Stakes vs. Stocks
From the September 1998 issue of The Free Market , a newsletter for members of the Ludwig von Mises Institute.
"Good corporate citizenship" is a familiar song that has topped the charts for far too long. Every two decades, it comes back with a slight variation, finding wild popularity. The new version arrived in the mid-Eighties with suggestive lines about corporate behavior. The traditional corporate enterprise, it sings, should modify its goals not only because it affects other people, but because it touches everything: animal, vegetable and mineral.
Recent mergers and acquisitions reach out and touch everyone. In turn, everyone wants to participate in the wave of executive soul-searching. It's true that parties affected by large transactions can occasionally assist in refining corporate values. But make no mistake about the dynamics of control: almost anyone would claim a seat at the bargaining table for a chance of lucrative reward. These seats are in fork's range of shares of the pie.
One unscrupulous way to wiggle into a seat is to claim, by right, a stake in the outcome. That starts the bargaining debate on a false premise, namely that CEOs should balance "stakeholder" interests rather than serve the owners (stockholders), acting as diplomats in a political rivalry rather than executives in an economic contest. From that starting point, the stakeholders' fight for benefits is intrusive and unprincipled.
As CEO Al Dunlap warns in Dunlapping the Corporation: "If you see an annual report with the term 'stakeholders,' put it down and run, don't walk, away from the company. It means the corporation has its priorities upside down." Dunlap is famous for his turnaround of Scott Paper with its highly publicized layoffs, but his media-made moniker, "Chainsaw Al," is the opposite of the truth: stakeholders wield chainsaws on corporate value.
Indeed, "stakeholders" are conceptually flaccid and politically muscular. Stakeholder advocacy is not a principled ideology. Rather, it's a jumble of policies forged out of resistance to the growing powers of free markets. But put these competitively disadvantaged groups together and they signal far more trouble than the sum of their parts:
* The political left calls for corporate responsibility as a means of instilling business with a social agenda they cannot pass legislatively. For example, Senator Tim Wirth, a post-Watergate Democrat, said he was leaving Washington because he was frustrated that no one could put new programs in place anymore.
* Labor unions endorse virtually any platform they believe offers protection from plant relocations and competition. When Senator Jeff Bingaman introduced the idea of the R-Corp (R for Responsible) as an alternate corporate charter, a key feature was the requirement of the adoption of a "community responsibility agreement" which would "temper" relocation decisions and layoffs.
* State and local legislators seek to protect established business interests in their districts, especially those of corporate managers who are campaign donors and who sense that their jobs are threatened by layoffs during hostile takeovers. Consider Greyhound of Arizona, once a target of takeover. One Arizona legislator said to a reporter that when Greyhound says "jump" the legislators ask, "how high?"
* Anticapitalists, especially former Labor Secretary Robert Reich, decry the alleged "excesses" of executive salaries that often accompany worker layoffs. Reich belittles the demands of profit-seeking investors on corporate management, dismissing the "shareholder model" as "a narrow view of stewardship."
* Liberal academics claim that corporate acquisitions are artificial transfers of wealth from workers to shareholders. They argue that corporate profitability in the past implied steady employment: workers "earned" secure employment, sharing the gains of rising productivity. Now, there are layoffs of workers for profit, exemplifying the redistributing of income from employees to shareholders.
Piling on corporations at lower levels are community activists, environmental radicals, and occasionally benign but misguided parties, such as archeologists and old-building preservationists. Of course, not everyone who claims a stake is out to destroy corporate profit-initiatives, but all seem to want a piece of the action.
For a wide range of motives, from the chance to dip into the kitty to the general anti-corporate sentiment, stakeholder laws are a solution. The coalition has succeeded in passing laws, known as constituency statutes, that fulfill the stakeholder ideal. In effect, they suspend the fidelity owed by executives to owners and transfer wealth from shareholders to other groups.
The main beneficiaries are labor and management, who are far more culpable for eroding the value of the enterprise than are the archaeologists and preservationists. It's not that Ralph Nader-types are bashing corporations and winning on their own; it's that internal management and organized labor align with anti-corporate activists when they wish to preserve their interests against shareholder wishes.
Together with media sympathy for established and parochial business interests, this coalition often wins. Thus, constituency statutes are a little-understood form of protection from competition for both professional managers and the employees they supervise.
The chief power that manager-diplomats receive is wider discretion over the potential payout to shareholders. But to get that power they must surreptitiously promise to grant favors to local politicians, environmentalists or regulators. To have the means of granting favors to the connected, executives must exercise wide control over the use the company's earnings.
Take the current wave of mergers and acquisitions involving banks and other financial institutions. Banks leapfrogged one another to promise huge expenditures on low-income, minority, gender-based and state-partnered lending. Banks, which are heavily subsidized and regulated, cannot fail to make such faddish promises. Indeed the more "public" the character of a business charter, in this case, the bank charter, the more likely you will find management directing business goals with politically correctness.
Ludwig von Mises noted that the pre-war emergence of the bureaucratic managerial class was an outgrowth of socialist-leaning European governments that aimed specifically to eliminate the influence of the shareholders. The expropriation of shareholder values was the first step in shifting power from free markets to state bureaucracy. The shift back to the financial markets in the Eighties was an overdue correction, due to implicit recognition that, as Mises said, "A successful corporation is ultimately never controlled by hired managers."
Since a corporation is an entity with a purpose, managers must set goals in accordance with a hierarchy--not a grab-bag-of values--in order to survive. Shareholders properly belong at the top of that hierarchy to whom management owes a fundamental responsibility. The owners, acting through representative directors, sanction the executive managers and bear the decisive risk: Will the firm have access to my capital? All legitimate interests in a company must be aligned with an unambiguous purpose that rewards capital. The shareholder model provides such a purpose: profitability through customer satisfaction.
Corporations work because shareholders expect exclusive loyalty from the directors. The web of mutual interests between the corporation and other stakeholders (banks, workers, customers) are protected under different forms of law, contract and civil. Advocates of stakeholder laws, by contrast, undercut the harmony of value. They threaten corporate survival when they demand that everyone connected to or affected by a corporation--suppliers, customers, managers, community neighbors--should be given an equal say in corporate decision making.
Under a stakeholder model of responsibility, there is no clear, unambiguous standard of corporate success. The interests of these diverse groups could never be harmonized under nebulous "public interest" goals. And they never are. They have shown in practice that they vote to benefit themselves and subvert the will to pursue profits and create wealth. Customers and shareholders suffer most, since they are the two most widely dispersed "stakes" in the enterprise. They are the hardest to organize for the collective action required to run a stakeholder corporation.
A corporation is not a democracy. CEOs who choose to balance diverse interests will squander value, and they will squander it on friends of management. Nor is a corporation autocratic. The alleged golden days before mergers and takeovers, when CEOs made deals between workers and corporations at shareholder expense, are indefensible. Economic democracy and autocracy are, at root, protectionist strategies.
The reasons for corporate acquisitions and restructuring, for the most part, are not artificial. These transactions are motivated by the goals appropriate to a system of representative governance. Turnaround CEOs like Dunlap increase shareholder wealth and preserve jobs that would otherwise be lost by offering no-nonsense values to customers. The artifice arises in Robert Reich's world, when corporations violate shareholder trust, juggling corporate assets for political interests, sacrificing the values of producers and consumers.
* Jeff Scott is a financial analyst at Wells Fargo Bank in San Francisco.
For further reading, Mr. Scott suggests Margaret M. Blair, "Wealth Creation and Wealth Sharing: A Colloquium on Corporate Governance and Investment in Human Capital," The Brookings Institution, Washington D.C., 1996; Harper's, "Does America Still Work?", May 1996; Stephen M. Bainbridge, "Participatory Management Within a Theory of the Firm," The Journal of Corporation Law, Vol. 21, No. 4, Summer 1996.