and services created by the entrepreneur's investment, then he would suffer a loss. Profit is the sign by which we can objectively say that the public need was served! There is no other way to objectively judge.

Finally, profits are not something that causes suffering. To think this way assumes that there is a fixed amount of wealth, which results in winners winning only at the expense of others. This analysis is simply wrong. Profits are the result of wealth creation. Both the producer and the consumers win. It is not a zero-sum game, it is a positive-sum game, where each side wins.

Anonymous said...

I can't believe a supposed doctor wrote this. It's so woefully shortsighted and is pretty much everything wrong about the modern economy. Is the system working as you describe right now? A resounding NO!

Profits are being made with no real resource being managed. It's profit being made off of profit itself, leeching away the value of real labor resources from the working classes. That's the problem!

Prices do not simply function as pieces of information, they are extremely powerful implements of social control. Who is the consumer in a stock transaction? The answer today is really no one, there is no person deriving use from a good that is sold. The primary "use" of stocks today is as placeholders of value -- their prices.

How then does a "good" get priced when its value is its price? The answer is that it cannot be priced in any way that is beneficial to an economy, by any system that makes any sense.

This is how the global financial system has essentially turned into a gigantic casino game. And that is not good at ALL.

P F Cwik said...

I have written a response to this, but sadly I have surpassed the 4,096 character limit. So I have made a new post that is called "The Purpose of Corporations II." It was posted on November 16, 2011. It is found here:

Anonymous said...

Many assumptions here :

1.) What is profit ? balance sheet figures, currency numbers ? infact this is the root cause of the imbalance that corporations are creating.

2.) making profit need not be a result of doing something right. corporations make profit out of lobbying, exploiting inherent loop holes in the system, and many other innumerable ways. for example, companies made huge profit advertising their product wrongly, but then were put to break after 4 years of successful sale. then does that justify their four year profit making as something good ? somethign right ?

I do not see depth, sorry. neither i see life as the center of discussion, if life and happiness is not at all at the center of something, then how can it even aim to increase its standards ?

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