Economic Organization #3

This post is about ownership and control, with substantial credit to the Alchian and Demsetz article.

In the classical capitalist firm one person is sole owner and dominates control. While there are joint inputs – by employees and suppliers – the owner (a) contracts for all inputs and does any renegotiation of said contracts, (b) holds the residual claim, and (c) has the right to sell his central contractual residual status to a new owner.

  

Ownership and control of most large corporations is largely separated.  The corporation acquires command over resources primarily by selling promises of future returns to those who -- as creditors or owners -- provide financial capital. The amount of capital is too large and risky for one or few persons, so it is obtained from many individuals. Risk is also thereby spread among numerous individuals.

Broad oversight is provided by a board of directors. Control of day-to-day operations is delegated to professional managers. If every stock owner were to participate in every decision for the corporation, not only would large bureaucratic costs be incurred, but many owners aren’t well-informed on the issues to be decided. Stockholders often even assign their proxy voting rights to the board of directors.  More effective control of corporate activity is achieved for most purposes by transferring decision authority to the smaller group of professional managers, whose main function is to negotiate with and manage (renegotiate with) the other inputs of the team. The corporate stockholders retain the authority to revise the membership of the management group and over major decisions that affect the structure of the corporation or its dissolution.

Consistent with outside stockholders’ lack of control is limited liability for blame. It protects them from any losses that are larger than the amount they invested.