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COPYRIGHT 2001 Stanford Law School
INTRODUCTION
Industrial organization and corporate governance affect one another, sometimes fitting together as complements, sometimes clashing. Monopolistic (or oligopolistic) rents from weak competition in a democratic polity fit with concentrated corporate ownership and its supporting legal apparatus. And the converse is true as well: bruising product market competition and diffuse ownership also fit together both with each other and with their supporting legal apparatus.
Some economies are less competitive than others. Weaker competition produces higher rents: monopoly profits above those needed to stay in business. These rents can affect firms, as the rents give managers slack and attract grabs by players inside the firm. And one might speculate that these rents, where large enough and widespread, affect democratic politics, as they must be divided up, and politics can be the arena where they are divided. In a nation where those rents are absent, one important task for politics--the division of widespread monopoly profits--is taken off the political agenda.
When rents are widespread, the players inside the firm have more room than they would otherwise have to contest the size of the corporate pie that each takes home. Moreover, shareholders would be acutely concerned about whether they would get most of the potential monopoly profit, or whether unconstrained managers, happy with extra slack, might lose it for them.
I begin with a model of industrial organization being established first, and I speculate on how differing degrees of competition affect corporate governance and ownership. I then speculate on how these could affect labor-oriented politics. (Later in the paper I relax the direction of causation.) Higher rents induce higher managerial agency costs for shareholders; higher agency costs induce shareholders to strengthen the inside-the-firm structures that keep higher agency costs within bounds. And higher rents plausibly provide the fuel for political parties, ideologies, and contests on how to divide up those rents in a national economy.
I. WHAT ARE RENTS AND FROM WHERE DO THEY COME?
A. Economics 101 and the Consumer Surplus.
1. Competition to maximize consumer surplus.
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The source of the rent is readily identified. It comes out of the large consumer surplus that a competitive market would otherwise generate, and that the monopolist can, but a competitor cannot, appropriate for itself. Some consumers would pay a high price for the good, if they had to. But producers compete, and a competing producer would lower its price down to the point where it covers its costs and its normal basic profit. This result is laid out schematically in Graph 1, a stripped down version of the basic supply and demand curves.
2. The monopolist's rectangle.
When a single firm dominates a product market, and when competitive entry is impossible (or costly), the monopoly firm has reason to produce less and raise its price. It produces less so that it can raise its price by selling to the high-valuing consumers who pay more. Hence, the monopolist produces less, raises its price, and seeks the price-quantity combination that maximizes its monopoly profits. The monopolist shrinks the total consumers' surplus: some consumers never get the product, because it's priced too highly for them, and some consumers pay more than they would in competitive markets. Value moves from the wallets of the remaining consumers who still buy (at the higher price) to the monopolist's bank account. This transfer, sometimes called the monopolist's "rectangle," obviously due to its shape, is illustrated in Graph 2.
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Shareholders want to get as much of those profits for themselves, preferring structures that induce managers to get those profits and put them in shareholders' pockets. And, when many firms cut back production and increase price, we could guess that they can affect basic issues in politics, as we speculate in Part IV. More firms have potentially high agency costs; those "rectangles," if many, yield a valuable pot for political players to contest; and that pot provides a basis for conflict and settlement that, although possible to accommodate inside the firm, is often divvied up nationally by political institutions. Let's keep our eye on the "rectangle," and on the players who want to grab a piece of it.
B. Who Owns the Monopolist's "Rectangle?"
1. Merely distributional?
Standard economic analyses downplay the importance of the monopolist's rectangle: the rectangle "merely" represents a shift in income from the buying consumers (who might be rich, for all we know from examining the graph) to firms (who might be struggling producers banding together in a cooperative, for all we know from examining the graph). The monopolist's core sin is to cut production and raise price, thereby denying the product to consumers who could pay what it would cost the monopolist to make it, but whom the monopolist refuses to serve so that it can raise its price to high-valuing consumers. The diminished consumers' surplus triangle is the loss, and the monopolist's sin in the standard analysis is in destroying that triangle, sometimes referred to as the "deadweight loss," not in grabbing the rectangle.(1)
2. Firms spend to get the monopolist's rectangle.
The classical idea that the monopoly rectangle is "merely" distributional was badly dented in recent decades in critiques from Richard Posner and Gordon Tullock. Firms anticipate these excess profits if they can acquire (or keep) a monopoly, and hence they spend to get (or to keep) that monopoly. In the limit case, they dissipate the distributional gain, spending it ex ante to acquire the monopoly or ex post to keep it.(2) One way of spending to get or keep those monopoly profits is spending on political organization.
3. But who is the firm?
These analyses are correct, and as far as they go I do not challenge them. But they view "firms" as black boxes, competing to get these rents. The "firm" is richer. Its owners are richer. The monopolist is richer. That monopolist is usually the "owner." Occasionally there are notations that the monopolist-owner can spend some of the monopoly profits on its inputs. So, in some oligopolies, labor, especially unionized labor, can get a piece of the monopoly profits for itself, in the form of wages higher than those of workers with similar jobs elsewhere.(3) For example, wages for members of the UAW (the United Auto Workers union) have typically been higher than those for similar assembly line workers elsewhere in the economy. Auto workers got a piece of the automobile industry's monopoly rent, especially before international competition among auto makers squeezed out much of that rent.
And it is this question--who gets the rent? (and by what means, political or corporate, do they get it?)--that I want to examine. Firms can be decomposed. They are made up of shareholder-owners, managers, employees, and customers. These players will also compete for the rents. It's not just firms competing against one another to get that monopolist's rectangle, but also players inside the firm--shareholders, managers, employees--competing to get a piece of that rectangle. The way they compete for the rents is reflected in corporate governance institutions inside the firm and, one suspects, inside the polity.
II. CONSEQUENCES INSIDE THE FIRM IF RENTS ARE HIGH: I
Consider first the corporate governance consequences of monopoly on a single firm.
A. Slack for Managers
We begin with managers, but will end with a more important inquiry, the implications of the relationships among employees, the monopolistic firm, and national politics.
1. Agency costs: standard analysis.
One would expect more monopoly to induce higher potential managerial agency costs in monopoly firms. The reason is obvious: the monopoly yields a bigger pot of value (bigger, that is, than the value an equivalent competitive firm would produce) into which managers can stick their fingers. The bigger the "rectangle," the bigger that pot.
Tightly competitive product markets can constrain managers: deliver a defective product and consumers buy a competitor's instead next time. That constraint may not always be tight, if all of the competitive firms are internally lax. But, obviously, product market constraints are lower, or nonexistent, for managers of the monopoly firm.(4) And there's evidence that market concentration reduces productivity and that competition enhances it.(5)
2. Why capital markets alone cannot tighten the slack.
Capital markets constrain managers only weakly when product market competition is weak. Consider how capital market competition constrains managers: managers, the explanation runs, must go to capital markets for funds, and when they do, stock buyers penalize poorly-performing managers by demanding a higher rate of return and a lower stock price, creditors penalize those managers by demanding a higher interest rate, and in the limit case capital providers refuse to give those managers any new capital and the firm withers. More effective firms with more effective managers eventually replace it. (True, capital markets do not even tightly constrain every competitive firm: a firm not needing new capital is not immediately constrained. It can run down capital in place and use up retained earnings. In time it should wither, and the need to avoid that withering can motivate some players. But no rule of law says the players cannot accept that withering, especially if someone else pays for it.)
The capital market constrains the monopolist's managers more weakly than it constrains a competitive firm's managers. The monopolist's managers can more readily generate sufficient profits internally to pay for needed capital improvements. And as long as they leave some of the monopolist's "rectangle" on the table for the original capital providers, the monopolist's return on invested capital would still be higher than a competitive firm's would be.(6) Capital markets constrain the monopolist's managers strongly not when they dissipate monopoly profits, but when they dissipate so much that they need new capital and their return dips below the competitive return for capital.(7)
So, if the monopoly rate of return is, say, 25%, when worldwide capital markets demand a 10% rate of return (for this type of company, this class of risk, etc.), then capital markets constraints would starve the capital-needy firm if managers throw away enough that the expected return declines below 10%. But capital markets will not directly constrain the managers as they take, share, or squander the first 15% of the monopoly's return. That 15% cushion is the monopolist's rectangle, the potential excess profits that create the potential for managerial slack.(8)
3. Agency costs from lowering value and agency costs from diverting value.
Higher agency costs are important even if monopoly rents do not go, dollar-for-dollar, into managers' pockets. Managers, if insufficiently aggressive, may lose a large slice of the monopoly profits at only modest gain for themselves. Agency costs to shareholders could be high even if the managers' gains are comparatively modest.
Managers in the standard agency cost analysis tend to expand firms without regard to profitability. Their gain may be less than the shareholders' loss. The shareholders want a mechanism to make managers more profit-oriented. When product markets are weak, two of their mechanisms--product market competition and capital market competition--are compromised.
4. The double meaning of "rents."
Industrial organization rents--the monopoly--could be confused with rents from corporate control--the value that controllers can skim off from the firm with impunity. The two are important and related--modest managerial rents in making mistakes is a kind of controller's "skim" and they can yield large monopoly rent losses to the owners--but the two concepts, despite the fact that they use the same word, are neither identical nor even opposite sides of the same coin. A small managerial "rent" in, say, falling asleep at the wheel, could induce a huge monopoly "rent" loss to shareholders as the rectangle is lost for a small snooze.
5. Agency costs: effects from employees.
There's more. Employees can claim a share of the monopolist's "rectangle." Wages should be higher, hours shorter, the workplace potentially less friendly toward shareholder profitability. Their claims may be straightforward grabs, or may be justified by claims of fairness and just entitlements. (On whose backs and with whose sweat was that monopoly built anyway?)
Employees seeking a piece of the rectangle raise managerial agency costs. They seek their share of that rectangle in higher wages, in better working conditions and, sometimes, in corporate governance authority....
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