I first came across the term of production capability in the Steven Covey book “Seven Habits of Highly Effective People“.  I could easily relate because at that time, our company was in the middle of a brutal stretch where we were overworking nearly everyone in the firm.  We were running on empty, stressing the golden goose, making hay when the sun shines and burning both ends of the candle all at the same time.  Whatever you’d like to call it; we were certainly taking advantage of robust market opportunities with little regard to our future production capability.

So why don’t all firms think long term? Why aren’t we all investing in the future?  At times it is shortsightedness.  In some instances it is greed.  But sometimes ensuring future production capability runs smack dab into the expectations, and in some cases, the legal rights of your shareholders.

Let’s have a look at our corporate history book.

In 1916, the Ford Motor Company had accumulated a capital surplus of $60 million and the company’s president and majority stockholder, Henry Ford, sought to end special dividends for shareholders in favor of massive investments in new plants that would enable Ford to dramatically grow the output of production, and numbers of people employed at his plants, while continuing to cut the costs and prices of his cars.  In defense of this strategy, Ford declared:

“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 in the business.”

While Ford may have believed that such a strategy might be in the long-term benefit of the company, he told his fellow shareholders that the value of this strategy to them was not a primary consideration in his plans. Theminority shareholders, including John Francis Dodge and Horace Elgin Dodge, who owned 10% of the company, objected to this strategy.  They wanted their special dividends now (turns out they were planning to start their own rival company).

The Court was called upon to decide whether the minority shareholders could prevent Ford from operating the company for the charitable ends that he had declared.

I often wonder had Ford framed his argument in terms of future production capability, would he have been better off in the courts.

But the Court held that a business corporation is organized primarily for the profit of the stockholders, as opposed to the community or its employees. The discretion of the directors is to be exercised in the choice of means to attain that end, and does not extend to the reduction of profits or the nondistribution of profits among stockholders in order to benefit the public, making the profits of the stockholders incidental thereto.

Because this company was in business for profit, Ford could not turn it into a charity. The court therefore upheld the order of the trial court requiring that directors declare an extra dividend of $19 million.

This case is frequently cited as support for the idea that “corporate law requires boards of directors to maximize shareholder wealth.”

Who knows if Ford wanted to deny the Dodge brothers their special dividends to avoid a new competitor.  Who knows if he really did want to reinvest for the future of mankind.  What we do know is that the courts ruled that publicly traded companies must run to make a profit to benefit their shareholders.

It is a great reminder that once your firm goes public, you have certain fiduciary responsibilities that go beyond those of a privately held company.  The grass isn’t always greener!