Thursday, November 29, 2012

Some Unnatural Limits on Corporate Interests


Photo: Light on Life Images


Two years ago at Thanksgiving, I was a new member of First Lutheran Church of the Trinity, and I was anticipating that we would launch some kind of visioning process in the new year, where we would plan out the future and how we would grow. That hasn’t really happened yet, in a formal way, but some visions have been coming in and out of focus as we work on other things.

Soon after that new year started, our pastor, Reverend Gaulke attended an organizing training that changed him, and affects his ministry. He’s always preached from the pulpit that God’s presence is manifest in how we treat each other, that Jesus spent his time on earth ministering to the poor, the weak and the outcast, and coaching his disciples to do the same. The training was conducted by IIRON, which organizes for social justice; it introduced him to SOUL, a group of other south side pastors with a tradition of standing up for their flocks against more powerful interests.

Since then, Pastor Gaulke has been taking part in some of SOUL’s actions, but he’s been careful about committing our church. First Trinity is not affiliated with SOUL like some other congregations are. Pastor wants the church to remain a sanctuary for people regardless of their political views. And historically, First Trinity has had a Republican tradition, especially among the older Germans who remembered Hitler as a socialist.

In the week after President Obama won the election, IIRON and SOUL joined a nationwide movement in a campaign to press the President and Congress to make the rich and corporate interests pay to fix the fiscal trap Congress set up last year.

Thursday that week, 40 pastors rallied outside the federal building, asking Senator Durbin, and all our leaders, ‘Who do you serve?’ They carried a golden calf, representing the false idol of wealth and corporate interests. Pastor Gaulke got to shatter it.

The next day, IIRON and its allies like Lakeview Action Coalition and Northside Power rallied 400 around the Federal Building while a handful of protestors went up to Senator Durbin’s office, to ask him to sign a pledge to defend Medicaid and Social Security from opposing interests. Some of them got arrested for their trouble, including Joe Hopkins, a Methodist seminarian from First Trinity. The Senator never acknowledged they were there.

I was at the Friday rally, and I think they are in the right. Not because I don’t like rich Americans, or corporate interests. In fact, I think I probably stand with most Americans in that I really like rich people, I wish we had more of them. On a civic level, having them around makes our city a more vibrant, exciting place to be; on a human level, you want to see what people who are less strapped by what they can spend can manage to achieve. In fact, on a frivolous level, I like to see what people with money to spend to extremes will go out and spend it on.

I do wish some of them took a less narrow view of what their interests are, but to a point, the narrow view isn’t entirely their fault.


Photo: Light on Life Images


Self interest was once summoned up as a moral concept. Four hundred years ago, philosophers hoped to make it a rational counterweight to the passions of aristocrats that had embroiled Europe in perpetual wars.

The passions led to a reckless chase of riches, glory and dominion; the interests would guide a more moderate, rational kind of advance. Under their influence, the ruler would recognize his prosperity was entwined with that of his subjects. And initially, his interests weren’t limited to his material prosperity alone, they included the whole field of human concerns. A person would have interests in wealth, power and influence, but also in things like health, honor and conscience.

In time, the term came to focus on a person’s interest in wealth. And in the US, a narrow focus on financial interests has created a false divide between 2 kinds of business concerns. For-profit companies defined by their pursuit of money profits flourish on one side of it; on the other is a shadow system of non-profit companies defined by their charitable purpose, by the absence of interest in profit, and, as a result, by their state of financial dependence.

Their dependence is written into the tax code. Federal tax exempt non profits that are not foundations, charged with distributing their wealth, must prove they are publicly supported by showing that most of their revenue comes from the charity of others, and not from earnings. They can raise a surplus, but they can’t distribute it to owners. That limits their ability to raise capital. Their lack of capital, and restrictions on distribution of their assets, limits their access to loans. In effect, these restrictions guarantee their staff will exhaust themselves scrounging for donations to keep the lights on.

There is no reason they can’t incorporate as for profits instead, except the risk that their interests will be narrowed to the pursuit of profit above all other things.

It is the fiduciary duty of corporate directors to show loyalty and care to the corporation’s interests. The corporation itself may define its interests in the most generous of terms. Johnson & Johnson is known for the breadth of its corporate purpose statement. It names the interests of its customers -- the doctors, nurses and parents who rely on its products -- as its first priority, followed by its employees, and the communities where they live and work. It names its duty to its stockholders last, because “when we operate according to these principals, our stockholders will realize a fair return.”

That statement was penned in 1943. By the 1960s it must not have been uncommon for corporate executives to talk freely of the social responsibility of corporations, to consider how they might help fight inflation by controlling prices, or set environmental standards above and beyond those of regulators, or find ways to hire the “hardcore unemployed.”

Because in 1970, trickle down economist Milton Friedman published an essay blasting such barbarisms in the New York Times Magazine. It was called “The Social Responsibility of Business is to Increase its Profits.” He ridiculed those businessmen he heard condoning broader goals as the “unwitting puppets” of certain intellectual forces that were undermining the basis of our free society.

Business in general can’t be said to have responsibilities, Friedman argued, only people have them. He concedes corporations, as artificial persons, may be said to have artificial responsibilities. Businessmen who run corporations clearly have real responsibilities, but those are to the owners who hire them to serve as their agents. They’re still free to fulfill their personal sense of social responsibility on their own time, and spending their own money.

But to spend someone else’s money for the public good amounts to a tax, taxation is a function of government, and only socialists believe that resources should be allocated by political mechanisms, which force people to cooperate in ways that may not even work out according to plan, and not market ones, which work when people have the freedom to judge their own interests, and to choose the transactions that serve them best.

Through the 1970s, the defense of the rights of shareholders gained momentum. And the clearest way to measure benefits for shareholders is to increase the value of their holdings, and bring them higher returns. To accomplish this, executive compensation was linked to stock performance to tie interests of management more closely to that of owners.

The shareholder movement had been reinforced by action in the courts. An accumulation of case law interprets the fiduciary duty of managers to corporate interests more narrowly as a duty to maximize the monetary of interests of shareholders. Even in cases where a corporation’s purpose statement aspires to broader goals, the possibility of being sued, and uncertainty whether consideration of other stakeholders is legally defensible, can have a discouraging effect on managers’ willingness to weigh other kinds of corporate interest – like their relationship with a community, or a well trained workforce.

In a Big Idea essay in Harvard Business Review in early 2010, Roger Martin looks back at the era of Shareholder Capitalism, compared to the era of Managerial Capitalism that preceded it, and finds shareholders haven’t actually done much better under the new regime.

In fact, he found managers delivered significantly better returns before the shareholder revolution than they did after it. He acknowledges if you fiddle with dates you can find a balance where performance was about the same, “but there is no sign shareholders did better when their interests were put first and foremost.”

[“The Age of Customer Capitalism,” Roger Martin, Harvard Business Review, January-February 2010]

Martin argues that’s because there are natural limits to shareholder value, which reflects the price shares fetch on an exchange. Stock price reflects the market’s expectations of future earnings. The best manager can only inspire expectations to rise so far before they become unrealistic. After a point, they must halt, or begin to drop. If the manager is clever, they won’t drop until the next guy’s watch.

When Jack Welch took the helm at GE in 1981, he was a vocal champion of the movement who put maximization of shareholder value above all else. And he delivered fabulous results. GE’s value was $13 billion when Welch became CEO; by the time of his retirement in 2001 it was $484 billion.

Martin says much of that growth was fueled by the expansion of GE Capital, which had been relatively insignificant before. GE Capital accounted for half GE’s earnings by the time Welch retired. Then it took such massive write-offs in the financial collapse that GE’s value dropped as low as $75 billion before beginning to climb more slowly – today it’s $219 billion, about half its value at Welch’s retirement.

Back in 1982, the year after Jack Welch stepped up at GE, Johnson and Johnson underwent its own tribulations. That was the year the Tylenol killer laced product with cyanide in some Chicago area stores. James Burke, the company’s CEO, was so aggressive about recalling every bottle of Tylenol, nationwide, that the business press marveled that the CEO of a publicly traded company could afford to act on principle so rashly. Tylenol represented a huge fraction of the firm’s revenues, and in the short term, the company’s profits and market value tanked.

Martin argues Burke’s bold action reflected the company’s purpose statement, and that it helped build consumer confidence in the brand in the long term. In 2009, Johnson and Johnson’s market capitalization was more than twice GE’s, at $167 billion; today it’s $191 billion.

Friedman’s essay on the social responsibility of business argued that if managers lost their focus on the bottom line, investors and customers would rebel, they’d take their business to more successful rivals. Now, 40 years later, a growing movement of investors and consumers seem to be protesting that shareholder capitalists got their interests wrong.

In fact, socially responsible investment funds have been on the rise for 30 years. According to the US Social Investment Forum, a member association for investors, the socially responsible investment movement now represents $3,74 trillion, or 11% of US assets under management. That includes assets of individuals and institutions whose managers screen for corporate responsibility, or practice shareholder advocacy, or fund “community investing,” lending in communities under served by traditional financial services. And it represents a 486% increase from 1995, when the Forum started tracking; compared to a 376% increase in US assets overall.

Upwards of 68 million US consumers prefer to make their purchases based on a sense of social and environmental responsibility, according to one study, conducted by the National Marketing Institute in 2008.

Earlier this year, the Wall Street Journal polled its online readers to measure their interest in locally sourced food. Thirty percent of respondents said their interest in buying local was strong, regardless of cost or convenience. Only 7% said they had no interest in their food’s provenance; the rest reported mild to significant interest, depending on price and convenience. The results seem weightier, considering whose readership was polled.

Businesses with social goals have also proliferated. One recent paper tallied the membership lists of business associations with sustainable goals, such as the Social Venture Network, GreenAmerica and the Business Alliance for Local Living Economies, and counted 65,000 businesses with $40 billion in revenues. But the paper goes on to argue that that the law still tilts toward profit maximization, and that tilt still exerts a “chilling effect” on directors, and their counsel. The sustainable business movement has been pressing states to create alternative corporate forms.

[“The Need and Rationale for the Benefit Corporation,” principle authors: William Clark and Larry Vranka; January 2012]

Back in the 1980s, when corporate buyouts were being used for plunderous effect, many states passed “constituency statutes,” giving corporate directors explicit permission to consider interests other than obtaining the highest price for shareholders in evaluating an acquisition bid. Illinois allows directors to consider the effect of their actions on employees, suppliers and customers of the corporation, as well as the communities in which they are located. But the Clark-Vranka paper argues even those permissions are not completely reassuring. There is too little case law interpreting what weight directors may give other constituents, much less how they might apply in contexts aside from a takeover bid.

Since 2010, seven states have enabled businesses to incorporate as Benefit Corporations, or B-Corps, which are required by statute to create benefits for society as well as for shareholders. Illinois is not one of them, but we do have a statute enabling low profit limited liability companies, or L3Cs.

L3Cs are designed to facilitate investment in for-profit ventures with limited returns, partly by attracting investments from charitable foundations. The idea is that the foundation would take on most of the risk, and less of the return, in order to create more attractive opportunities for other investors.

Normally, foundations can be slammed with penalties for jeopardizing their capital with risky investments. But they are allowed to make what are known as Program Related Investments (PRIs), as disbursements in line with their charitable goals. L3C statutes are designed to create an entity that would automatically qualify for “program related” rather than “jeopardy” investments, though the Treasury has been coy about promising to recognize them as a class.

All these machinations may make you wonder if the principle of our capitalist system is really to ensure all participants the freedom to make decisions about their own best interests. If it is just to defend one interest, the chase for riches, above all others, then maybe we have made an idol of wealth.

Next Thursday, December 6th, IIRON will be returning to the Federal Building for a noon rally to attract Senator Durbin’s attention. They’ll be asking him to promise to preserve the safety net for the elderly, and health care for the poor. They’ll ask him to avoid the fiscal cliff by taxing the rich.

It would be a modest increase, the rich can afford it. In fact, it’s really a return to a tax rate they’ve paid before without ruining their status, or slowing a surge in the economy. Milton Friedman didn’t want business to pay for social goals. But he did make the case that the right way to pay for such things would be to convince our representatives in government to levy a tax.


Photo: Light on Life Images

2 comments:

  1. Quite a good commentary, I must say.

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  2. Thanks for this analysis, Kristin! Good stuff.

    ReplyDelete