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Shareholders, not stakeholders Samuel Brittan: Contribution to RSA and Economist Debate 06/02/03 Bust Competitive market capitalism has many faults. But as Churchill said about democracy, all the other systems that have been tried are far worse. Let me deal with the bad news at the beginning. First, anybody whose faith in market capitalism was based on the US stock market bubble of the late 1990s deserved to have his faith destroyed. All market systems have been subject to boom and bust since records began. Four years ago, and a year before the bubble burst, I wrote an article describing the so called new US paradigm as nonsense on stilts. The run-up to the stock market peak of 2000 was remarkably similar to that leading up to the 1929 crash. Equity analysts based themselves on totally absurd predictions of annual rises in corporate earnings. Moreover American consumers had stopped saving and were running down their financial balances: something which could not go on forever. It is usually regarded as bad form to say "I told you so", but as I am not normally any kind of stock market commentator I feel I should get away with it. The Corporate Crisis Secondly there has been a crisis in the running of large corporations (I hate that horrible word governance). Events such as the Enron fiasco cannot be dismissed as being due to the few bad apples found everywhere. The root of the problem is the separation of ownership from management - or in modern economic jargon the principal agent problem. This has grown worse because of the decline of influential individual shareholders who align the longer term interests of owners and managers; and their replacement by essentially passive institutions who lack the incentive to hold corporate management accountable. Such managements inevitably use their enhanced power for their own gain, often at investors' expense(1). 1 R Monks and A Sykes, Capitalism without Owners will Fail, CSFI, November 2002.One obvious weakness is that auditors are appointed by those whose performance they are meant to inspect. The threat of a takeover is - for all its messiness - the nearest approximation we have to a discipline over lazy or unscrupulous corporate executives. It has proved insufficient. The emphasis on short term performance at the expense of the longer term is partly due to the brief tenure of fund managers who are expected to regulate the activities of chief executives. The report from which I have been quoting has four main proposals for restoring effective shareholder control: -
The Long View Any judgment on competitive market capitalism has to be based on a longer historical span. Lord Keynes, writing in 1930 in the middle of the Great Depression, pointed out that in the 4,000 years up to around 1700 there had been no great change in the average standard of living: ups and downs, but no progressive improvement. But since 1700 average living standards had risen fourfold in Europe and the US. Since then, between 1930 and the year 2000, real UK GDP per head has again risen four fold. In the last few decades there has been an even more remarkable rise in the living standards of many Third World countries, with notable exceptions such as Southern Africa. To those who want to dismiss this improvement in human well being as a rise in inequality I have nothing to say. Let the statisticians argue it out. Compared with these basic facts the supposed differences between the varying models of capitalism are pretty insignificant. The Role of Markets There are only three ways of arranging human affairs: voluntary co-operation, markets and coercion. Voluntary co-operation is wonderful to the extent that it works, which seems to be most likely in relatively small face-to-face groups. State coercion has mercifully performed least well of all three methods. Mercifully because to me the great virtue of the market system is that it is compatible with personal freedom. It empowers ordinary people who choose what to consume, where to work and how to make the various tradeoffs between the good things of life, such as take home pay and leisure. You don't need to tell me that none of this works perfectly and we could spend many days discussing how markets can be improved. Attention is rightly paid to the role of incentives. But the role of markets in providing information on dispersed wants and opportunities is just as vital. And it is one that no computer system could possible replace. The criticisms of the market system have been very similar throughout the centuries. First is the inequality that it is supposed to engender. There are worse inequalities, especially of power, in feudalism as well as in the real existing socialism which came to an end in the former Soviet bloc in 1989. It is a matter for psychopatholgy that people who worry about high rewards for businessmen regard with equanimity the spectacular gains from gambling in for instance the National Lottery or the huge earnings of pop stars and footballers. But I do not want to go too far along this road which is paved with envy and jealousy. It is perfectly possible to redistribute both income and capital towards the losers, as British governments do, so long as we are careful not to kill the goose that lays the golden eggs. Another indictment is the allegedly irrational pursuit of ever more fanciful and unnecessary consumer goods. But no one is forced to consume and it is not an indictment of an economic system that some of us cannot resist blandishment and temptation. The system could function just as well if the fruits of growth were taken in the form of more leisure or better public amenities. Admittedly greed is an unlovely thing. But given that it exists is it not better that it should be harnessed to providing the public with goods and services rather than to rob rivals or plunder in war? It was again Keynes who said that is was better that a man should lord it over his pocketbook than over his fellow men. Alternative Capitalisms We have seen a vogue for all kinds of alternative capitalisms: starting with the French planning model, then Scandinavian social democracy, then the German corporate system; and for a long time we were told to be more like Japan. All of these have proved big disappointments with the partial exception of Scandinavia which retains more market competitive elements than Old Europe does. The primacy of the shareholder in the Anglo-US is not an accidental quirk. The essential point is that those who enjoy the residual gains also bear the residual losses when all contractual payments have been made. In most corporations this variable residual belongs to those who put up the equity capital. But it does not have to be like that. In employee share ownership plans (ESOPs), employees enjoy the profits and losses and bear the responsibility of equity ownership. Worker-owned businesses have in some places achieved noteworthy results. One instance is the John Lewis Partnership; another is the Mondragon Group in the Basque region of Spain. Whoever owns the equity, the role of the management is to promote the value of that equity. It is the task of the law, unwritten rules and of public policy to ensure that its efforts to do so benefit the general citizen. There is usually enough uncertainty about what will maximise long term profits to justify many different approaches. Capitalism will not collapse if a business tries to produce a pleasant working environment or a playing field at the back of the establishment! The present corporation is certain to evolve. But the stakeholder idea is a step backwards. If it means anything, it is that managements should do something other than strive for the best return on their assets. The losers are not just top hatted capitalists but worker-owners, consumers and all the rest of us. The stakeholder idea is really a call for managers to take over the political task of offsetting market falures and even to lay down goals for their society. No wonder a few besotted managers embrace the idea. The stakeholder approach is to promote a general mushiness. Everyone is supposed to pursue the interests of everyone and no one is really accountable for anything. A manager is theoretically responsible not only to shareholders, or even to workers, but to suppliers, customers and the public at large. This is no operational meaning. In practice it is simple a charter for management to do what is likes. How we are to decide in a relocation decision between the conflicting claims of employees, and other so called stakeholders who would benefit from jobs nearer the site? One enthusiast advocates that every company should have a metaphysical director who could supposedly resolve such conflicts of interest and value. This would indeed provide jobs for bogus philosophers. The Real German Model There are too many romantic notions about how businesses are run in supposedly stakeholder countries. A Financial Times reader remarked (David Morgan, January 24, 1996) "It is a warm, comforting notion that a chief executive who stands before his shareholders could justify a big training initiative without being able to say he believes it would lead to profit now or in the future." I am sure that the chief executive would last no longer in Switzerland than in the UK, and rightly so. A recent investigation by a DTI steering group suggested that the issues affecting board members in countries such as Germany, Austria, the Netherlands and Sweden are little different from those who operate in the UK. For instance although large German corporations are required to have two tier boards with union representation on the top steering one, the chairman's casting vote has usually been enough to see that the interests of shareholders prevail. A 1995 OECD report in Germany pointed out that so far from being stakeholder concerns, German companies accounting for 80 per cent of business turnover are run by a small and medium sized unincorporated companies with a close correspondence between owners and managers. Many German companies escape the conflicts between owners and managers by making the two one and the same person. This explains far more about Germany than any amount of stakeholder theory. On the other hand many US states have manager friendly laws designed to dilute shareholder influence. They have mostly been the result of lobbying by managers trying to free themselves from activist shareholders and playing on the concern of state legislatures for local employment. European planners at a Brussels convention could learn something from the diversity of corporate legal structures that exist within the federation known as the United States. A Genuine Stake for All Where do we go from here? Mine own slogan has for a long time been the rather ungainly one of Redistributive market liberalism. The idea is to allow the market system to function freely and competitively against a background of law and monetary stability. The Third Way element is cash redistribution of some of the rewards to those who would otherwise do less well in the lottery of life. This can go quite a long way, if done with care. The main problem with unearned, investment income and equity ownership is too few of us have them and are able to enjoy their benefits and risks. In addition to the redistribution of income through the tax and social security system I have long advocated capital distribution to everyone at birth to make a reality of the slogan property owning democracy. If some commentators want to call this stakeholder capitalism so be it. But I would avoid putting much weight on so mushy and contentious a word. Few people have noticed that the last Labour manifesto did have a proposal for giving every child at birth a financial holding which he or she would realise on coming of age with or without restrictions as to use. The objective has been reaffirmed by the Chancellor, Gordon Brown. Unfortunately it has been somewhat relegated because of the fashionable preoccupation with public services; and those who are really interested in shaking up the structure of capital ownership would do well to push for a higher place for it in the government's agenda. The Government needs to find some funds of a capital nature to finance it. Privatisation proceeds and the successful auctioning of state spectrum rights for mobile telephone licences were wasted opportunities. There are still sources of capital for this enterprise on which a reformist government could draw. For instance vast increments of value are created without any effort or enterprise by the simple granting of planning permission. There is a long and respectable advocacy of site value taxation - enthusiasts going so far as to call it the Single Tax. A more modest version of the same idea would - and one which the lawyers might find harder to undermine - would be the auctioning of planning permission on a full market basis. Conclusion Unfortunately the financial and business worlds are not reformist in any of the ways at which I have hinted, but are simply wimpish in the face of their attackers - partly because they do not have the appropriate dialectical skills and partly because they are victims of various organisations who extract a sort of Danegeld in the form of membership and subscriptions. |
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