Common Good Economics, Seminar 4: Corporate Governance
Seminar Four: Corporate Governance and the Common Good
There is a widespread recognition that the prevailing form of capitalist accumulation is degraded, in terms of reward, effect and reputation and yet there is no constructive alternative to replace it.
The unilateral nature of power within the contemporary corporation places a primacy on shareholder return and diminishes accountability to other aspects of the corporate body. The Corporation is no longer conceived of as a self-governing institution constituted by its various mutually dependent parts as befits its status as a civic body but as a cash machine based upon profit maximisation.
We have outlined some of the processes at work throughout the contemporary economy that exert pressure on the corporation to act in this way. Of importance is the centralisation and concentration of capital and the pressure of financialisation, the necessity of finding new markets and of profit maximisation, of the nationalisation of risk and the privatisation of reward, which leads to the intensification of commodification, in which human beings and their natural environment are turned into factors of production in the form of labour, land, housing and food markets subject to fluctuating prices with the assumption of fungibility between the different factors.
We examined these forces when we looked at both banking and at vocation. In this seminar we will examine the power structure of the firm, its corporate governance and enquire as to how it could be rendered more accountable, reciprocal and productive. Unilateral power has a tendency to corruption and self-reward. This is not restricted to the economy. The same is true of politics and societal institutions. Accountability and feedback structures from different parts of the body are vital for its effective functioning. We will also suggest ways in which a corporation can be embedded in a wider civic ecology and what incentives can be offered to sustain a beneficial relationship with the other institutions necessary for its well-being. Capital is by its nature promiscuous, volatile and mobile and we will examine the constraints necessary so that its energy is mutually beneficial and not merely self-regarding. In that sense, corporate social responsibility is not a form of philanthropy but a central concern of the organisation.
The political and economic consequences of the 2008 crash are practically real but theoretically confused. We drew on the work of Karl Polanyi in the first seminar in developing a different conception of the economic actor model and the economy that were both embedded and embodied. The purpose of this series of seminars in common good economics is to articulate an approach and a programme that is rationally superior to its market and state based alternatives. The method is built around a form of statecraft that strengthens decentralised civic and economic corporations that can generate a form of resilience built around strengthening institutions that generate non exclusively pecuniary goods.
The goal is a form of national renewal that is not nationalist, a form of capitalism that constrains the domination of capital and a form of socialism that is not exclusively statist. Keynes provided the framework for the 1945-1979 consensus, Hayek the framework between 1979 and 2008. Both remain important in terms of the management of macro-economic cycles and the superiority of the price system respectively but neither are capable of recognising their own limitations and provide a constructive alternative to the state-market cycle and the hollowing out of society. That is the purpose of Common Good Economics. We have both argued that ‘large and logical leaps of the imagination are required’.[1] This is our attempt to do that. One could almost call it a ‘shared economy’.[2]
The Green Paper on Corporate Governance Reform published but not pursued by the previous Government in 2016 states that there is a prevailing assumption that ‘executive pay had become increasingly disconnected from both the pay of ordinary working people and the underlying long term performance of the company’.[3] The average pay of a CEO was £1 million in 1998 but had risen to £4.3 million in 2015, down from a peak of £4.75 million in 2011. In 1998 the FTSE CEO pay ratio in comparison to the workforce was 47:1, in 2010 it was 132:1.[4] The polarisation and hollowing out of the labour market discussed in seminar one was intensified by a public policy built around the administrative state and the financial sector. This model climaxed in the financial crash of 2008 in which incentives to vice, narrow self-interest and a general breakdown of accountability. The National Audit Office claim that the cost of the bailout to the state was £1.162 trillion. Quite a sum.
In seminar one we developed the concept of reciprocity as an equal partner to contract and redistribution in the organisation of the economy and the importance of labour value in thinking about productivity. Further, it was argued that human beings are not commodities but are better considered as social beings with a desire to earn and belong and that there has been a depletion of their inheritance; economic, civic and political which has generated disaffection in the form of stagnant wages and low productivity.
The conception of a firm as being ultimately and exclusively a monetized entity controlled by its owners remains a fundamental assumption of economic theory and practice. There is no practical alternative to nationalisation or privatisation, the state or the market. The conception of an economic concern that is neither private nor public eludes our political imagination but that is precisely what a corporation is.
The three fundamental problems, intensified since the financial crash are those of productivity, personal debt and ethical leadership. The financial crash revealed an inadequate system of accountability and a lack of productivity within the real economy which were concealed by first inflation, then public debt and then private debt.[5] It revealed that capital centralises every bit as much as the state and that there was no effective system of accountability so there were incentives to vice in which managerial self-interest undermined the particular firm and the general economy. The category of labour was subordinated to that of capital and that has impoverished the productive power of the general economy. Reciprocity was undermined.[6]
Catholic Social Thought brings a set of conceptual tools as well as a plausible narrative concerning the limits of both the market and the state, and argues for a humane and embedded economic system. What are the distinctive concepts of CST in this regard?[7]
1. It has a well-developed concept of a balance of interests in corporate governance and retained the idea of the corporation as a body, requiring a workforce which has an interest in the well-being of the firm.
2. It allies this with the idea of ‘relational accountability’ which requires the representation of the workforce in corporate governance as a ‘real physical presence’. It develops the idea of reciprocity, of give and take over time, and develops it as an economic category.
3. It argues that the domination of capital is a menace to itself and others without accepting the domination of a centralised state. This leads to the idea of beneficial constraints that are negotiated by the component parts of the corporate body.
4. It retains labour value as constitutive of capital or more specifically that value is co-produced by capital and labour.
5. It develops the importance of virtue and vocation in the reproduction of value within the economy. This was the topic of the last seminar.
6. It is central to Catholic economic thought that neither human beings nor nature were created as commodities.
7. It stresses the method of aligning interests to reciprocity through incentives, institutions and negotiation.
8. It develops the idea of subsidiarity as a means of resisting the centralisation of capital and the state by developing decentralised institutions within the economy. We looked at this in some detail in seminar two when discussing banking reform and a vocational labour market.
All of these directly address the causes of 2008. There was a lack of accountability, there were incentives to vice, there was a domination of labour by capital, an idea of a corporation without a body, and a lack of productivity in the economy which led to a reliance on financial services and debt, compounded by a lack of vocation and skilled labour.
Our theory requires an explanation of what went wrong, particularly in relation to the growth of debt and the lack of genuine private sector growth.
The denuding of the country of its institutional, financial and productive inheritance by the higher rates of return found in the City of London, and then the vulnerability of those gains to speculative loss is the story we confronted in 2008 when the ‘doom loop’ and ‘super charged risk shifting’ came into play.[8]
The question remains of how the German economy generated a trade surplus of 46 Billion Euros in 2017 when it has the greatest level of worker representation in its corporate governance, the most intense system of vocational interference in labour market participation and the greatest degree of constraint in its banking system. Their political economy retained ideas of status that we discarded in favour of flexible labour markets and yet they proved better at adapting to the change in circumstances generated by new technology and financial innovations. They asserted that globalisation was not a fate that required a single response. An Aristotelian conception of internal goods, of internal negotiation and co-operation, of a balance of interests within a corporation and not an exclusive assertion of external ownership and unilateral managerial prerogative characterised a system built upon strong self-organised democratic institutions within the economy. It applied a Burkean approach to the economy stressing the small platoons.
The comparative superiority of the social market economy indicates the importance of a national system of decentralised institutions which function within the economy to strengthen reciprocity rather than contract or redistribution alone. In other words the generation of a system that generates value rather than debt and the proposed changes in corporate governance are a response to an economic model with a bias towards immediate forms of financialisation by attempting to constrain the short term imperatives of profit-maximisation within a set of institutional relationships.
The loss of the corporate body.
It is worth briefly reviewing the history of Corporate Governance in Britain and how we arrived at our present impasse.
We will define Corporate Governance as the set of arrangements that determine a company’s objectives and how control rights, obligations and decisions are allocated among various stakeholders in the company.[9]
Corporation means body and their establishment initially required a Royal Charter or Act of Parliament. As self-governing bodies governed by their members the Charter guided their mission through reference to their purpose. The Charter of the Bank of England, for example, was to promote ‘the public good and benefit of our people’. The corporation is a civic body governed by a purpose.
The decisive change, generated by a series of business failures and the subsequent destitution of directors, was the emergence of limited liability in 1855. The central dilemma emerging from this was that if managers were no longer personally liable for failure, what interest did they have in protecting investor’s money?
The resolution of this principle/agent problem was that the high risk carried by shareholders gave them the strongest possible incentive to safeguard the interests of the company. Without shareholder constraint managers would have incentives to corruption, defined as the private use of public goods, and pursue their interests at the expense of the company. The conflict was resolved by aligning shareholder and managerial incentives in that remuneration simply needed to be linked to shareholder returns.
This however, did not resolve the tensions within the corporation. Dispersed and disorganised shareholders found it difficult to discipline management. This was compounded by the velocity of share ownership which has fallen from an average of 6 years in 1950 to six months today. While it used to be understood that dividends rose and fell, that was no longer assumed and the preservation of share value was given a higher priority than investment in either research or expansion. Financialisation was more important than productivity because the time horizons of finance were shorter than those of production. The result was that the common good, defined as the mutual benefit of the various parts of the corporate body, owners, workers and creditors, were subordinated to those of the shareholders and their returns were given priority. This is to set aside the risk carried by the locality and society in general by their actions. In the Act of 2006, for the first time in British history, shareholder primacy was hard-wired into a companies’ statutory purpose. The result is that private companies invest substantially more than public ones. The shareholder model has constrained investment.[10]
And then, of immediate importance in the crash of 2008, there was the unresolved tension between shareholders and creditors and the tendency to increase value by shifting risk from shareholders to debtors. The meaning of ‘incentives to vice’ can be understood through this. The present system works by judging performance by the share price of a company but its permanent maintenance requires the generation of significant risks ranging from not investing in either the workforce, research or expansion in order to enhance immediate returns to stretching creditors, in order to boost share price. This is the meaning of ‘super charged risk shifting’. Leverage rose with intensity in the run up to the crash when the quest for shareholder returns was aided and abetted by creditors who charged a low and falling rate to the banks, further fuelling incentives to ever greater risk which ended up as systemic recklessness. The implications of risk shifting are doubly troubling. Not only does it generate excessive risk taking and credit creation during upswings. As importantly, it also contributes to excessive caution and a credit crunch during the downswing. It is a cost to the creditors and for the macro-economy.[11]
Restoring the corporate body
The financial crash was the result of a failure of many things, but one of them is corporate governance. A comparative analysis of corporate restructuring strategy in Germany and Britain tells the story clearly. The resilience of German industry was based upon two fundamental differences with Britain, both relating to corporate governance.[12] The first was that in Germany each stakeholder interest; capital, labour and management has access to the same information about the state of the firm and the sector and could negotiate a common response.
The German High Court ruled in 1982 that co-determination took priority over the claims of shareholders as it was a matter of ‘public good’ and this overruled the civil law concerning the ownership of capital by joint stock companies. This would have been a plausible outcome in British Law if the principle/agent problem generated by establishing limited liability had not been resolved through share price alone.
In Germany, the governance and strategy of the firm became a matter of negotiation as the workforce and their representatives gained a knowledge of economic performance and a practical role in the management of the economy. The workforce has interests in the flourishing of the firm and an internal expertise in the work of the firm and they carried risk, in terms of losing their livelihood if the company failed.[13] The sacrifices asked of workers were balanced by their participation in the process of production as an institutional partner.
The common good model of corporate governance ensures that the workforce have the information and institutional power to negotiate enterprise and sectoral strategies of renewal.
Given the problems generated by the inadequacy of the prevailing system of corporate governance to generate productive growth, or resolve a series of tensions between shareholders, management, workforce, and creditors, it is necessary to develop a constructive alternative that can correct its weaknesses while preserving its strengths.
The constituent parts of the corporate body are capital; the workforce and the management of the firm. The German system has two boards, management and supervisory but there is no need to reproduce this. One of the merits of the British system is a unitary board system that can make decisions and share information.
We are suggesting, for discussion, that corporate governance reform should be that a third of the seats are reserved for capital, shareholders, banks and other creditors. Another third should be elected by the workforce, and that the final third are split between the management of the firm and representatives of the local community. Each of these interests have a mutual interest in the flourishing of the firm and the necessity of reaching a negotiated settlement rather than a unilateral decision.
The common good approach recognises that the corporation is a body constituted by complex and mutually dependent functions and the representation of that in the corporate governance model means that a common good of the firm can be negotiated. German industry works within a legal category of the ‘equalisation of the burdens’ in which the burdens of decisions must be balanced between owners and workers and the sharing of burdens should be the goal of a statecraft oriented to the common good. It is not, however, a stand-alone policy but requires complementary institutional reform in relation to both vocation and the banking system which have been discussed in the previous two seminars.
[1] See for example, Andy Haldane, ‘Labour’s Share’, TUC, 12th of November 2015. This also gives the data on the ‘largest and longest squeeze on wages since 1850’ and the fall in productivity.
[2] There are different names for this. Of importance in developing this analysis has been the work of Karel Williams at Manchester and the idea of the Foundational Economy. See Karel Williams, et al, The End of the Experiment? From Competition to the Foundational Economy, Manchester University Press, 2014. See also, ‘Productivity puzzles’, Speech given by Andrew G Haldane, Chief Economist, Bank of England, London School of Economics, 20 March 2017. See also, Rachel Reeves, The Everyday Economy, 1988.
[3] ‘Corporate Governance Reform’ Green Paper, p.18. 2016.
[4] ibid, p.16.
[5] See Wolfgang Streeck, Buying Time, London 2014.
[6] See seminars two and three.
[7] For a more detailed account see Maurice Glasman, ‘Catholic Social Thought as Political Economy’, Ratio, 2014.
[8] For the doom loop see Haldane, A (2012), ‘The Doom Loop’, London Review of Books, vol 34, pages 21-22. For super charged risk shifting see ‘Who owns a company?’ Speech given by Andrew G Haldane, University of Edinburgh Corporate Finance Conference 22 May 2015
[9] Allen, F. and Gale, D (2000), ‘Comparing financial systems’, MIT Press. Also, Haldane, ‘Who owns a company’, p.3.
[10] Asker, J, Collard-Wexler, A and De Loecker J (2014), ‘Dynamic Inputs and Resource (Mis)Allocation’, Journal of Political Economy, vol 122
[11] Alessandri, P and Haldane A G (2009), ‘Banking on the State’, speech delivered at the Federal Reserve Bank of Chicago, available at: http://www.bankofengland.co.uk/archive/Documents/historicpubs/speeches/2009/speech409.pdf
[12] Gregory Jackson and Igor Filatotchev, ‘Financing, business strategy, corporate governance and the growth of medium-sized business: an exploratory comparison of the UK and Germany’. The Centre for Business Performance, August 2009. See also, Carsten M. Jungmann, ‘The Effectiveness of Corporate Governance in One-Tier and Two-Tier Board Systems – Evidence from the UK and Germany’, European Company and Financial Law Review 3(4), April 2007.
[13] Stephen C. Smith, ‘On the Economic Rationale for Co-determination Law’, Journal of Economic Behaviour and Organisation, Vol. 16 1991, pp. 261-81.