Imagine you could genetically engineer a creature, and you chose to omit a brain, opting instead for local controls that cause each part to do whatever it does, while generally ignoring the state of the other parts. Would this creature be an effective actor in the world, capable of sustaining itself by its own action? I think you would find that it would die pretty quickly, because each part is pulling in a different direction, without any coordination between the parts.

Such would tend to be the fate of a large business without the central control of a chief executive. He/she along with other executives, serves as the “brain” of the company. He provides the overall direction of the company and works to keep its parts coordinated to accomplish major goals. Without executive guidance, the decisions and goals of the various departments would often conflict. (1) The body manufacturing division of a car company, for example, may think that the company should be producing more sports cars, and start shifting its production to sport car bodies. But the engine manufacturing section may think that vans and SUVs are on the rise in the market, and so start shifting production to big-block engines for trucks. The mismatch between the vehicle bodies and engines will waste resources and stop the company from selling as many vehicles to dealers as they otherwise would.

What is needed to avoid such problems is a party to provide overall direction and coordination to the company. This role is filled by the executives, especially the CEO.

For a CEO to guide the company effectively in a free market, he needs to have a great deal of knowledge about his industry, past and present. This knowledge, along with an active, creative mind, is necessary so that he can have a viable vision for the future of his company. He also has to have a solid grasp of the organization, attributes and capabilities of his company. He has to keep all of his company’s moving parts in mind as he makes crucial, high-stakes decisions. One wrong decision can doom the company and cost him his job, potentially making him unemployable as a CEO in the future. A series of right decisions can make the company very successful and very profitable. Being a CEO is hard, stressful, mental work and involves very long hours.

In a free market, a CEO can’t count on government favors or bailouts to save his company from any bad decisions he makes. (By definition, the government does neither of these things in a free market.)

Some people say that hired top managers, such as corporate CEOs, are problematic because they don’t have a stake in the long-term health of the company. This is not entirely true, even if they are completely paid in cash: Just like any other employee, their reputation as a good and productive employee is at stake, based on their performance. But most corporations add greater personal stakes for their CEOs by paying them a significant portion of their initial salary in the form of company stock. This makes their personal fortune dependent on how well the company does.

Some people, generally of the egalitarian/Marxist persuasion, think that company executives can be replaced by a “democratic” procedure, in which (non-executive) company employees meet to vote on company decisions. While a business can be run this way, at least temporarily, it is vastly inferior to a structure that includes executives. Welders, construction workers and the like do not have the time or the expertise necessary to make good, timely decisions on the future of the company. Executives, whose specialty is evaluating business decisions and goals in light of the state of their industry, are much better and more efficient as company heads. This is just one instance of the greater efficiency of a division-of-labor economy. (2)

Professional Investors

If the top executives are the “brain” of the “corporate organism,” then investors are those who provide the “food” on which it grows. They provide much of the funding that businesses need to be successful. They serve as a check on business activities, determining which are likely to be profitable and which aren’t.

In a free market, where business profitability depends on efficiency in the satisfaction of market demand, rather than on how much the government likes a business, the successful investors are those that are quick to provide money to the economically deserving, while withdrawing money from the economically undeserving. They have to do research on companies and know the market, predicting where it will head in the future, to make money. To really do well, they have to spot good ideas before most other people would.

Making enough money to make a living off of investments is not easy; it takes constant work. (This is evidenced by the prevalence of investment advice columns and TV shows, and investment consulting and management firms.) Those who are good enough to become rich off of investing alone are very rare. In a free market, investment income is earned income.

Today’s financial market, however, is highly regulated. In the US, there are a plethora of regulations and institutions that would not exist in the free market. Foremost of these institutions is the Federal Reserve, which artificially manipulates interest rates and the quantity of dollars in the economy. The manipulation and regulation of the economy by government requires investors to be less focused on the productivity of a company, and more focused on Ben Bernanke’s moods. The dictates of regulators like Bernanke, the FTC, the CPSC and the FDA–of the president–and of legislators like Barney Frank, can make or break a company. And the decisions of such government parties cannot be reliably predicted by the attributes of the company and the state of the market. (For example, the Consumer Products Safety Commission may arbitrarily decide to bully one company out of business, while leaving its similar competitor untouched.)

This atmosphere of regulated business, dependent on the unpredictable tempest of government regulatory enforcement, makes investment less systematic, shorter range and more akin to a game of Russian Roulette for pay. This atmosphere is less favorable to diligent, honest investors and more favorable to dishonest, range-of-the-moment shysters looking to grab a quick buck and escape. (This was part of what happened in the 2008 Financial Crisis.)

But in a free market, honesty is the policy that wins out in the long-term. The honest, beneficial, productive activities of investors help to fuel the creation of great wealth, and they properly deserve proportional compensation.

I recommend Dr. Yaron Brook’s course, The Corporation. Dr. Brook also offers a course on Investing: An Objective Approach.

An excerpt from Capitalism: The Unknown Ideal by Ayn Rand:

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(1) The analogy between a business and a living organism is a loose one. Unlike in a living organism, the individual members of the business are a part of it by their own choice. An organism can rightfully do whatever it wants with its parts, because its parts don’t have minds of their own. But the upper echelons of a company may not rightfully do whatever they want to the other employees. All employees retain fundamental sovereignty over their own lives and the option of leaving the company. There are no Hegelian super-organisms of human beings.

(2) For anyone who thinks that average CEO pay is too high and should be “corrected” by government action, I recommend this article: The Corrupt Critics of CEO Pay.

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Related Posts:

Wealth is Created by Action Based on Rational Thought

Wealth is Not Money — Monetary Wages vs. Real Wages

What Caused the Financial Crisis: It Wasn’t Capitalism or Deregulation

Why Healthcare in the US is So Expensive, and What Can Be Done About It

The Nature of the Morality of Rational Egoism: Short Notes