CHAPTER THIRTY-NINE
A Crisis of Capitalism: Who’s in Charge?
“CORPORATE CAPITALISM” was the buzzword of the 1960s. The American Challenge, a worldwide best-seller by a prominent French intellectual, Jean-Jacques Servan-Schreiber, predicted that by 1980 the world’s manufacturing would be in the hands of a dozen or so giant American multinationals.
Under corporate capitalism, these economic superpowers were run by autonomous managements. With share-ownership dispersed among millions of individual investors, corporate management had the power to appoint itself, was accountable only to itself, and enjoyed unchallengeable security except in the event of a huge scandal or the firm’s bankruptcy. However, these managements promised to be “enlightened despots” and to manage their companies in the best balanced interest of shareholders, employees, consumers, suppliers, plant-cities, and the economy and society as a whole—as any number of annual reports in those years asserted.
Even Jean-Jacques Servan-Schreiber would agree 20 years later that his prophecy was far off the mark. The multinational manufacturing giants are trying desperately to cope with changes in technology and demographics that threaten to make them obsolete if not to drive them out of business. Top managements in publicly owned U.S. companies, almost irrespective of size or performance, cower under golden parachutes and in deadly fear of the corporate raider and of his ultimate weapon, the junk bond.
Hostile takeovers and their raiders—such as T. Boone Pickens and Carl Icahn—get the headlines. But the hostile takeover is an effect rather than a cause, and perhaps only a symptom. What finished off corporate capitalism was the emergence of the “institutional investor”—primarily the pension fund—as the controlling shareholder in the U.S. publicly owned corporation. With $1.5 trillion—and soon to reach $2 trillion—in assets, pension funds now own a third of the equity of all publicly traded companies in the U.S. and 50 percent or more of the equity of the big ones. There are thousands of corporate pension funds, of course. But a few very large ones lead the pack, with most of the others following faithfully.
Vicious Circle
Stock ownership has thus become more concentrated than probably ever before in U.S. history. Therefore any business that needs money—every business sooner or later—has to be managed to live up to the expectations of the pension-fund managers. And a pension-fund manager has little choice but to focus on the very shortest term; his own job depends on showing immediate gains, with his performance in most cases judged quarter by quarter. This is because the earnings of his boss, the company whose pension fund is being managed, depend in large measure on the short-term performance of the pension fund. If it shows substantial short-term gains, the company’s liability for its pension-fund contribution goes down that year and its reported profits go up.
Conversely, if the pension fund in a given year underperforms, the company’s liability for pension-fund contribution goes up and its earnings go down. Company managements thus put relentless pressure on their pension-fund people to produce immediate gains; the pension-fund people, in turn, pressure the managements of the companies in which they invest to produce short-term gains. These, in turn, pressure their pension-fund managers to produce short-term gains, and so on in a vicious circle.
But pension funds are also trustees for the beneficiaries, the company’s employees, rather than the owners themselves. If a raider offers a little more for a stock than its current market price, fund managers are legally obligated to say “yes.” If they don’t and the stock, a few months later, sells for less than the raider offered, they may face a suit for damages and for a breach of fiduciary duty.
Corporate capitalism promised that large corporations would be run in the interests of a number of “stakeholders.” Instead, corporate managements are being pushed into subordinating everything (even such long-range considerations as a company’s market standing, its technology, indeed its basic wealth-producing capacity) to immediate earnings and next week’s stock price. A Marxist might well say that corporate capitalism has turned into “speculator’s capitalism.”
Corporate capitalism was a delusion from the beginning, and an arrogant one to boot. Management in the large corporation has—and must have—considerable power. And power, to be legitimate, has to be accountable. Enlightened despotism has always ended up impotent and repudiated. When attacked, no one supports it—as U.S. managements found out as soon as the raiders appeared. And most U.S. top managements spurned the constitutional safeguard that might have provided genuine accountability: a strong, independent board able and willing to set performance standards and to remove any management not living up to them.
But speculator’s capitalism is the wrong remedy. Its side effects threaten to kill the patient.
Speculator’s capitalism is probably not even very good for the shareholder. At least that seems to be the conclusion of America’s major shareholders, the pension funds. They are forced to sell their holdings to the raider in the hostile takeover. But in most cases they then refuse to stay interested in the company that has been taken over. They either demand cash or they immediately sell whatever securities they get from the raider. They know why; many—perhaps most—businesses are doing less well a year or two later than they did before they succumbed to the hostile bid. And the shareholders in West Germany and Japan, where companies are still primarily being managed for the long term rather than for short-term gains, have, on the whole, done better—and certainly no worse—than American shareholders in comparable businesses.
But the evidence is also mounting that the short-term focus is bad even for the pension funds. Despite the armies of well-paid security analysts employed by stockbrokers, investment advisers, and pension funds, most pension funds have done rather poorly, and at best no better than the stock market. Their performance amply proves the old saw: “Thinking short term makes traders rich and investors poor.” Indeed, there are growing complaints—for example, by Sen. William Cohen (R., Maine)—that their short-term focus forces pension funds to underperform and thus puts them into an irreconcilable conflict with the interests of the ultimate beneficiaries, the future pension-recipients.
Finally, there is little doubt that the short-term focus that speculator’s capitalism imposes on managements is deleterious to both U.S. business and the U.S. economy. In some cases it has been the main—perhaps the sole—cause of the loss of competitive position in an important industry or market. One example is video-cassette recorders, invented and developed in America. No U.S. company now produces VCRs; they all abandoned the field to the Japanese. The only reason was that the recorders would not have yielded immediate gains but would have required a few years of investment.
In other industries and markets the short-term focus has been a major contributing factor to the bad performance and decline of a U.S. company or industry; it explains in large measure why General Motors failed to respond in time to Japanese competition. Everyone who has worked with American managements can testify that the need to satisfy the pension-fund manager’s quest for higher earnings next quarter, together with the panicky fear of the raider, constantly pushes top managements toward decisions they know to be costly, if not suicidal, mistakes. The damage is greatest where we can least afford it: in the fast-growing, middle-sized high-tech or high-engineering firm that needs to put every available penny into tomorrow—research, product development, market development, people development, service—lest it lose leadership for itself and for the U.S. economy.
Mr. Pickens would argue—and so would Wall Street and even the SEC—that all this is irrelevant. The shareholders are the owners, and the company is theirs with which to do whatever they deem to be in their own immediate interest. But are the institutional investors really owners? They have no interest whatever in the business: all they care for is making a quick buck. More important: an owner is supposed to have the freedom to decide whether to buy, to sell, or to hold on. But the pension funds can decide freely only on buying. When it comes to selling, they cannot say “no” even if they would rather hold on. They do not really have the owner’s freedom either economically or even in law. This is a new and totally unprecedented situation for which we have no rules. But to call it “ownership” may be more legal fiction than reality.
Or so the Japanese think. Their law is exactly like ours. But in practice they treat the public shareholder not as an owner but as a claimant whose interests (save in the event of liquidation) are subordinated to the maintenance of the business as a wealth-producing, goods-producing, jobs-producing entity. And we in the U.S. are slowly moving in the same direction.
We are beginning to limit the voting power for the institutional investor by splitting the shares of the publicly held company into two (or more) groups—one, for the “insiders,” having full voting rights; the other, for the “outsiders,” having sharply reduced voting power or none at all. Both General Motors and Ford are already traveling down this road. Both the institutional investors and Wall Street are protesting—and there is much to be said for the old principle of “one share, one vote.” But while the institutional investors protest, they quite happily buy the low-vote or no-vote shares if they like a company’s prospects.
Moreover, as Senator Cohen notes, it would take only one major scandal to make us change our laws so as to forbid a company to treat gains in its pension plan as earnings of its own—which would go a long way toward easing the pressure for short-term performance. Within the pension-fund fraternity there is also growing concern. Robert A.G. Monks—President Reagan’s chairman of the Pension Benefit Guaranty Corporation—has founded Institutional Shareholders Services Inc. to infuse “social responsibility” into pension-fund management. Speculator’s capitalism may thus be nearing its peak.
But the real issues will still be with us. They are political and moral rather than financial or economic. Can a modern democratic society tolerate the subordination of all other goals and priorities in a major institution, such as the publicly owned corporation, to short-term gain? And can it subordinate all other stakeholders to one constituency—the shareholder—even to a “socially responsible” one?
The Short and Long of It
Corporate capitalism failed primarily because under it management was accountable to no one and for nothing. In this the raiders are absolutely right. The first performance requirement in a business is economic performance. Indeed, the first social responsibility for a business is to produce a profit adequate to cover the costs of capital and with them the minimum costs of staying in business. Adequate profitability alone can provide for the risks, growth needs, and jobs of tomorrow. These needs are all, however, long-term rather than short-term. Indeed, the one thing we know about commitments to the future—which production and services require and trading does not—is that long-term profits are not being achieved by putting up short-term gains. Short-term earnings are promises rather than results in themselves.
But equally important: Should economic results, even long-term and lasting ones, be the one and only goal in the large publicly owned enterprise, the goal to which all other considerations are to be subordinated and sacrificed? Or are even optimum economic goals achieved only by balancing competing claims? All conservative thinkers have held since Aristotle that to subordinate a major institution to a single value is a grievous mistake that will ultimately deprive the institution of the ability to produce any results. We may indeed be best advised to strive for the balance that corporate capitalism proclaimed. This may be what “free enterprise” really means—it clearly was meant to be more than a euphemism for capitalism let alone for speculation. But how can we build accountability for such balance into the management structure? And to whom and in what form is this accountability to be exercised?
The proponents of corporate capitalism 20 years ago thought that they had the right answers. Speculator’s capitalism has proved them wrong. But they may well have asked the right questions. Now that speculator’s capitalism is in turn proving inadequate, and indeed a threat to America’s longterm economic future, we have to tackle these questions again. On our answers to them the future of free enterprise—and perhaps whether it has much of a future—may well depend.
[1986]