Introduction
Anthropic—the artificial intelligence (AI) company that created Claude—was founded in 2021 by former OpenAI employees concerned about AI safety.
With purpose in mind, the founders chose an innovative governance structure: They formed Anthropic as a benefit corporation and gave control of the business to a charitable long-term benefit trust.
The founders populated the trust with independent trustees with experience in “AI safety, national security, public policy, and social enterprise,” all of whom were duty-bound to advance the company’s purpose of “responsible development and maintenance of advanced AI for the long-term benefit of humanity.”
Anthropic is one of many modern examples of “nonprofit enterprise.”
Nonprofit enterprise—which this Essay defines as a nonprofit (or related charitable organization such as a trust, foundation, or enterprise foundation) that generates revenue primarily through business operations—looks and feels like a for-profit business. Nonprofit enterprises are typically managed by high-powered and highly compensated managers and are not primarily engaged in charitable causes. And yet, they are organized as, or primarily controlled by, nonprofits.
Danish beermaker Carlsberg is another example: It is controlled by a nonprofit foundation.
British newspaper the Guardian is organized similarly: It has only one shareholder, which is a nonprofit charity.
Luxury retail conglomerate Rolex is owned by a Swiss charitable trust,
and iconic American candymaker Hershey is controlled by the Hershey Trust Company, which also manages the endowment of a private school for low-income children.
Taking a look beneath the hood of Swedish furniture giant IKEA reveals that within its labyrinthian corporate organization, it, too, is owned by a set of nonprofits.
Civica, the generic drug maker, is organized as a nonprofit,
alongside AAA, the national motoring association that funds its activities via its roadside assistance business,
and ProPublica, the investigative news organization.
Why does nonprofit enterprise exist? Fifty years ago, Henry Hansmann proposed the leading economic theory: contract failure.
In certain industries—such as hospitals, nursing homes, and education—consumers cannot easily evaluate or bargain with service producers. For example, consumers often find themselves seeking hospital services during an emergency, making it hard for them to shop around for the best deal. This contract failure is ameliorated when the producer organizes as a nonprofit: The nonprofit form assures the consumer that they are purchasing services from a business that cares about healthcare, for example, rather than one that is primarily motivated by generating profits for shareholders.
Hansmann’s elegant theory anchors an important literature on nonprofit enterprise.
And yet, in the years that followed Hansmann’s article, it has become clear that contract failure is not the whole story. Today, nonprofit enterprise proliferates across a broad spectrum of industries, beyond those with severe consumer information asymmetries. Nonprofits successfully run clothing manufacturers,
insurance companies,
beer breweries,
candy manufacturers,
furniture makers,
and more
—that is, industries in which consumers can easily evaluate goods and services. Changes in the information environment also undermine the existence of contract failure in Hansmann’s paradigmatic examples. Hansmann theorized, for example, that parents sending their children to college might not be able to evaluate such a “complex and subtle service,” preferring to rely on nonprofit status as an indication of quality.
Of course, modern college rankings and college advisory services offer detailed descriptions of colleges;
therefore, it is difficult to attribute the success of nonprofit colleges to contract failure alone.
This Essay therefore offers a new “purposeful enterprise” theory to explain the existence and persistence of nonprofit enterprise. It posits that corporate purpose can play an important role in both the selection of the nonprofit form at the outset and the success of the entity over time.
In particular, our theory explains how nonprofit enterprise can flourish despite departing substantially from “good governance” practices thought to be responsive to the central problem in corporate law and governance—that of managerial agency costs.
Agency costs are inherent in many business entities—when the owners of an entity are not the managers of the business, managers have an incentive to behave self-interestedly and to the detriment of the business.
A complex corporate governance machine has risen to combat agency costs in for-profit business, with shareholder monitoring and control at its core.
Through the power to elect directors, make shareholder proposals, and review books and records (among other rights), shareholder monitoring and control is thought to ameliorate managerial agency costs.
An enduring puzzle of the nonprofit form is that nonprofits are, by definition, entities without shareholders.
As such, they should suffer from pronounced agency costs.
Without shareholder monitoring, who will monitor management and ensure that they pursue the organization’s mission and not extract undue private benefits?
And yet, nonprofit enterprises not only exist, but thrive. Certain industries—such as hospitals and higher education—are dominated by nonprofit businesses, which outcompete their for-profit rivals.
Other industries, including technology,
retail trade,
and pharmaceuticals,
are seeing more and more productive activity conducted by nonprofits. What explains this expansion and success?
Purposeful enterprise theory provides an answer. It argues that nonprofit enterprises can harness corporate purpose as a substitute for shareholder monitoring and intervention rights, mitigating agency costs in the process. In particular, our theory draws on insights from behavioral economics and organizational science to describe how an authentically communicated purpose can provide direction for management, serve as a powerful source of motivation across the organization, and empower stakeholders as enforcers. Indeed, because authenticity of purpose depends on the sacrifice of profits, nonprofits have a head start relative to for-profit enterprise, as nonprofits are defined in part by their nondistribution constraint.
This Essay further explains how purposeful enterprise can generate organizational efficiencies by eliminating an expensive stakeholder with powerful control rights that may undermine the organization’s mission, thus increasing the resilience and stability of the organization over time.
Moreover, purposeful enterprise theory extends beyond nonprofits and sheds light on blended entities that pursue both purpose and profit—including insulated benefit corporations, which cut off shareholder intervention rights using dual-class structuring and antitakeover provisions.
Our analysis shows that these blended entities resemble nonprofit businesses when they use corporate governance to elevate purpose and cut off shareholder control.
Therefore, insulated benefit corporations offer similar advantages to enterprise foundations, which can use nonprofit ownership of a for-profit subsidiary to cut off shareholder intervention and elevate purpose.
Moreover, our theory sheds light on the success of each of these three entity types and helps us understand the trade-offs presented by each form of social enterprise.
Although our theory explains why certain nonprofit enterprises may succeed over time and even outcompete for-profit competitors,
it is largely descriptive. It does not suggest that all companies should become nonprofits or use purpose as a substitute for shareholder control—indeed, it suggests that calls for a mandatory corporate purpose
are misguided because they undermine the authenticity of purpose that is necessary to secure the benefits that we observe.
Instead, our analysis helps us understand why purposeful enterprise has emerged and thrived in certain areas. In particular, it explains why companies ranging from AI developers
to pasture-raised egg farmers
choose—and succeed under—a purposeful enterprise form.
All in all, purposeful enterprise theory represents an important development in how scholars and practitioners currently think about nonprofit and other purposeful enterprises. Specifically, it offers a serious critique of the economic disaggregation of purpose and profit. Common economic and legal understanding asserts that embracing a corporate purpose other than shareholder wealth maximization is inefficient and undermines profit incentives.
Our analysis of nonprofit enterprise demonstrates that this assertion is incorrect: Corporate purpose may actually enhance the profitability of certain organizations.
This Essay also sheds light on fundamental debates in corporate law and governance, including that of a corporation’s purpose in society. Conventional wisdom posits that corporations should be managed for the benefit of their shareholders, although advocates of alternative stakeholder governance theories have been gaining ground.
Shareholder primacy proponents have greeted this interest in “stakeholderism” with dismay, arguing that directing management to pursue a purpose other than profit will undermine discipline and lead to runaway agency costs, to the detriment of all.
Our analysis of nonprofit enterprise shows a different picture in many places—one not of rampant organizational inefficiency, but of prolonged economic success.
As such, our analysis provides an important counterweight to scholars who contend that accountability to shareholders is the only or best way to respond to agency costs and promote efficient business.
Our analysis further provides practical guidance for entrepreneurs who wish to engage in purposeful enterprise. It describes how founders can elevate purpose and use it to provide discipline for motivation across the organization. Although not all companies will be able to secure the benefits of purposeful enterprise, certain firms—and dual-class firms in particular—could potentially benefit from using purpose to respond to agency cost problems created by the governance structure, improving efficiency and profitability.
The remainder of this Essay proceeds as follows. Part I begins with an overview of the existing literature on the nonprofit business form. It focuses on Hansmann’s pathbreaking contract failure theory—the leading economic explanation for the existence of nonprofit enterprise. Although this lens helps explain an important advantage of nonprofit enterprise, we show that it is imperfectly explanatory. Part II introduces and elucidates purposeful enterprise theory. This Part centers on two major claims. First, by elevating corporate purpose, the business can mitigate agency problems by motivating management and lower-level employees, providing direction and promoting stakeholder enforcement. Second, the nonprofit form can create business value by eliminating an expensive stakeholder that can redirect the entity’s mission over time. Importantly, this Part also explains that our theory is not universally applicable. Some businesses would benefit from a purposeful form of business, while others would not. Instead of offering a normative account, this Part concludes by explaining which types of business might be a good fit for purposeful enterprise. It further shows how our theory has descriptive purchase over the types of businesses that have become nonprofits and related purposeful businesses. Part III then turns to implications for theory and practice, including implications for the ongoing debate about corporate purpose.