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Is corporate governance a first order cause of the current malaise?

Gordon, J. N.

The United States, indeed much of the OECD, is facing a ‘Triad’ of three salient problems: significant inequality; economic insecurity; and slow economic growth. In the search for causes and remedies, some have identified the governance of large public corporations as a first order cause. 

For example, US Democrat Senator Elizabeth Warren has recently proposed an “Accountable Capitalism Act” based on the view that relentless maximisation of shareholder value has caused many of America’s fundamental economic problems. The remedy is a corporate governance solution involving co-determination for all companies with revenues over $1 billion, with at least 40% of the directors selected by employees. 

This paper argues there are important corporate governance elements in inequality and economic insecurity but not in slow economic growth. It offers a board reform that could enhance financial inclusion and could perhaps lead to some additional growth. Its most far-reaching proposal calls for a new government-private sector “match” in human capital renewal.

The most important consequence of corporate governance changes since the 1980s has been a risk-shift in the adjustment costs of economic change from shareholders to employees. Shareholders have had access to effective vehicles for diversification, but employees’ firm-specific investments are harder to diversify. Firms have reduced job security for employees and shrunk guaranteed pension payouts tied to employment-based wage levels.

The principal reason for these shifts is an increasingly competitive environment with global product markets and capital markets. Pressures also come from domestic disrupters which have up-ended retail distribution networks of goods, entertainment, and media. These forces have forced adaptations within many firms on cycles that are shorter than the career-span of most employees, leaving few companies with the capacity to provide the “thick” insurance packages conducive to human well-being.   

The paper proposes a new form of subsidy or “public endowment” between the government and private sector, with lifetime advanced training and retraining to give employees the freedom to choose careers and life plans, and provide an initial allocation of bargaining power. 

This ‘insurance’ may help address the risk of skills obsolescence, a modern form of dis-ability that calls out for socialization. Risk diversification techniques have given shareholders protection against firm-specific risks. Owners benefit from growth in the economy as a whole, irrespective of whether particular firms are diminished or even survive. Employees simply cannot effectively diversify against these risks.

The author does not call for redistribution, or simply an effort to assure that gains that increase the whole pie do not result in smaller slices for many. Rather, a long-term strategy is needed to address adverse demographic trends and the increasing mismatch between tax receipts and the cost of social benefits.

Enhancing on-going productive capacity will enlarge the labour force. The classic defence of downsizing and layoffs is not that it increases shareholder value, but that it frees up scarce resources. Given the specialized training that many good jobs require, a government-backed life-time re-training offers the promise of high dividends.   

There also need for innovations in the board. For example, the present board model is not well-suited for companies whose projects and business strategy may be difficult for equity market analysts to evaluate. Independent directors may lack the skills to serve as credible monitors of management’s strategy and operational performance. 

This governance shortfall may provide an economic reason both for high levels of executive compensation and for the growth of the private company equity market relative to the public equity market. The development of a new, optional board 3.0 governance model consisting of “thickly informed” directors with deep commitments, will be more credible with investors. It would be optional for firms whose business model justified the extra monitoring costs. A board 3.0 option would make public markets more inviting, which would enhance financial inclusion and growth in public companies. By contrast, mandatory co-determination for the boards of all US companies is likely to degrade US economic performance.

The United States, indeed much of the OECD, is facing a ‘Triad’ of three salient problems: significant inequality; economic insecurity; and slow economic growth.  In the search for causes and remedies, some have identified the governance of large public corporations as a first order cause.   

For example, US Democrat Senator Elizabeth Warren has recently proposed an “Accountable Capitalism Act” based on the view that relentless maximisation of shareholder value has caused many of America’s fundamental economic problems. The remedy is a corporate governance solution involving co-determination for all companies with revenues over $1 billion, with at least 40% of the directors selected by employees.  

This paper argues there are important corporate governance elements in inequality and economic insecurity but not in slow economic growth.   It offers a board reform that could enhance financial inclusion and could perhaps lead to some additional growth.  It’s most far-reaching proposal calls for a new government-private sector “match” in human capital renewal.

The most important consequence of corporate governance changes since the 1980s has been a risk-shift in the adjustment costs of economic change from shareholders to employees. Shareholders have had access to effective vehicles for diversification, but employees’ firm-specific investments are harder to diversify.  Firms have reduced job security for employees and shrunk guaranteed pension payouts tied to employment-based wage levels.

The principal reason for these shifts is an increasingly competitive environment with global product markets and capital markets. Pressures also come from domestic disrupters which have up-ended retail distribution networks of goods, entertainment, and media. These forces have forced adaptations within many firms on cycles that are shorter than the career-span of most employees, leaving few companies with the capacity to provide the “thick” insurance packages conducive to human well-being.   

The paper proposes a new form of subsidy or “public endowment” between the government and private sector, with lifetime advanced training and retraining to give employees the freedom to choose careers and life plans, and provide an initial allocation of bargaining power. 

This ‘insurance’ may help address the risk of skills obsolescence, a modern form of dis-ability that calls out for socialization.  Risk diversification techniques have given shareholders protection against firm-specific risks. Owners benefit from growth in the economy as a whole, irrespective of whether particular firms are diminished or even survive.  Employees simply cannot effectively diversify against these risks.

The author does not call for redistribution, or simply an effort to assure that gains that increase the whole pie do not result in smaller slices for many.  Rather, a long-term strategy is needed to address adverse demographic trends and the increasing mismatch between tax receipts and the cost of social benefits.

Enhancing on-going productive capacity will enlarge the labour force.  The classic defence of downsizing and layoffs is not that it increases shareholder value, but that it frees up scarce resources. Given the specialized training that many good jobs require, a government-backed life-time re-training offers the promise of high dividends.    

There also need for innovations in the Board.  For example, the present Board model is not well-suited for companies whose projects and business strategy may be difficult for equity market analysts to evaluate. Independent directors may lack the skills to serve as credible monitors of management’s strategy and operational performance. 

This governance shortfall may provide an economic reason both for high levels of executive compensation and for the growth of the private company equity market relative to the public equity market.  The development of a new, optional Board 3.0 governance model consisting of “thickly informed” directors with deep commitments, will be more credible with investors. It would be optional for firms whose business model justified the extra monitoring costs.  A Board 3.0 option would make public markets more inviting, which would enhance financial inclusion and growth in public companies. By contrast,  mandatory co-determination for the boards of all US companies is likely to degrade US economic performance.

 

For further information please contact the Project Manager on FOTC@thebritishacademy.ac.uk.

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