Ius & Iustitium welcomes submissions from academics, practicing lawyers, and students interested in the classical legal tradition. J.S. Liptrap is Assistant Professor, Law Department, University of Sussex; Research Associate, Centre for Business Research, Cambridge Judge Business School. The author adds: “Subject to the usual caveats, thanks to Conor Casey, Michael Foran and Adrian Vermeule for helpful discussions on an earlier draft of this essay.”
Introduction
This essay, based upon an ongoing project, is the first in a two-part contribution that (i) critiques shareholder capitalism on classical legal grounds and then (ii) provides a preliminary sketch of what the UK corporate governance system would look like if it were more closely anchored in the classical legal tradition. Before delving into the first part of the project, though, a brief remark on academic humility is in order. The classical legal tradition has an ancient pedigree, and it has enjoyed something of a resurgence in recent memory and contemporary debates thanks to the labors of many commentators, some of whom were kind enough to discuss this project’s overall aims and direction of travel. Their contributions are mainly confined to constitutional and public law spheres, and my task, such as it is, is to adapt that body of work to the corporate governance field.[1] Hence, it is only right to acknowledge that intellectual debt at the outset. With that said, the impetus for the project is that there are perhaps myriad orthodox ways to critique shareholder capitalism, but they do not pierce the heart of the problem. When we shine a spotlight on the root problem with shareholder capitalism, referencing the classical legal traditional positions us to understand why reforms are actually necessary.
Orthodox Critiques of Shareholder Capitalism
Shareholder capitalism, loosely, is a form of capitalism in which shareholders’ interests dominate all others. Corporations operate for the primary purpose of maximizing profits, and returning the highest possible yields to shareholders. In terms of orthodox critiques, we might begin with the assumption that a corporate legal regime attuned to shareholders will produce a number of material benefits for the public at large in their overlapping capacities as investors themselves or employees. But this, unfortunately, does not appear to be the reality. For one thing, the UK is not a country of widespread capital ownership. Likewise, it is no secret that UK real wages have stagnated over the last decade or so (and, indeed, further back), and this is exacerbated by the ongoing cost of living crisis. Meanwhile, in 2021 dividend distributions climbed back to pre-COVID levels for FTSE 100 firms (£73.7 billion). Since these material benefits do not seem to reach the average citizen, one might reasonably wonder how shareholder capitalism is exactly improving social welfare in Britain today.
We could also critique another of shareholder capitalism’s assumptions about executive compensation from an orthodox perspective. The logic goes that, because shareholder wealth maximization is the most socio-economically desirable end to corporate governance (which is highly debatable), corporate managers ought to be incentivized in line with the wishes of the general meeting, and the capital markets more broadly. By wedding executive pay packets to share price performance, corporate managers have a compelling incentive to work hard and do a good job. If they do not, they can be removed by a simple majority vote, or they otherwise risk the prospect of a takeover, which may well also result in their removal from office further downstream. Whilst this arrangement incentivizes corporate managers, it also discourages them from shirking their duties, or engaging in self-enrichment, at the corporation’s expense. However, recurring episodes of corporate misconduct indicate that tying executive compensation to share price performance creates a pathway to achieving great personal wealth. For this reason, it should not be surprising when corporate managers are implicated in severe fraud, financial malpractice and brazen accounting manipulation. The recent Patisserie Valerie and Carillion scandals are garden-variety illustrations highlighting that this attendant dimension of shareholder capital does not necessarily function in the envisioned manner, and it has an exacting social cost.
The Root Problem
These orthodox critiques of shareholder capitalism are adequate and reasonable, insofar as they are consistent with the internal lexicon and modes of thinking that corporate governance commentators typically rely upon when they engage with each other. However, the internal lexicon and modes of thinking have intrinsic limitations. These limitations are borne out of the law and economics movement, a movement that has maintained an assertive chokehold on corporate governance scholarship (and policymaking) for many years. A result of the law and economics movement’s influence on the discipline is that, whilst other academic fields have advanced, the study of corporate governance remains, to a greater or lesser extent, static and continues to be driven by antiquated conventions and philosophies. Thus, unless one is prepared to abandon the standard law and economics toolbox, asking certain questions about shareholder capitalism is essentially out-of-bounds. And the trouble, in my view, is that the root problem with shareholder capitalism lies in a deeper conviction that the law and economics movement holds as sacrosanct, which a researcher observing the discipline’s internal lexicon and modes of thinking simply cannot reach in the customary way.
The root problem is that, although shareholder capitalism is supported by discrete assumptions like those above, its foundations are in a more general – and inaccurate – assessment of human nature. This assessment hinges on caricaturing humans as “rational egoists” with an insatiable appetite to consume and pursue material gains. When this natural state of being is leveraged within competitive market settings and scaled to a population level, it has a certain dynamism and ability to deliver larger and larger accumulations of wealth. This is in the public interest, not least because competition ensures the efficient allocation of societal and natural resources. As Paddy Ireland notes, in the corporate governance context, these “ideas have found expression in the idea that ‘maximising shareholder value’ benefits not only shareholders but society as a whole”. I have already offered a few examples of why we should be skeptical of the shareholder wealth maximization proposition, but these are merely offshoots of a more profound issue. The root problem underpinning the larger system is that it is assumed that this conception of human nature is fixed and has an unalterable, pre- societal and regulatory existence. Here, the best function of law is to harness and track that nature. To borrow from Hans Kelsen, this is the “grundnorm” of shareholder capitalism from which all else flows.
However, this assessment of human nature was refuted some time ago. In particular, what studies on human evolution reveal is a rather different, more complicated story about us – one that has yet to be absorbed into the corporate governance canon. Utility-seeking egoism is part of the equation, it is true, but evolutionary economics commentators, like Geoffrey Hodgson, demonstrate that this facet of human behavior is only as dominant as our communal codes and principles of morality allow it to be. To be sure, those studying the evolution of human cooperation, such as Samuel Bowles and Herbert Gintis, show that law and legal institutions can serve as cues for cultivating equally important facets of human behavior, like goodwill, mutual trust, reciprocity and solidarity. This is not to say that self-interest is somehow absent, but rather that “other-regarding” motivations and preferences can become dominant in the right institutional environments. In other words, law matters. It is a principal driver dictating how humans behave within society, including within substructures like capital markets and corporations.
What can be distilled from this is that law and legal institutions can either be used to promote self-interest and what the German economist Goetz Briefs described as “marginal ethics”, or something else. Ultimately, how capitalism, and by extension the corporation, functions is a political and legal choice, not an inescapable conclusion arising from our nature as a species. Granted, much of the root problem is obscured by the neo-liberal “political project” that David Harvey details, of which the law and economics movement is a part. However, as alluded to by Susan Strange, the current corporate capitalism in operation in the UK, and more globally, exists “under the authority of and by permission of the state” and is “conducted on whatever terms the state may choose to dictate, or allow”. E. P. Thompson was, therefore, right when he opined that human beings do not behave like rational egoists, striving to improve their positions at others’ expense, because the human condition is immutable and cannot be re-directed to more appropriate ends. Human beings behave this way because of socio-legal institutional signals.
The Classical Legal Tradition
This is where the classical legal tradition comes into play. Put plainly, should the state allow this formulation of corporate capitalism – and all the societal and environmental hazards that go hand-in-hand with it – to subsist? More to the point, should the function of law and legal institutions be reduced to stimulating the expression of humanity’s most destructive traits instead of its best ones? The classical legal tradition takes a view on these questions, and in that sense it positions us to understand why reforms are actually necessary. Reforms are not needed because shareholder capitalism has the wrong idea about how to tabulate and achieve aggregate utility, as counter narratives like stakeholder capitalism would have us believe. It is because the proper function of law and legal institutions is to promote the common good, and the legitimate exercise of public authority is contingent on upholding and furthering it. The Thomistic tradition further specifies that the common good is not achievable at all unless policymakers take care in orientating citizens to a community of civic friendship with each other.
Although developments in our understanding of human evolution in group settings confirm that we are capable of cultivating things like mutual trust and solidarity (even in market settings), this does not seem possible where the state has institutionalized a set of prescriptions for provoking what Oliver Williamson referred to as “self-interest seeking with guile”. That is to say, policymakers have made a collective choice to opt for lax corporate governance rules and ethical norms that condition and encourage people to bend or avoid societal and environmental obligations if it generates market or material advantage. From a classical perspective, such arrangements cannot be regarded as legally genuine and valid. They are frauds or imposters, and more like acts of violence than “law” properly construed. They indicate that political authorities have lost touch with what the common good means; what the purpose of law is – this is why reforms are necessary.
In the second instalment of this two-part contribution, I offer a preliminary sketch of what corporate capitalism would look like in the UK if it was more closely anchored in the classical legal tradition, with particular attention paid to the tradition’s controlling principle that policymakers have a duty and corresponding authority to promote the flourishing of all members of the community.
J.S. Liptrap
[1] Note that this is not the first occasion that Ius & Iustitium has featured an essay on the corporation and the common good.