The public often imagines corporations as self-contained actors that provide a set of goods and services to consumers. Underpinning this image have been ideas of ownership, rights to capital and intellectual property, and corporate responsibility to stakeholders including consumers, workers, and shareholders. But what if almost everything we are told about the essence of the firm is wrong? So writes Sir John Kay, a British economist, corporate director, and longstanding fellow of St John’s College (Oxford) in his new book, The Corporation in the 21st Century. The book revolves around contrasts between historical conceptions of corporations, capitalism, and contemporary practices. Kay writes, “A central thesis of [this] book is that business has evolved, but the language that is widely used to describe business has not.” In the 19th and 20th centuries, firms could be defined in terms of their control over material forms of productive capital (factories, steel foundries, railways, etc.) Socioeconomic critiques of capitalism, most prominently from Karl Marx, often centered on firms’ control of the means of production. Kay contends that firms today access productive capital as a service. For example, Amazon does not own its warehouses but rents them from another firm. Kay writes that today’s corporations and capitalism “[have] very little to do with ‘capital’ and nothing whatsoever to do with any struggle between capitalists and workers to control the means of production.” Kay joins Luigi and Bethany to discuss the implications of this evolution in firms’ relation to capital: Why is it important to capitalism that its biggest firms no longer own their means of production? Why does the language used to describe this matter? What do Apple's manufacturing facilities, Amazon's warehouses, and TikTok's algorithms tell us about our notions of business ownership? How have these changes to capitalism redefined the struggle between the owners of capital, managers, workers, and consumers? In the process, Kay, Luigi, and Bethany explore the failures of capitalism and imagine what could and should be the purpose of the 21st-century corporation
The public often imagines corporations as self-contained actors that provide a set of goods and services to consumers. Underpinning this image have been ideas of ownership, rights to capital and intellectual property, and corporate responsibility to stakeholders including consumers, workers, and shareholders. But what if almost everything we are told about the essence of the firm is wrong? So writes Sir John Kay, a British economist, corporate director, and longstanding fellow of St John’s College (Oxford) in his new book, The Corporation in the 21st Century.
The book revolves around contrasts between historical conceptions of corporations, capitalism, and contemporary practices. Kay writes, “A central thesis of [this] book is that business has evolved, but the language that is widely used to describe business has not.” In the 19th and 20th centuries, firms could be defined in terms of their control over material forms of productive capital (factories, steel foundries, railways, etc.) Socioeconomic critiques of capitalism, most prominently from Karl Marx, often centered on firms’ control of the means of production. Kay contends that firms today access productive capital as a service. For example, Amazon does not own its warehouses but rents them from another firm. Kay writes that today’s corporations and capitalism “[have] very little to do with ‘capital’ and nothing whatsoever to do with any struggle between capitalists and workers to control the means of production.”
Kay joins Luigi and Bethany to discuss the implications of this evolution in firms’ relation to capital: Why is it important to capitalism that its biggest firms no longer own their means of production? Why does the language used to describe this matter? What do Apple's manufacturing facilities, Amazon's warehouses, and TikTok's algorithms tell us about our notions of business ownership? How have these changes to capitalism redefined the struggle between the owners of capital, managers, workers, and consumers? In the process, Kay, Luigi, and Bethany explore the failures of capitalism and imagine what could and should be the purpose of the 21st-century corporation.
Show Notes:
Read an excerpt from the book (published by Yale University Press) on ProMarket
In Bethany and Luigi’s closing discussion of Kay’s book, Luigi cites several articles he has published on the topic, which we have linked below for the listener’s reference. In this past scholarship, Luigi studies how a firm and its operations often intertwine with other firms to form an ecosystem, and it is only through this ecosystem that value is created. Apple and Foxconn provide one example. Legally, they are distinct firms, yet Luigi contends they can be understood as elements of an ecosystem that creates value. Hence, it is sometimes productive to think beyond legal boundaries to consider how multiple firms may compose such a value-creating ecosystem in practice. Within the Apple/Foxconn ecosystem, Apple has a significant influence in dictating terms for Foxconn. Further, if Apple has such dominating power over its suppliers, then Apple could be said to have market power that raises antitrust concerns, which are less obvious if we take the legal boundaries of firms as the correct method of conceptualizing them.
Zingales, L., 2000. In search of new foundations. The Journal of Finance, 55(4), pp.1623-1653.
Rajan, R.G. and Zingales, L., 1998. Power in a Theory of the Firm. The Quarterly Journal of Economics, 113(2), pp.387-432.
Rajan, R.G. and Zingales, L., 2001. The firm as a dedicated hierarchy: A theory of the origins and growth of firms. The Quarterly Journal of Economics, 116(3), pp.805-851.
Zingales, L. (1998) Corporate Governance. In: Newman, P., Ed., The New Palgrave Dictionary of Economics and the Law, Palgrave Macmillan, London.
Lancieri, F., Posner, E.A. and Zingales, L., 2023. The Political Economy of the Decline of Antitrust Enforcement in the United States. Antitrust Law Journal, 85(2), pp.441-519.
>> John Kay: The language that we've used for 200 years to talk about capital and capitalism doesn't have much to do with the reality of modern business.
>> Bethany McLean: I'm Bethany McClean.
>> Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?
>> Luigi Zingales: And I’m Luigi Zingales.
>> Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.
>> Bethany McLean: And this is Capitalisn’t, a podcast about what is working in capitalism.
>> Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?
>> Luigi Zingales: And most importantly, what isn't.
>> Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.
>> Bethany McLean: When I started working at Fortune magazine all the way back in 1995, Fortune thought of itself as a management bible. It was what executives needed to read in order to understand how to run a business. This was my first encounter with management theory. The first time I realized that telling people how to run a business was itself a business. One that of course encompasses schools and books and consultants and theory and practice and on and on and on. I did a quick search, of some of the titles today. The five dysfunctions of a Team, the new One Minute Manager, what got you here won't get you there the first 90 days, critical success for all Leaders, and so on and so on. And I'm not making fun of all these books, but man, are there a lot of them.
Okay, Luigi, how does management theory intersect with economics? How do the two disciplines think about each other?
>> Luigi Zingales: So, I think that traditionally there was a clear distinction between management theory and economics. Management theory focus mostly on internal operation and organization, where economics study market behavior, kind of supply and demand and general economic allocation. And methodologically, I think management theory incorporated traditionally more insight from psychology, sociology and other social sciences. And economics, was more kind of a discipline on its own where you assume that individual maximize utility. Now of course, over the last, 40 years, everything has been mushed together a bit. Economics started to incorporate certainly some, element of psychology. Think about the entire field of behavioral economics. But also there is an entire branch of economics called "theory of the firm" that tries to deal with organization, what the firm is and so on and so forth. And so that is really an intersection.
>> Bethany McLean: So where does today's podcast ask John Kay sit? He's an economist, but he's an economist who has branched more and more in his writing into this area of management theory. Is that fair?
>> Luigi Zingales: I think he's fair. I think that if you will ask him, I would say that he labels himself as an economist. However, in term of his practice and his writing, et cetera, I think he is much m more eclectic than the typical economist.
>> Bethany: So for those who don't know who John Kay is, he's a British economist and a writer who's had a long career that spans everything from academic work to serving as a corporate director, among many other things. He has been a Fellow of St. John's College at Oxford since 1970. He was the first Dean of Oxford said Business School, and he's held chairs at the London Business School, the University of Oxford, and the London School of, Economics. His writing has won many, many awards, and he was knighted in 2021. So when we heard that he had a new book out, arguing that we're getting it all wrong, we were, of course, all ears. And the title of his book is "The Corporation in the 21st Century: Why almost Everything We're Told About Business Is Wrong." He says that his book was written in the hope that a better account of how business and its stakeholders flourish will point the way not just to a better understanding of business, but to the better conduct of business itself. Obviously, this is a critical topic for our times, so without further ado, we welcome John Kay.
So let's just start with a big basic, broad question, which is the subtitle of your book, "Why Almost Everything We're Told About Business is Wrong." What's wrong with what we're told?
>> John Kay: Most of the criteria which were put forward were put forward 100 to 120 to 200 years ago, when typically, what business consisted of people building large plants, steelworks, textile, mills and so. And recruiting relatively unskilled workers to man these plants. And the plants were of necessity built by rich individuals or people who had access to substantial amounts of capital. So we've been talking. A hundred years ago, we'd have been celebrating Henry Ford and Ford Motor. And Ford had this obsession with controlling everything that went into the car. So there's even an area of, Brazil called Fodlandia, because he wanted to grow the rubber for the tireres, which would go on on Ford cars. You can see now how different production and products are. The archetype of the modern product is really the iPhone. And the iPhone is remarkable for all the things it combines.
>> Luigi Zingales: But let me push back a little bit because it's true that in the United States, Apple is mostly a design company, but we have Foxconn, that produces the iPhone that actually produced that phone in China that looks very much like an old for this plan and even in the United States. Think about Elon Musk. Elon Musk seems to be they moren4 obsessed with control on not 100% of it but a large chunk of it and by the way as superior voting rights. So it controls it. So it doesn't seem that it's changed that much.
>> John Kay: Well you're right to draw attention to Foxcon and the way in which our most manufactured goods that you see are now made not in America, Western Europe, Arban and Southeast Asia. Most Apple products are assembled in China. The largest supplier of parts is actually Samsung or Apple's principal rival in selling smartphones. This is the modern corporation which is essentially a hollow corporation. It's characterized by all the things that brings together rather than as Ford's Motor Company was by the integration of a whole variety of things. And that's the nature of modern business. The modern business is a collection of capabilities. And that's what Apple is and that's actually what Tesla is.
>> Bethany McLean: Why does it matter if we describe business in the right way? Take it for granted for now that what you say is right. Why does the language in our conception of business matter? Why can't business just operate as business does? If we're describing it incorrectly? Why does it matter?
>> John Kay: It matters because what has happened is that this is greatly overestimated the role of capital and finance describing business. So that over the last 50 years we've had this enormous expansion of the financial sector. an expansion which is mainly about trading in existing assets rather than it as it was in Ford's day, building new ones. And that sucks quite a lot out of the corporate sector. Apple is an example we've just been describing. Most of the capital is actually being that's used as actually being provided by other people elsewhere. Amazon is in some ways an even more extreme example of that. You see Amazon vans m you pass Amazon warehouses or fulfillment centers as they prefer to call them. most people don't realize that Amazon don't own these things. In fact the goods that are in the fulfillment centers, Amazon hasn't paid for them before you report them. There is nothing in Amazon except a collection of capabilities. So the language that we've used for 200 years to talk about capital and capitalism doesn't have much to do with the reality of modern business.
>> Bethany McLean: Why have those two things happened concurrently if there's such a disconnect between the growth of finance and the requirements or the capabilities of modern business. Why has finance continued to grow and become more central even as, as you describe its role has become. The role of capital has become less important.
>> John Kay: It's an interesting story. It's the idea that management became a kind of professional business. Management was about making money and it is done a great deal of harm. Good example is one which is really in all our minds and in all our papers at the moment, which is the story of poing. That was one of the great companies of the second half of the 20th century. Bill Allen, who was CEO of Boeing, famously said he wanted to eat, sleep and breathe the world of aeronautics. And they built. All the great achievements were really the 737 and the 747 which became the dominant planes worldwide and which brought low cost aviation to a massma market. At the turn of the century there was this merger of Boeing and Madonald Douglas and culturally it was actually to take over in large part by Madonnell Douglas and the McDonnell Douglas Ah, executives were shareholder oriented. Hary Stone Cipher, who was a Donl Douglas executive who became CEO of po famously said people say this is a great engineering company, it is a great engineering company, but people invest in a company because they want to make money. And that was the Boeing that was created and the Boeing that built the 737 Max 2019. The Boeing Max fell out of the sky in the Boeing share price.
>> Luigi Zingales: And this imp importated to you notion of firm as a collection of capabilities. In fact 25 years ago I defined a firm in an article as a nexus of specific investments.
There is a question about what is ownership in the firm
However, there is a question about what is the role of the formal organization, the hierarchy, ownership in the firm. What is the difference in your view between being inside the firm and outside of the firm? And you're being the directors in many companies. What do directors do? Where does their power come from?
>> John Kay: Well, the power comes from their role as directors of the business, but not.
>> Luigi Zingales: Of the people in Director of the business. What is the business? Sorry, what is the business? Because if it's not defined by the ownership of the asset, it's defined by what? If it's defined by people. They don't own the people.
>> John Kay: No, the business is defined by as a collection of capabilities and nobody owns it. I've written at some length about this, discussed in the book about what lawyers mean by ownership. And the best description I can find is that there's a list of criteria of ownership. It's about like outside Facebook that There isn't a sharp distinction between a friend and a not friend. If you looked at Apple, you would conclude that in terms of the bades of ownership, the shareholders owned very few of them. If you are an Apple shareholder and you go to Apple, headquarters, you will be turned away. If you incur debts, Apple assets aren't available to settle your debts and so on and so on. Thinking about ownership in relation to a corporation just isn't helpful. Just as I teacher at Oxford University. Nobody owns Oxford University and it's not useful to think about ownership in talking about the institution.
>> Luigi Zingales: It's true that ownership has many characteristics, but it's also true that if I were to post a sign of Oxford University, Oxford University would sue me. So at the very minimum Oxford University owns that sign and I cannot create another university next to it called Oxford. So there is a sense in which there are some assets where tangible or intangible that are control. And if I am a director of Oxford University, at the very minimum I can decide how the building are used, but also how the name Oxford is used. So I think ownership does play a role. I agree that it's not necessarily certainly in the university, it's not in the ends of the faculty or there are no shareholders. But even in the firm they're not in the hands necessarily of the shareholders, but they are controlled by management. So ownership does play a role o management.
>> John Kay: Control is important, but that's different from ownership. Tim Cook is CEO of Apple. That doesn't mean he owns it. Apple is defined as Oxford University is defined by its collection of capabilities. You can point to the buildings of Oxford University, my college for example, when we borrowed some money we had for various reasons to give security, against the borrowing. So we gave security of some of the buildings. I have no idea what if we defaulted on the loan, which we won't. The bank would do, with the buildings. It certainly wouldn't get the university by having control of some of the buildings where they're teaching takes place. Oxford University is defined by the capabilities, the cap, the reputation of the university, by the abilities of the people who teach there, by the students who value the networking opportunities as well as the education and gives them. And to ask who owns it, it's just not an interesting question. And the same is actually true of Apple.
>> Bethany McLean: So if a firm is a collection of capabilities, what role do the employees of that firm play? Are they part of the capabilities? And if they're part of the capabilities, are they part of it? And theus specifics of those employees as people. I guess what I'm getting at is do people matter in this equation or are the employees is one of the capabilities replaceable with other employees?
>> John Kay: Most of are not replaceable. Whereas the businesses of 200 years, over 100 or 200 years ago, relatively unskilled workers who were recruited from agriculture to m man the textile mills and the steel plants, now the workers are the capabilities and the business is a collection of teams of people.
>> Bethany McLean: So if nobody owns them and the purpose of a company isn't to produce profits for its owners, what is the purpose of a company? What should the purpose of a company be?
>> John Kay: The purpose of a company is to be a great business and to do the kind of things that Boeing did and App Bill does. And in the course of doing that you need to assemble a variety of capabilities. The people who invented the software and the ideas and the design that went into the iPhone. That's the nature of modern business.
>> Bethany McLean: And why would you argue that this is important? Why does it matter that people think about business correctly?
>> John Kay: Well I think we've had a very good illustration just in the last month we have this extraordinary phenomenon of the CEO of United Healthcare being murdered in the streets by someone who was, he wasn't murdering Browian Thompson, he was murdering the CEO of United Healthcare. And worse than that, surveys showed that high proportion of Americans actually were at least somewhat approving of that kind of action. We desperately need to make business a legitimate admired activity. And the murder of Thomon M is an illustration of the opposite of that. There's an equally forceful illustration with which I begin the book which is the discussion of Goldman Sachs who was sued by some of their investors who claimed they had relied on the Goldman Sachsthics statement which says our clients always come first. And the Goldman Sachs defense as I point out out'not that this statement is true, it is rather that the statement is obviously not true. That no one could reasonably invest on the basis that it is true. We need to rescue business from that kind of nonsense.
>> Luigi Zingales: So you mentioned very often ah, the stakeholders. Can you define the stakeholders for our listeners?
>> John Kay: I'm not particularly keen to define. I write quite a lot of what's going on here is that we want to precise definitions of things like ownership that actually defy ownership definition. In that sense who is a stakeholder, Everyone who's involved in a business in some way. Employees, investors, managers, customers and so on.
>> Luigi Zingales: I'm sorry, maybe I'm too much of an academic But I think definitions are very helpful to understand also practically what you want to do. Your definition of stakeholders you have not included. And I'm not questioning that, I just want to question the consequencesces you're not included. The community and the environment in general. Now you are, and you have been directors of many companies. Can you tell us whether in your choices you have ever sacrificed profits for the environment?
>> John Kay: It's never come up. It doesn't come up. And that's a sort of straightforward way. I can't think of an occasion on which we in the company were asked to do it and declined to do it, or did, or chose to do it. Being a great business is, involves creating a great environment. And that means you won't pollute if you can help it. You will spend money to avoid polluting. You won't spend unlimited money to avoid polluting. You have multiple objectives. I mean, I believe in essentially virtue ethics as a system rather than an utilitarian one. Virtue ethics, meaning a good company, is defined by a whole variety of criteria. Happy customers, satisfied employees, satisfied investors, and so on. And that's what one means by a good company. And for the first 20 years of my career, I thought people went around maximizing something things and they optimize their utility, they maximize their utility, business maximize their profits, and so on. Then I got involved with people in real businesses and I realized they weren't really maximizing everything, they weren't maximizing profits. So I started asking, so what are they maximizing? They're not maximizing profits. And I came to realize that people run real businesses typically aren't maximizing anything. They're trying to cope with a complex and constantly changing environment. And to do that, they have to satisfy all the stakeholders that we've been talking about. Employees, the investors, the lenders and the community in which they operate.
>> Bethany McLean: So it seems to me that we have a whole system built around a concept of ownership and profit maximization. It's not just within companies and how executives are rewarded, but we have cultures, not just in the US but around the world, where the stock market is central to the way people think about wealth and retirement and savings. So if your conception of business as something that nobody owns, where profit maximization isn't the goal is, right. How does that flow through the entire system? How do all of us on the other end of it who are putting our retirement savings in the stock market, then think about it?
>> John Kay: Well, we're not putting our stock retirement savings in the stock market. We're placing them with various intermediaries who will in turn invest them in the stock market. Or we talked about Amazon as warehouses. The largest owner of Amazon Warehouses is actually proloious, ah, real estate investment trust financed partly by bank finance. And the largest shareholder is of course Black Rock, which is the largest shareholder and whole variety of things. That's the complex structure of capital in the modern world. Now in talk about different countries and it's quite important to notice that different countries differ quite a lot in these respects. I mean in Germany the stock market isn't remotely as important as it is in the United States or Britain. There are corporate legal structures that differ across different countries. In Germany it's Beverly clear and it's also true in Britain that it's not the obligation of directors to maximize profits. In Britain the law says that duty of a director is to promote the success of the company. And it goes on to say for the benefit of the members. So the members will benefit from the success of the company. But that's the way round it is. It's not a matter of maximizing profits.
>> Luigi Zingales: So I'm sympathetic that people don't necessarily maximize. But as an economist you understand there are trade offs. Maybe I misunderstand your view, but my impression of your view is that if you build a great companies company they are basically no trade off because everything falls in line. So let me give you one trade off. Think about the one company in your book that has been successful throughout the entire period is Exon. Exon has been very successful for example by creating fake science about climate change, basically manipulating the political system in order to make it difficult to introduce carbon taxes. There is a big trade off there. So how do you resolve that?
>> John Kay: You are right that what has happened over the last 50 years, basically since 1980 we have had this vision that what companies exist to do is to make profits. And in addition to that we've incentivized managers, who senior executives of these companies to maximize profits. So part of the change we're talking about has been a change that has enabled managers, senior managers to take a much larger share of the value which is added in their businesses. Now part of the thesis of my book is that all this is deplorable and we would do much better if we recognize that businesses are collections of capabilities. And we would do much better if we understood that the job of managers is not to maximize profits but to build great good businesses which add value to the resources that are used in these businesses and in adding value in that way they will make returns for investors. But that isn't all it's about and it isn't primarily what it's about.
>> Bethany McLean: So if you were putting in place in the US at least, I'm not sure about around the world, but in the US at least, executives are still primarily paid on financial performance. Other measures may be incorporated, but they're weighted much less heavily than financial metrics are. So if you and the hallmark of a well designed pay package is so called pay for performance. So if you were instead to design your ideal pay package, what would it be? How would you define performance? How would you incentivize managers if it's not financial metrics?
>> John Kay: I would, I would recruit managers who want to do a great job. And that's what I mean when I say I want to make management a profession which indeed is how most of the best managers really think of it. You know, when, Elon Musk set out to build Tesla space, he wasn't, I'm trying to become the richest man in the world. What he was trying to do was build extraordinary businesses. And that's true again and again when I, identify or see the people we regard as successful entrepreneurs.
>> Luigi Zingales: But again you have served and you're still serving on a lot of companies board. So when you are there designing their pay package, what do you do differently?
>> John Kay: What I do differently is quite difficult. As you say, incentive, based pay is now pretty general and also rather generous. pay is rather general. I think, if we need to pay several million pounds a year to get someone to do this job, then I'm not sure we're recruiting the right person to the job. And I think, well, that's one of the things that has gone wrong with business in the last 20, 30, 40 years. If we recruit people whose motivation is primarily financial, then we're recruiting the wrong people to big jobs. That was most true in the financial sector. The truth, the truth is that the companies that went bust or that brought about the collapse in 2008, they were being run by people who were there to make money for themselves. And in the end they destroyed or nearly destroyed because the government in most cases maile them out. They nearly destroyed the businesses that they've created.
>> Bethany McLean: Who do you blame most for what has gone wrong? Is it the fault of the managerial class? Is it the fault of business schools who are teaching that the wrong things matter? Is it the fault of shareholders and their demands or activist investors or all of the above is there a place where the daisy chain begin end.
>> John Kay: It's all of them above and yet none exclusively of above. It's a climate that has evolved over 20, 30, 40 years. and needs to be changed back to say what is the origin of this kind of change in our thinking. And the pile memorandum at the beginning of the 70s which essentially said that what business has to do is create an academic community that is much more business friendly than the one we have in the 1960s. And we had in the 1960s. And I can see why it made sense to do that. But the result of that was a shareholder value movement and a particular nexus of contracts view of the nature of corporations. The incentives which were given to senior managers and the like. All of that was put together and really as a result of these kind of reactions, against The social upheaval really of the 1960s and 70s.
>> Luigi Zingales: You seem to be sort of A trapped into this Celebration of the past of business. But if we look at the past it was even more brutal since John Rockefeller was brutal. And if you read the accounts of IA Turbo, he basically supported Ludro massacre of Striking workers in Colorado. Just to mention one, not to mention all the tricks he did against these competitors. And to buy politicians and all the Robert barons were one worse than the other. That s reason why they called Robert Barn. So what are the leaders? Can you point out a great leader of the past. That you unconditionally support as an example of the good capitalists you're describing?
>> John Kay: Well, let's take the people who in the first half of the 20th century tried to create a profession of management. Alfred Sloan would be the archetype of that. Or he and his colleagues. And that's an important qualification. He and his colleagues built a great company. And they very sensibly I think thought they wanted to create a manual of what it is they had done that would be useful for people and other businesses. That's my example. But also equally I talked earlier about Bill Allen, and Boeing, and the Boeing Company as it was in the later part of the 20th century. It was people who wanted to build great planes, who wanted to create a great business. And they did create a great business.
>> Bethany McLean: So we've talked about how leaders should think about business differently. What about how employees should think. We all. I think it's a human desire to be loyal to something. Should you be loyal to your capability or should you be loyal to your company? In other words, if a company is just A collection of capabilities. Is there something there for an employee to be loyal to?
>> John Kay: I think you should be loyal to your capabilities. But if the company is using your capabilities, well, there isn't a contradiction between being loyal to your capabilities and loyalty your company. But of course the, the capabilities that go into making a particular company successful will probably change over time.
>> Bethany McLean: I think that's a perfect note to end on. And we are out of time, so thank you so much for your time, John. It was really interesting and I hope that you are feeling better.
>> Luigi Zingales: Yeah, thank you very much, John.
>> John Kay: Good. Pleasure to talk to you.
>> Bethany McLean: If you're enjoying the discussions we're having on this show, then there's another University of Chicago podcast network show you should check out. It's called the Chicago Booth Review Podcast. What's the best way to deliver negative feedback? How can you use AI to improve your business strategy? And why is achieving a off landing so very hard? The Chicago Booth Review Podcast addresses the big questions in business policy and markets with insights from the world's leading academic researchers. Its groundbreaking research delivered in a clear and straightforward way. Find the Chicago Booth Review Podcast wherever you get your podcasts.
So, Luigi, one of the things I thought was really interesting that I had actually never thought about and didn't realize was a whole study, or a whole almost field in and of itself that you and Oliver Hart have focused on is this concept of ownership. Did anything he say change your mind about ownership or make you think differently about it?
>> Luigi Zingales: No, I am sympathetic to his view that physical assets are not that important anymore. It just. They are important, but not that important. Where I think he was coming close to something that I, studied many years ago. The idea that the business, firm does not necessarily coincide with the legal firm. So when you think about Apple, for example, the supplier of Foxconn is really dependent very strongly on Apple and vice versa. Legally they are not part of the same firm. But if you think about the ecosystem that creates value, I think that Foxon and Apple, belong to the same ecosystem now. They are not under the same legal umbrella. I think he was refusing, I don't know why, but he was refusing the fact that the legal umbrella carries some role, which I think it does because, when I am on the board of Oxford University, the fact that I can claim to use the title Oxford and the name Oxford is very valuable. And that is to me what gives the, board of Director of Oxford some power. Honestly now, that's not the only source of power. This is where the stuff that I Developed withagian, differs from the stuff that Oliver Har has produced because he emphasize really very much on the pure ownership of assets, which is an important element. And assets should be interpreted broadly, even known, physical assets like the name Oxford. But I think there is also some power that comes from being for example the only buyer of a particular product. So if Apple says something to the CEO of Foxconn, probably the CE of Foxcon will obey without much, dispute. because, yes, they could try to supply other people, but their survival in business depends so much on selling to Apple that Apple has a lot of influence. I think that this distinction between legal organization and business organization is very important. But in spite of my pushing, it never flew. And I think it never flew because, people are afraid of opening up the boundaries. Also from a antirust point of view, because if all of a sudden I say that I have power over my suppliers, then I might have some kind of market power that might get in the way of the antitrust. So I think that the economic profession is very resistant on going that direction. I still, of course we think that it's still a great idea, but don't ask, the who if the one is good.
>> Bethany McLean: What did you think about Kay's overall idea that a business is a collection of capabilities? Did that seem to you like a, relevant or interesting or expansive way of thinking about a business? Or did it feel like the same old thing said in a different way?
>> Luigi Zingales: The question is what is inside and outside a firm? if you don't have a clear notion of boundaries, then you don't have a clear notion of firms. And it seems that the John K. Refuses to have clear definitions. He likes, ambiguity and he's written a lot of books about ambiguity. So I think he likes ambiguity. But I think from a research point of view you need to have clear boundaries in order to understand what is s an out and see whether that concept is useful or not. If the concept is vague, is about everything and nothing. And so it's not particularly useful. To his credit, I think that the notion, maybe because it's similar to what I said many years ago, the notion seems to me useful to try to understand because it is true that one of the important things is to maintain these capabilities alive and make sure that these capabilities are not appropriated by somebody else. And we have plenty of examples of capabilities that were approiateied by other firms that develop on their own. Ah, you know that intel was founded by some, employees of Fairild Semiconductors who basically understood the capability of the silicon wafer and walk away and started a different firm. actually I should have asked John K. But was Virtual Semiconductor a great company? Because if you think about from a SoCal point of view they created a lot of span off that created a lot of technology including Intel. So it's a great company. Too bad that the investor lost everything because they weren unable to appropriate the return of that investment. So his notion that if you do the right thing, everything will work out is very beautiful. But I'm not sure he's right And I didn't find in the book any compelling evidence except a few underoges that this is true.
>> Bethany McLean: Continuing on the intel theme, if you think about Intel's outsourcing of all of its manufacturing to TSMC for a time it appeared that maybe that was a capability that didn't have to be a first hand capability. It could be a second hand capability. But as more and more innovation has come in the manufacturing, maybe the manufacturing is a first hand capability. And so I think I wanted him to be a little more specific also about what needs to be core to affirm how you should think about what capabilities need to be held close and what need to be actually part of the firm and what capabilities need to be outside the firm. But if you're not willing to be specific about what a company even is or who owns it, then it's very difficult to be that specific about it. And as much as I love the beautiful idea of a corporation being about running a business well, we've had a long history of grandiose ideas of running businesses well and running them for other stakeholders. And those companies also haven't survived. Of course we have a long history of companies that have been run for the bottom line and those companies haven't survived either. So I'm not really sure that anybody has it figured out.
>> Luigi Zingales: No, but I think that you're right that he doesn't have a theory of what is a core capability, what is not. Part of management theory is trying to explain exactly what is caing the capability, what is not. So that is in the spirit and people may mistake. And he says, I don't think that we can blame his theory if intel management made a mistake because these things are not written in stone and people do make mistakes. I'm actually more puzzled by this view that if you do a great business, I would like to paraphrase this line that the only social responsibility of Business is to run a great business. If you think about from a societal point of view, that's not necessarily true. He has this great view of Alfred S Loan as like, the greatest guy on the face of earth. But let's face it, Alfred Sloan was the one who invented plan obsolescence. That from an environmental point of view is a disaster. Was constantly spying on the workers, trying to not to unionize. And this happened shortly after he left. But was his GM M that created, the famous corvert that our friend Raader criticized unsafe at any speed? So was GM a great business at the time or not? And maybe it was a great business from the insider's point of view, but not from the customers or society at large.
>> Bethany McLean: But that actually is interesting because I tried to pin him down and didn't have much luck either on this idea of how executive compensation should work. Then if it's not going to be profits first. But maybe there is an argument that you could look at every single stakeholder and measure a CEO on, give them a sliding scale on each stakeholder, stockholders, environment, our children's children and employees. And on each one they could have a different weighting. And maybe the bottom line shouldn't be first and foremost. Maybe. In other words, what I'm trying to say is that maybe his argument isn't so much that the bottom line doesn't work, it doesn't matter. Is that it's order of operations and it's that the bottom line should be the result of all these other things. But if the bottom line should be the result of all these other things, and all these other things should need to be measurable and need to have a scorecard affixed to them. Because if the bottom line stays the scorecard, then in the order of operations that's going to come first.
>> Luigi Zingales: I think you're absolutely right. But this is where ownership matters. Because suppose I run the firm like you describe what guarantees me from the possibility that a raider will take over the firm or an activist will buy enough stock, the size throughw the workers, throughw the environment, maximize profits, the raider will make a lot of money. as a manager I have only two choices. Either I do that myself or I get fire and I let the raider do that, on his own. Precisely because ownership matter. If ownership didn't matter, there was me no raider, nor take cover, right? but the moment ownership matters, this is a possibility. And so short of having some restriction to take overs, I don't think it's going that direction. But then you have to some restriction takeovers. This is a possibility and with this possibility it's very difficult to deviate.
>> Bethany McLean: So I think we come back to the idea that things need to be defined in order to know what it is that what we're actually talking about.
I did have another. This is a bit of it's a bit of a side note but I did find what he said really interesting about the role of finance. But maybe I didn't ask my question clearly but I didn't think he answered it clearly. He's getting at something really important. If capital is more and more of a service, un less and less a critical ingredient in a business, why has the role of finance in our society become bigger and bigger instead of smaller and smaller? And I think either he's wrong or the invisible hand isn't working very well. Because if capital is becoming not the critical element, if we're no longer in a Marxian world, than those who arrange the capital shouldn't be the best paid people in our society and finance shouldn't be becoming a bigger and bigger portion of our gdp. Or am I missing something?
>> Luigi Zingales: There is no doubt that today is much easier to manage big amount of physical capital. So think about a plane. A plane costs a fortune. But if I start an airline, I can start an airline without owning any planes. I can lease them. Think about computing power. In the old days if I wanted to start a bank, one of the biggest obstacles is I had to buy one of those IBM machine that cost an arm and the leg and without that I couldn't function. So it was a huge buyer to entry. Today you can rent on Amazon, bank as a service and you can scale it up. You can buy at the beginning very few units and then you double the amount of clients, you double the amount of aws, space and it's very easy. So some aspects have become much much easier to handle. However, there is the critical component of the business risk of starting a firm that cannot be easily lease or bought as a service precisely because the rest has become so commoditized. All the value is concentrated in debt. So think about venture capitalism. Venture capitalist is the one that takes the risk of putting this stuff together. While the amount of money might be less than the amount of money you put on a plane, the amount of money put on plane is fairly secure these days. You're not going to lose much and the only possibility is that the plane blows up. But you are insured so you're not going to lose much. On the other hand, if you start an airline company, you can lose 100% of it. Allocating that with capital properly is really, really important. And this is where the venture capitalists and your friends, the private equity guys are so important.
>> Bethany McLean: That's a really interesting idea. Maybe that would be a way to think. I mean, we think about it in financial terms as capital having different pricing, whether it's at risk or not. But when you think about it in the larger ecosystem of the corporate landscape, at risk capital versus not at risk capital or capital where you're going to get some back regardless of what goes wrong in capital, where you're going to lose everything. I mean, obviously that's reflected in the rates people pay for the capital. Unless we're in a complete bubble frenzy as we've been in for a while in venture capital land. But it's kind of an interesting. I don't know, maybe current capital models already take that into account. But I was thinking as we were talking that maybe that's the shift in our economy is toward more the importance of the at risk capital.
>> Luigi Zingales: Yeah.
>> Bethany McLean: Versus the way.
>> Luigi Zingales: That's the reason why I am intrigued by his book because I think touches on some important elements, but touches at a very high level without going into the detail in any of them. and so that's kind of the tension. So it's very good in term of breath, not very, deep in term of depth.
>> Bethany McLean: I'm definitely more intrigued by it after talking to him and talking to you and you had mentioned before when we were talking about this that he comes at these things in an oblique fashion. And maybe that's the best way to describe it, that it is actually very thought provoking, but not in a direct way. He makes you sort of reach to pull together the tangents.
>> Luigi Zingales: Yeah. You know, he has a previous book called Oblique, where he makes this general point that sometimes it's better to not aim at the target to reach the target. And the most interesting application I know that is precisely with the firm where he says that the best way to make profits is not to target profits, but to target a great business and the profits, will follow. Which, you know, it is a very reassuring theory. I don't know to what extent is correct and I don't know to what extent is actually deceiving. Because, if really you'targeting profits and you claim you're not targeting profits in order to target profits, are you simply playing a deception game or what it is. But if I want to again be on the positive side. In his book, he quotes Michael Sandel for an important point, which is saying that instrumentality breaks a lot of social, interactions. So if we are friends just because, we have a business interest in being friends, ours is not a friendship. He'a business relationship. So he claims that the more economists have to say brings instrumentality into business, the more they destroy the social nature of business. One of the claims he makes in the book, which I find it intriguing, is that business is a social institution that relies on a social structure that can be undermined by excessive instrumentality.
>> Bethany McLean: So then that would explain why he's reluctant to affix very specific definitions to things, because then they become modes of instrumentality. Whereas if you leave them vague, you force associ social interpretation of them. So actually there is, ah, if I take what you're saying and apply it to his way of writing and thinking, then there is actually an analytical framework behind it, even if it's not one that, entirely resonates with my brain.
>> Luigi Zingales: That's a very clever interpretation. I didn't think about it, but that's a very clever interpretation of his writing.
>> Bethany McLean: Oh, good. I like the idea of being clever.