GOVERNANCE OF MARKETS

"The modern corporation may be regarded not simply as one form of social organization but potentially (if not actually) as the dominant institution of the modern world…Where its own interests are concerned, it even attempts to dominate the state"
- Adolph A. Berle and Gardiner C Means, The Modern Corporation and Private Property

• Oliver Williamson
• Ronard H. Coase
• Cesar Ayala
• Adorl Berne
• Gardiner Means
• Herbert Spencer
• Baran and Sweezy
• Michael Jensen
• Peter Rona

Institutions of legal and social control

Assuming that money is an instrument of control and power, and actually 'rule the world', the way financial markets and corporations are run, control and supervision should be of great interest to everybody. However, American public speech confined these debates to a narrow circle of professionals in the business elite sphere. Thus, according to John Pound (1995), an editor of the Harvard Business Review, identified the "three critical" constituencies of a firm: managers, the shareholders and the board of directors, which obviously does not include ordinary workers, customers or suppliers.

Very little attention is paid to financial structures as institutions of legal and social control as changes in corporate investment are treated as the results of changes in interest rates or stock prices. This presents various problems. There is a difference, for example, between financing a project with debt or equity. Oliver Williamson (1988; 1993) argued that the appropriate form of finance varied with the nature of the underlying asset. It is not recommended to finance a highly risky project with debt, but rather with assets that could be easily sold to cover the debt in the case of bankruptcy. More specialized investments, which depend on either narrow market or specific firm, should be financed with equity, as the suppliers have the right to replace managers if something goes wrong. However, in reality, shareholder's supervision is difficult, if not impossible and we should keep that in mind.

Conflicting Interests

Doug Henwood points out that the relations between financial and governance structures were given more attention, as the structure of international differences in corporate ownership were seen to affect economic performance. Another issue to keep in mind before deciding on the way to finance a project is that there is a fundamental difference between the interests of stockholders and bondholders. When a firm gets into trouble, stockholders are likely to favor some degree of debt forgiveness, because if the firm collapses, there is no guarantee that they will receive their money back; while creditors want to see shareholders wiped out and the firm liquidated to satisfy their claims. Managers, on the other hand, want the firm to continue to exist due to the convenience, habit or firm-specific-human capital.

Profits vs. Efficiency

Despite the fact that conventional neo-classical economics still treats the economic system as capable of fixing the problem and self-regulating, in fact there are substantial costs of time and money devoted to making the system work according to Ronard H. Coase (1937). The view of Veblen is very interesting; he believes that many transactions are undertaken not for efficiency, but for reason of power, specifically to undermine competitors or to secure monopolistic position. He puts an emphasis on the firms' incentive to make profit, rather than created efficient industrial system. For example, advertising, predatory pricing and spurious innovations are profit-maximizing activities, but rather useless if not harmful to the society.

Robert Baron, Managerial and Bank- Spheres

Cesar Ayala (1989) divided the literature on the control of corporations into 3 schools of thought - Robert Baron, Managerial and Bank- Spheres. Robert Barons' school believes that "Big Business have reintroduced 'feudal elements' in the society", Managerial school stands on idea that managers rule the economy, and the Bank Sphere states that banks have all the control. Lets examine each school individually. Robert Baron's school holds that the Morgan's and Rockefellers of this world have appropriated the wealth of the nation through violence and conspiracy that was once belonged to the small producers and firms. Unlike the school Marxist school and business historian, which are fond of the idea of American capitalistic myth, Baron's school sees such appropriation as the perversion of a 'natural state' of competition due to the violence and criminalization that marks the process. However, there is no doubt that larger firms are far more efficient than the smaller firms they have replaced. It has also been proven on the example of British business, which was dominated by the small and mid-sized firms through 19th and 20th century, that besides efficiency, larger firms generate more investment.

Managerism

The second school of thought, Managerism, is closely tied with the work by Adorl Berne and Gardiner Means. According to them, modern capitalism is characterized by the simultaneous concentration of production in the large corporation and the dispersion of ownership among shareholders. While the ownership was dispersed into the hands of millions shareholders, the actual control fell to mangers, responsible to the shareholders, but in reality quite independent and self-sustaining. This presents a problem of transparency, rent-seeking behavior and perks on the part of the managers, and asymmetric information. However, Berne and Means also argue in their update of The Modern Corporation and Private Property, that growth and competition by long term corporate planning and administered prices have replaced the sole profit maximization of the entrepreneurial capitalism. However, even if managers might maintain high labor standards out of 'professional pride' that might be maximally profitable for the shareholder, shareholders have little or even close to none control of the state of corporation, the decisions and projects its pursuing and the way it finances them. It is the ability of the shareholder to sell his shares on the market quickly and cheaply that outbalances his inability to sell corporate property as it would be expected, and makes the system work.

Bank Sphere and the Purest Banker Control Theory

Herbert Spencer (1972) argues that managers not only do not have long term interests in the firm, but they may bend the affairs of the firm to fit their needs and maximize their personal profits rather than the firms. Baran and Sweezy (1966) have dismissed Bernes and Means argument that the corporations have come to balance social responsibility with profit making, arguing that on the contrary, managers in the bigger corporations were in a better position to maximize their profits due to the longer planning horizons. Galbraith (1967/1978) has pointed out that the stockholders had no control of the management due to the unorganized structure, dispersion and innumerability. He interestingly argues that the techno structure of the corporation had little to gain from high profits, as it would be passed to the shareholders, and might undermine managerial autonomy. However, increased cash flows or revenues signify growing power and prestige, thus making an expansion of output and sales more desired than efficient structure of the corporation, which generates high profits. Managerism has shared the idea that competition was an obsolete notion, which was shattered by the recession of 1973-75 and the increased competition from Japan and Europe that followed. As the deep bear market of 1973-75 was replaced by the fresh wave of activities, managerial ideal was under attack.

One of the recent theories of corporate governance has incorporated the ideas of Michael Jensen, who states that stockholders should not trust their managers and there should be major restructuring changes in the way corporations are run nowadays. He poses an important question as to why millions of individuals are willing to become residual claimants on the basis of anticipation that managers will make the right decisions in operating the firm and increase shareholders wealth? Definitely, the idea of the division of labor and convenience plays a role in this debate, but there is more to the subject. It could be argued that the growth in the use of the corporate form and in the market have been satisfactory to the lenders and investors, but why such issues as agency costs, perks and leveraged buyouts aren't addressed by the shareholders is another question. Jensen argues that managers need to be put under the new disciplinary structure, where the interests of shareholders with the positive cash flows revenues is not conflicting with the decision of the management to invest in R&D projects, investment or perks. In fact, beginning the early 1980 up until recently, big corporations received huge cash flows due to the increased cost of capital and therefore, required highest and fastest profit making projects to be undertaken, and were faced with the problem of where, how and when to utilize the money. Jensen's suggestion to load companies with debt, which will bond them to repay the interest uncompromisingly, has a drawback of artificially inflating the interest rates.

Leveraged buyouts

Leveraged buyouts (LBO) ideology, when a group of investors, often along with the firm's senior management, take a company private by going into debt, proved to be successful in the early years. After 1989, it became obvious that the new corporate form had failed to deliver sustained profit to its investors. Peter Rona rebutes Jensen's LBO theory by pointing out that he failed to address the questions of what the rights and privileges of the shareholders should be, as well as provide empirical evidence the shareholders are better judges of capital projects than managers are. Such issues as negative externalities that appears in the process of LBO, as lost jobs and cut wages for the workers as well as environmental effects were not taken into consideration.