Ownership: Then vs. Now by Horizon Kinetics
March 2014
Introduction
The directors of such [joint stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own…Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company. – Adam Smith, 1776.
Adam Smith’s unambiguous suspicions of joint stock companies—the public corporations of his time—and his broader contemplations on conflicts of interests and incentives in The Wealth of Nations, foreshadow the importance of corporate governance in the study of management of public corporations.
It is upon this account that joint stock companies for foreign trade have seldom been able to maintain the competition against private adventurers. – Adam Smith, 1776.
We believe Smith’s observations are as relevant today as they have been at any point in history. Hence, this paper puts forth our thoughts on company ownership, and, ultimately, substantiates what we believe is an attractive wealth opportunity.
Ownership: Then vs. Now
Prior to the industrial revolution, most enterprise owners worked directly in that trade. The industrial revolution introduced large managed work forces, removing owners from the toils of day-to-day operations, beginning the separation of wealth and operational control. This split has continued to widen such that the modern corporate system is one in which those who control the wealth don’t own it and those who own the wealth don’t control it.2 Corporate structures were originally employed as simple legal entities to facilitate the transactions of enterprise owners. The wealth, control, and property of the enterprise belonged to the proprietors and their families. However, corporations have indefinite duration, which necessitates retention of the interests in and control of the enterprise over time.
How removed is today’s public shareholder from ownership? Today’s owners are generally passive participants holding entitlements with respect to an enterprise, but with little if any control over the enterprise itself. Becoming a shareholder of a public company requires no blood, sweat, or tears. One can purchase interests in a variety of enterprises, and often one does so through investment funds or other delegates, guaranteeing complete disassociation from the enterprise. In exchange for liquidity, the majority of today’s owners have reduced their wealth to stock certificates—electronic accounting entries in today’s reality—and subjected their wealth to constant appraisals and the erratic behavior of market participants.
The Principal-Agent Problem
If ownership does not entail management, and management does not require ownership, then something must be done to align the interests of managers and owners. Academia’s treatment of the principal-agent, incentives and self-interest problems has produced a rich social science littered with models that attempt to quantify highly subjective situations with sweeping assumptions. Let’s survey some of the key topics as we develop our own perspective. We will touch on three specific areas: management interests, compensation as a control, and shareholder control to conclude with a more general theory on the evolution of corporate decision making.
Management Interests
Directors and managements of public corporations wield enormous influence. While generalizations abound regarding their motivations, individual managers have unique sets of influences. Money, pride, politics, reputation, risk aversion and even religion are all relevant to varying degrees. Shareholders, although subject to similar influences, generally care about two things with respect to the companies in which they invest: profits and risk. Aligning the interests of these two constituencies is a complicated affair.
Risk aversion is widely cited as the most significant influence on management decisions. When corporate decision-making puts at risk anything a manager values, the potential for the manager’s motivations to conflict with the interests of shareholders arises. However, a company that avoids all risk cannot survive in a competitive market—while risk management is important, it cannot preclude taking calculated risks, lest it impede growth.
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