Can Capitalists Really Bring Down Capitalism? A New York Times writer asked that question earlier this year, as accounting scandals piled up at major U.S. companies. No, he concluded, probably not. A few rotten apples won’t contaminate the entire orchard, the markets will eventually sort the good from the bad, and in due time, the world will go on as before.
Not everyone is so complacent. Markets depend on rules and laws, but those rules and laws depend on truth and trust. Hide the truth or destroy trust and the game becomes so unreliable that no one wants to play. Markets will empty and stock prices will collapse, as ordinary people look for other places to put their money—in their homes, perhaps, or under their beds.
Capitalism’s great virtue – that it provides a way to use society’s savings to create wealth – will be lost. So we will become increasingly dependent on government to create our wealth, something they have always been clearly bad at.
Such extremes may have seemed laughable a few years ago when the triumph of American-style capitalism seemed self-evident, but no one should be laughing now. In recent scandals, truth was sacrificed for expediency and necessity, as companies saw it, to ensure that profits were on target.
John May, a stock analyst at the US Investor Service, pointed out that the pro forma earnings announcements of the top 100 NASDAQ companies in the first nine months of 2001 inflated actual audited profits by $100 billion. Now it seems that even audited accounts often made things look better than they really were.
Trust, too, is fragile. Like a piece of china, once cracked it is never the same. And people’s faith in business and those who lead it is crumbling today. Many find that executives no longer run their companies for the benefit of customers or their shareholders and employees, but rather for their personal ambitions and financial gain.
A Gallup poll conducted earlier this year found that 90% of Americans felt that the people who run corporations could not be trusted to protect the interests of their employees, and only 18% thought that corporations cared a great deal about their shareholders. Forty-three percent believed that senior executives were only in it for themselves. In Britain, according to another survey, the figure was 95%.
what went wrong It is tempting to blame the people at the top. Keynes once wrote, “Capitalism is the astonishing belief that the worst man will do the worst for the greatest good of all.” Keynes was exaggerating. Personal greed, insufficient scrutiny of corporate affairs, insensitivity or indifference to public opinion: these charges can be leveled against some business leaders, but few, fortunately, have been found guilty of willful fraud or wickedness. They are just playing the game by new rules.
In the current Anglo-American version of stock market capitalism, the criterion for success is shareholder value, expressed by the company’s share price. There are many ways to influence share prices, one of which is to increase productivity and long-term profitability. Cutting or postponing costs that are geared for the future rather than the present will increase profits immediately, even if they cause long-term losses. Buying and selling businesses is another favorable strategy.
It’s a faster way to grow your balance sheet and share price than relying on organic growth, and it can be more interesting for those at the top. The fact that most mergers and acquisitions ultimately do not add value has not deterred many executives from trying.
One consequence of share price obsession is the inevitable shortening of horizons. Paul Kennedy is not alone in believing that companies are mortgaging their futures in exchange for the current high stock prices, but he may be optimistic about the end of the obsession with shareholder value.
Stock options, the new favorite child of stock market capitalism, must also shoulder a large part of the blame. While only 2% of executive pay in the United States was tied to stock options in 1980, it is now believed to be over 60%. Officials, not unnaturally, want to identify their options as soon as possible, rather than relying on the actions of their successors. Stock options have also gained new popularity in Europe as more and more companies go public. However, for many Europeans, grossly undervalued stock options are just another way to allow executives to steal from their companies and their shareholders.
Europeans raise their eyebrows, sometimes with envy but more often with indignation, at the level of executive pay under stock market capitalism. Reports that US CEOs earn 400 times the wages of their lowest-paid workers make a mockery of Plato’s ideal, which admittedly, in a small and simple world, no individual should be worth more than four times as much. Why should business executives be so financially rewarded than those who serve society in all other professions? The suspicion that, rightly or wrongly, business takes care of itself before taking care of others, only increases latent mistrust.
Europeans are looking at America with a mixture of envy and fear. They admire dynamism, entrepreneurial energy, and insistence on the right of everyone to chart their own lives. But they worry now, as they watch their own stock market go downhill on Wall Street, that the flaws in the American model of capitalism are contagious.
America’s disease isn’t just a matter of questionable personal ethics or a few rogue companies raking in odd billions. The entire commercial culture of the country must have been distorted. It was the culture that made America happy for a generation, it was the culture that declared the market king, that always put the shareholder first, and that business was the main engine of progress and should therefore take precedence in policy decisions. It was an overarching doctrine that simplified life with its grassroots theory and infected Britain in the Thatcher era. It certainly revived the entrepreneurial spirit in that country, but it also contributed to the decline of civil society and less attention and money to non-commercial sectors such as health and education.
Continental Europe was always less enamored with the American model. Many of the assumed benefits of European citizenship had no place in stock market capitalism – free health care and quality education for all, housing for the disadvantaged and guarantees of old age, sickness or a reasonable standard of living despite unemployment, a lack of dynamism in Europe across the Atlantic, a sclerotic economy mired in regulation and accusations of dull management. started doing and started to catch the way of American business in the continent as well. Now, after a series of its own examples of skullduggery at the top in Europe and some high-profile corporate collapses due to over-ambitious acquisition strategies,
During the boom years of the 1990s America often created value where none existed, with companies bidding for market capitalization at 64 times earnings or more. And that is far from the country’s only problem. With the nation’s debt owed to foreigners, the level of US consumer debt may not be sustainable. This undermines confidence in the balance sheets and boards of directors of some large US corporations, and casts doubt on the entire system of converting citizens’ savings into productive investments. Europe is afraid of this contagion.
Capitalist fundamentalism may have lost its luster, but there is an urgent need to address its flaws while retaining the energy generated by the old model. Better and stricter regulation would help, as would a clear separation of auditing from consulting. Corporate governance will now be taken more seriously by all concerned, accountability will be more clearly defined, penalties will be clarified and watchdogs will be appointed. But these will be ointments on open sores. They will not cure the disease at the root of commercial culture.
We cannot escape the basic question of who and what is business for? The answer seemed obvious once, but not anymore. Business terms have changed. Ownership has been replaced by investment, and the company’s assets are growing not in its buildings and machinery, but in its people. In light of this transformation, we need to rethink our assumptions about business purpose. And as we do so, we should ask whether American business can learn something from Europe, just as Europeans have learned valuable lessons from the dynamics of Americans.
Both sides of the Atlantic would agree that, first, there is a clear and important need to meet the expectations of the company’s theoretical owners: the shareholders. However, it would be more accurate to call most of them investors, maybe even gamblers. They have no pride of ownership or responsibility and frankly are just in it for the money. Still, if management fails to meet their financial hopes, the share price will fall, exposing the company to unwanted predators and making it more difficult to raise new finance.
But to turn stakeholder needs into an objective is to be guilty of a logical fallacy, missing a necessary condition of sufficiency. One must eat to live; Food is a necessary condition of life. But if we live mainly to eat, making food the sufficient or sole purpose of life, we will become obese. The purpose of business, in other words, is not to make a profit, full stop. It is to make a profit so that the business can do something more or better. That “something” becomes the true justification for business. The owners know this. Investors need not worry.
To many, these may sound like words. Not so. It is a moral issue. To miss the last resort is to turn on oneself, which St. Augustine called the greatest sin. Deep down, skepticism about capitalism is rooted in the feeling that its instruments, corporations, are immoral because they have no other motive than themselves. To assume this may do a great injustice to many companies, but they have let themselves down with their own rhetoric and behavior. It is salutary to ask of any institution, “If it did not exist, would we invent it?” “Only if it can do something better or more useful than anyone else” would have to be the answer, and profit would be a means to that greater end.
Those who finance are not the financiers of the company but its rightful owners, an idea that dates back to the early days of business, when the financier was the real owner and usually the chief executive. A second and related hangover from the past is the idea that the company is subject to the laws of property and ownership. This was true two centuries ago, when corporate law originated and a company consisted of a set of physical assets.
Now when a company’s value lies largely in its intellectual property, its brands and patents, and the skills and experience of its employees, it seems unrealistic to treat these things as the property of financiers, to be disposed of at will. It may still be the law, but it doesn’t seem to do justice. sure,
It was bad. By law and in the accounts, the company’s employees are considered assets of the owners and are recorded as expenses and not as assets. This is absolutely reprehensible. Expenses are things to be minimized, assets are things to be preserved and increased. Business language and solutions need to be reversed. A good business is a community with a purpose, and a community is not something that is “owned”.
A community has members and those members have certain rights, including the right to vote or express their opinion on key issues. It is ironic that countries that boast so proudly of their democratic principles derive their wealth from institutions that are undesirably undemocratic, in which all serious power rests with outsiders and internal power is exercised by a dictatorship or, at best, an oligarchy.
Corporate law in both the US and UK is out of date. It no longer fits the reality of business in the knowledge economy. Perhaps they did not even fit the profession in the industrial age. In 1944, Lord Eustace Percy of Britain said: “Here lies the most urgent challenge to political invention ever presented to a statesman or a jurist. The human organization which actually produces and distributes wealth, the association of workers, managers, technicians and directors, is not an organization recognized by law. A statutory association – an association of shareholders, creditors and directors – is unable to produce or distribute and is not required by law to perform these functions.
We have to legislate real association and take away meaningless privileges from imaginary ones. ” Nearly 60 years later, European management writer Ari de Geus argued that companies die because their managers focus on the economic activity of producing goods and services and forget that the true nature of their organization is a community of people. It seems that nothing has changed.
Mainland European countries, however, have always considered the corporation to be a community whose members have legal rights, for example, in Germany, half of the seats on the supervisory board, minus one, the right of employees. Several safeguards against dismissal without cause and a range of statutory benefits.
These powers certainly limit management flexibility, but they help develop a sense of community, a sense of security that enables innovation and experimentation, and loyalty and commitment that see the company through bad times. Shareholders are seen as trustees of wealth inherited from the past. It is their duty to preserve and if possible enhance that wealth so that it can be passed on to future generations.
Such an approach is easy for companies on the continent. Their more closed systems of ownership and greater reliance on long-term bank finance protect them from predatory and short-term profit pressures. In many cases, company shares are concentrated in the hands of other companies, banks or family networks, with private shareholders owning only a small percentage.
Pension funds are also not as large or as powerful as in the US and UK, with mostly European companies keeping pensions under their own control, using the funds as working capital. Ownership and governance structures differ from country to country, but in general it can be said that the cult of equality is not as prominent in mainland Europe. As a result, hostile takeovers are difficult and rare.
Countries are based on their history. The Anglo-Saxon nations could not adopt either of the European models despite their desire. However, both cultures need to restore confidence in the wealth-creating possibilities of capitalism and its tools, the corporation. Some things need to change in both cultures.
More honesty and realism in the reporting of results will help in the beginning. But when so many of a company’s assets are now invisible, and therefore uncountable, and when the web of alliances, joint ventures, and subcontracting partnerships is so complex, a simple financial picture of a large business will never be possible. Find a number that sums them all up.
However, if this new requirement reduces the obligation to tell the truth, it may have some positive effects. If a company takes seriously the idea of itself as a wealth-creating community with members rather than employees, it would only make sense to have members validate the results of their work before presenting them to financiers, who would, perhaps, have more faith in the accuracy of those statements. And if the stock-option cult is decimated by a stock market decline and companies decide to reward their key people with a share of the profits, those members are more likely to take an interest in the truth. The numbers who contribute their skills as well as those who contribute their money feel that dividends should be paid. Most of the latter, after all,
It may take some time for such changes to take place. Already, people whose personal assets are highly valued—bankers, brokers, movie actors, sports stars, and the like—make profit shares or bonuses a condition of their employment. Others, such as authors, derive all of their compensation from income streams. This form of performance-related pay, in which the contribution of a single member or group can be recognized, is likely to increase with the bargaining power of key talent.
We should not overlook the examples of organizations such as sports teams and publishing houses, whose success has always been tied to the talents of individuals, and who have struggled for years, if not centuries, to figure out how best to share both. The reward of risk and innovative work. In the growing world of talent business,
Some small European corporations already distribute a fixed proportion of after-tax profits to workers, and these payments become a very tangible expression of member rights. As the practice expands, it makes sense to discuss strategies and plans in broad outline with member representatives so that they can share responsibility for their future earnings. Democracy, in a way, through salary packets, would have brought a hope, more understanding, more commitment and more contribution.
Such changes in compensation may help offset capitalism’s democratic deficit, but they will not repair the image of business in the wider community. In fact they may seem to be spreading the creed of selfishness a little too widely. Two more things need to happen to cure capitalism’s current ills – and there are signs that these changes are already underway.
The ancient Hippocratic Oath that many doctors take upon graduation includes the command to do no harm. Today’s anti-globalization opponents claim that global businesses not only do harm, but that the harm outweighs the good. If these charges are to be refuted, and if business is to restore its reputation as the friend, not the enemy, of progress worldwide, the leaders of those companies must bind themselves to the same oath.
Doing no harm goes beyond meeting legal requirements regarding the environment, employment conditions, community relations and ethics. Law always follows best practice. Business needs to take initiatives in areas such as environmental and social sustainability rather than being pushed into perpetual defensiveness.
John Brown, CEO of BP, the oil giant, is one person who is willing to do some much needed advocacy. In a public lecture broadcast on BBC radio in 2000, he said that the business community is not against sustainable development but is necessary to provide sustainability, because only business can produce technological innovations and provide the means for real progress.
Front and business needs a sustainable planet for its own existence, because some companies are short term entities; They want repeat business for decades. Many other business leaders now agree with Brown and are beginning to shape their actions to fit their words. Some have found that there is money to be made from creating products and services essential to sustainability.
Unfortunately, the majority of companies still see concepts like sustainability and social responsibility as businesses only the rich can afford. For them, business is business and should remain so. If society wants to place more restrictions on the way businesses operate, they reason, they can pass more laws and enforce more regulations. Such a minimalist and legalistic approach looks like a potential business destroyer that needs to be reined in. And because of the legal time gap, the reins can always seem too loose.
In the knowledge economy, sustainability must extend to the human as well as the environmental level. Many people have seen their ability to balance work with the rest of their lives continue to deteriorate, as they succumb to the stress of a long-hours culture. An executive life, some worry, is becoming socially unstable. We are at risk of companies becoming the modern equivalent of monks, who give up everything for their calling. If contemporary business, with its foundation in human assets, is to survive, it will have to find better ways to protect people from the demands of jobs.
Ignoring the environment can alienate customers, but ignoring people’s lives can alienate key members of the workforce. Here, again, it helps companies see themselves as communities whose members have individual needs as well as individual skills and talents. They are not anonymous human resources.
The European example—with its five to seven weeks of annual leave, legally mandated parental leave for fathers and mothers together, the increasing use of sabbaticals for senior executives, and work weeks of less than 40 hours—helps promote the idea that long work is not. Essentially good work, and the organization serves its own interests when it protects the overzealous from itself.
Many French companies were surprised that productivity increased when their last government required them to limit the working week to an average of 35 hours (the current government has abolished this requirement). Europe’s approach is a manifestation of the concept of the organization as a community. Another is the growing practice of customizing workers’ contracts and development plans.
More corporate democracy and better corporate behavior will go a long way to improving the current business culture in the eyes of the public, but unless these changes are accompanied by a new vision of business purpose, they will be seen as palliative. It is time to raise our vision above mere pragmatism. Article 14, Section 2 of the German Constitution states, “Property imposes duties. It should also be used for public welfare.
” There is no such clause in the United States Constitution, but the sentiment is echoed in the philosophy of some companies. Dave Packard once said, “I think a lot of people wrongly assume that a company exists only to make money. While this is an important consequence of a company’s existence, we have to dig deeper and find the real reasons for our existence. While we investigate this,
The contribution ethic has always been a strong driving force. Not enough to survive, even to prosper. We aspire to leave footprints in the sands of time, and if we can do that with the help and company of others, so much the better. We must connect with a cause to give purpose to our lives. Pursuing a cause need not be the prerogative of the charity and non-profit sector. Nor does the goal of improving the world make a business a social enterprise.
By creating new products, spreading technology and increasing productivity, increasing quality and improving services, business has always been an active factor in progress. It helps make the good things in life accessible and affordable to more people. The process is driven by competition and the need to provide adequate returns to those who risk their money and their careers, but this in itself is a noble cause. We should do more of that. Like charitable organizations, we must measure success in terms of results for others as well as ourselves.
The son of pharmaceutical company founder George W. Merck, always insisted that medicine is for patients, not for profit. In 1987, with this core value in mind, his successors decided to provide a drug called Mectizan, which cures river blindness, a scourge in many developing countries. Shareholders were probably not consulted, but if they were, many would have been proud to be associated with such a gesture.
Business can’t always afford to be so generous to many people, but doing well can make a reasonable profit. For example, you can earn money by serving the poor as well as the rich. As CK Prahlad and Alan Hammond recently pointed out in this journal, there is a huge neglected market among the billion poor in the developing world.
Companies such as Unilever and Citicorp are beginning to adapt their technology to enter this market. Unilever can now deliver ice cream in India for just two cents because they have rethought refrigeration technology. Citicorp can now provide financial services to people, even in India, who only have $25 to invest, through re-thinking technology. In both cases the companies make money, but the driving force is the need to serve the neglected customer. Profits often come from progress.
There are more stories of such savvy business in both American and European companies, but they remain a minority. Until they become the norm, capitalism will be seen as a rich man’s game, serving mainly himself and his agents. High-minded talent can get away with it, and customers abandon it. At worst, democratic pressures can force governments to shackle corporations, limiting their freedom and regulating the smallest details of their operations. And we will all be losers.