The Prisoner's Dilemma of Stockholders in Social Enterprises

Abstract

A burgeoning academic literature expresses optimism that economic activity directed by corporate planners, rather than by markets, might improve social welfare compared to market outcomes.

This paper shows that corporate planners and stockholders should not expect market-based corporate governance institutions—including voting mechanisms—to adequately address externality problems that arise from market failures in the first place. Modeling joint ownership of a corporate social enterprise as a public goods game, the Article shows that liquid trading in ordinary voting stock operates to produce a foreseeable change in control to a coalition of stockholders committed to rooting out costly nonfinancial activities and maximizing profits. The friction producing this result is that coordination by stockholders with similar nonfinancial preferences is costly.

The paper then shows how pre-commitment to a corporate public benefit through corporate governance institutional design can eliminate the identified prisoner’s dilemma incentives. However, these institutional design decisions create their own costs. The Article presents a corporate governance trilemma framework for assessing the tradeoffs of corporate different institutional designs. Case studies of close corporations and public benefit corporations support the institutional claims.

Thus, the transaction costs of co-ownership, and the institutional mechanisms that affect these costs, help explain not only the ownership structure of firms, but also corporate purpose.

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