The Faith of Fiduciaries

Originally published December 24, 1984













IN A RECENT issue of the Wall Street JournalPeter F. Drucker, the most prolific authority on the modern corporation, made an impassioned case against unfriendly takeovers, suggested some ways of inhibiting them, and concluded that “none of the policies we are likely to adopt will solve the basic problem, the one created by the shift in voting power from ‘owners’ to ‘fiduciaries.‘” Drucker has worried about this problem for some time. In so doing, he pursues, perhaps unwittingly, an attack on the way much, perhaps most, business has been done in this country since the invention of the limited liability corporation.

The fiduciaries troubling Drucker are the trustees of pension funds and (though he does not mention them) of charitable endowments, churches, foundations, universities, and private trust funds generally. He estimates that pension funds alone control between one third and one half of the stock of our great corporations. And these trustees have, as he says, “a legal duty to accept whatever gives their beneficiaries the highest immediate return.”

The courts, it must be sadly recognized, will always look with favor on accepting the highest immediate return, because this is in accordance with the antediluvian economic notions they are possessed by. At least since Adam Smith, the actors in the economic drama have been supposed to seek their own gain and to be led as by an invisible hand to achieve the social end of a wealthy nation. In fact, the managers of mutual funds, whose obvious interest is to maximize their gains, are acknowledged by Drucker to vote for takeovers exactly as do the trustees of pension funds. On the takeover question, legal theory and business practice are congruent.

Nevertheless, Drucker sees in “the takeover wave that is engulfing American industry” a threat not only to the companies being raided but also to the companies used as vehicles of the raids. Nor is this all. The ever-present danger of a raid forces managements to concentrate their attention on the next quarter’s bottom line, even though long-range development is thus sacrificed to short term profits. This tunnel vision, Drucker holds, is a leading cause of the decline of America’s competitive strength. In addition, it results in the demoralization of companies’ employees, “from senior middle managers down to the rank and file in the office or [on the] factory floor.” Conservatively managed companies, which have prudently written down their assets to the lowest reasonable figure, are especially attractive takeover targets.

If things are as bad as Drucker says (and they are), something should be done about it. He suggests that the Comptroller of the Currency might forbid banks to lend money for unfriendly takeovers. For my part, in the general interest of inhibiting speculation I would forbid lending money to facilitate the purchase of any securities, I would have the Federal Reserve Board close down margin accounts, and I would try to persuade the Congress to end the special tax treatment of capital gains.

But these measures, desirable though they are, do not meet Drucker’s fundamental concern: the erosion of the idea of property. He would deal with that by reviving the ancient Roman understanding of property. The Romans, he says, held that ownership entailed a responsibility to the thing owned. A farmer must not mistreat his land. A workman must not mistreat his tools. Even a slave master must not mistreat his slaves.

In their turn, it may be added, the Church Fathers were throughout careful to balance rights with duties, and that evenhandedness is intellectually very appealing. Similarly, the standard picture of the entrepreneur of the early Industrial Revolution is emotionally very appealing. He was celebrated by Joseph A. Schumpeter as the man who gets things done. Even John Maynard Keynes noted that” if human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation.”

The classical entrepreneur defined himself through his enterprise. He was a textile manufacturer, a dry goods merchant, a railroad man. But to be a conglomerate person or a holder of a diversified portfolio is to be nobody in particular, with no commitment to anything except the bottom line – the bottom line being, indeed, the real reason for the conglomerate or the portfolio.

Today the typical corporation is itself the entrepreneur. Regardless of the occasional brilliance and frequent flamboyance of its managers, it is a public corporation. The profits (or losses) go to the stockholders, who own it. They, moreover, and they alone, have the right to sell the corporation or any part of it and to take for themselves the entire net proceeds of the sale. Yet as everyone knows, in reality the stockholders have nothing to do with the corporation beyond endorsing dividend checks and occasionally signing proxies, and this indifference is particularly true of the individual stockholders, whom Drucker in the end mistakenly celebrates. In contrast, fiduciaries and mutual-fund managers are likely at the minimum to have studied the quarterly statements and annual reports.

Not only do the stockholders have practically nothing to do with the corporation, most of them never wanted to have anything to do with it. They merely had some money and were eager to place it where it would be reasonably liquid and have a chance of returning something more than bank interest. The 19th-century invention of the limited liability company was a blessing for such people, and the blessing was magnified by the development of efficient securities markets. Since, with negligible exceptions, shares are” fully paid and nonassessable,” those who hold them do not have to worry about the company’s debts or legal involvements, or fear the loss of more than they paid for the stock. Because they can sell out at any time, they need not fuss either about providing alternatives to company policies they find dangerous or unsatisfactory.

The owners of a limited liability corporation accept no responsibility. They would not have become involved if responsibility had been expected of them. How could they have known that the gasoline tank of the Pinto was unsafely designed? How could they have known that DES might cause cancer? How could they have known that exposure to asbestos could lead to leukemia 20 years later? Assuming there was some way knowledge of this kind could be made available to stockholders, it still would be impossible for individuals holding a few shares or even thousands of shares to participate effectively in the daily operations of Ford or Lilly or Johns Manville. On the other side, the managements of those companies would claim they could not operate with participatory ownership. Apart from the confusion that would result, they could not then protect trade secrets (whatever these may be).

HAVING no responsibility other than to the thickness of their pocketbooks, individual stockholders will do what is necessary to get the highest immediate return precisely as fiduciaries and mutual- fund managers do. Thus they will put pressure on brokers to find them companies (new or old) that will bring quick returns; brokers will put pressure on investment bankers to float the issues of such companies; investment bankers will put pressure on commercial bankers to give priority to the needs of such companies; and all pressure will be brought to bear on the management of every public company to do whatever it can to increase the bottom line.

There you have the triumph of finance over enterprise. In these circumstances, loyalty is, as Drucker observes, comprehensively destroyed. No one is or can afford to be loyal to the enterprise – not the owners, not the fiduciaries, not the financiers, not the management, not the work force. Nor are owners, fiduciaries, financiers, managers, or workers encouraged to be loyal to each other. This atomization of concern is doubtless a major cause of the widely deplored decline in standards of workmanship and service. It is certainly a major cause of increased speculation on Wall Street.

The public consequences of atomization are matched by private consequences, whose severity cannot be overemphasized. Loyalty is one of the fundamental virtues; Josiah Royce held it to be the fundamental virtue. Deprive men and women of the opportunity for loyalty, and you shrivel their souls. Encourage them to be disloyal, and you corrupt them.  Cynicism cannot cure itself; it must be surprised – happily by joy, unhappily by catastrophe. The damned are those who are not surprised.

We find ourselves in danger of this damnation because of the success of the limited liability corporation and the efficiency of today’s security markets. Drucker would cure our cynicism by barring pension funds – another successful idea with unexpected consequences – from owning shares in corporations. But what is true in law of the trustees of pension funds is equally true of the trustees of eleemosynary institutions. And it is true in practice of practically each individual stockholder as well as of the managers of mutual funds. All of these people are – in business practice and legal theory – interested only in their own gain. None – in fact or in theory – has a responsibility to the corporation that happens to be, for the moment, their property.

Who, then, is left? Who in the modern public corporation is willing and able to accept duties to balance the rights of ownership? No one. The stockholders assert the rights of ownership but accept no duties. The workers, including the managers, have no ownership rights and reasonably shirk the duties that might balance those rights. Financiers, fiduciaries, brokers, bankers, and speculators are totally irresponsible. What is to be done? I will address that question in my next column.

The New Leader


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