Corporate Governance As If People Mattered

Leiden, a.d. VIII Id. Mar. MMDCCLXIX A.U.C.,

Climate change, smog, oil spillage, to name just a few typical examples of negative externalities, are some of the main reasons people oppose capitalism and multinationals. Concluding that companies often harm people is not a Nobel prize winning claim, the million dollar question is how we can make companies behave responsibly vis-à-vis stakeholders, how we can make companies internalize externalities, how we can make companies behave ethically correctly. Of course regulation and nationalization are two options to force companies to behave in a certain way, but what if we do not believe in big government, do we then have any options left? How can we achieve corporate responsibility without large scale government intervention; can we encourage corporate governance as if people mattered?

We might very well have some options, and different solutions will be suitable for different problems. All these solutions are based on the idea that we need to align the interests of corporate managers to the interests of the stakeholders. Of course, given the fact that stakeholders are heterogeneous, this is something you can never achieve in full. This is also why different forms of corporate governance are probably better suited to solve different problems, because they give more, or less, power to different stakeholders. So, depending on whether the company should behave more responsibly towards second or third parties, you want different groups to be represented.

For example, in the case of externalities, so in situations in which a company makes profits at the expense of a third party, we would like the management to take into account the interests of this third party. Financial economist Mark Latham argues that theoretically it should be possible to arrange this by increasing the power of the shareholders. Because shareowners often hold very small shares in a company (even the largest investment funds and banks do not hold more than one percent of all shares of a company) the dividends they receive from one company will only be a minor part relative to their total property. So, the externalities that help a company make a profit, harm shareholders more than they gain from those profits. Apart from being shareholders, they are also citizens, people who will suffer from climate change, just like any other person. Pension funds, banks or investment funds represent ‘normal’ people, who suffer from the externalities caused by the companies they own. The only ones really gaining from these externalities are the directors and top level managers, who receive large salaries for the shareholder value they created by exploiting externalities (and from more legitimate business practices). Due to the low profits to be gained from one single company causing externalities, shareowners have practically the same incentives as a non-shareholder with regards to a lot of externalities. Consequently, by giving shareholders more power, they would, out of their own self-interest, also protect the interests of non-shareholders to a significant degree. Shareholders will suffer just as much from environmental catastrophes as non-shareholders, so by giving them the power to change the policies of the companies they own, hopefully they will take their responsibility, and help society progress.

Increasing shareholder power can also help mitigate some of the nastier sides of capitalism, such as regulatory capture, a situation in which companies influence the regulatory bodies that were meant to regulate them (as I discussed earlier), subsidies and trade barriers. In all these cases one company, or companies from the same sector, lobby for government support. Obviously, for one company or sector that is very useful, and for them it increases profitability. However, society as a whole incurs great losses due to lobbying practices. Seeing shareholders have a diversified portfolio, they cannot possibly gain from unfair business practices. For example, if the American steel industry lobbies for trade barriers on steel, this sector increases its own profits. However, for the shareholder, who also holds shares of General Motors, the higher profits for one company, are a loss of profits for the other: more expensive steel is killing for GM. So shareholder democracy could increase general welfare by limiting externalities.

The biggest problems which need to be solved in order to give shareholders more leverage is making voting less costly, so reducing transaction costs, giving shareholders more information about what they can vote for, so decreasing the information asymmetry, and lastly making sure investment managers help their investors with voting according to their preferences and becoming more attentive to the substantive issues themselves. So in the first place, shareholders should be given more options to vote in an informed manner. Right now it is often the board of directors who gives voting advise, and because it is the only professional advise available, investors often simply follow this advise. When an incumbent board advises on electing new members of the board, or on appointing new CFOs or CEOs, there often is not even an alternative available to shareholders, which leads to Putin-style election results. Also on other corporate policies we see that a lack of information leads to a ‘consensus’ unseen in properly functioning democracies. For example, last year the board of Standard Chartered faced a ‘shareholder revolt’ when 41% of the shareholders voted against a new pay package. Any political leader would love to have 59% of the population behind him, but in corporate governance it counts as a revolt. So by making sure shareowners have more information, they know what alternatives they have, and they can thus gain power vis-à-vis boards of directors. Moreover, according the Mark Latham, letting them decide on the auditor and having an independent third party set the agenda for director elections should also help in giving the shareholders the upper hand in relation to the board of directors.

This could be achieved by using companies specialized in scrutinizing boards of directors, potential candidates, potential auditors, setting the agenda and giving professional advise to investors on how to vote. Increasing the information available to shareholders reduces both transaction costs, because professional advise saves shareholders having to research themselves, and solves the asymmetric information problem. Interestingly, the Times has started a campaign which urges big financial groups to allow “each investor in a fund or pension policy would be allowed to vote the equivalent of his or her stake in the various companies that the fund or insurer holds.”

However, shareholders do not necessarily need to care about long term profitability of holding a stock. They can always sell it, while the employees probably have a preference for long term profitability, because they are far more dependent on the company they work for. Moreover, shareholders do not need to care about externalities in the local environment, or human rights abuses, forced labour or child labour, as long as profitability is not reduced. This makes Schumacher, author of Small Is Beautiful: A Study Of Economics As If People Mattered, defend the case of cooperatives. By rooting a company firmly in its environment, by making the employees the owners of the company, long-term planning is secured, and externalities on the local level will not be popular with the owners of the company, because shooting yourself in the right foot, so you can buy a fancy shoe for your left foot is never a smart strategy. So, in order to prevent ‘short-termism’ and local externalities, cooperatives are a good option, as research has shown that cooperatives do not reduce productivity or reduce profitability. A good example is Mondragon, a Basque cooperative with a large turnover and profits. Maybe labour unions should, in times of financial downturn when wage increases are impossible, ask for salary in the form of stocks. This will reduce the costs of wages, due to inflation, yet provides employees with more power over their own jobs, and shares of the profits when the economy starts growing again.

Thus by restructuring ownership and what ownership means, we might align the diffuse, in the case of shareholders, or the long-term, in the case of cooperatives, interests of owners with the interests of wider society. It thus deserves the fullest support of governments, in facilitating platforms for the diffusion of best practices, or for instance government intervention to give shareholders more power. For instance, recently in France long-term owners of stocks gained voting power. In a way, this would imply some government intervention now, to prevent a whole lot more government intervention at a later stage, which I think is worthwhile. However, shareholders will also have to fight for themselves, and so should labour unions and employees, we cannot wait for the government to simply take care of it.

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Bottom Line: If we manage to align the interests of corporate managers with the interests of wider society, we can make society at large better off. We can do so by thinking about the way we organize ownership of companies, and what ownership actually means in terms of influence on corporate policy.