Henry Ford vs. The Shareholders: An Informative Exercise In Capitalism

September 14, 2011

In 1916, Henry Ford made a controversial decision that did not sit well with the other shareholders of the Ford Motor Company: he vowed to stop paying “special dividends” to shareholders (of which there were only eight at the time, including Mr. Ford’s 58% share), and instead pay only a regular dividend of $1.2 million, while investing the remaining profits back into the company in the form of lower prices and higher wages for his employees.

Here is an amalgam of two statements made by Mr. Ford explaining his decision, separated by the ellipsis*:

My ambition is to employ still more men; to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this, we are putting the greatest share of our profits back into the business… . I do not believe that we should make such an awful profit on our cars. A reasonable profit is right, but not too much. So it has been my policy to force the price of the car down as fast as production would permit, and give the benefits to users and laborers.

Between 1911-1916, the company had paid a total of $41 million in “special dividends” distributed among it’s eight shareholders ($811,040,605 in 2010 dollars). Ford’s intention was to end these payments and re-invest them into the company.

The Dodge brothers, who co-owned a 10% share in the company, brought suit against Ford. The Dodge brothers argued that Ford has breached his duty to run the corporation so as to maximize its profitability for shareholders, as governed both by Michigan statutes and by the Certificate of Incorporation and bylaws of the Ford Motor Company.

The trial court sided with the Dodge brothers, and ordered Ford to declare a dividend equal to 50% of the surplus cash of the company minus special dividends paid between the time at which the suit commenced and July 31, 1917. This amounted to $19.3 million ($325,198,065 in 2010 dollars), to be distributed among the shareholders of the company.

The Michigan Supreme court, affirming this portion of the ruling, said the following:

[Mr. Ford’s] testimony creates the impression, also, that he thinks the Ford Motor Company has made too much money, has had too large profits, and that although large profits might be still earned, a sharing of them with the public, by reducing the price of the output of the company, ought to be undertaken. We have no doubt that certain sentiments, philanthropic and altruistic, creditable to Mr. Ford, had large influence in determining the policy to be pursued by the Ford Motor Company…[but] A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the non-distribution of profits among stockholders in order to devote them to other purposes. It is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholder and for the primary purpose of benefiting others.

In other words, corporations have a legal duty not to run their business for the benefit of their employees or even consumers. They have a legal duty to maximize the profits of their shareholders. All other duties are subordinate to profits.

This is something to keep in mind when analyzing the wild rhetoric of “angry Leftists” who seem to be irrationally pre-occupied with the immorality of the corporate business model. You may question their partiality on the issue, but the law actually supports their view: corporate Boards have a legal duty to maximize profits, even if they do so at the expense of potential benefits to employees and consumers. The example of what was done to Henry Ford by the Dodge Brothers demonstrates how this has played out at pivotal moments in our history, and how the law actually protects and encourages a profits-driven approach to Corporate Governance, at the expense of employees and consumers.

*all quotes taken from Eisenberg & Cox, “Corporations and Other Business Organizations,” Ch.4, 10th Ed., 2011.

UPDATE: I feel honor-bound to mention that modern law is not as draconian with respect to fiduciary duties to shareholders as it was in 1916. For example: today many states have statutes which encourage corporations to engage in reasonable charitable giving. However, these statutes do not allow charitable giving which significantly undermines the profitability or value of the company’s shares. Thus, while some leeway is given by modern statutes, it still does not undermine the legal duties of corporate fiduciaries to maximize profits. Shareholder profits still come first. And it is doubtful that Henry Ford’s case would be resolved any differently today, since his decision had a massive impact on the profitability of the Ford Motor Co. for its shareholders, even though the benefits would have flown directly to consumers and his employees.

3:01pm | URL: http://tmblr.co/ZMMjnx9WUPn_

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