She’s unveiling a bill to make corporate governance great again.
Elizabeth Warren has a big idea that challenges how the Democratic Party thinks about solving the problem of inequality.
Instead of advocating for expensive new social programs like free college or health care, she’s introducing a bill Wednesday, the Accountable Capitalism Act, that would redistribute trillions of dollars from rich executives and shareholders to the middle class — without costing a dime.
Warren’s plan starts from the premise that corporations that claim the legal rights of personhood should be legally required to accept the moral obligations of personhood.
Traditionally, she writes in a companion op-ed for the Wall Street Journal, “corporations sought to succeed in the marketplace, but they also recognized their obligations to employees, customers and the community.” In recent decades they stopped, in favor of a singular devotion to enriching shareholders. And that’s what Warren wants to change.
The new energy on the left is all about making government bigger and bolder America, an ideal driven by a burgeoning movement toward democratic socialism. It’s inspired likely 2020 Democratic contenders to draw battle lines around how far they’d go to change the role of government in American life.
Warren supports expanding many of the programs in play, and she’s voted to do so. But the rollout of her bill suggests that as she weighs whether to get into the presidential race, she’ll focus on how to prioritize workers in the American economic system while leaving businesses as the primary driver of it.
Warren wants to eliminate the huge financial incentives that entice CEOs to flush cash out to shareholders rather than reinvest in businesses. She wants to curb corporations’ political activities. And for the biggest corporations, she’s proposing a dramatic step that would ensure workers and not just shareholders get a voice on big strategic decisions.
Warren hopes this will spur a return to greater corporate responsibility, and bring back some other aspects of the more egalitarian era of American capitalism post-World War II — more business investment, more meaningful career ladders for workers, more financial stability, and higher pay.
As much as Warren’s proposal is about ending inequality, it’s also about saving capitalism.
The Accountable Capitalism Act — real citizenship for corporate persons
The conceit tying together Warren’s ideas is that if corporations are going to have the legal rights of persons, they should be expected to act like decent citizens who uphold their fair share of the social contract and not act like sociopaths whose sole obligation is profitability — as is currently conventional in American business thinking.
Warren wants to create an Office of Corporate Citizenship inside the Department of Commerce and require any corporation with revenue over $1 billion — only a few thousand companies, but a large share of overall employment and economic activity — to obtain a federal charter of corporate citizenship.
The charter tells company directors to consider the interests of all relevant stakeholders — shareholders, but also customers, employees, and the communities in which the company operates — when making decisions. That could concretely shift the outcome of some shareholder lawsuits but is aimed more broadly at shifting American business culture out of its current shareholders-first framework and back toward something more like the broad ethic of social responsibility that took hold during WWII and continued for several decades.
Business executives, like everyone else, want to have good reputations and be regarded as good people but, when pressed about topics of social concern, frequently fall back on the idea that their first obligation is to do what’s right for shareholders. A new charter would remove that crutch, and leave executives accountable as human beings for the rights and wrongs of their own decisions.
More concretely, citizen corporations would be required to allow their workers to elect 40 percent of the membership of their board of directors.
Warren also tacks on a couple of more modest ideas. One is to limit corporate executives’ ability to sell shares of stock that they receive as pay — requiring that such shares be held for at least five years after they were received, and at least three years after a share buyback. The aim is to disincentivize stock-based compensation in general as well as the use of share buybacks as a tactic for executives to maximize their one pay.
The other proposal is to require corporate political activity to be authorized specifically by both 75 percent of shareholders and 75 percent of board members (some of whom would be worker representatives under the full bill), to ensure that corporate political activity truly represents a consensus among stakeholders, rather than C-suite class solidarity.
It’s easy to imagine the restrictions on corporate political activity and some curbs on stock sales shenanigans becoming broad consensus points for congressional Democrats, and even part of a 2019 legislative agenda if the midterms go well. But the bigger ideas about corporate governance would be a revolution in American business practice to undo about a generation’s worth of shareholder supremacy.
The rise of shareholder capitalism
The conceptual foundations of the current version of American capitalism are found in Milton Friedman’s well-titled 1970 New York Times Magazine article “The Social Responsibility of Business Is to Increase its Profits.”
Friedman meant this provocative thesis quite literally. In his view, which has since become the dominant perspective in American law and finance, corporate shareholders should be understood to own the company and its executives should be seen as their hired help. The shareholders, as individuals, can obviously have a variety of goals they favor in life. But their common goal is to maximize the value of their shares.
Therefore, for executives to set aside shareholder profits in pursuit of some other goal like environmental protection, racial justice, community stability, or simple common decency would be a form of theft. If reformulating your product to be more addictive or less healthy increases sales, then it’s not only permissible but actually required to do so. If closing a profitable plant and outsourcing the work to a low-wage country could make your company even more profitable, then it’s the right thing to do.
Friedman allows that executives are obligated to follow the law — an important caveat — establishing a conceptual framework in which policy goals should be pursued by the government, while businesses pursue the prime business directive of profitability.
One important real-world complication that Friedman’s article largely neglects is that business lobbying does a great deal to determine what the laws are. It’s all well and good, in other words, to say that businesses should follow the rules and leave worrying about environmental externalities up to the regulators. But in reality, polluting companies invest heavily in making sure that regulators underregulate — and it seems to follow from the doctrine of shareholder supremacy that if lobbying to create bad laws is profitable for shareholders, corporate executives are required to do it.
On the flip side, an investor-friendly policy regime was supposed to supercharge investment, creating a more prosperous economy for everyone. The question is whether that’s really worked out.
The economics of shareholder supremacy
The shareholder value era has pretty clearly brought about an explosion in inequality in the United States. It succeeded, for starters, in greatly increasing the value of shares of stock in the English-speaking countries where Friedman’s doctrine has been most influential.
You can see this in the evolution of a ratio known as Tobin’s Q — the value of all the shares of stock outstanding divided by the book value of everything publicly traded companies own.
Historically, this ratio was well below 1, and it remains below 1 in Germany and Japan, where shareholder value does not reign supreme. But in the US, Britain, and Canada, the Q ratio has soared — meaning the financial value of corporate ownership has risen faster than the actual growth of the underlying enterprises — leading to huge increases in wealth for people who own shares of stock.
Since 80 percent of the value of the stock market is owned by about 10 percent of the population and half of Americans own no stock at all, this has been a huge triumph for the rich. Meanwhile, CEO pay has soared as executive compensation has been redesigned to incentivize shareholder gains, and the CEOs have delivered. Gains for shareholders and greater inequality in pay has led to a generation of median compensation lagging far behind economy-wide productivity, with higher pay mostly captured by a relatively small number of people rather than being broadly shared.
Investment, however, has not soared. In fact, it’s stagnated.
And a range of scholars believe shareholder capitalism is to blame. Dong Wook Lee, Hyun-Han Shin, and René Stulz find that firms enjoying high Q now invest in share buybacks rather than reinvesting in business. Heitor Almeida, Vyacheslav Kos, and Mathias Kronlund find that companies strategically time buybacks to manage earnings per share metrics in line with Wall Street expectations and that “EPS-motivated repurchases are associated with reductions in employment and investment, and a decrease in cash holdings.”
Germán Gutiérrez and Thomas Philippon empirically test seven possible causes of decreased business investment, and find that changes in corporate governance (along with reduced competition and a shift to intangible goods becoming more important) is a major factor.
The heterodox economist William Lazonick of the University of Massachusetts puts the thesis very squarely, arguing that “from the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations.” But since the Reagan era, business has followed “a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders.”
This is, of course, not an uncontested view. Jesse Fried and Charles Wang argued earlier this year that the real amount of buybacks is overstated by politicians who focus on gross share repurchases that are partially offset by new share issuances. Joseph Gruber and Steven Kamin reviewed the issue in a 2017 survey for the Federal Reserve and pronounced the evidence “inconclusive.”
Policymakers, of course, don’t have the time for fully conclusive evidence. And Warren seems to believe Lazonick’s basic observation that “since the mid-1980s net equity issues for non- financial corporations have been generally negative, and since the mid-2000s massively negative.” In the modern era of shareholder supremacy, in other words, owners take more money out of the corporate sector in the form of buybacks and dividends than they put in via new investments.
Whether one sees this as a cause or a consequence of poor growth outcomes is up for debate, but the Warren view is that fundamentally, shareholder supremacy is a cause of poor economic performance by starving the business sector of funds that would otherwise be used to invest in equipment or training or simply to pay people more and increase their purchasing power.
But while on an optimistic view, stakeholder capitalism would produce stronger long-run growth and higher living standards for the vast majority of the population, there’s no getting around the fact that Warren’s proposal would be bad — really bad — for rich people. That’s a fight her team says she welcomes.
Codetermination is a huge transfer of wealth
In conversations with ex-staffers of Hillary Clinton’s presidential campaign during the winter of 2016-’17, it was repeatedly said that their research showed an extremely high level of public interest in the idea of making corporations share profits with rank-and-file workers, but that they’d never managed to make the media or the public focus on their plan to increase profit sharing.
The reasons for this, however, are not that mysterious. The Clinton profit-sharing initiative, though worthy in its way, was designed as a somewhat opaque tax measure that would incentivize companies to adopt profit-sharing plans. It was, in other words, deliberately structured to not seriously alarm business leaders — a good match for an overall campaign strategy that was focused on the idea that decent people from all walks of life should unite to reject Donald Trump.
Warren’s plan is not like that. If imposing stakeholder responsibilities on businesses and requiring half of the seats at the biggest firms to be elected by workers pushed the S&P 500’s Q ratio down to German levels, share prices could fall by 25 percent. For the vast majority of people who earn the majority of their income by working for wages, cheaper stock would be offset by higher pay and more rights at work.
But for billionaires with huge stock holdings — and for CEOs with compensation packages tied to share price performance — it would be a disaster. If they thought the idea stood a snowball’s chance in hell of happening, rich people would denounce it to anyone who would listen — and since executives and major investors enjoy privileged access to the media, their denunciations would be heard.
Indeed, it seems likely that literally trillions of dollars of paper stock market wealth could be eliminated by weakening shareholder hegemony in this way. But as economist Ed Wolff has shown, that lost wealth is owned overwhelmingly by a small minority of the overall population.
In exchange, the laboring majority would make important gains.
Most obviously, the large share of the private sector workforce that is employed by companies with more than $1 billion in revenue would gain a measure of democratic control over the future of their workplace. That wouldn’t make tough business decisions around automation, globalization, scheduling, family responsibilities, etc. go away, but it would ensure that the decisions are made with a balanced set of interests in mind.
Studies from Germany’s experience with codetermination indicate that it leads to less short-termism in corporate decision-making and much higher levels of pay equality, while other studies demonstrate positive results on productivity and innovation.
One intuitive way of thinking about the proposal is that under the American system of shareholder supremacy, an executive increases his pay by finding ways to squeeze workers as hard as possible — kicking out the surplus to shareholders and then watching his stock-linked compensation soar. That’s brought America to the point where CEOs make more than 300 times as much as rank-and-file workers at big companies.
Under a codetermination system, by contrast, an executive wins a pay increase by convincing shareholders and worker-representatives alike that he deserves it — something you can only do if workers are sharing in the benefits of growth. Consequently, German executives earn only about half as much as their US counterparts, even as major German firms like BMW, Bayer, Siemens, and SAP produce world-class results.
Of course, this kind of huge transfer of economic power from rich shareholders to middle- and working-class employees would provoke fierce resistance. But reform of corporate governance also has some powerful political tailwinds behind it.
Curbing shareholder supremacy is popular
This starts with the fact that proposals to overhaul corporate governance poll well — almost shockingly well, in fact, for an idea that’s had no organized advocacy community or high-profile champions until extremely recently.
Earlier this year, Civis Analytics, a Democratic data firm, asked a large sample of Americans about codetermination, complete with an explicit partisan framing:
In many countries, employees at large companies elect representatives to their firm’s board of directors in order to advocate their interests and point of view to management. Democrats say this gives regular workers a greater say over how their companies are run and will increase wages, while Republicans claim that this makes companies less efficient and be bad for the economy. Would you support letting employees at large companies elect representatives to their firm’s board of directors?”
They found broad support for the idea, even with Republican-leaning voters.
Indeed, when the left-wing advocacy organization Data for Progress teamed up with Civis to produce credible polling outlining popular support for a bold progressive reform agenda, they found that reforming corporate governance was the most popular idea of all — outperforming many better-known progressive policy ideas that are themselves popular.
Combining its large sample with demographic information, Civis is able to model support for these different ideas down to the congressional district level and finds that, astoundingly, codetermination polls well in literally every single House district. Looking state by state, it commands 58 percent support in Wyoming and is more popular than that everywhere else.
It’s likely a big reason for this is cost. Most progressive ideas tend to be either cheap, but therefore small-bore and a little weird, or bold and clear but expensive, in a country that remains averse to taxation. Warren’s corporate accountability initiatives would have huge economic implications but zero budgetary cost. At a time of low levels of public trust in institutions, Warren’s proposals don’t ask anyone to have faith that government officials are going to make good use of resources.
What’s more, while the codetermination aspect of Warren’s proposal does draw inspiration from Germany, fundamentally, the pitch for the overall package is a lot closer to “Make America Great Again” than to “make America like Scandinavia.” The basic notion is that the American private sector used to operate in a better, more inclusive way before the rise of shareholder supremacy and with a couple of firm regulatory kicks we can get it to work that way again.
My late grandfather, who was an old-line communist in his day, used to tell me with mixed admiration and regret that FDR had saved capitalism by entrenching institutions that guaranteed broadly shared prosperity. Those institutions, fundamentally, are what was undone in the shareholder value revolution.
Warren’s bet is that at a time when the political right is increasingly not even bothering to pretend to offer economic solutions anymore, America can pull off the same trick a second time — offering the public not a huge new expansion of government programs, but a revival of the midcentury stakeholder capitalism that once built a middle class so prosperous that the idea of surging mass interest in socialism was unthinkable.
Author: Matthew Yglesias