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The aberration that is shareholder primacy has long exacerbated inequality and wealth concentration. For all the reasons Lenore Palladino mentions—from the highly-skewed distribution of shareholding to the social irresponsibility of large corporations—it is time to systematically purge our laws and institutions of this idea.
Palladino’s remedies sound promising; a size threshold for comprehensive federal regulation of corporations is apt when large multinational corporations increasingly operate in a universe unto themselves. But introducing wide employee shareholding, while practically useful, deserves more careful attention. In our current system, shareholding is tantamount to ownership, and ownership bestows control and voice. To empower workers, the argument goes, and potentially other “stakeholders,” we should make them owners. Yet it is worth interrogating the logic underlying this assumption because it says a lot about the sustained role of ownership in the ways we understand democratic participation.
As Palladino demonstrates, three concepts have been central in shaping the shareholder-primacy paradigm: risk, profit, and ownership. The ownership stakes of shareholders meant that they assumed the firm’s risk and therefore rightfully earned its profits. The “incomplete contractual relationship” of the 1970s meant that shareholders were exposed to uncertain returns and therefore enjoyed ultimate control rights. Indeed, these concepts have a long history of explaining and justifying each other. Traditionally, profits belong to the owner of an asset. If I enjoy the right to use my possessions, I have an equal right to their fruit. Similarly, risk was also seen as inextricably linked with property ownership. “No man can carry a risk,” argued American economist John Bates Clark in 1892, “who has nothing to lose.”
But understanding risk and profit in this way has important political implications. Private-property rights are bound up with values such as self-governance, autonomy, and equal dignity. It was by controlling property and managing expectations that individuals could, by this logic, manifest and actuate their autonomous will. For this reason too, property-requirements long remained a barrier to political participation.
The analogy between profit and risk in their relation to ownership makes intuitive sense: that which may be won can also be lost. And yet, the relationship between risk and profit has developed a life of its own, often unraveling older links to property rights. In fact, the history of economic thought shows that risk and profit have been used as tools for organizing labor relations as much, if not more, than property relations. By re-examining the precise role of risk and profit in creating myths such as shareholder primacy, we can therefore bypass the instinctive turn to ownership, when what we want to achieve is worker participation, corporate accountability, and wide wealth-sharing.
As Palladino notes, the ownership status of shareholders has been questioned and undermined since the days of Berle and Means, though without much impact on the priority of shareholders. One reason property didn’t really matter, was that profit had long liberated itself, at least conceptually, from property. Adam Smith, for example, saw the “undertaker” of business as separate from the landowner and capitalist; she receives profits for her “risk and trouble.” Unlike contemporary notions of entrepreneurial risk-taking, this “risk” was seen as an economic constant and profit acted as a social insurance on “regular losses.” It wasn’t conceived, as it is today, as a highly unpredictable, conspicuous prize for the daring. Smith’s real innovation, however, was his interpretation of the entrepreneur’s “trouble.” Smith called profit-makers “employers” because the most important thing they did was maintain labor throughout the production process. The wages paid to labor, regularly and securely, were the ultimate justification for the profits siphoned off at the end of the process. The fate of the entrepreneur was bound with that of labor.
Resonances of Smith’s ideas are evident in the work of American economists around the turn of the twentieth century. The “risk theory of profit,” developed by J. B. Clark and F. B. Hawley, was a protracted discussion on the right relationship between risk, profit, and ownership. Here too, the entrepreneur was separated from the capitalist. Clark argued that only the firm’s owners assumed its risks. Their return for risk-taking was treated as part of the firm’s regular costs. Profit, on the other hand, was the remainder: the amount left over after all costs, including labor, capital, and risk, were paid out. The entrepreneur had an added incentive to minimize costs, including risks.
Frank Knight slightly complicated this picture. Some risks, he argued, cannot be predicted in advance—and worse, cannot be regularly compensated for in the price of finished goods. Unpredictable outcomes were more accurately called “uncertainty” and the entrepreneurs who took them on earned the right to whatever “remainder” came their way. At times, these were spectacular gains, but, more often, losses. The important point Knight was making with his distinction between risk and uncertainty was that true uncertainty-bearing by some meant a much more predictable and secure economic world for everyone else. Entrepreneurs bore their uncertainty by providing workers and capitalists with guaranteed incomes at guaranteed times. Just like the “contract theory of the firm” Palladino describes, entrepreneurs earned the right to control the firm’s decisions, because, according to Knight, they had assumed the brunt of the responsibility for its success.
Whether or not we accept these theories’ conclusions, they nonetheless reveal an important link between risk and responsibility and between profit and labor. Smith and Knight both saw profit and risk as severed from ownership stakes. Instead, entrepreneurs earned their profits by taking responsibility for the production process and for productivity more broadly. Despite having radically different notions of profit, both also agreed that profit is justified by its role in providing greater security, especially a thriving labor market. This is the essence of Knight’s idea, however controversial, that uncertainty comes with greater title to control and leadership.
So, what does this mean for employee ownership? I believe the story of profit and risk shows that we don’t need to imagine shareholding as an ownership stake in the firm just so we can justify greater employee participation. First, unlike the diversified portfolios of large investors, holding a single firm’s stocks is, in fact, highly risky. Capped at 10 percent of total shares, as Palladino proposes, it also does little to substantively redistribute the wealth the firm produces. Seemingly rewarding “contribution,” moreover, it neglects the broader contributions of society and the labor of nonemployees to the firm’s success. In this sense, a better plan might be to widely distribute stakes in the “market portfolio,” that is, the market as a whole.
Second, if the real risks of a firm lie with its workers and managers (as noted by Knight) and with the communities that house it, then there should be no need for ownership status to guarantee voice, control, and broad participation. Since investment-risk is broadly distributed through shareholding, and since uncertainty is the true mandate for control rights, wide participation in leadership is more justified than shareholder primacy.
Third, without accepting all that goes into idealizations of risk-takers, we can still concede Knight’s important insight: there is value in making wages wholly different from profit, especially on the question of security. As such, any claims to the profits of firms, must first guarantee security for the many. This should include job security, regular and fair wages, and long-term health as a firm’s top priorities.
In a world in which all three conditions hold: widely-distributed shareholding, broad participation, and strong protections for labor (and “passive” capital), we can then have a conversation about the desirability of employee shareholding. Perhaps it would incentivize greater productivity and innovation, reduce risk-taking, or increase loyalty. These are great benefits and they might well be worth the risk. But without more fundamental change, employee shareholding remains a problematic solution by reaffirming a foundation of inequality: property as the condition for political participation.
Roni Hirsch is a postdoctoral fellow at the EJ Safra Center for Ethics at Harvard University and a Polonsky Academy Fellow at the Van Leer Jerusalem Institute. She is currently completing a book manuscript titled Who Profits, on the history of profit and its meaning for distributive justice today.
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