The Shareholder — The Firm, Plate vii

The plate before this one settled what ownership is: the residual right to decide everything the contract left open, the authority over an asset that no agreement could fully specify in advance. But that account carries a silent assumption — that the owner is at hand to exercise the right, that the person who holds the residual claim is the same person who makes the residual decision. For the proprietor of a workshop, or the partners of a firm, the assumption holds: they own, and they command, and the two are one act. In the great corporation it comes apart. There, ownership has been divided into thousands or millions of shares, spread among holders no one of whom owns enough to direct anything, while the directing is done by salaried managers who may own scarcely a share between them. The residual right and the residual decision, united in the older firm, have separated; and the question this raises is the one the plate must answer — when ownership and control no longer reside in the same hands, who, in truth, governs the corporation: the owners who do not manage, or the managers who do not own?

That the two had separated, and how far, was the finding of Adolf Berle and Gardiner Means, who in 1932 looked hard at the largest American corporations and reported what the law had not yet caught up to. A century of incorporation, of selling shares to the public to raise the vast sums that railroads and steelworks and motor companies required, had dispersed the ownership of the great firms across a multitude of small holders — a scattering so wide that the largest single block in many a giant company commanded only a slender fraction of the votes. Ownership, in the sense of the residual claim on profit, had become a thing held by the many; but control, in the sense of the power actually to choose the directors and set the course, had passed to the few who ran the place — to a management that, owning little, nonetheless governed much, because the owners were too numerous and too scattered to govern themselves. The corporation had not abolished ownership; it had pried ownership loose from control and let the two drift to opposite ends of the firm.¹

1. Berle and Means (1932) examined the largest American corporations and found ownership dispersed across a multitude of small holders — the largest block in many giants commanding only a slender fraction of votes. Selling shares to the public to raise the sums that railroads and steelworks required had scattered the residual claim among the many, while control — the power to choose directors and set the course — passed to a management owning little but governing much, because the owners were too numerous and too scattered to govern themselves. Ownership was not abolished but pried loose from control.

The significance is not that managers are dishonest, but that their position differs from the owners' in a way no honesty erases. The owner of the residual claim wants the firm's profit made as large as it can be, for the profit is his. The manager who controls but does not own bears only a sliver of that profit, if any, while bearing in full the daily experience of the firm — and so his interest pulls, at the margin, toward things the owners would not choose: toward a larger empire than is profitable to run, because size brings prestige and salary; toward comfort and safety and the avoidance of the bold risk that might pay the owners well but cost the manager his post; toward the retention of earnings the owners would rather have paid out, because earnings under management's hand are management's to deploy. This is the divergence the next family of the firm's theory would name and price — the agency cost that the fourth plate set out, the wedge that opens whenever one party acts for another whose interest is not his own. Berle and Means did not formalize it; they discovered the condition that makes it inevitable. The separation of ownership from control is simply the agency problem written at the scale of the whole corporation, with the dispersed shareholders as the principals and the entrenched managers as the agents who cannot easily be brought to heel.²

2. The point is not that managers are dishonest but that their position differs from owners' in a way no honesty erases. The owner wants profit maximized, for it is his; the manager bears only a sliver of profit but the full daily experience of the firm, and his interest pulls toward empire (prestige, salary), comfort and safety over bold risk, and retained earnings he may deploy. This is the agency cost the fourth plate priced — the wedge that opens whenever one acts for another whose interest is not his own. Berle and Means discovered the condition that makes it inevitable: the agency problem at the scale of the whole corporation.

⁂

Why, then, do the owners not simply discipline the managers, as a principal disciplines any wayward agent? Because they are many, and that is the heart of it. A single proprietor watches his manager closely, for every dollar lost is his own; but a shareholder who owns a thousandth of a great company gains only a thousandth of any improvement his vigilance might produce, while bearing the whole cost of the vigilance himself. It does not pay him to study the accounts, to organize the other holders, to mount the challenge to an entrenched board; the rational course, for each small owner, is to stay ignorant and passive, and to sell rather than fight if he dislikes what he sees. So the owners, though they are the principals in law, behave as a crowd of bystanders, each waiting for another to bear a cost none finds it worth bearing alone — and the managers govern in the space that collective inaction leaves them. This is the answer the plate's question presses toward, and it is uncomfortable: in the great corporation, control is exercised by the managers who do not own, because control, not ownership, is what governs from day to day, and the owners cannot cheaply wield the control their property nominally carries. The shareholders own the corporation in the way that the public owns a public square — entitled to it, and unable to run it.³

3. The owners do not discipline the managers because they are many. A proprietor watches his manager closely; a shareholder owning a thousandth of a company gains a thousandth of any improvement his vigilance produces while bearing its whole cost. It does not pay him to study the accounts or mount a challenge to an entrenched board — the rational course is passivity, and to sell rather than fight. The owners, principals in law, behave as bystanders, and managers govern in the space collective inaction leaves. Shareholders own the corporation as the public owns a square: entitled to it, unable to run it.

It does not follow that the managers govern wholly unchecked, for the century since Berle and Means has been in large part an effort to build the apparatus that would bend management's interest back toward the owners' — to manufacture, by contrivance, the alignment that the separation destroyed. The board of directors is meant to sit between them, elected by the shareholders to monitor the management on their behalf, though boards have a way of being captured by the very managers they oversee. Executive pay is loaded with shares and options, on the theory that a manager made into a part-owner will think like one, though the theory has its own pathologies, rewarding the manager who games the measure rather than serves the firm. Above all there is the market for the corporation itself: a company so badly run that its shares fall cheap becomes a target, for an outsider may buy control at the depressed price, install new managers, and capture the gain — so that the threat of the takeover disciplines from without what the dispersed owners cannot discipline from within. And around these sits the law's demand of a fiduciary duty, and the requirement of disclosure that lets the absent owners at least see what is done in their name. Each of these is a patch on the separation, and none of them seals it; corporate governance is the standing name for the unfinished work of binding a controller to an owner who has lost the power to bind him.⁴

4. The century since has been an effort to build the apparatus that bends management toward owners. The board, elected to monitor management, is often captured by it. Executive pay is loaded with shares so the manager thinks like an owner — rewarding, too, the one who games the measure. Above all the market for the corporation: a badly-run firm's cheap shares invite a takeover that installs new managers, disciplining from without what dispersed owners cannot from within. Around these sit fiduciary duty and disclosure. Each is a patch; none seals the separation. Corporate governance is the unfinished work of binding a controller to an owner who cannot bind him.

What Berle and Means had seen, beneath the question of who runs the firm, was that the great corporation had quietly transformed property itself. In the old conception that the previous plate inherited, to own a thing was to command it: ownership and control were two names for one bundle, and the residual right to decide flowed from the residual claim on what was left. The modern corporation broke that bundle in two and handed the halves to different people. The shareholder holds the claim without the command — property emptied of control, a right to the residue with no say over how the residue is made. The manager holds the command without the claim — control emptied of ownership, the power to decide over assets whose profit is mostly another's. Neither is the owner of the older theory, and the corporation they jointly inhabit is therefore not the thing-with-an-inside that the residual-rights account described, but a structure of governance: a contested space in which a dispersed body of claimants and a concentrated body of controllers are held in an uneasy relation by an apparatus that is always being re-engineered and never quite works.⁵ This is the institution that the flagship will find at the center of the modern economy — the great managerial enterprise, run by a professional command that the separation of ownership from control is precisely what called into being. The visible hand of the eighth plate is the hand of the manager who does not own; and this plate is the account of how that hand came to hold the firm.

5. Beneath the question of who runs the firm, Berle and Means saw the great corporation transform property itself. In the old conception the previous plate inherited, to own was to command: ownership and control were one bundle. The corporation broke it in two — the shareholder holding the claim without the command (property emptied of control), the manager the command without the claim (control emptied of ownership). Neither is the owner of the older theory, and the corporation is not a thing-with-an-inside but a structure of governance.