The Corporation in a Democratic Society: In Whose Interest Ought It To and Will It Be Run?

This file is a single-author essay/chapter by Friedrich A. Hayek on the corporation’s place in a democratic order. Its scope is institutional and normative: Hayek asks not simply who in fact controls large corporations, but what legal framework can prevent corporate management from becoming an autonomous political and moral authority.

My thesis will be that if we want effectively to limit the powers of corporations to where they are beneficial, we shall have to confine them much more than we have yet done to one specific goal, that of the profitable use of the capital entrusted to the management by the stockholders.

The crucial move is Hayek’s distinction between a corporation’s specific aim and the general rules within which it acts. He does not exempt corporations from law, decency, or ordinary moral restraints. Rather, he argues that once management is licensed to pursue “social” purposes, it gains discretion over values that properly belong to individuals, owners, or public law.

Power, in the objectionable sense of the word, is the capacity to direct the energy and resources of others to the service of values which those others do not share.

The essay proceeds by testing rival claimants to corporate purpose: management, labour, stockholders, and “the public.” Management’s claim is dismissed as self-serving. Labour’s claim is treated more seriously but rejected because a firm run for its existing employees becomes a closed interest against consumers and mobile workers.

The fact is that an enterprise cannot be conducted in the interest of some permanent distinct body of workers if it is at the same time to serve the interest of the consumers.

Hayek then turns to the stockholder-public relation. His argument for stockholder primacy is not that owners are morally superior, but that profit-seeking under general law is the mechanism by which dispersed resources are directed toward socially valued uses without managerial choice among ultimate ends. Corporate philanthropy, political spending, or cultural patronage may seem benign, but for Hayek they transform trustees into rulers.

To allow the management to be guided in the use of funds, entrusted to them for the purpose of putting them to the materially most productive use, by what they regard as their social responsibility, would create centres of uncontrollable power never intended by those who provided the capital.

The later sections shift from principle to corporate law. Hayek insists that the corporation is not a natural market fact but a legal institution, especially because limited liability is granted by law. Therefore democratic society may legitimately redesign corporate rules to make management more accountable to owners.

In this sense limited liability is a privilege and it is a valid argument to say that it is for the law to decide on which conditions this privilege is to be granted.

His two main reforms are exploratory but revealing. First, he proposes that stockholders should individually decide each year whether to reinvest their share of profits, rather than letting management and majority votes routinely retain earnings. Second, he questions whether corporations should exercise voting rights in other corporations, since pyramids of ownership can separate control from genuine ownership.

I must admit that I have never quite understood the rationale or justification of allowing corporations to have voting rights in other corporations of which they own shares.

The relevance of the essay lies in its early and forceful critique of what later debates call corporate social responsibility. Hayek’s fear is double: in the short run, managerial “responsibility” enlarges private, unaccountable power over cultural and political aims; in the long run, it invites state direction, because if corporations are meant to serve public purposes, government will claim the right to define those purposes. The defense of free enterprise therefore depends, in his view, on narrowing corporate purpose rather than enlarging it.

Unless we believe that the corporations serve the public interest best by devoting their resources to the single aim of securing the largest return in terms of long-run profits, the case for free enterprise breaks down.