Sunday, January 31, 2010

More on a "rethink of capitalism": The purpose of a business and "profit maximisation"

In recent months due to The Crisis, many have called for a fundamental rethink of capitalism, the French (right of center) President of France, M. Nicolas Sarkozy, most recently at the Davos World Economic Forum.

This is part of my contribution to the (re)think:

The purpose of a business is to produce and/or market goods (tangible or intangible) and/or services that satisfy needs and wants of enough people (or organisations) at a price that and cost that makes the endevour worth it for the owners - shareholders. And IMO there is nothing wrong or faulty in that.

Plus, "Greed" per se and in general, although much discussed or used as an explanation for systemic socio-economic problems these days, is IMO not a factor. What is IMO/IME a factor, and a main causal one at that, is that most corporations have become so large and so impersonal - bureaucratic that they can only operate based on a single factor (mono-variable). And that factor becomes profit (or shareholder value) maximisation.

On the other hand, micro and small companies tend to remain small enough that they can operate based on a multi-variable set of goals, that includes no only profit but other factors as well that cause owner satisfaction (fame, personal ambitions and dreams, ideas, etc).

Corporations that have stocks publicly traded (ie in stock markets) have an additional source of monolithic (mono-variable) pressure ie one that focuses exclusively on profit - shareholder value maximisation: The financial market and its analyses.

What I mean by that? Most often, critiques of capitalism overlook that fact that there is no "capital" per se in large corporations at least, ie the capital-labor-knowhow triangle/model is too simplistic to describe the "system". Why? Because most operators in the financial markets are not the owners of the invested money themselves. They handle the money of clients, many clients, and, this is the key IMO, they have to compete with other operators for their business - clientele. This competition too is based on too narrow, IMO, factors: expected return (and at best, expected risk and their combo (see the "expected risk vs expected return trade-off and the max efficiency frontier). That is the best approximation of the "greed" many politicians and other "accuse", but It is not real greed, it is the competition between money managers for attracting and maintaining their clients based who will offer them the best return. It is that which, in cascade, causes the "profit maximisation" prime and single-directive on publicly quoted corporations.

So whereas in theory, other parameters could be introduced, eg social and/or environmental "responsibility", it is profit maximisation that is dominant.

That's my theory.

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