Social Purpose without Social Responsibility : Rethinking the Corporation

 The history of man is dominated by, and reflects, the amount of available energy  
 — Frederick Soddy Science and Life (1920), 

Capitalism evolves in stages : mercantile in the 18th century, industrial in the 19th and global capitalism throughout the 20th.

Each period broadly based on the concept of capitalisation — That is, the net value stored in all forms of capital — natural, share, intellectual, human, financial, social, promissory and manufactured — tended to increase as a result of economic processes and transactions.

Capitals Canvas (capital).png

Value creation is the constant of capitalism. But what is value?

Value is the energetic p0tential of a capital to do the work of change. Value is energy in its social form. From a theoretical perspective, money is not value. Money is but one type of capital that stores value. This distinction is fundamental to understanding how value is created.

Based on this definition of value, value creation during each stage of capitalism broadly followed a basic set of principles:

  1. Value is the energetic potential of a capital to do work.

  2. Value is stored in capital.

  3. Capital comes in many types - human, intellectual, social, natural, manufactured and financial capital to name a few.

  4. The value of a capital is determined qualitatively and quantitative. A capital that exhausts through use (financial capital) is qualitatively lower than a capital that can increase through use (intellectual capital).

  5. Value is created when one form of capital is transformed into another with greater potential value. I call this “capitalisation”. Put simply, the output capital could do more work than the input capital (after the costs of transformation).

What is described as a business model, is best understood as a system for exploiting these basic laws of value. Value stores connected to value sources by transformation systems. The history of capitalism is thus the history of how society has developed new ways to transform all forms of capital to create more potential for positive change, or in the language of business - value.

Decapitalism

Turning something with greater value than money into money is not value creation

The latest epoch of capitalism has seen the process of capitalisation reversed.

Under this new stage of capitalism, the capitals are no longer transformed to create the greatest value but the greatest profit.   This defies reason.  For if the other seven capitals invested for that profit hold greater value than the resulting financial capital there is no capitalisation or increase in value.  The net effect is logically a reduction in total value or what I call "decapitalisation".

My argument is that an economic system that seeks to maximise and prioritise financial capital above all else has the tendency to create a negative return on the investment of all eight capitals when measured in terms other than money.

The paradox of decapitalism is that it produces more money but less value and less energy to support the growth of society.

Closing factories, slashing costs, cutting jobs, reducing research, automation and not paying tax may all boost the financial bottom line. But, when measured in the universal currency of energy and value, the alternative balance sheet might well be negative.  

Commentators call these management measures “short-termism”.  But the reality is that short-term decisions have very little to do with time horizons. What makes a short-term decision so damaging is that they invariably  involve an inefficient transformation of capitals. The negative return on the investment of capitals reducing the total value available to sustain individuals, corporations and even nations.

Look around. Decapitalist efficiency turns out to be an highly inefficient way to allocate the worlds limited resources. Exchanging the worth more for the worth less.

Capitals and Capitalisation

The decapitalist understands value to be a measure of revenue or profit. Whether wilful blindness or ignorance, the decapitalist misunderstands the basic building blocks of capitalism.

A full theoretical understanding of the concepts of capital are beyond a blog posting but the following points capture the main features:

  • Value is the potential of a capital to do the work of change

  • Capital is where value is stored

  • There are multiple types of capital

  • Value is created when one type of value is transformed into another that has a greater capacity to do the work of change.

Once these basic principles are understood economic processes and transactions can be viewed from a new perspective

  • Money or an asset that can be turned into money are two forms of capital.

  • There are at least 6 other forms of capital - natural, human, intellectual, social, promissory and share capital.

  • Each capital has qualitative differences.

  • The quantity of work each form of capital can do is unique to the capital. Capitals are not created equally. Each form of capital has unique properties and qualitative characteristics that make them, in energetic terms, more or less useful. For example:

    • social capital increases by use and financial capital exhausts by use (and non use - inflation)

    • some capitals cam be accumulated over time - natural capital. Others exhaust over time - human capital.

  • The potential value of a capital will also be determined by the individuals ability to release that value which will largely depend on two factors:

    • possessing a business model that connects internal values stores to external value sources to transform capitals efficiently; and

    • possessing a portfolio of other capitals to be bundled as part of transformation. Economic processes seldom involve individual capitals.

Again it is impossible in a short blog to describe the objective and subjective elements of each characteristics of each form of capital. The key point I wish to share is the concept that each type of capital has a different value. Once this concept is grasped, the next question is how these differentials produce value.

  • Capitals are subject to laws of conversion. Like Joule discovered the laws of energy conversion in relation to physical energy, Karl Marx and Adam Smith were in search of the laws economic conversion.

  • Capital can be transformed by conversion or exchange:

    • Capitals can be converted from one form into another. For example natural capital in the form of timber, can be converted using human and intellectual capital into manufactured capital in the form of chair.

    • Capitals can be exchanged with stakeholders. For example, the chair may be exchanged for financial capital and depending on its price, quality etc also into social capital in the form of brand and reputation.

  • In broad terms, the efficiency of conversion/exchange of capitals (the value proposition or impact) is determined by several factors:

    • the value embodied in the input capitals;

    • the business model (value system);

    • the transaction costs of transformation;

    • the value embodied in the output capitals.

  • Not all capitals can be converted or exchanged directly into financial capital and vice versa. The price mechanism cannot co-ordinate capitals:

    • that have value but no price (social capital); or

    • that are stored and transformed with a corporation.

  • Value is only created when capital is transformed into another form and the second form (the output capital) can do more work than the first (the input capital) after the deduction of transaction costs. The chair has greater capacity to do work than the the other capitals used in its creation.

  • The subjective element also explains why both parties can win from economic transactions. A low value capital for one party may be a high value capital for another. This explains why capitalism seems to defy the first law of thermodynamics.

  • An efficient conversion/exchange of capital results in capitalisation - greater net value ie. the capital outputs are greater than the capital inputs (including transaction costs) measured in terms of value or capacity to do work. For example, in a successful research grant scenario there is more capacity in the resulting intellectual capital to do work than in the financial capital paid for that capital.

  • Decapitalisation results from an inefficient conversions of capitals that decreases net value calculated across all capitals. A theory of capitalism based on neo-classical economic assumptions is a recipe for the the growth of financial capital and the decline of other capitals. Remembering if that financial capital has led value there is less value available to do the work of positive change. Capitalism can not defy the second law of thermodynamics.

If this all sounds too theoretical you need only consider the modern corporation to see the principles of capitalism and decapitalism at work.

Once seen through the lens of value and capital you may change your mind as to why corporations exist.

The Social Purpose of the Corporation

Culture develops when the quantity of energy harnessed by man per capita per year us increased; or as the efficiency of the technological means of putting this energy to work is increased; or as both factors simultaneously increased.

White, Energy and the Evolution of Culture (1943)

If the central organising principle of capitalism is capitalisation, the purpose of the corporation as a legal and economic construct, is fantastic.

In the same way that Watt exploited the principles of energy conversion to invent the steam engine, the unnamed architects of the 1856 Joint Stock Companies Act, exploited the laws of capital and capital conversion to invent the ultimate energy conversion system — the modern corporation.  A legal person and not property that instead of converting forms of physical energy converted energy in its social form.

Whether by design or accident, lawyers had created the new prime movers of capitalism with three critical features:

  • Their own private property - the capitals.

  • Their own power to transform their capitals to create value - the right to make and enforce contracts.

  • Their limited liability to shareholders - corporations are not liable for the debts of their shareholders.

Features that both separate the corporation from its surroundings and enables this now independent entity to capitalise or “feed” on the capital of stakeholders. Receiving and accumulating value in the form of financial capital, intellectual and social capital, and rendering back to the stakeholder by way of trade, manufactured capital. A capital with less value to the corporation than the other capitals imported from the stakeholder. Creating the essential conditions for corporations to exist separately from shareholders and stakeholders and reproduce their existence into perpetuity. A primitive form of artificial life.

The Economist was prescient when it declared in 1926 that: 

“The economic historian of the future may assign to the nameless inventor of the principle of limited liability, as applied to trading corporations, a place of honour with Watt and Stephenson, and other pioneers of the Industrial Revolution."

Lawyers had created an animate form of engine capable of transforming vast amounts of capital into ever increasing value.  

To be clear, corporations can be conceived in law and for other purposes as autonomous and animate energy conversion systems that maintain their existence independent from their surroundings through a process of efficient capitalisation (not unlike metabolism) — converting and exchanging useful energy stored in various capitals and accumulating the same for later use.    

The genius of the 1856 Act is the invention of an entity that could efficiently convert and exchange capitals with their surroundings — shareholders, customers, employees, suppliers and other groups — and thereby accumulate more net energy/value than an individual could and do so in perpetuity.      

In this way, corporations do not seek profits for their shareholders they seek utility to sustain their own existence.  The neo-classical economic assumption that “individuals maximise utilty and firms maximise profits” is flawed in the eyes of the law (and society).   Firms (in the form of a corporation) being granted existence  by the law must seek utility by exploiting the laws of capital to sustain their own existence.   Maximising profit at the expense of utility is a death sentence.

In my model “i” represents the independent corporation. The greater than symbols “><“ represent the external sources of capital and the objective of the corporation to ensure that the value returned is greater than the value invested:

How corporations capitalise

How corporations capitalise

Capitalisation might not sound that important. But in science, net energy, or the energy available to an organism or society after investments to obtain that energy is considered critical to long-term survival and the well-being of both humans and society (Tainter 1988; Hall and Klitgaard 2012). Indeed, in the history of human progress, the single most important factor has been breakthroughs in energy conversion efficiency.

The sublime innovation of the corporation is that by creating an entity whose existence depended almost entirely on capitalisation, the legislators had assured the future social energy needs of society.

If energy is stored capitals, the modern corporation is the high performance engine of capitalisation. Created in law with the powers to convert social and physical energy into all the capitals required to drive both social and economic growth. What ever the purpose of the incorporator of an individual corporation, the legislature had invested in the legal form a far greater ambition — whether they were aware of it or not.

What this means is that corporations don’t just exist, as economists and some lawyers argue, because they reduce transaction costs for shareholders. After all, transaction costs are the energy/value used to convert or exchange one capital into another.  More importantly, reducing transaction costs can never turn a negative value return on the value invested into a positive one. This is because the transaction costs are always deducted from the net value.  Rather, corporations exist to grow all forms of energy in a way that individuals simply can’t.

Critically the corporation is agnostic when it comes to the form of capital. From a theoretical perspective, once a corporations financial capital needs are satisfied, there is no logical reason to maximise financial capital as is often assumed. Indeed, it is irrational to maximise financial capital at the expense of capitals with greater value.

Provided the corporation is agnostic as to the form of capital and instead guided by the energy return on investment, it is my proposition that incorporated entities will naturally increase the efficiency of value/energy conversion within society as a whole.

The social responsibility of a corporation is therefore simply to be a corporation. For embedded in its design as a legal and economic entity that sustains itself through capitalisation, is the increase of net value/energy available to individuals and society.   Social purpose without social responsibility. In this way corporations are not unlike plants.   Whereas plants convert forms of energy to exist thereby producing oxygen, corporations convert forms of energy to exist thereby producing the building blocks of society - the capitals.  Humanity has a vital symbiotic relationship with both these animate prime movers.     

The Rise of the Decapitalists and the Fall of Capitalism

In a 1970 New York Times article, Milton Friedman famously argued that a businesses’ social responsibility was to generate profit for shareholders. The late economist was a decapitalist. Who, along with Jensen and Meckling in 1976, broke capitalism by turning corporate boards against their corporations.   

In fact, many who claim to be the champions of capitalism are better understood as decapitalists. Consider the following statement from Warren Buffett defending a Brazilian private equity firm known for “zero-based budgeting,” or in plain speak, cutting jobs, closing factories and slashing costs:

“ they have followed the standard capitalist formula, market system formula, of trying to do business with fewer people,” ….”That benefits everybody, particularly benefits the owner, but it’s a painful process and sometimes there’s a big political reaction to it.”

This is the decapitalist formula. Fewer people does not necessarily mean more value — particularly if the fewer people worked in research and development. More money, yes in the short term. But it does not follow that value, as described herein, has been created.

All too often, Buffett’s formula results in the impossible task of trying to do business with less and less energy. This makes no sense other to the investment industry. Investors and the industrial complex behind them who can only capitalise their businesses by convincing company directors to decapitalise theirs. Buffett’s intentional mistake is to confuse his business model with capitalism.

A corporation that converts capitals with a greater value than money into money and then transfers this to its shareholders where it can no longer be used is exhausting its energy. It is literally killing itself.

This is madness. Group think masquerading as “good corporate governance”. When in fact it is nothing more than the corporate equivalent of “Cotard’s Syndrome”.

This does not mean the corporations should not seek profits. What my analysis suggests is that corporations should strive for both increasing profits and increasing value at the same time. Because if profits go up and net value goes down, what has happened is that the corporation has been decapitalised. More money but less total energy to draw on to sustain its own existence. Remembering that key factor in determining longevity is the total energy returned on the energy invested. If that’s negative, the corporation is less likely to survive.  

If you doubt the impact of the decapitalists, consider that the average “lifespan” of a corporation listed on the S&P 500 has decreased by over 50 years in the last century. From 67 years in the 1920’s to under 15 years today and predicted to decline further. I think (and hope to one day prove) that there is direct causality between corporate mortality and life expectancy and the inefficient use of the 8 capitals.  

The grim reality is that since the time of Friedman’s article directors have been encouraged to decapitalise their corporations. Under the influence of shareholder primacy, the mantra of maximizing profits and the goal of financial efficiency corporations have been systematically turning capitals with more value than money into money. Resulting in less overall value available to sustain not only the existence of the corporation but society as whole. The impact of this ranges from regulatory capture, rising rates of public company mortality to broader social inequality to the very way we measure growth.

Long-termism, better culture, ethics, b-corps, CSR, tougher laws, greater diversity etc. will slow the fall. But for capitalism to rise and work for all we must go to basics and learn the 3cs - capital, capitalisation and corporations.

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