Saturday, October 31, 2009

Management, or feudalism?

How management captured the economy, and what we can do about it.

Americans are so cowed by this point that they hardly register a flicker of resentment when Wall Street executives give themselves billions in bonuses after flushing trillions down the drain and saying a begrudging "thank you" for more trillions in government life support. How did we come to this pass?

One of the great changes in the last 50 years has been the broadening of stock ownership. Out with the smoke filled rooms and blue-chip bespoke trading, in with mutual funds, etrade, and all-in dot-com stock investing. This has been great in many ways, putting more money to work in productive enterprises and earning regular people substantial gains (at times, at least).

But it also had the paradoxical effect of diluting ownership of corporations. When everyone owns a company, no one does. And management eventually learned what this meant- that they could run their companies as they wished, subject only to the whims of stock "analysts", but not to their true owners, who might have a longer-term interest. Boards of directors, previously direct representatives of the shareholders, now became hand-picked cronies of the management, ready to "motivate" management with lavish pay in an arms race of executive generosity.

The Reagan era helped generate the latest edition of this culture, claiming that America's greatness lay in its executives, and its economic prospects in trickle-down economics. Cultural progress emanated from the boardroom, not from the shop floor. Unions were there to be broken, not negotiated with. While the cult of entrepreneurialism remains a positive aspect of this culture, the cults of MBA-ism, management consulting, cronyism, and open corruption in boardrooms and in government lobbying has been anything but. And the bonuses and guaranteed stock options now being paid out of tottering or under-water balance sheets clarifies just what management meant by that "motivation" that was supposed to tie them to market "discipline".

It's a mess, and a recent article in the New Yorker article about a few corporate do-gooders who urge large stockholders (pension funds, mutual funds) to militate against a few of these excesses was nice, but far, far short of what is needed. We need a revolution in corporate governance that recognizes the limitations of the new corporate ownership model where some benefits are shared broadly, but many (sometimes most) are concentrated in the hands of a feudal management, which is left by the current owning, legal, and cultural regime to run its show unmolested, for its own benefit.

In the economics literature, this is called the agency problem, and pervades all sorts of interactions. We hire someone to do something for us, like build a wall. This requires supervision, but how can we comprehensively supervise the process without giving up and doing it ourselves? We can't. At some point, one has to either have faith that the person hired is honorable and will not make hidden errors, or one has to delay the payment so much that any errors become apparent prior to payment, perhaps postponing payment for 25 years or more. The latter is neither practical or palatable, so we put up with uncertainty in contractors, paying them before we really know the quality of their work.

With corporations, the agency problem is likewise enormous, and getting bigger all the time as ownership dilutes and legal protections, often legislated from the courts, expand. Specifically, the problem boils down to a few points:


1. Management is overly free of supervision by owners, leading to orgies of empire-building, vanity projects, short-term stock pumping, political freelancing, and other problems.

2. Management is paid in an undisciplined way, neither accounting for true long-term impact, nor being immediately subject to a coherent system of checks and balances. The "labor market" for executives is not just inefficient, but riddled with corruption.

3. Management meddles in government by lobbying, attaining disporportinate influence. The recent ruckus over the Chamber of Commerce only shines a brief and flitting light on this cancer in the body politic.


Corporations are creations of the state. They are not free associations of citizens in the classic sense, but are a special class of association (by charter) with several government sanctioned benefits, including limited liability, special tax structures, separate legal personality, regulatory services (not to mention bailout services), and more. Thus it is entirely reasonable, contra the supreme court, to restrict the free speech "rights" of corporations (i.e. their right to corrupt the political process by lobbying and political activism by management with corporate funds).

So we don't have to put up with corporate lobbying, corporate political donations, or corporate meddling in the political process. We don't need Wall Street bankers designing their own bailouts, and we don't need health "insurers" telling us whether we can or can not legislate health insurance reform.

Secondly, corporate governance needs to be reformed in a basic way. Pay must of course be reformed to reflect long-term incentives and the more prosaic recognition that management skill is neither as rare nor Empyrean as often portrayed by managers. But this will never happen while management appoints its own overseers. While ideally, corporate democracy would be re-established with true control by shareholders, this is impossible at the current levels of dilution, and at the level of apathy appropriate to the reciprocal form of dilution- which is to say that each individual investor in vehicles like pension funds and mutual funds has miniscule levels of any particular stock and thus miniscule interest in its governance. So some other mechanism is needed to guard the public good along with the shareholder interest.

I would recommend addition of a public board to all public corporations. This board would be legally superior to the private board constituted by current rules, able to fire that board and managment, run shareholder elections, and otherwise control the corporation in times of urgency. Such a board would in normal times represent the government and regulatory interests, keeping an eye on the company's affairs. Two of its members would attend private board meetings, and vice versa as well. Extra activity of this public board (beyond monitoring and regulation) would be decided by shareholders in a simple voting system, where rather than vote for specific people, (such as nominees of the management to a private board), votes would be for a level of confidence, perhaps from one to five.

In this way, shareholders would have a simple and direct way to register general concern with the enterprise, which in turn would tell this public board, appointed by the chartering government, (or the federal government for inter-state and international corporations), to either (#5) stay out of the affairs of the company, it is doing just fine, or (#1) take all actions necessary to correct a bad situation and right the affairs of a problematic management.

This idea recognizes that most corporations behave appropriately most of the time. It adds a check in cases of problems where a public board can be automatically activated at shareholder discretion, expressed in a straightforward way that gets around the difficulties of evaluating particular candidates and allows a general no-confidence attitude by shareholders to result in action to discipline management and resolve the situation. Such boards could also aid in the liquidation of businesses the government is otherwise reluctant to touch (see Lehman).

Naturally, there would need to be rules of various sorts to stipulate the kind of public boards that could be formed, insulated from political as well as corporate influence, perhaps diversified by origin in the civil service, academy, party affiliation and private sector. It would not be a board of expertise, but one of oversight, able to hire new executives and private board members in extreme circumstances, and to investigate the other actors. Members would be paid minimally, perhaps by the chartering institution or by general fees, similar to how the FDIC is funded.

There may be many other (and perhaps better) ways to approach this issue in corporate governance. The no-confidence vote system might directly remove a current board or management, instead of empowering a public board. It is a complicated issue, but the existence of the problem is not complicated at all- it is patent and in need of deep reform. It is eating at our politics, economic system, and culture, and we can only hope that capitalism is capable of undergoing further evolution for the common good.





PS- I have a special solution for the financial industry, whose gambling addiction appears to be more serious than previously suspected. Which is to levy a small tax on every transaction. Every share bought, sold, every derivitive conjured and sliced, would be taxed at a small rate, say 0.5% of value. This would have several beneficial effects- it would slow down financial transactions, of which there is far too much churning. It would enforce visibility of all such transactions, going into all relevant markets, whether currently regulated or not. It would raise huge amounts of revenue, which we could really use at this point (ahem!). And when applied to international currency speculation, it would lend some stability against being whipsawed by vast in/outflows of money. The recent program of super-fast trading by way of special computer networks by Goldman is exhibit A of trading that is simply contrary to the common good, and for which we need a systematic solution.


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