Colin Mayer is the Peter Moores Professor of Management Studies at Saïd Business School, Oxford University, and the former Peter Moores Dean of the School between 2006 and 2011. He is an expert on all aspects of corporate finance, governance and taxation, and the regulation of fnancial institutions. He has consulted for numerous large frms and for governments, regulators and international agencies around the world.
What are corporations for? Why do they exist?
Colin Mayer: Corporations exist to perform functions that benefit the customers or communities of the corporations. That refects the origins of corporations. The first named corporation was established in Rome to undertake public functions during the first few centuries AD. The roman concept of corporation was designed to undertake public work and it was subsequently adopted by the Roman Catholic Church. And in each case they had a specifcally designed function. The works of corporations included the building of public buildings, roads, the provision of public services. Also one of the earliest known forms of corporation is the university.
Public goods as we would call it today.
CM: Yes, exactly. And in the case of the catholic church it was literally to run and provide the administration. In the case of universities it was to provide education. And in the middle-ages it was part of the formation of the guilds overtaking trading functions, providing training for people working in those guilds.
Would you agree with the statement that the purpose of a company is to maximize its profits?
CM: No, not at all. The purpose of a company is to perform functions that will beneft to communities, societies, customers and in the process of doing that the owners of a company generate profits but profits are not as such the objective of a corporation.
What are profits for then?
CM: Profits provide the incentives for those who put up the capital for the business to do so, it is the reward for doing so. But just as those who work for the company should be rewarded for doing so. That does not make the maximization of profits the objective of the company. The objective of the company is to deliver things that will benefit to others and just in the process to make profits.
„The purpose of a company is to functions that will benefit to communities, societies, customers and in the process of doing that the owners of a company generate profits but profits are not as such the objective of a corporation“
Today not many people have the impression that this is the purpose of the corporations that exist. How was this in in the past and in ancient Rome, Did the corporations really work for the public benefit? What was different?
CM: What is different about companies of Rome and those established in middle ages was that they were established under license. So they had a fundamental purpose to fulfil those public functions. In the case of the medieval guilds it was to perform the roles in terms of the delivery of particular services. In the case of the medieval companies they got the licence from the king, the monarchy and then subsequently from parliament. For example corporations in the 18th and 19th century, 18th century in particular, which built railways and canals did so under licences from parliament. The corporation up until the 19th century was essentially licenced by government or monarchies to perform its functions with a clearly defined public purpose behind them. The establishment of the colonies in the United States changed that. The colonies were established as corporations. So, for example Massachusetts, Pennsylvania etc. were established as corporations. And then in turn they committed others to establish corporations within those states. That is how the freedom to incorporate emerged and became a feature of corporation during the 19th century. And thereafter corporations no longer had distinct and explicit public functions.
That‘s interesting. And what was the ownership structure of these companies during the period of licensing?
CM: There were public subscriptions much along the lines of what we have today. For example the East India Company, which was one of the largest companies of its time in the world, had public outside subscribers and the notion of there being shareholders was well-established. But the diference was, that those companies although they had shareholders, had to perform this public function. So, in history the fundamental purpose of the company was to fulfil its licenced condition. And as part of that, it would then generate the profits. So that‘s why I‘m saying: the underlying notion of corporations was not to maximize its profits.
Was the East India Company the first company that actually had shareholders in the sense, that people who did not work in the company owned it?
CM: It was not the frst. For example there was the Russian Company or the Hudson Bay Company, which were established to undertake trading activities. They all had that same notion that a corporation has a purpose and objective of the establishment and had shareholders who invested in them. Now, if you look at other ones, the universities, eg. you take the Cambridge Colleges, you‘ll fnd that today, every single Cambridge College has its own Royal Charter, its own legal form of purpose. They don‘t have outside shareholders, but the people who run them are the fellows of the colleges.
Are they the owners?
CM: No. They are if you like the trustees. They are responsible for insuring that the purpose is fulfilled and that the original Charter is met. There are no owners as such. They are if you like ownerless corporations.
That’s really interesting. Now, what does this mean in legal terms? They are trustees and as such, they hold the voting right in order to govern the particular corporation during the time they work for it, is that right?
CM: Yes, as long as they work there and as they retire they are no longer members of the governing body of the college.
If we split the term ‘ownership‘ or ‘property‘ into a bundle of rights including the ability to govern, to receive the profits, to sell it, inherit it or even destroy it, then as I understand, the college fellows exclusively hold the right to govern.
CM: Yes, they have if you like ‘management rights‘ but not ‘ownership rights‘. This particular was an important element to the corporation because what the companies like the Russian Company did was it took the notion of the guild – they had this ‚ministeric‘ role, they were just purely ministering the activities like merging or trading – but then it fused into the notion of having capital and being able to raise more capital. So the real invention behind things like The East India Company is to take the notion of a guild as administration and to fuse into that the notion of being able to raise capital. And that‘s what really gives rise to the distinctive feature of corporation; it is that combination of capital and administration.
In your book, you make strong claim about what problems corporations face. Why is the corporation widely seen as a problem for society, an actor that only maximizes its own profits?
CM: Well you really described the problem by your question. The problem is, the original intention of corporations is being lost. And the fact that you open your remarks by saying, well actually everyone thinks that the corporation is having the objective to maximise its profit is basically the source of the problem that you‘re talking about. And it might therefore just help to understand how this has come about and how we‘ve gone from the notion of corporation in the middle ages to where it is today. Freedom of incorporation as I described it is not itself a problem, indeed, initially corporations performed a very strong purpose and function. Not necessarily a public function, but they clearly had a notion of servicing their customers.
It was really during the 20th century, with the change in nature of the ownership of corporations that the emphasis shifed to the importance of the shareholders, to maximize in terms of shareholders. The legal form of a corporation specifes very clearly that the objective of those running the corporation is to promote the interest of the corporation, not to promote the interests of its shareholders. In principle, the fiduciary responsibility of directors is to the company as such, but in practice that is of little significance, when in fact all of the control rights reside with the shareholders. And the reason that has happened is that shareholding has moved from individual shareholding, which is what it used to be and in many countries still is (predominantly in the hands of families) to large numbers of outside shareholders and then to institutional shareholders. Those institutional shareholders, since they are responsible to their ultimate investors, regard their sole responsibility – perhaps quite rightly – as being just to extract as much as they can in terms of returns of the companies in which they invest. So the system has moved over time into one that has essentially conferred all of the right and control to shareholders and shifed it away from those who run the corporation, who had an interest in insuring what the interests of the corporation itself were.
The motives for that were the technological changes occurring around the time of Industrial Revolution in particular. There were a lot of new opportunities and in particular manufacturing opportunities that emerged that previously had not existed. Which meant that the functions that needed to be performed in econo- my were not based simply on public works and infra- structure. They all indeed were run in agriculture. So, around the time that Adam Smith was writing, there was a change in process, in terms of the meat of what corporations should have to fulfl, towards much more innovative activities. And it was those innovative activ- ities that then gave rise to a pressure to have a freedom of incorporation. So, afer the collapse of the South Sea Company in 1720 the bubble act prevented people from establishing private companies. But people were getting round that through essentially using partner- ships, in other words unincorporated businesses. Peo- ple were using unincorporated partnerships as a way of creating companies. In fact, the law was allowing people to establish surrogate corporations and in the case of Britain in 1856, it was decided at that stage that really one had to establish private corporations as legal entities and not to encourage this way of getting round the law to establish companies.
Was this also when the limited liability act was implemented?
CM: Yes, limited liability came in in 1856 and that was designed to facilitate the raising of capital of companies that were being incorporated. And the notion of limited liability was much opposed at that time. It was a very important component to the law of corporations to flourish. Some people say that limited liability is really the problem behind the corporation and if one had freedom of incorporation without limited liability than we wouldn‘t have the current problem. But that is a complete misunderstanding. I mean, it is true that in the absence of limited liability those who own banks have a greater interest in insuring they don‘t engage in reckless activities, but to be able to have a market and shares in companies, you have to have limited liability. Because otherwise, in terms of purchasing shares, you would only be willing to buy shares if you knew how much wealth everyone else in the company had in order to know what your liability actually is. And so, it is infeasible to run a system without limited liability.
We already touched on it briefly but what exactly is the problem with these shareholder-driven companies?
CM: The problem with starting from the notion of saying that companies’ objective is to maximize their shareholder‘s interests is that it potentially undermines what the real objective of the corporation is, and that is to fulfil its purpose. The great thing about freedom of incorporation and the reason why this was a massive step forward is, that with freedom of incorporation you can have a myriad of purposes of companies. Companies that are designed to produce the cheapest products; companies that are designed to produce the most reliable products, those that are most innovative in some area, etc. Whereas previously, it was only the monarch or parliament who could actually identify what should be the purpose of a company. So, the freedom of incorporation has allowed for a huge diversity of purposes and through permitting people to identify the purpose you then allow them to identify what is the mechanism by which they can best deliver that purpose. And they show, that they will actually deliver the best washing machines, the most reliable cars or whatever. And the answer to that is that in some cases it hinges critically on employing the most skilled people, people who are really dedicated to producing the services that are required. In some cases it is to raise large amounts of capital. But what this means is there are lots of different interests in the companies. In some cases it is the suppliers who are critically important, for example, a company that I do a lot of work with is one of the natural chocolate manufacturers and for them, access to the cocoa producers in the world i.e. having a reliable source of cocoa supply is important. How they treat the cocoa suppliers and the commitment they make is critical to their success. They don‘t have outside shareholders. To them raising capital is not the key element. To a large manufacturing firm very dependent on capital intensive investments, raising outside equity is critically important. The shareholder-view of the corporation imposes the notion that the only part that really matters are the equity providers. Increasingly, that is simply not the case. One of the things I talk about is how we have moved away from the capital intensive world to a world of actually human capital and intellectual capital. And that means that the corporation today is really dependent on something that is very different from that of the shareholder-interests of the past. This focus on the notion of shareholder-oriented corporation, is actually undermining the commercial success of corporations, let alone its role in insuring that the environment is protected and that societies are protected.
Let‘s put it like this: It would be in the shareholders interest that companies don‘t focus on shareholder interests.
CM: Exactly. And indeed, that‘s true for the most successful companies in the world. They have objectives that are not maximising shareholder value and in the process of delivering their purpose, they succeed in delivering substantial terms for their shareholders.
What sort of companies do you have in mind?
CM: Companies like Bertelsmann, Bosch these are all owned by foundations. Their objectives are clearly defined purposes. They have a long term stable ownership that allows them to focus on the purpose of the corporation. In general there is an increasing realization that the changing ownership structure of companies is being very detrimental to the achievement of long-term purposes.
What would you say is the corporation of the future? Where are we heading?
CM: There are three themes that are really emerging in the current discussions about corporations. Those are 1. purpose, ensuring purpose, 2. ownership and the nature of ownership that‘s contributive to the delivery of that purpose and 3. governance and the way in which the management of companies is aligned to the delivery of that purpose. Those are the three key elements that are emerging.
What‘s going to be the feature of the corporation, in the 21st century?
CM: There are two possibilities: One is, we continue along the current trajectory, and actually we have continuing failures and collapses of economies and financial systems and continuing environmental degradation. The second is, that we actually recognize, the fact that there is a fundamental problem and that reform comes about. And if reform comes about, what we will end up with is corporations that reflect in many respects what I was describing with this original feature of corporations, that deliver substantial benefits to communities, nations and customers.
I‘m optimistic, I may be naive but I believe that there is now a sufficient realization that this needs to happen, that change is going to take place. I‘ll give you an example of the way I think change is manifesting: The curriculum of business schools around the world is changing dramatically from being focused on how management should deliver for shareholder returns to recognizing that actually, that‘s not the right focus of business school curriculum. And the right focus has to be: what is the purpose of a corporation and how should it deliver on that.
What does this mean on a company level? If we shift towards purpose-driven companies, do we stick to the current ownership structure with shareholders or what do you suggest?
CM: There are two changes taking place: Institutions like pension funds and life-insurance companies are increasingly realizing that the approach they have taken in the past century of portfolio management, holding diversifed portfolios, is not beneficial for them and that success actually comes from being engaged long-term shareholders. Not hedge-fund activism, but activism in the form of being supportive of management and insuring that managing will deliver on its purpose. That is one change that is taking place in terms of the nature of the institutional investment. The other change that is taking place is, companies are increasingly realizing, that the infuence of the stock market on their activities is being incredibly detrimental. One of the developments that is taking place during the past few years is a collapse of stock markets in the West. So, for example, over the last twenty years, the number of companies listed in the London Stock Exchange has halved from 2000 to 1000 and the same is taking place in the US. Companies are voting with their feet, private equity is rising and companies are going private. But private equity is not the solution. Companies need many ways to raise capital. What will emerge is a very diferent nature of ownership. Companies will still be listed on stock markets but will have long-term committed shareholders.
Does this mean the shift only consists of the fact that shareholders, e.g. pension funds, invest with a more long-term perspective? Who will hold the control rights?
CM: The ultimate control rights reside in those who have an interest in the delivery of the long-term purpose of the corporation. That may not necessarily be pension funds and insurance companies. The interesting feature of companies like Bertelsmann and Bosch is that they are not controlled by pension funds but by foundations and that, I think, is a very interesting alternative model that has some advantages over the pension fund / life insurance approach.
You also described the structure of the corporations within colleges like those at Cambridge and Oxford. You called the trustees “responsible cooperating partners”. Do you think this could be a model for companies, too?
CM: That is basically like the foundations. If you like, the foundations are not ownerless companies. But they are almost ownerless because foundations themselves, are not answerable to any outside investor. So, the Oxford College model is in many respects a bit like an industrial foundation.
If you could design a perfect legal form, what would it look like?
CM: I would design it in a way to encourage, as much diversity in corporate forms as possible. So, legislation should be enabling a company to choose that form which is best suited to their situation. Not being prescriptive in laying down any particular right form. For example, in some cases employee-owned companies are appropriate, in other cases industrial foundations may be appropriate. An unfortunate feature of what the European Commission is trying to do is based on trying to harmonize, not recognizing the immense benefts that come in the European system from diversity.
You started off by describing historical elements of corporations, especially the fact that every company needed a “licence“. Who will be the ‘purpose licence-provider‘ of the future?
CM: In many of the most successful companies, the essential purpose comes from those who founded the organization. And that‘s where the advantage over public licensing comes from. You can have a lot of individual ideas what the purpose should be. In my book, I talk about this a bit like having lots of islands, the world is populated by islands with different purposes and people can choose which island they want to live in, buy from, work for, invest in.
This also goes in line with studies from Harvard and also Zurich University, that 90% of founders of companies are actually intrinsically motivated and they don‘t strive for profit maximization. But then the question is, how can we make sure, that this purpose drive remains when the company all of a sudden needs more money etc.?
CM: That was the problem behind corporations. For example, in Britain we had a lot of highly motivated and altruistic family companies which became invalid due to stock market development. Foundations have two advantages: They can retain control and by that avoid dilution. And they can overcome the heredity problem. Essentially they can choose from a much richer gene pool. It is not always the case that the descendants have the entrepreneurial abilities of their parents.
Let‘s go 50 years into the future. We have a lot of purpose driven companies. How is this going to infuence the economy?
CM: Well, I can illustrate that simulation to perhaps the most troublesome area of economy at the moment: the banking system. Basically, we‘re trying to insure that the objectives of banks are aligned with the public purpose simply through regulating.
The problem with that is, that the objects of regulators in upholding the public purposes is diametrically opposed to the owners in terms of maximizing proft. So, they do whatever they can to get around the regulations. Now, what I‘ve just been describing – in terms of changing the purpose and in the case of banks ensuring the licence condition – is part of the purpose that means that the fiduciary responsibilities of the director is no longer to simply maximize profits, but to deliver in the company’s purpose. So, the interests of the bank and the regulator would be aligned as corporations would actually benefit public interest not circumventing it anymore.
… we could deregulate and still uphold the public interest.
CM: Yes, the role of the regulator would become much less intrusive than at present.
Thank you very much for this interview!