Ford case defined role of business

August 23, 2018

Sen. Elizabeth Warren hopes to see a new legal charter adopted by big American businesses. The Massachusetts Democrats idea being to kill the notion that creating shareholder value is the only valid purpose of a corporation.

One thing thats puzzling about her ideas, as described in a Wall Street Journal essay last week, is the suggestion that the focus on shareholder value is some sort of late 20th-century development.

In fact business executives have been arguing over the purpose of a corporation at least since the case of Dodge v. Ford Motor Co., a decision coming up on its 100th anniversary.

The Ford shareholders won here, too, although they got far less than they wanted. Whats important is that Ford Motor founder Henry Ford still had the right to do exactly what got him sued in the first place going ahead with a plant expansion rather than pay out all the money to shareholders.

This doesnt seem to be a landmark legal case, maybe because it was decided by a state supreme court, but it sure is a great story. The star witness was the Steve Jobs or Elon Musk of his era, and its a fun case to show how this issue isnt black and white.

Ford was a headline-making celebrity even before he was taken to court by brothers John and Horace Dodge, the entrepreneurs who gave us the Dodge automotive brand. They were all once upstarts in Detroit when it was the Silicon Valley of the early 20th century, the hotbed of an emerging industry.

Ford had already flopped twice by the time Ford Motor Co. was formed in 1903. There is plenty to suggest all he wanted was to run a car business without any directors, investors or other parasites, as he called them. But he needed money. He also needed suppliers.

The Dodge brothers in 1903 agreed to build motors and transmissions for Ford. They also invested $10,000 none of it in cash in exchange for ownership in Ford Motor Co.

Its no real surprise the partners later had trouble getting along. They had the same risk problem, just different sides of it. Ford could replace them by bringing work in-house, yet Ford had to rely on a key supplier that could easily become a tough competitor.

What made all of them spectacularly rich was the creation of the Ford Model T, a reliable car first rolled out in 1908 that was far more affordable than competing Oldsmobiles or Buicks.

In the 1910 fiscal year, Ford produced more than 18,000 cars and the Model T was priced at $900. Six years later, Ford produced nearly 500,000 cars and the price of a Model T had been cut in half.

Thats when Ford, the company chief executive and nearly 60 percent owner, decided there would be no more special dividends to shareholders.

The Dodge brothers still owned 5 percent of the company each and knew Ford Motor was awash in money in the summer of 1916, with $54 million in cash and investments, or about $1.3 billion in 2018 dollars. It had just earned about $60 million for the fiscal year. Yet Henry Ford claimed the company needed the capital to keep expanding.

Ford put his ambitions this way, in testimony quoted in the court decision: 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.

Ford is a complicated hero for anybody cheering for corporations to act more like this. For one thing, he wasnt just a paternalistic employer but authoritarian, creating a sort of Ford Motor secret police to keep tabs on workers when they were off the clock.

Some of the initiatives hes famous for, like his shocking move to more than double worker pay in 1914 to $5 per day, could also be seen as self-serving.

Boosting wages turned out to be one fix to a massive employee turnover problem, as it wasnt much fun working on a moving assembly line and workers had been quitting in droves. Paying $5 also kept labor cost pressure on undercapitalized competitors.

By 1916, that included the Dodge brothers. So another reason to keep the Ford Motor profits in the company was to keep the Dodge boys from investing their Ford Motor dividends in the Dodge Brothers car business.

They sued Ford Motor about the missing dividends and also sought the courts help to block a massive new Ford manufacturing plant, which would only lead to an even bigger competitive disadvantage for them.

Luckily for them, Ford proved to be a terrible defendant. He suggested investors like the Dodge brothers had already made enough money on Ford and didnt deserve any more. On the witness stand, he complained that we dont seem to be able to keep the profits down and insisted Ford Motor was organized and run to only incidentally make money.

One theory on the case is that Ford decided he cared more about being viewed as a regular guy than winning, and had he not talked nonsense from the stand, no judge would have had to write that the primary purpose of a corporation was making money for owners.

Yet while the Michigan higher court said the Dodge boys (and other shareholders) should receive some of the profits, it let Ford Motor go ahead with its big expansion. It was up to the managers and directors, not the court, to decide how the company and its owners were better off.

This is the legal laymans lesson out of this story. A lot of what Sen. Warren complains about, like putting capital into buying back stock rather than plant expansions, isnt required by anything in the law. Repurchasing shares could easily be shortsighted. A CEO also should be able to defend, as competitive strategy, becoming known as the best-paying employer in an industry.

It also seems clear that neither the Dodge brothers nor Henry Ford would have had much respect for managers whose only ideas for creating shareholder value were cutting costs and buying back shares.

lee.schafer@startribune.com 612-673-4302

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