Capitalism Under Siege — Part I
Watering Down of Corporate Governance Raises Red Flags
In 2019, a book I wrote was published entitled Governance Arbitrage: Blowing Up the Public Company Governance Model to Maximize Long-Term Shareholder Value. I wrote this book because I believe that boards of public companies underperform and that this underperformance is the result of a governance model that is, at best, sub-optimal. The book’s thesis is that the current model results in a board that is an undervalued/underperforming asset and by shifting to a more robust value maximization model the asset value of the board could be materially improved resulting in capital allocation optimization and maximization of company performance and shareholder value thus resulting in a “governance arbitrage.”
It was clear to me in writing this book that its thesis would, more likely than not, run into a wall of resistance from the governance community (and management) status quo due to its much more aggressive focus on results, different director selection criteria and heightened management accountability to name just a few the of many reasons for push back. What was peripherally in my vision to some degree but certainly not front of mind was that while I am advocating for a more shareholder focused, thus more capitalistic, model there would be a major effort to pull the current public company governance model in the opposite direction away from capitalism. It is now crystal clear that corporate governance is not immune to what has been a growing anti-capitalist agenda operating in many countries including the U.S. Some examples are:
UK Corporate Governance Code — rather than a “duty of loyalty” to shareholders, the revised code mandates an equal duty of loyalty to employees, community, supplier and other constituencies. Writing in the governance publication Boards & Directors, veteran and accomplished public company director Betsy Atkins said, “This means you are no longer a capitalist organization. It is mission drift into the role of public policy and government.”
Accountable Capitalism Act — this is the bill introduced by Senator Elizabeth Warren which is anything but capitalism. Warren claims that this bill would compel more socially welcome behavior (why is this the government’s job?). The bill would require any business with more than $1 Billion in revenue to become federally charted. One of the provisions of this federal charter would require 40% of board members to be elected by employees rather than shareholders. Here it is helpful to keep in mind that Marx’s initial theories were directly aimed at shifting power away from capital into the hands of the workers.
Board Quotas — California was the first state to pass a resolution for board gender quotas. This is now being followed by Illinois and Massachusetts which include gender and race. And, as an update to the original version of this article, NASDAQ has now received a go ahead from the SEC for a similar provision applicable to certain of its listed companies. In part, this takes the free choice away from shareholders as to whom will serve on boards in which they have capital invested. I will be the first to argue that there is a huge deficit in the criteria for director selection. But, my argument is that public company directors are not selected based on competence relative to the value creation requirements of the company being governed. This view, which is purely capitalistic, would have competencies clearly defined based on these value creation with the search process then being completely open as to gender, race and ethnicity. In fact, one recent board that I was involved in developing for a company raising outside capital for the first time ended up with 60% women and 40% men. However, we did not set out to have a “diverse” board. Instead, our only consideration was to put in place a board that could be the best it could be to maximize the return on the shareholder’s capital. And, directly relevant to the subject of this article, the shareholders in place at the time of the organization of this board were free to select the board with no government interference.
Stakeholder Model of Governance — not only are the new UK code and Senator Warren pushing for “stakeholder” models of corporate governance but there is also pressure from many in academia, the governance community and other arenas for movement in this direction. Then, in August of 2019, the Business Roundtable issued a new policy statement on the “purpose of the corporation” which advocated the “stakeholder” model. (I have written extensively on this issue). This obviously creates a high degree of concern regarding a shift away from capitalism, but it also is simply not practical — not if all stakeholders are to be “equal.” It is axiomatic in any organization that “accountability to all results in accountability to none” not to mention the utter lack of context that results for decision making. Some real world examples:
1. Analysis has shown that the installation of robots on the packaging lines of a company’s manufacturing plants would result in exceeding the established return on investment hurdle rates. But, if the robots are installed, some employees will lose their jobs. In a stakeholder model, how does the board decide between the employees and shareholders?
2. A potential supplier to a company is offering lower prices for their products which are of equal quality to the current supplier. The current supplier will not lower their price. In a stakeholder model, how does the board or management decide between the current supplier (which in this model is a stakeholder) and the shareholders?
3. A company has just been acquired. As a result of in-depth analysis done immediately post-closing, it is determined that a small percentage of the customer base is not profitable. Further analysis has determined that no viable pathway exists to move this group of customers to a level of profitability. The customers are also stakeholders — is a decision made to drop these customers and benefit the shareholders or is it made to keep the customers and continue to incur losses?
In addition to the lack of practicality of the stakeholder model, because accountability is so diluted, it also can act as an entrenching device for boards and managements. It is interesting (and telling?) that this model is being advocated at the same time that corporate managements are some the largest supporters of proposed new proxy rules, which if enacted, would make things more difficult for shareholders.
Finally, do those who advocate for a stakeholder model actually believe that in pursuit of the maximization of performance and longer-term shareholder value that all of the “stakeholders” are abused? How could a board ensure the full development of the potential of a company while completely ignoring the so called stakeholders? This defies common sense. And, it also defies the fact that many stakeholders also have clear responsibilities to the company. Yet, by its structure and the language of its promoters, the “stakeholder model” puts all of the responsibility on the company.
Consider what the past may tell us. From the end of World War II into the 1980’s the “stakeholder model” was operative. Many Business Roundtable members and other CEOs were focused more on social than commercial issues. This was also the era of the imperial CEO, rubber stamp boards and by the 1970’s wide spread complacency and stagnation. Then along comes the Japanese and the Germans who were focused only on performance and excellence wreaking havoc on U.S. industry. Business now functions in an even more hyper-competitive market where international competitors including the Chinese have none of these constraints. Will not the “stakeholders” be losers right along with the shareholders if our companies are weakened by this attempted movement away from capitalism?
These are just a few of the examples from the corporate governance world that are a part of a much larger movement to, at best, dilute capitalism and at worst, over time eliminate it. But just who are the capitalists that will pay the price from this? Certainly this would include those who are considered “the rich.” But what about all of the other people who have pensions or 401(k) plans that are purported to be helped as this drive for “equality” gains traction? Those who are the advocates for stakeholders seem to forget that in aggregate, the employee stakeholders are also make up a huge percentage of the shareholders.
And, if it goes too far, how about those individuals who desire the freedom to stretch as far as their potential will allow? Moving away from capitalism will not just harm the rich and weaken business, it will be damaging over time to anyone who functions with an ethic of personal responsibility. See Part II for more on the risk posed to the development of human potential.
