wealth distribution and corporate control

[Michael Harrington <mharrington@milken-inst.org>]

Dear Ownership Group,

Regarding some of the emails last week and Keith Wilde's strategy, I went
back to review some of the literature I remember on ownership and the theory
of the firm. I came across an 1988 article by Harold Demsetz titled "The
Control Function of Private Wealth" and found it very relevant to the points
I was trying to make on the orthodox economics approach to the issue of
ownership. It's in his book Ownership Control and the Firm, Basil Blackwell,
1988.
Incidently, Harold Demsetz and his colleague Armen Alchian are probably the
foremost proponents and academic researchers  extending Coase's theory of
the firm in the 1960s and 70s. They are renowned for their contributions to
the theory of property rights as well as the theory of transactions costs in
the fields of industrial organization and economic development. Demsetz's
specialization is corporate ownership and governance issues. 

To quote from his article:
"Probably no large topic in economics is so likely to spark heated debate as
wealth and its distribution. ...Economists show less hostility than other
social scientists... to inequality in the distribution of wealth. [This]
stems from the belief they generally share that wealth-seeking ultimately
promotes the common good by guiding resources into more productive uses,
and, through competition between wealth-maximizers, by broadly distributing
the gains that result."
....Differences in wealth are demonstrably explained by differences in
investment in human capital, intelligence, hours worked, risk of employment,
and so on."

While I would not wholly disagree with his statements (except I would argue
that differences in wealth are explained more so by ownership of financial
assets, as Edward Wolff's research shows), we can see that his approach is
guided by questions of corporate efficiency and economic incentives of
private property. Thus the free-rider problem in corporate governance that
results from a diffusion of ownership is economically inefficient and thus
bad. 

Demsetz claims that "[the productive function of the having of wealth] is
unlikely to be served well, even in wealthy societies, if wealth is equally
distributed. ....Private, concentrated ownership is required... and...is
securable to a society on a broad scale only if the society is privately
wealthy and tolerant of a skewed distribution of wealth." 
Finally, he concludes: "Assuming that scale economies are more prevalent in
industrial undertakings, this suggests that patient accumulation of private
wealth, and toleration for skewness in its distribution, are part of the
preconditions for accelerated development." 

Now, I don't disagree with his premises:
1. private property is a necessary condition for maximizing economic growth;
2. diffusion of ownership presents collective action problems of governance
and control through free-rider problems;
3. efficient risk taking is essential for business development

But I definitely disagree with his conclusion that a highly skewed
distribution of wealth creates the optimal conditions to resolve these
problems. If fact, as many have pointed out, it sets up the politics of
redistribution that hampers economic growth. 

So, one task is we must show that a flatter distribution of wealth can
enhance stable, long-term economic growth while adhering to the dictums of
private property and incentives for efficient risk-taking. I think ESOP
theory has tried to demonstrate this, and I am convinced, but I would like
to counter this orthodoxy with some convincing empirical and theoretical
research.

Regards,


Michael Harrington
The Milken Institute
mharrington@milken-inst.org
(310) 998-2699




































Michael Harrington, Ph.D.
The Milken Institute
mharrington@milken-inst.org
(310) 998-2699