Corporations: What Went Wrong?

The Divine Right of Capital
By Marjorie Kelly

Reviewed by David Cogswell

This review appeared in the American Book Review

"The Divine Right of Capital" by Marjorie Kelly addresses some of the most pressing problems of our age. While many assume that the corporate system is based on some sort of natural law, Kelly shows that the structure of the modern corporation is based on ideas that are so deeply ingrained in society we don't even recognize them as ideas.

Kelly, the founder and editor of Business Ethics the magazine and Web publication, carefully deconstructs the ideas and the history of what has evolved into today's corporate system. She conducts what Michel Foucault called "an archaeology of knowledge" to show the historical basis of the legal foundation of the corporate world.

There are some who would say there is absolutely nothing wrong with the corporate system or the effect of corporations on society. Certainly the 10% of the population that controls 90 percent of the wealth would approve. The wealthiest 1 percent, who have increased their share of the total wealth from 20 to 40 percent in the last two decades, may be quite happy with the progress of events. Over half of the total gain in marketable wealth between 1983 and 1998 went to the richest 1 percent. But for many others the problems Kelly addresses, "wealth inequality, layoffs, speculative excess, corporate welfare, sweatshops and environmental indifference," need to be examined.

Kelly is remarkably clear in her analyses, and makes the arcane easy to understand. The problems, she says, are clearly spelled out on the balance sheet of a modern corporation. In its most basic form a balance sheet shows an equation that says revenue minus costs equals profits. Simple enough. The costs are defined as labor plus materials. Costs are supposed to be kept low, so what is paid to the people who work at the corporation and in fact produce its wealth, is supposed to be kept to a minimum so that the profits can be kept to a maximum. This is arbitrary, Kelly says, and could be structured differently.

Corporate law, which has evolved not through legislation but through case law in the courts, mandates that a public corporation must maximize the revenue to shareholders, and that is the extent of its obligation to the community.

In practice that custom leaves out two other parts of the community that are as important as the shareholders: the people who work for the company, and the community in which the company operates.

According to custom, the people who work for the company are considered only as an expense, as property, similarly to a feudal estate. Wages are kept as low as possible. The community in which a company is based also does not appear on a balance sheet at all. If the work of a company fouls the environment and destroys the resources of the community, it is of no concern to the corporation. Cleaning up after itself costs money and reduces profits, so the corporation will not do it. The mandate to maximize shareholder returns reinforces that attitude.

According to Kelly, these biases favor the wealthy and are left over from an earlier age. Alexander de Tocqueville, the author of "Democracy in America," said there are two great ages of history, the aristocratic age and the democratic age. Though it was a gradual process with many marking points, the Western world crossed the threshold into the democratic age after the American Revolution, when the English colonists used the ideas of the enlightenment to structure a new society in which one class no longer automatically had privilege over another, and one in which governmental authority issued from the consent of the governed.

It took more than pen on paper to create a democratic society, of course, and slavery was the most glaring exception to the democratic order that took root in America. De Tocqueville commented on the striking difference one experienced when crossing from the free states to the slave states. A free society was buzzing with energy, the energy of free enterprise fueled by self-interest. Democracy went hand in hand with the free market.

But in the post-Civil War period, the rise of the robber barons coincided with an evolution of corporate law that was rooted in the pre-democratic world. Corporations, which had been strictly limited in what they could do, were gradually altered through the courts to create the basis of a new aristocratic society. In the 19th century corporations were opposed by conservatives because they undermined both democracy and the free market. The tension between the aristocratic model of society and the democratic one is still with us today. In recent decades that tension is winding tighter as the extremes of wealth and poverty in the United States grow to resemble those of third world countries.

Kelly points out that in the 20th Century, two world wars laid waste most of the monarchies of the world and by the century's end most governments were structured as democratic republics. Although political systems had crossed the line from the aristocratic age to the democratic one, economic systems are still strongly rooted in the pre-democratic world.

The mandate of a public corporations to maximize the return to shareholders is usually justified on the basis of the shareholders being investors, who provide the capital on which the business operates. But Kelly shows this commonly held belief is not true. Shareholders own the stock of the corporation and receive its profits, but they do not fund the corporation. The only time money from sale of stock goes to the corporation is when the new stock is issued. This takes place when a company goes public and perhaps after that, but only at very rare intervals when a corporation issues a secondary offering. In the steel industry, for example, a study shows that during the growth years of 1900-1953, issues of common stock provided only 5 percent of the working capital of the industry. The sales at the stock exchange represent only money changing hands from one speculator to another.

Kelly suggests ways to restructured corporate law to better balance the wealth among the shareholders, the producers and the surrounding community. She predicts that political democracy will be followed by political democracy in the 21st century. De Tocqueville, who seemed nearly clairvoyant, predicted as much when he said, "Can it be believed that the democracy that has overthrown the feudal system and vanquished kings will retreat before tradesmen and capitalists?"

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