This is an example of what economists call the “agency problem.” The people we trust to act on our behalf—“agents”—may use the authority and resources we put at their disposal to further their own interests instead of ours. In corporations, the agency problem arises between shareholders and managers, and this was one of the reasons Adam Smith denounced corporations as early as 1776. Commenting on managers, he complained:

. . . being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners of a private copartnery frequently watch over their own . . .  ¹

Writing 150 years later, Berle and Means (1932) noted a fundamental change in this agency problem. Stock ownership of large corporations was becoming widely dispersed. This was democracy of capitalism, but it meant that individual holdings were shrinking. Shareholders were losing influence over managers. Berle and Means wrote:

Under such conditions, control may be held by the directors or titular managers who can employ the proxy machinery to become a self-perpetuating body, even though as a group they own but a small fraction of the stock outstanding. ²

Berle and Means were witnessing the beginnings of a phenomenon called “managerial capitalism.” In Adam Smith’s day, shareholders still held sway over managers, and the agency problem was a matter of managers not exercising “anxious vigilance.” Under managerial capitalism, shareholders have totally lost control of managers, and the agency problem is one of managers enriching themselves to the extent applicable laws allow or otherwise exploiting their positions to pursue money, power, social connections or other perks.

With shareholder voices stifled, expedience dictates how corporations are run—child labor is exploited in third world countries; the media is polluted with sex and violence; corporate dollars flow to lobbyists and politicians; the environment is destroyed ...

On top of all this, the “self perpetuating body” of corporate managers, which Berle and Means described, is an insular network. CEOs sit on each others’ boards. Theirs is a world where who you know is more important than vision, expertise or enthusiasm. Cronyism replaces competition at the top, depriving corporations of visionary leadership that might boost shareholder returns and raise everyone’s standard of living.

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¹ Smith, Adam. 1776. An Inquiry into the Nature and Causes of the Wealth of Nations: Edinburgh, Scotland. Book V, ch. I, part III, article 1.

² Berle, Adolf A., and Gardiner C. Means. 1932. The Modern Corporation and Private Property. New York: MacMillan. p. 8.