Alternative approaches to financing innovation

Abstract

Introduction – The principle of shareholder value maximization raises concerns about reduced levels of investment in innovation (Lazonick, 2011a). Since shareholder value maximization entails to maximize profits for the shareholders of corporations, the principle is connected to the allocation of capital in markets. There are concerns about the hampering impact of the short-term orientation of investors in capital markets on corporate governance (Abernathy & Hayes, 1980; Hill, Hitt, & Hoskisson, 1988; Kelm, Narayanan, & Pinches, 1995). A recent survey among corporate executives revealed that 78% of the participants would give up economic value if this would enhance quarterly earnings. Moreover, 55% of the executives would reject very profitable projects in the face of quarterly earnings pressure (Graham, Harvey, & Rajgopal, 2005). This seems to be problematic especially when innovation is concerned. Innovation is a cumulative, uncertain process which requires financial commitment of capital-providers (Lazonick, 2007). This thesis, therefore, attempts to answer the following research question: Research question – “How and under what conditions can finance be linked with innovation?” Research approach – The research conducted for this thesis is mainly theoretical for the reason that corporate governance is shaped to a large extent by the economic theories that corporate executives, investors and policy-makers hold as valid. Importantly, scientific theory and practice can be mutually reinforcing (Miller, 1999; Ghoshal, 2005). Scientific theory can even be self-fulfilling because it generates knowledge that human beings hold (Schwartz, 1997). Thus, in order to see economic theory in relation with corporate governance a research approach is needed that takes into account both theory and practice. The approach taken here is based on the human uncertainty principle (Soros, 2013). Human uncertainty applies to situations in which ‘participating agents’ are part of the world they try to comprehend. Since individuals can manipulate or have an impact on the world, there is reflexivity between the subjective understanding of the participating agents and objective reality. The framework also assumes fallibility at the part of individuals. Finally, Soros (2013) assumes for his framework that individuals make an impact on the world for the purpose of their self-interest. This thesis takes issue with this assumption and subjects it to the principle of reflexivity in itself. Only if such an assumption is not taken for granted, a thorough analysis of its impact on the circular dependency between theory (including moral philosophy) and practice is possible. Two existing theoretical perspectives are analyzed with regard to the question how finance can be linked with innovation: the set of theories that together prescribe shareholder value maximization, and the ‘regulatory’ perspective. For both perspectives the ethical foundation is analyzed as well. In addition, a third perspective based on various extant ideas and an alternative ethical foundation is advanced. Defining innovation – Innovation is a cumulative, uncertain process that aims to develop new or better goods and services by exchanging and creating knowledge (Lazonick, 2007; Landry, Amara, & Lamari, 2000). In literature different kinds of innovation are distinguished, most importantly technological and non-technological innovation, and product and process innovation (Armbruster, Bikfalvi, Kinkel, & Lay, 2008). Technical change as a result of technological innovation is acknowledged to be a driver of economic growth (Rosenberg, 2004; Cameron, 1996). A much quoted piece of work in this field comes from Solow (1957) who derived estimates for total factor productivity (labour and capital) and concluded that technical change is the main cause of economic growth. However, in order to capture all types of innovation and to include innovations that do not necessarily lead to marketable products, innovation is here defined as the development of new ideas, methods, products and processes. Why is innovation important? First, innovation can create benefits for consumers that result from the use of new or better goods and services (West, 1996). Second, innovation can create productivity growth (Cameron, 1996). The productivity of countries is positively associated with national living standards (Abernathy & Clark, 1985), which is often measured by income per capita (Van Ark & McGucklin, 1999; Baregheh, Rowley, & Sambrook, 2009). However, the use of resources that are freed as a result of productivity growth determines whether innovation really leads to higher living standards across society (Wolf, 2014). The gains from higher productivity can result in a shift of the income shares received by workers and capital-owners (Wolf, 2014). During the last decades an increased share of income has gone to capital income at the expense of the share of labour income (Mishel, 2012). An important concomitant fact is that capital income is predominantly received by a small fraction of the population because the ownership of financial assets is concentrated among the wealthier households (Wolf, 2012). The implication is that the distribution of the gains from innovation is an important determinant of the benefits that society reaps from innovation. An interesting concept that aims to evaluate innovation is Responsible Innovation. The following working definition is assigned to Responsible Innovation: “a transparent, interactive process by which societal actors and innovators become mutually responsive to each other with a view on the (ethical) acceptability, sustainability and societal desirability of the innovation process and its marketable products” (Von Schumberg, 2011, p.9). However, how are acceptability, sustainability and desirability operationalised? The responsibility criteria might have different connotations among different groups in society. The meaning of acceptability, sustainability and desirability depends on what human beings think these criteria entail. This implies that the notion of responsibility is tautological: something is responsible if we (the innovators and societal actors) think it is responsible. Hence, the operationalisation of responsible innovation is problematic. Another concept that aims to assess the responsibility of corporations is corporate social responsibility (CSR). This may as well be applied to innovation. CSR refers to the question what the responsibility of firms is beyond their responsibility toward shareholders (Cochran, 2007). However, the bulk of CSR literature focuses on how CSR can enhance profitability (cf. Porter & Kramer, 2006; Motion & Weaver, 2005; Harjoto & Jo, 2011). The lack of rigor renders CSR prone to being used as a strategic instrument, rather than what it was really meant for: assuring that the activities of firms are of public benefit, which was argued by Dodd (1932). CSR is, then, also of little help for the research problem at hand because it lends itself to be used for profit maximization, whilst concerns about underinvestment in innovation exactly revolve around profit-maximizing behavior of corporations. Responsible innovation – and its conceptualization as the inclusion of public values (Correljé, Cuppen, Dignum, Pesch, and Taebi, 2014) – is a more strict subset of CSR, because it gives criteria and explicitly requires the involvement of the public. The use of the concept of responsible innovation requires that responsibility is considered internal to the firm because the production and distribution of goods and services that result from innovation are intrinsically linked to the business. This makes firms more accountable because the boundaries of the concept of responsibility are less ambiguous, leaving less space for unrelated ‘compensation behavior’. However, the fact the distribution of gains from innovation is an important determinant of the benefits of innovation across society – and thus its desirability - implies that there are consequences of innovation – beyond the innovation process and its marketable products – that affect the criteria proposed by Von Schumberg (2011) for the assessment of responsible innovation. It would be sensible to include the economic consequences of innovation in the responsible innovation framework as well. The standard economic approach to financing innovation – The standard theory of the firm consists of several theories that together explain profit maximization for shareholders. First, agency theory analyzes the transaction costs that arise within the firm as a result of ever-growing organizations (Jensen & Meckling, 1976). Jensen and Meckling propose solutions for the agency problem that arises when the ownership of corporate stocks and control over the corporation are separated. This is typical for firms in the Anglo-Saxon world, where ownership is dispersed and individual external shareholders have little control over the firm (Desender, 2009). Agency theory arose because scholars were concerned with the performance of organizations in which the agents who take decisions do not bear the wealth effects of their decisions (Fama & Jensen, 1983). In agency theory, the firm is modelled as a ‘nexus of a set of contracting relationships’ (Jensen & Meckling, 1976, p.9). Agency theory proposes an internal solution to regulate the relationship between shareholders and firm executives by means of a contract that creates incentives for executives to maximise shareholder value. The external solution is to use capital markets as a disciplining device (Jensen & Meckling, 1976). Second, agency theory is based on the corporate objective function of maximization of shareholder value, because it presumes that firm performance equals stock performance. The contractual relationship that arises in the organizational context limits the risks of the agents by promising a fixed payoff, while the principals have the right to claim the remaining net cash flows (Fama & Jensen, 1983). This means that if the responsibility of the firm is to maximize profits, this is equivalent to maximizing shareholder value because the residual cash flows flow to the shareholders under this contract. This idea of shareholders as residual claimants derives from the Anglo-Saxon world and is legally determined in the United States and the United Kingdom (Weimer & Pape, 1999). The assertion that the only responsibility of the corporation is to maximize profits was coined in an essay by Friedman (1970). He argues that any deviation from maximizing shareholders’ profits is against the interest of the executive’s employer – the shareholder - , rendering the appointment of an agent to make decisions on behalf of the principal unjustified. Friedman (1970) further argues that any social responsibility other than profit maximization exercised by executives undermines the basis of free society. The assumption on which this argument rests is that a free society provides individuals with the possibility to maximize personal, material gains. Importantly, if a corporation pursues only profit maximization, it will only attract those investors who seek to maximize their profits. Also, executives who focus on short term profit maximization attract investors who are concerned with quarterly earnings (Brochet, Serafeim, & Loumioti, 2012). On the contrary, if a corporation decides to pursue social objectives other than the maximization of shareholder value, it can attract those investors who have the same social objectives. This means more concretely that if a higher level of investment in innovation comes at the cost of private gains, it may still be justified if it is what the shareholder wants. Yet, the ability of corporations to choose which objectives to pursue is restricted if they are obliged to engage in profit maximization for shareholders. Using Soros’ (2013) reflexivity, a reinforcing mechanism exists between what the corporate objective is and what investors are attracted to the corporation. The possibility for corporations to pursue other objectives than profit maximization is smothered by educating standard economic theory in business schools, which purports that the purpose of corporations is to maximize shareholder value (Ghoshal, 2005), and the widespread acceptance of this assertion among executives and investors. More generally, the embodiment of the idea of self-interestedness in agency theory and the principle of shareholder value maximization has shaped the use of the stock corporation as a vehicle for the pursuit of self-interest via the principle of reflexivity. Third, economic agents looking for profit maximization are in charge of the allocation of capital in markets. However, throughout time the volatility in market prices has been much higher than could be possibly explained by rational expectations about future dividend payouts (Shiller, 1981). This raises the question whether the efficient markets hypothesis is founded on appropriate premises. The efficient markets hypothesis is based on the assumption that individuals are making rational decisions, only care about personal consumption and wealth as ends in itself, have independent and determinate preferences and have a rate of time preference (Mäki, 2002; Gintis, 2000). However, in ‘From Efficient Markets Theory to Behavioral Finance’ Shiller (2003) describes how initial enthusiasm for the efficient markets hypothesis and its assumptions have turned into more realistic thinking about human behavior. This illuminates the importance of understanding human behavior in the light of capital allocation beyond the rational actor model (Shefrin & Statman, 2011). Since the beginning of the 1980s real stock prices show that investor expectations increasingly exceeded what rational expectations of actual returns would have implied. This coincides with two trends in executive pay. First, executive pay has increased dramatically since the 1980s. Second, executive pay has become more closely linked with stock performance since the 1980s (Jarque, 2008). This suggests that investor expectations are more closely related to executive pay, rather than to the discounted value of all future cash flows. The assumption of rational decision-making based on full information is further violated by the uncertain character of innovation. Innovation is a process that is riddled with uncertainty (Jalonen & Lehtonen, 2011). A market allocation of capital to innovation may not be efficient exactly because markets cannot deal with the uncertainty surrounding innovation. Stock prices cannot reflect fundamental value if it is unknown what the fundamental exactly entails. Furthermore, unlike the Modigliani-Miller theorem – which advances that it does not matter how firms are financed and their market value is independent of the allocation of returns (Villamil, 2008) -, several studies indicate that short-term oriented investors can negatively influence investment in research and development (Dore, 2008; Brossard, Lavigne, & Sakinc, 2013; Stockhammer, 2006; Graves & Waddock, 1990; Demirag, 1998). Moreover, the cumulative character of innovation violates with the pace at which capital can be transferred. Ortt, Tabatabaie, Alva, Balini & Setiawan (2009) found that the time span between the invention of a new scientific or technological principle and the large-scale production and distribution of marketable products in five high-tech industries is as much as seventeen years on average, whilst David (2010) shows that the average holding time of stocks on the New York Stock Exchange has declined from up to twelve years in 1940 to approximately seven months in 2010. This implies a mismatch between the time horizons of capital and innovation. Finally, profit maximization guides capital allocation based on the premise that if firms maximize their market value, social welfare is maximized (Jensen, 2001). However, shareholder value can be created without necessarily fulfilling the needs of society by providing goods and services. Firms can pursue financial goals (Epstein, 2005), engage in stock buybacks or simply raise investor expectations (Lazonick, 2011a). Executives cannot do this indefinitely, but it confuses the allocation of capital based on profit maximization because the various ways in which shareholder value maximization can be created violate the justifying assumption that social welfare is maximized if the market value is maximized. Given that self-interestedness is problematic when investment in innovation is concerned, and given that the link between private and social gains is questionable, alternative approaches to financing innovation may be desirable. The ethical foundation of the standard economic approach – Standard economic theory shows resemblance with utilitarianism in two respects: (1) it assumes “the notion of maximizing behavior on the part of all individuals”, whilst managers “[..] will make operating decisions which maximize [..] utility” (Jensen & Meckling, 1976, p.312). This is understood to be profit maximization (Friedman, 1970); (2) it connects individual maximization with social welfare maximization (Jensen, 2001). Thus, the outcomes determine human behavior. This suggests utilitarianism, which holds that the consequences of actions determine the moral rightness of these actions (Van de Poel & Royakkers, 2011). Utilitarianism holds that the ‘greatest amount of good for the greatest number of people’ should be attained (Driver, 2009). The justification for the principle of shareholder value maximization also resembles this principle. Jensen (2001) states about this: “Two hundred years of work in economics and finance implies that [..] social welfare is maximized when each firm in an economy maximizes its total market value” (p.1). Utilitarianism is subject to several criticisms. First, the ‘greatest good for the greatest number’-principle does not take into account the distribution of the good. This is problematic, especially since this thesis is concerned the distribution of the gains from innovation. Second, some matters can not be quantified because they do not carry a quantitative or monetary value (cf Hansson, 2007). Furthermore, utilitarianism depends on value judgments if qualitative values have to be translated into quantitative values. Third, utilitarianism assumes that (1) pleasure is the only thing that is desired, and (2) all other things are instrumental to this (Rachels, 2009). Put differently, pleasure or happiness, is intrinsically good while other things are instrumentally good. This may not be true, since individuals may consider things other than pleasure to be good. Utilitarianism could be stretched to include matters beyond what is assumed to be valued in the standard economic framework. The latter simply assumes that individuals “only advance material self-interest” (Dohmen, Falk, Huffman, & Sunde, 2009, p.1). Importantly, utilitarianism does not necessitate self-interestedness. It is essential to distinguish between three ethical theories which together form consequentialist theories: ethical egoism, ethical altruism and utilitarianism (Craig, 1998). Ethical egoism refers to looking after your self-interest, while ethical altruism refers to looking after the interests of others (Heathwood, 2014). Utilitarianism means to look at the total utility by adding up the self-interest and interests of others. The implication for the standard economic framework is that if utilitarianism is amended to include ethical altruism as well, it may solve the problem of underinvestment in innovation. However, how will we decide on the balance self-interest and the interests of others? Egoism and altruism are still separated, meaning that there is ultimately a divide between the utility derived from self-interest and other-interest. Neglecting this division means to neglect the distribution of utilities. Second, the problem of making value judgments remains. Investors may come to different conclusions than innovators or societal actors, whilst some matters cannot be easily quantified. The implication is that an ethical foundation that looks at what human beings value may be more helpful, because utilitarianism depends on value judgments for which it has in itself no answer. A regulatory perspective on financing innovation – In attempts to address concerns of underinvestment in innovation two more ‘regulatory’ approaches may be taken: (1) publicly financing innovation and (2) a stakeholder approach to financing innovation. Publicly financing innovation - Underinvestment in innovation in capital markets is generally modelled a consequence of the incomplete appropriability of knowledge (Romer, 1990; Hall, 2002). Jones and Williams (2000) point out that a solution for the resulting under-investment in R&D is to publicly fund R&D by creating tax incentives or providing for basic research. These solutions aim to resolve the problem of underinvestment in innovation. However, this approach leaves the market allocation intact, whilst trying to repair what markets are incapable of. Importantly, financing R&D activities publicly has important implications for the distribution of risks and returns. The uncertain character of innovation creates inherent risks associated with investment in innovation. Publicly funding innovation implies that the cost and risks of R&D are borne by taxpayers (Lazonick & Mazzucato, 2013). Bearing in mind the proposed extension of the framework for responsible innovation – which is to include also the gains from innovation – it is not a sufficient argument to justify the publicly funding R&D because it provides society with innovations. Since it leaves the principle of shareholder value maximization intact it can even exacerbate the problem of income and wealth inequality as a result of productivity growth. Stakeholder theory - In an attempt to ventilate discontent about shareholder value maximization as the only corporate responsibility Freeman (1994) developed stakeholder theory. This theory holds that business is concerned with values and has to deal with several other parties beyond shareholders (Freeman, Wicks & Parmar, 2004). Stakeholder theory does not give pre-set clues on how to resolve disputes that can arise as a consequence of taking into account the interests of different parties. This leaves stakeholder theory open to subjective interpretation. Phillips (1997) noted this void and proposed that a principle of fairness can be used as a ‘source of obligation to stakeholders’. Stakeholder theory has important drawbacks that renders it unsuitable for better explaining investment in innovation than the standard economic framework. First, let us consider what stakeholder theory means for innovation. Given that the innovation process is a learning process in which knowledge is exchanged and built (Landry, Amara, & Lamari, 2000), workers within innovating firms make an important contribution to innovation. In this regard workers are essential stakeholders. Indeed, the level of knowledge available in firms positively contributes to innovation and firm performance (Thornhill, 2006). However, the application of the concept of fairness is problematic. Blair (1999) and Lazonick and Mazzucato (2013) claim that capital-providers are not the rightful owners of residual cash flows, but rather the workers themselves. However, others (e.g. capital-owners) may come to a different conclusion. Ultimately, fairness depends on the virtue by which it is established. Second, individuals are seen as stakeholders if they are connected to the corporation in their own interest, though they are bounded by fairness (Weiss, 1995). This means that maximizing behavior is limited to what is considered fair. However, stakeholder theory purports that: “[Stock] owners have financial stake in the corporation in the form of stocks, bonds, and so on, and they expect some kind of financial return from them” (Freeman, Wicks, & Parmar, 2004, p.42, italics added), implying that stakeholder theory accepts the view that capital-providers are interested in return on capital in the first place, because this is what connects them to the corporation. Third, the outcomes of innovation unfold much later in time. This means that a fair distribution of benefits and costs cannot practically be established at the time of the commitment of capital, because the outcomes are unknown. Thus, stakeholder theory is not sufficient for explaining investment in innovation, because fairness is conceptually challenging, and practically impossible to determine when innovation is concerned. The ethical foundation of the regulatory perspective – Stakeholder theory sees the firm as a collection of persons who are aiming to fulfill their self-interest (Donaldson & Preston, 1995). Stakeholder theory, then, seeks to answer a distributive question in which several individuals aim to maximize the fulfillment of their own interest. This raises two questions: on what model of human nature is stakeholder theory based? And, in which ethical foundation is this grounded? An alternative to the rational actor model of standard economic theory is the homo reciprocans model. Research supporting this model suggests that rationality of individuals does not mean that human beings only pursue self-interest (Gintis, 2000; Fehr & Gächter, 1998; Fehr, Kirchsteiger & Riedl, 1993; Dohmen et al., 2009; Falk, 2001; Aktipis & Kurzban, 2004). Individuals are prepared to incur substantial costs in order punish someone else for ‘free-riding’, even though this does not give any direct or indirect benefits (Bowles & Gintis, 2002). Individuals are reciprocal and have a propensity to cooperate. However, it cannot be argued that self-interest plays no role in the H. reciprocans model. Individuals can cooperate also for the purpose of self-interest. This thesis argues that stakeholder theory is based on the H. Reciprocans model. Notwithstanding the motivation that underlies H. Reciprocans (which can be ‘selfless’ reciprocal or ‘selfish’ reciprocal), the model aligns with stakeholder theory since it acknowledges interactions with various other individuals who are connected through their interest in something. Freeman (1994, p. 42) indeed argues that ‘[..] the stakes of each [stakeholder] are reciprocal, since each can affect the other in terms of harms and benefits as well as rights and duties.’ The question that is left unanswered by stakeholder theory and by the H. Reciprocans model is: what is fair? Some principle to determine fairness has to be embraced in order to reach conclusions. Blount (1995) set up experiments in which it was clearly ventilated to subjects that the distribution of benefits and costs was determined by a computer instead of an experimenter. He found that the tolerance for unequal outcomes among subjects was much higher if these were generated by a computer, suggesting that the violation of a cooperative norm is at work, rather than an aversion of unequal outcomes alone (Gintis, 2000). However, what is the source of these norms? When innovation is concerned, how is a moral rule established that is prescriptive for investment in innovation at the part of capital-owners? Phillips (1997) proposes to determine the distribution of benefits and costs among stakeholders by embracing the notion of fairness. Two prominent principles that can be used to make judgments about distributive fairness are the principles of equality and equity (Mayer, 2013; Welsh, 2004). First, the equality principle proposes that everybody should share in benefits equally. Second, the equity principle postulates that the distribution of benefits should tie in with the relative contributions of individuals (Mayer, 2013). If the equity or equality principle is used, then we may argue that it is a form of deontological ethics because it sees human action as morally right if it is in accordance with moral rules or principles (Van de Poel & Royakkers, 2011). Deontological ethics refers to a group of theories of which the work of Immanuel Kant is considered the most important (Mitcham, 2005). Kant argued that everybody should be able to reach conclusions about rules by logical reasoning. Another seminal work in this field is A Theory of Justice (first published in 1971) in which John Rawls explains that the ordering of principles or duties results in a theory of justice. The theory of Rawls is a deontological theory because it sees the protection of freedom of all individuals in society as a fundamental principle to which human action should obey. In his approach it depends on what duty one has to adhere to whether human action advances freedom in the various ways we can interpret it. The implication is that deontology can lead to a moral judgment comparable to the one resulting from a utilitarian approach to the extent that the protection of individual freedom to maximize wealth can be seen as a duty. Following John Rawls approach it depends on the perception of individuals among society whether this is indeed a duty. The implication is that it depends on how individuals across society are capable of reaching conclusions about what freedom they want to have protected. This could mean for capital-owners that they behave in an unjust way if individuals across society perceive their behavior as violating a moral rule (e.g. the rule to invest in innovation for the purpose of maximizing social welfare). This implies that self-interestedness is permitted up to the point where individuals across society think it is no longer fair. In consequentialism the happiness of some may be reduced if it maximizes total happiness for all (Scott, 2003). However, this may also violate the principle of justice as proposed by Rawls. On the other hand, if individuals derive utility from the protection of freedom of others, then consequentialism is not conflicting with deontology. Consequentialism in its widest conception includes both ethical egoism and ethical altruism, implying that it can be applied to stakeholder theory (by the inclusion of fairness). Human behavior based on cooperation and reciprocity can, then, simply be the result of attempts to maximize overall utility. In this regard the stakeholder perspective fits in a consequentialist framework. Importantly, both utilitarianism and deontology depend on human capacity to reason in order to make value judgments or to establish fairness, respectively. This implies that a theoretical perspective based on an ethical foundation that takes into account the human beings themselves may be more helpful for establishing the link between finance and innovation, because the outcomes of utilitarianism and deontology depend both on human capabilities. An Aristotelian perspective on financing innovation – This thesis advances a third perspective on financing innovation: an Aristotelian perspective. Aristotelian ethics was used in some recent attempts to connect ethics with economics (Meikle, 1996; Solomon, 2004; Sison, 2011). However, the Aristotelian perspective presented here does not exist yet in literature to the degree that various ideas are combined. Essential to the Aristotelian perspective is a different set of assumptions about human nature. According to Aristotle, the ultimate goal of human action is to realise human potential (Van de Poel & Royakkers, 2011). Importantly, human beings have to bring out the best in themselves and their community (Solomon, 2004). Realizing human potential can be understood in many ways. Houghton Budd (2011) points out that most people want to become ‘something’. Keynes (1930) also described a future in which human beings are no longer struggling for subsistence and have to look for alternative, non-economic purposes to devote their energy on. Furthermore, Maslow (1943) proposed a theory that outlines how the needs of human beings change once lower level needs (‘physiological needs’) are fulfilled. Lower level needs are ‘instinctoid’, whilst the highest level needs comprise matters such as developing morality, creativity and problem-solving. The conclusion that can be derived from these theories is that there may be a plurality of ways in which human beings can develop beyond the fulfillment of material (financial) needs. This can be different for each and every individual. What does this mean for capital? In Aristotle’s view, ‘wealth is a collection of tools’ that is a means toward realizing human potential (Politics I, 8, 1256b, 37-38; Nicomachean Ethics I, 5, 1096a, 5-7, in Giovanola & Fermani, 2012). Sison (2011) points out that Aristotle distinguished between natural wealth-getting and non-natural wealth-getting. Natural wealth-getting refers to the amount of wealth required to lead a good life. Any level of wealth-getting beyond this necessary amount of wealth is non-natural, because it does not advance the realization of human potential. Houghton Budd (2011) establishes the link between Aristotle and the distinction between material and immaterial needs by arguing that capital is also needed to finance the immaterial needs of human beings (this is called ‘aspirational capital’). How is innovation connected with immaterial needs of human beings? Innovation is a process of exchanging and building knowledge (Landry, Amara, & Lamari, 2000). Thus, we may ask ourselves: what is innovation other than human development in some sort of way (dr. Naastepad, personal communication, April 2014)? Innovation is a knowledge process that requires intellectual achievement for the purpose of building this knowledge. However, human development can happen in many ways (cf. Wachsmuth, 2014). This implies that human development does not equal innovation. Rather, innovation is one particular aspect or dimension of human development. This means that investment in innovation is inherent to the Aristotelian perspective presented here, because it advances that capital serves human development. If innovation is one dimension of human development, then wealth also serves innovation. It is important to note that the provision of aspirational capital is precluded by the standard economic framework and the regulatory perspective. However, Houghton Budd (2004) proposes that the stock corporation is the pre-eminent place for connecting capital with individual initiative. This can happen under the condition that human beings are not solely self-interested and have limited material needs. If human action is based on self-interest, then human beings have no interest in firms which do not lead to benefits for them. This also means that individuals have no incentives to let others establish a ‘Right On’ corporation. In fact, self-interestedness may preclude the establishment of such corporations because human beings would rather prefer corporations that produce benefits for them. In other words, self-interested capital-owners would not provide capital to a corporation which does not yield personal benefits. The implication is that the theoretical embedding of the idea of self-interestedness at the part of all individuals, and the practical entrenchment of it in policy-making and corporate governance conflicts with the existence of the stock corporation in which innovation can take place without being subordinated to profit maximization. The Aristotelian perspective sheds a different light on the concept of freedom. In Development as Freedom Amartya Sen argues that human development is the ‘process of expanding the real freedoms that people enjoy’ (Sen, 1999, p.1). Amartya Sen clearly contrasts narrower understandings of human development – such as gross national product or personal income – with the advancement of freedom. In his view, matters such as personal income are indeed important means of development but exactly that: these matters are a part of the process, but not an end in itself. If freedom is understood in accordance with Sen (1999), then capital-owners can expand the freedom of others by investing their capital in others. The implication is that the understanding of ‘freedom’ is crucial for how a ‘free society’ is actually shaped. Friedman’s (1970) appeal to free society is based on the normative premise that individuals who enjoy freedom will maximize profits. From an Aristotelian perspective the protection of profit maximization as a freedom hampers the expansion of other freedoms. Exploratory case study results – Exploratory case-study research is conducted in order to investigate examples of firms that pursue objectives other than profit maximization. The principle of shareholder value maximization derives from the Anglo-Saxon world (Lazonick, 2011b), implying that cases should not be drawn from this context. Indeed, the Anglo-Saxon model is generally market-oriented and shareholder-centred (Aguilera & Jackson, 2003) whilst the principle of shareholder value maximization has less (legal and cultural) prominence in the Continental European world. Thus, three Continental European firms are studied, because in this context there is more space for firms and capital-owners to finance innovation with aspirational capital. Nevertheless, the Continental European model shows resemblance with the regulatory perspective, because it emphasizes the involvement of workers in corporate governance (Koslowski, 2009). The cases are therefore on the fringe of the Continental European context, rather than typical cases. The principal finding of the case studies is that firms are able to find individuals who are prepared to put their capital in service of the corporate objective. This happens under very different circumstances. L’Aubier, a biodynamic farm in Switzerland, manages to attract investors who put their capital at the disposal of sustainable development. These investors receive a below-market rate of return and cannot sell their shares back to L’Aubier. On the other hand, Mondragon, a worker-cooperative in Basque country manages to lock in profits that are actually owned by its workers. Mondragon was founded as an answer to high unemployment and poor local economic conditions. This means that Mondragon has not been operating in a particularly capital-abundant context. The available evidence further suggests that firms can create additional aspirational capital, depending on the degree to which they can generate profits from their innovations. Firms can also use capital that is generated by other, unrelated activities. The cases also suggest that firms may understand corporate performance in alternative ways beyond profitability alone. Most notably, developments in the fields of sustainability may even reduce profitability from a standard economic or stakeholder perspective, while it may increase performance from the perspective of the innovators. Corporate performance may also include providing individuals with an income by providing education and jobs, technological development itself or community projects, rather than the financial gains that derive from it per se. In the cases under review capital-owners put their proprietary capital at the disposal of the firm, reducing the possibility to instantly change the destination of their capital to alternatives where returns are higher, and reducing full control over proprietary capital. Put differently, capital-owners make use of their freedom to put their capital to the use they consider good. Since to refrain from maximizing self-interested gains happens autonomously, to use positive freedom implies by definition a reduction of self-interested gains. Clearly, the firms under review do not engage in profit maximization. Otherwise it would not be possible for L’Aubier to research biodynamic farming and to hold equally high standards against its suppliers if it does not translate into higher profits. It would also not be possible for Mondragon to create jobs at the cost of profitability, nor for Trumpf to invest in community projects. There may be many purposes for which capital can be used within firms, and the available evidence in this thesis only provides a small sample. This shows there may be various outputs of business activities that may be valued and on which firm’s performance can be judged. Conclusion and discussion – Self-interestedness has become a self-fulfilling prophecy because it is a fundamental assumption of standard economic theory. This has led to underinvestment in innovation, essentially because the pursuit of self-interest does not lead to the maximization of fulfillment of all interests. The mechanism by which the theory of self-interestedness has become valid in itself does not imply that the theory is false. It means that the validity of assumptions about human behavior depends on the choices of human beings with regard to how to behave. Thus, the validity of the fundamental assumptions of the Aristotelian perspective presented in this thesis as an alternative to conventional theoretical perspectives depends also on the choice of human beings to behave accordingly. This thesis advanced an alternative perspective that takes limited needs and self- and other-interestedness at the part of individuals as starting points. The link between finance and innovation can be established if self-interestedness and maximizing behavior do no longer guide the design and use of the stock corporation. The symbiotic relationship between scientific theory and practice implies that the general cognition of the existence of corporations where capital-owners provide capital without demanding a return can be a driving force of change. It can be concluded from the exploratory case studies that there are corporations where capital-owners provide capital without demanding a return. The cases contradict standard economic theory and the regulatory perspective, whilst collaborating the Aristotelian perspective in the sense that capital-owners do not aim for profit maximization and that capital-owners (and workers alike) do not act upon self-interest only. This thesis has shown how different scientific theories have shaped the design and use of the stock corporation and the allocation of capital. The added value of this thesis lies in how the alternative theoretical perspectives are related to financing innovation. However, the contribution of this thesis is limited to the validity of the human uncertainty principle. Furthermore, an analysis of reflexivity with regard to the ethical considerations of human beings was possible only if the assumption of self-interestedness was dropped. Finally, the validity of the empirical findings is dependent on how we reach normative conclusions. The boundaries of the Aristotelian perspective are dependent on the actual thinking and decisions of human beings. This means that the eligibility of the perspective depends on culture. Indeed, financial aspirations form a central aspect of capitalist cultures whilst these can preclude happiness derived from non-material achievements (Kasser & Ryan, 1993). Thus, the assumptions may not be valid for an Anglo-Saxon context in which human beings choose to be self-interested profit-maximizers. Yet, in a truly free society citizens are free to choose otherwise.