“Corporations, which should be carefully restrained creatures of the law and the servants of the people, are fast becoming the people’s masters.” ~ US President Grover Cleveland in 1888
The concept of incorporation was born in Rome, 3 centuries before the birth of Christ. Societas publicoranum addressed a pressing problem: how a group of people could hold property together and make contracts for their common enterprise, independent of any particular participant. (The first pollution with global impact was a Roman corporation, mining silver and lead in southern Spain (366 BCE–36 CE).)
7 centuries later, the followers of Christ took corporate form. Beginning in the 4th century, the Catholic Church claimed corporate status so that it could receive gifts of land and hold property in perpetuity.
In the late 19th century, industry had a voracious appetite for capital. Firms found funds by listing ownership shares publicly traded on stock exchanges. It became a way for the little man to think he could have a piece of the action: money for nothing but a gambler’s stake.
Successful corporations came to be self-sustaining: having little need for investor-supplied capital. This freed them to behave as they would, constrained only by the limits that governments imposed: governments which corporations could effectively purchase, as politics has always been lubricated by money, and politicians in thrall to the moneyed elite.
During the early 20th century incorporation became the ubiquitous form of business organization throughout the world. In doing so, societies inadvertently put their trust in the hands of corporate masters, whose interests were in no way aligned with that of their societies.
The shift of the industrial wealth of the country to ownership by large corporations vitally changes the lives of property owners, the lives of workers, and necessarily involves a new form of economic organization of society. Management becomes, in an odd sort of way, the uncontrolled administrator of a kind of trust. ~ American diplomat Adolf Berle in 1932
Corporations do everything possible to maximize their profits. The first measure is to lower costs as much as possible. Packaged foods are exemplary. A successful brand tries to ramp its profits by cheapening ingredients and product quality, along with lessening portion sizes. Every American adult is familiar with the quality of favorite packaged products declining over time. Such selfsame degradation is seen in all sorts of consumer products, sustaining the hoary adage: “they don’t make them like they used to.”
Companies often employ outright deception to sell their products. No doubt you have encountered this yourself.
In Walmart, Target, CVS, and other major American retailers, skin gel, sold by virtue of it being advertised as having Aloe vera, actually has none of the medicinal plant in its contents. There is no government regulation to halt such chicanery.
Fraud is a common corporate tactic. The profit motive provides ample incentive to cheat customers and skirt regulations intended to protect people and the environment.
There are no standards for authentication of herbal products. The industry suffers from unethical activities by manufacturers, which includes false advertising, product substitution, contamination, and use of fillers. This is not only food fraud. 55% of manufacturers illegally claim to treat, prevent, diagnose, or cure specific diseases. ~ Canadian botanist Steven Newmaster et al
The North American herbal supplement industry is swamped with swindling. A study of 44 products produced by 12 companies found that only 2 companies offered 100% authentic ingredients; contrarily, 2 companies pedaled fully fake pills. All told, 83% of herbal product makers sold diddled supplements.
The US Food and Drug Administration (FDA) and Canadian Food Inspection Agency (CFIA) are responsible for ensuring the safety of edible products in their countries. The FDA and CFIA do nothing about fraud in herbal supplements.
Corporations keep their costs low by polluting the air, land, and water around their facilities, rather than paying to lessen wastes and emissions.
“Economic organizations attempt, at every turn, to “externalize” the costs of doing business, to shift to the wider society the burden of dealing with the social and environmental problems they create.” ~ American sociologist Frank Elwell
Vehicle makers throughout the world have a long history of producing products with known defects and denying their existence until forced to. General Motors ignored for years problems with ignition switches that ended up claiming 124 lives.
Toyota made cars with unintended acceleration problems that resulted in the company recalling 8.1 million vehicles and paying $1.2 billion to settle a US criminal investigation.
With its cities blanketed in air pollution, the US passed laws in the early 1970s to limit exhausts. This was costly to vehicle makers, who vigorously opposed the legislation.
Complying with clear air regulations can add thousands of dollars to an automobile’s price while diminishing performance that customers want. So, many manufacturers committed fraud on this count. Audi, Caterpillar, Chrysler, Cummins Engine, Fiat, Ford, General Motors, Honda, Mack Trucks, Nissan, Porsche, Volkswagen, and Volvo were all apprehended engineering their vehicles to evade exhaust pollution laws.
From the 1990s into the 2010s, European manufacturers colluded to limit competition on vehicle emissions technologies, retarding innovation and ensuring the most pollution they might get away with. The companies included BMW, Daimler, Volkswagen, Volvo/Renault, and a few large parts makers.
Volkswagen has been a repeat offender. It got caught installing temperature-sensitive switches that killed emissions control in 1973.
Then in 2015, VW was found fiddling their diesel cars to pass emissions tests but spew prodigious noxious pollutants while on the road. Unsurprisingly, Volkswagen had lured customers with advertisements that lauded their “clean diesel” technology.
The US Environmental Protection Agency (EPA), responsible for monitoring vehicle emissions, was negligent in not testing passenger cars. The EPA instead had focused on makers of trucks and heavy equipment, which had an extensive history of cheating on emissions tests, and whose products generated much greater pollution.
The EPA trusted the auto companies to tell the truth. And the auto companies have proven time and again that they don’t tell the truth. ~ American attorney Dan Becker
Exhausts were not the only facet of fraud in autos in recent decades. Japanese airbag manufacturer Takata was caught selling lethal versions of a product designed to protect auto occupants. To conceal its crime, Takata falsified test reports.
“For a long time, there’d been this policy of going easy on foreign enterprises. The government didn’t want to cause embarrassment or give outsiders the impression that China is plagued with corruption. But they’re not thinking like that anymore.” ~ American legal advisor Jerome Cohen
The corruption of British drug maker GlaxoSmithKline may have been stupidly egregious, but it still is exemplary of how large corporations operate. Other multinational pharmaceutical companies, including Eli Lily and Pfizer, have also been caught out on similar practices.
Glaxo committed systematic fraud and corruption in China, and in other countries across the world, by bribing doctors and hospital workers who prescribed its medicines.
Another tactic was to aggressively market medicines for unauthorized treatments. Glaxo almost killed one Chinese patient with this practice. They bought her silence for $9,000.
For over a year, the company brushed aside repeated warnings from an inside whistleblower in China, then retaliated against her.
The company could not even find the fraud that was going on. Its internal compliance scheme was a cover-up operation.
We take all allegations of bribery and corruption seriously. We continuously monitor our businesses to ensure they meet our strict compliance procedures. We have done this in China and found no evidence of bribery or corruption of doctors or government officials. However, if evidence of such activity is provided, we will act swiftly on it. ~ Glaxo in 2013
Once Chinese government officials got wind of Glaxo’s illegal actions, Glaxo bribed them to try to make the problem go away. The company did not even bother to investigate the allegations, change its marketing practices, or heighten its internal controls.
In 2014, following a 1-day trial, Glaxo paid a $491 million fine to China. This was on top of a $3 billion fine in 2012 that Glaxo paid for similar criminal activity in the United States.
“These are complicated organizations, and unless they are assiduously managed, they can’t cope with the complexities of the technologies they are dealing with.” ~ American organizational management maven Baruch Fischhoff
The most difficult operational aspect of managing a large corporation is information flow, something which too few corporate managers appreciate. This problem becomes amplified when a company produces products which have safety implications, which most engineered products do.
The Three Mile Island nuclear accident in Pennsylvania owed to a faulty valve: identical to one that got stuck at an Ohio nuclear plant a year and a half earlier. The builder, Babcock & Wilcox, failed to recognize the significance of the problem, and had not advised the operators appropriately. Nuclear plant operators were being trained to do the wrong thing.
“Senior decision makers are basically isolated from safety information.” ~ Iranian American systems engineer Najmedin Meshkati
General Motors had a string of safety defects in its vehicles. Most were due to communication mishaps between engineers and management. Mary Barra, CEO of GM, spoke of her company being “siloed,” with each department compartmentalizing its own problems and not communicating with others in the organization.
GM is by no means unique in this regard. There were no surprises in the kinds of difficulties encountered by drillers at the British Petroleum well that blew out on 20 April 2010 and fouled the Gulf of Mexico with the largest oil spill in history. By dint of failing to communicate, negligence is a common corporate code of conduct.
“The information distribution network does not match the organizational decision-making network.” ~ Najmedin Meshkati
“Corruption, embezzlement, fraud, these are all characteristics which exist everywhere. It is human nature. No one has ever eliminated any of that stuff.” ~ Alan Greenspan
A proximate cause of the evil inherent in corporations lay in their structure. Shareholders own corporations, and managers typically run their corporation in pursuit of shareholder tribute.
The problem is that shareholders don’t have a company’s best interest at heart. Shareholders often insist on strategies that maximize short-term profits. A manager who does not abide this short-termism is likely to be booted, especially during turbulent times, when foresight is most needed and least appreciated.
Shareholders are the most mobile of a company’s stakeholders: they may sell their shares at any time, disabusing their financial investment in the wink of a trade. In contrast, the other stakeholders – managers and employees – are vested with their livelihoods. Their interest is in the company’s abiding well-being, so that they may continue to earn a living, and do so decently.
“Ease of exit is exactly what makes shareholders unreliable guardians of a company’s long-term future.” ~ Ha-Joon Chang
The flip side of shareholder short-termism is untoward agency cost: that management may not have maximizing the corporation’s worth as its objective.
An agency cost is the economic concept of a principal having an agent act on its behalf and paying a price for doing so. Because the principal and its agent may have different self-interests, and the agent has more relevant information, the principal cannot ensure that its agent is always acting in the principal’s best interests. In the case of a corporation, the principal comprises the shareholders who collectively own the company, and the agent is corporate management.
The interests of management, who might own little or no stock in the corporation, may be to maximize their own gain at company expense. In its most extreme form, management may brazenly loot the company, as happened with WorldCom, Enron, and Adelphia.
More subtly, managers can pad expenses, pay themselves lavishly, or invest company capital in ego-gratifying empire building at the considerable risk of profitability. The merger of Time Warner and AOL is a prime example.
Shareholders can theoretically limit agency cost by tossing out management; but to do so requires going through the corporate board, which may align itself with management rather than disgruntled shareholders. Corporate board members typically get on well with the CEO and other managers and are in the same social circle.
Corporate Management Quality
It may seem problematic to make a broad characterization about the quality of corporate management on a global basis, but it is hard to think of a better measure than what those who lend money to corporations think of the risk they are taking in doing so.
The credit quality of the corporate debt market globally has dropped steadily since 1980, from A to BBB–. The median bond quality is now just one notch above “junk”: pure speculation.
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It does not help that accountants are commonly incompetent. A 2016 global survey found 42% of corporate audits deplorably flawed. The largest accounting firms are periodically found to egregiously violate regulations. (Governments don’t regulate businesses diligently, and typically find violations when they bother to audit.)
In the wake of the 1970s oil crises, capital was flooding into the American oil and gas industry in the early 1980s. Erstwhile conglomerate Apache Corporation sought to tap the capital flow in a novel way: wrapping private oil & gas assets into a new ownership structure that was akin to a partnership, but which was traded as a stock company.
This master limited partnership (MLP) gimmick spread, going mainstream in the 21st century. The essence of an MLP is retaining very little of its earnings. MLPs are “pass-through” companies which annually pay out more or less what they take in. As contrasted to earnings-retaining corporations, MLPs are distorporations.
Many of the standard rules that corporations have to follow about retaining earnings do not apply to distorporations. As earnings are distributed, distorporations largely avoid corporate tax, which is the one of the allures.
Distorporations still protect investors from liability. Unlike corporations, which may fund themselves via retained earnings, pass-through businesses have to be far more intertwined with investors: staying alive means routinely inhaling and exhaling capital.
Distorporations now have a valuation on American markets well in excess of $1 trillion (2012). Distorporations represent 9% of the number of listed companies, and pay out 10% of the total dividends, but soak up 28% of the equity raised.
These statistics underplay the gravity of the American distorporation. Distorporations house the management of private-equity firms, and thus sit atop industrial empires of much greater worth than their stated value.
Distorporations can be spectacularly lucrative for their financiers: able to pay out outrageous dividends which C corporation shareholders would revolt over. The complex setup creates a shell in which the views of “limited partners” matter little. Nonetheless, Lilliputian distorporation shareholders often receive dividends double or triple the market average.
Distorporations shareholders are a select clique. Quirks in the investment and tax laws keep distorporation shares out of the hands of staid institutions and the average stock punter. Hence, little-understood laws amplify wealth inequalities in the capital-owning class.
Because of their abiding need for continual financial support, distorporations inject fragility into the economic system. The establishment of distorporations has created a structural change in American capitalism which has gone largely unnoticed.
Raising the scale of operations can decrease marginal cost, raising profit potential. Cost advantages that accrue from size – increasing level of output or scale of operations–is called economies of scale.
Economies of scale have driven corporate gigantism since industrialization. They were fundamental to Henry Ford’s revolutionary assembly line and continue to spur mergers and acquisitions.
There are 2 types of economies of scale: internal and external. Internal economies of scale occur when a firm benefits from upscaling regardless of the industry it is in. External economies benefit a firm because of the way the industry is organized.
Research and development (R&D) of new drugs drives profits in the pharmaceuticals industry. Yet the cost of discovering the next blockbuster drug is enormous and increasing. Mergers in the drug industry in recent years have been driven by companies’ desire to spread their R&D costs across a greater volume of sale.
Economies of scale have a dark side. The larger an organization becomes, the more complex its bureaucracy has to be. The inefficiencies that creep in with bureaucratic inertia eventuate in diseconomies of scale.
It’s unusual to find a large corporation that’s efficient. I know about economies of scale and all the other advantages that are supposed to come with size. But when you get an inside look, it’s easy to see how inefficient big business really is. Most corporate bureaucracies have more people than they have work. ~ American business magnate and financier T. Boone Pickens
Economies of scope are related to economies of scale: factors that make it cheaper to produce a range of products or provide a menu of services. Economies of scope can come from businesses sharing centralized functions, such as marketing or finance; or they can come from interrelationships, such as cross-selling products or services together (horizontal integration) or using the outputs of one business as the inputs of another (vertical integration).
Whereas the corporate drive toward consolidation in an industry owes to economies of scale, diversification across related industries – related in any sense – is inspired by economies of scope.
Diseconomies of scope can be as bad, or even worse, than diseconomies of scale. Companies in different industries commonly have distinct cultures. Banging together incongruent cultures is an excellent formula for dysfunctionality, as tribal behaviors come to the fore.
Economies of scope seldom bring economies of scale, especially with centralization, as managing distinct businesses well requires somewhat different skill sets; whence purges through divestiture of acquired companies unrelated to core competency, often resulting from shareholder pressure to improve corporate performance.
Mergers & Acquisitions
A company may merge or acquire another to ostensibly obtain a competitive advantage or better serve its customer base. Disney’s acquisitions of Pixar, the animated movie maker, and Lucasfilm, creator of Star Wars, enlarged the corral of characters for Disney theme parks and merchandise. The mergers also enlivened Disney overall. Disney’s acquisition story with a happy ending is all too rare.
It is well known that acquirers tend to overpay in corporate acquisitions. Classical auction theory, which assumes that bidders set their bids without regard to the identity of other bidders, does not apply to the market for corporate control. ~ American corporate law professor Robert Miller
3PAR was a cloud computing company founded in 1999, back when cloud computing was in its salad days. The company had some leading-edge technology when it began, but 3PAR had not been profitable when both Dell and HP set their sights on acquiring it in mid-2010. Dell and HP both felt anemic in cloud computing, though each already had its own division; and the rivals wanted to keep 3PAR out of the other’s hands. A bidding war ensued, which HP won by grossly overpaying: over 3 times 3PAR’s share price. The 3PAR acquisition did HP no good: it only drained HP’s financial reserves at a time of strategic floundering that led to the company’s decline.
A merger between large corporations which had been competing typically births a bloated behemoth with a bad rash of culture clash.
In 1998, Daimler Benz merged with US automaker Chrysler to create Daimler Chrysler, at a cost of $37 billion. The logic was obvious: create a trans-Atlantic powerhouse. The merger sputtered. In 2007, Daimler dumped Chrysler for $7 billion: 19% of what it had paid only 8 years earlier.
Due diligence? Daimler Benz never did due diligence before it bought Chrysler, never looked into the future to see whether Chrysler could be competitive. ~ American economist George Peterson
Contrasting cultures and management styles dogged Daimler Chrysler during its brief marriage. Whereas Chrysler represented American adaptability and valued managerial empowerment, the Teutonic Daimler prized a more traditional respect for hierarchy and centralized decision-making.
Sometimes an acquisition just does not make sense, even though it seems to for the love-struck acquirer. In 1994, grocery-store legend Quaker Oats bought the bottled tea and fruity-drinks maker Snapple for $1.7 billion: $1 billion more than many analysts thought Snapple was worth. Fresh from their success with Gatorade, Quaker wanted to sport Snapple as their next success story.
Quaker set out to situate Snapple in every grocery store and chain restaurant, spearheaded by a new marketing campaign. The effort failed miserably.
Snapple had found its niche in gas stations and small, independent stores, backed by quirky advertising. Quaker Oats management failed to grasp Snapple’s identity. 27 months after turning Snapple sour, Quaker Oats sold it for a mere $300 million; making the acquisition a daily loss of $1.6 million for Quaker.
In 1900, there were ~500 American car makers. In 1908, 200 remained, having gobbled the others. In 1960, Britain had 16 banks; a decade later, 6. In both instances, rapid consolidation came from a flurry of mergers. In everything from soft drinks to steelworks, mergers happen in waves.
During America’s 1st merger wave, which lasted 5 years and peaked in 1899, 700 mining and milling companies disappeared, along with 500 food retailers. The next 4 waves were in the 1920s, 1960s, 1980s, and 1990s. Other countries have had their own merger waves.
Shocks set off merger waves. Some firms are quicker than others to respond to the disruption or suffer less damage. This divergence lets the strong mop up the weak. Ronald Coase had suggested as such in 1937.
In the late 1990s, computer-related businesses underwent merger waves as the commercialization of the Internet was blossoming. The bursting of the housing bubble in 2008 was an orgy of the biggest banks eating the little ones who had been caught out.
Any industry-shaking shock may trigger a merger wave. A slump in demand can leave factories and shops idle. Spare capacity prompts more efficient firms to take over the sloppier ones.
Regulatory shocks are also important. The deregulation of US airlines spelled consolidation. Many deals in the late 1990s were spurred by the government loosening its grip.
Once a merger occurs, industry copycats become likelier. The first deal removes a competitor, potentially raising profitability for all. Other targets take on a shine to acquisitive bosses. Meanwhile, more pessimistic firms see the creation of a larger rival as a threat and seek defensive unions. The sensible strategic response to one deal may be another. A wave forms.
Shock and strategy explain how a merger wave begins within a single industry, but not why simultaneous waves occur. The answer is found by following the money.
Financial conditions are paramount. Managers have to pay for their merger meals. Piling on debt is only possible when lucre is loose and interest rates low.
The most active acquirers are those with mounds of cash on hand. To acquire a hoard of lucre without giving it back to shareholders in one way or another indicates strong-willed management: the domineering attitude characteristic of corporate empire builders.
“Through monopolistic mergers the people are losing power to direct their own economic welfare. When they lose the power to direct their economic welfare they also lose the means to direct their political future.” ~ American Senator Estes Kefauver in 1950
The lure of economies of scale drives companies to dominate and consolidate, forming oligopolies. An oligopoly is the overwhelming dominance by a few firms within an industry: usually a half-dozen or less.
Unless there is a strong countervailing force, such as an inherent localization to doing business, oligopolization is the overriding trend of modern business practice. Oligopolies are everywhere: airlines, beer, cable TV service, cars, drugs, food stores, health insurance, cell phone service, computer operating systems, mass media, music, movies, soft drinks, tobacco, steel, and many more.
Worldwide, well over 50,000 companies do business internationally. Fewer than 150 corporations control 40% of the monetary value of all transnational companies. Most of them, including the most powerful, are financial firms.
“It’s all flowing into the same few hands.” ~ Swiss statistician James Glattfelder
The penultimate achievement is monopoly: a single firm dominating all others. For decades, Microsoft had a virtual monopoly in desktop computer operating systems, until the advent of smartphones; it still does for office productivity software.
Oligopolies and monopolies are to market economics what massive bodies are to spacetime in physics: a powerful warpage. Market power sucks the “free” out of “free enterprise,” and turns societies into plutocracies as politicians fall into the gravity of corporate concentration.
“Declining competition is partly responsible for the US business sector under-investing since the early 2000s.” ~ French American financial economist Thomas Philippon & economist Germán Gutiérrez
In the 2010s, US corporations reaped spectacular profits, which were matched by runaway share prices. Meanwhile, despite it being dirt cheap to finance, these companies did not bother to invest large sums. They did not need to; the competition had been largely vanquished. (Start-ups as a share of all companies declined in many wealthy nations around the world during the early 21st century. In the US, start-ups went from 10% of all companies to 8% 2000–2015, continuing a well-established trend.) Barriers to market entry that companies had erected let these corporations contentedly milk their customers. Profits as a share of output rose by 50% in the 30 years 1985–2015.
Over 75% of American industries have become more concentrated since 1980. The concentration is especially pronounced in the technology sector. Apple and Google provide the software for 99% of all smartphones. Amazon utterly dominates online shopping and is encroaching into streaming music and videos.
50% of all American financial assets are controlled by just 5 banks. In the late 1990s, the top 5 banks controlled little more than 20%.
In the 2010s, 6 of the largest US airlines became 3. As of mid-2018, 4 companies controlled 98% of the American wireless market. If allowed by the federal government, the merger of T-Mobile and Sprint would reduce wireless market control to 3 firms.
“Many large US corporations are earning substantial incumbency rents.” ~ American economist Carl Shapiro
Consumers pay handsomely for the privilege of modern capitalism. The difference between how much it costs American companies to make their products and how much they sell those products for – a metric of market power – was in 2019 at its highest level in a century.
The lack of competition in the market for mobile phone service in America costs consumers $65 billion a year. Such rent-taking (excessive profits) is common in countries which do not effectively regulate corporate power (antitrust regulation). The United States is exemplary.
“This economy is rigged.” ~ US Senator Elizabeth Warren in 2017