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Henry Manne on Corporate Philanthropy

An email from Henry:

I have just been reading your blog comments on corporate philanthropy, and, as usual, you are perfectly correct.  However, I would like to add an intellectual complication to your formulation, particularly as it relates to the business judgment rule.

The only source of funds for truly philanthropic as opposed to business-advancing charitable behavior is economic rents of some sort.  If a company exists in that never-never world of perfect-perfect competition, each input receives its correct competitive return, and there is zero left over for non-business motivated activities of any kind.  One penny in this heuristic scenario to a charity and its bottoms up for the firm.  But, of course, we do not live in this perfect world (who could survive it?), so there are plenty of rents around for corporate philanthropy.  The major source of such rents today in large, publicly-held companies (by which I mean that no one has a large enough bloc to consummate a transfer of control of the company) is the cost of takeovers.  This cost has been inflated enormously in the modern era by federal laws like the Williams Act, state legislation on poison pills, judicial holdings, and the self-interested behavior (much of it political) by large corporate management.  This, I strongly believe, explains the much ballyhooed extravagant compensation packages of executives.

As the cost of takeovers rises, so the rents available to managers rises. This not only explains higher compensation, it also explains I think an increase in corporate philanthropy, often a form of higher compensation (but, since it is all from economic rents, it really makes no difference what we call its use, it being the nature of economic rents not to affect allocational efficiency.) It then follows that the greater money available for philanthropy attracts the activist moths we see raising all manner of sophistical arguments for how that money should be directed.  And since the source is economic rents, it also makes no difference what is done with the money (except of course to the recipients). Thus there is greater reason than usual to invoke the business judgment rule, since (and, you will notice, I am unpersuaded by “fairness” type arguments) it really does not matter much what happens with this money, and judges are no better at untying Gordian Knots than are executives.  Please note in this that the rents will never be zero since the cost of a takeover will never be zero, and thus there will always be funds available for somewhat greater than perfectly competitive salaries or for non-business contributions or simply pissing it away on poor management.  Thus it is unlikely that there will ever be a company without some “rents” available for philanthropy if that is what the managers want to do with it.

Now, as we move to companies where there is a control bloc of shares, the point is a bit more complicated.  The reason a control group might want to retain control is to guarantee no arguments about the distribution of what we call a “control premium” but which in other contexts becomes the takeover premium and the source of the rents discussed above.  Since the law generally allows them to take all of this “premium”, there would seem to be no rents available to managers of companies that have a control group. Since the takeover-cost rents are not available, there will be smaller rents available to managers for discretionary spending, and such non-business activity actually costs the minority shareholders more than it would in the other companies, more in the sense of lost opportunity to get the money for themselves, though we have already indicated that they have no special claim to it.  But nonetheless one would expect courts to be a bit more strict with giving in such companies than they are in diffused ownership firms, since the conflict of interest might seem to judges to be closer to the surface. This is so in spite of the fact that it does nothing to lessen the force of your quasi-jurisdictional argument for the business judgment rule, but judges, being what they are, may not understand that. I have no idea whether this hypothesis would hold up to empirical scrutiny, but it sure would not surprise me if we found a different law-in-action (as it used to be called in another era) result for smaller companies than for the large ones with diffused shareholdings.

Henry