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Hypothesis #9—Agents of Change: Institutional investors have the
fiduciary responsibility and the democratic power to democratize capitalism by
reforming company practices and government policies.
Institutional investors
could move the American economy towards democratic capitalism in a surprisingly
short time by using means that already exist, namely by influencing the policies
of companies that are largely owned by working people, and by bringing to bear
on both companies and the government the democratic voting power that this
ownership of shares represents.
During the last quarter
of the twentieth century, a new wage-earner capitalism emerged, called either
“pension fund socialism” or “employee capitalism” by Peter Drucker, but I prefer
to call it “democratic capitalism.” This new capitalism is a realization of Marx
and Mill’s visions of a synergistic relationship between labor and capital, a
development that has come about not through radical restructure or political
revolution but through evolutionary means.
This new relationship
between capital and labor was expedited by ERISA, a new federal law passed in
1974, that mandated the funding of future pension benefits out of current
corporate earnings. The flow of funds started by this law increased with the
401(K) law that encouraged savings from pre-tax dollars. As a result of these
new laws, the ownership of American public companies has shifted towards wage
earners. Pension funds, mutual funds, insurance companies, banks, foundations,
and university endowments increased the amount of money to be managed from under
a half-billion 1970, to $8.5 trillion by 2001. Ownership of public companies by
wage earners grew from under 15% to over 50%.
The explosive growth of
wage-earner capitalism should have diffused economic and political power.
Instead of diffusion, however, wealth and political influence became more
concentrated. Instead of becoming more accountable for the long-term financial
and social benefits of their majority owners, most of the wage earners’ money
managers supported ultra-capitalism, attracted by its presumed better short-term
results. Ultra-capitalism came to dominate the economy because the enormous flow
of new cash into the stock market gave new power to reward or punish CEOs based
on how closely they followed Wall Street dictates (see chapter 8). If this
observation sounds like a lament by an ex-CEO, consider the words of an
ex-banker:
| Corporate CEOs got the message. Forecast 20% growth and
20% return—or fake it. Does this provide any clue as to why the fictitious
earnings of Enron, WorldCom and the like have become so widespread? Either
CEOs and auditors play ball, or Wall Street has them replaced with more
“performance oriented” players. |
Wall Street’s new power
came from an extraordinary contradiction in which more democratic ownership
resulted in more concentration of wealth and a less socially sensitive
capitalism. This contradiction can be traced to the egregious government
mistakes that caused the excessive volatility and liquidity that launched
ultra-capitalism (see chapter 7 and hypothesis #4). Instead of using the growing
democratic power to counteract the lobby power of ultra-capitalism,
institutional investors in most cases supported ultra-capitalism.
The Congressional
designers of ERISA failed to analyze alternative uses of this new flow of
democratic capital. In the early 1970s, when ERISA was being designed, Senator
Russell Long (D., Louisiana) and his committee proposed, and Congress passed,
new tax laws that encouraged employee ownership through ESOPs (Employee Stock
Ownership Plans). A magic opportunity was missed to design new financial
instruments to invest tax favored ERISA funds in the job-growth economy, which
would have resulted in large dividends, long-term appreciation, and security.
The government, instead of responding to the needs of the people and recycling
the capital into economic growth, responded to the Wall Street lobbyists and
sent the money to the stock market where it pushed stock prices to artificially
high levels in the bubble economy. A new chapter in the book of making money
from special government privileges was being written: Since the beginning of the
Industrial Revolution, finance capitalism had exploited the workers’ labor; now
in the early stages of the Information Age revolution, ultra-capitalism was
learning how to exploit the workers’ capital!
We need to listen to, and
act upon, the insight of Peter F. Drucker, who skewered ultra-capitalism as
follows:
| What emerged from this frantic decade [hostile takeovers,
leveraged buy-outs, downsizing, et al.] was a redefinition of the purpose
and rationale of big business and the function of management. Instead of
being managed in the best balanced interests of stakeholders, corporations
were now to be managed exclusively to “maximize shareholder value.” This
will not work, either. It forces the corporation to be managed for the
shortest term, but that means damaging, if not destroying, the
wealth-producing capacity of the business. It means decline and finally
swift decline. Long-term results cannot be achieved by piling short-term
results on short-term results. They should be achieved by balancing
short-term and long-term needs and objectives. Furthermore, managing a
business exclusively for the shareholders alienates the very people on
whose motivation and dedication the modern business depends: The knowledge
workers. An engineer will not be motivated to work to make a speculator
rich. |
The alienation that Marx
identified as the impediment to greater and more widely distributed wealth,
should have disappeared with the advent of the Information Age and wage-earner
capitalism. An industrial environment that releases the cognitive power of
people is mutually exclusive with alienation because the working class (“labor”)
is now also the owner class (capitalists), as well as the bosses (“management”).
As Drucker pointed out, however, the alienation will persist as long as
ultra-capitalism prevails.
I argue, therefore, that
institutional investors ought to examine and accept the hypothesis that
democratic capitalism maximizes long-term shareholder value because the system
that maximizes the innovation and productivity of each will add up to the
maximum profits to be shared by all. Exclusive concentration on short-term
profits is eventually self-defeating because it destroys the motivation upon
which the long-term success of any enterprise depends. Drucker made this point
many years before the 2002 crash of ultra-capitalism, and so did I!
The first priority of the
institutional investors should be to put pressure on companies to invest capital
surplus in more growth and to pay the stockholders large dividends, rather than
wasting surplus on non-strategic acquisitions and stock buy-backs. At the same
time, institutional investors can become the antidote to Wall Street lobby power
by lobbying changes in the tax laws for tax-free dividends and tax-free capital
gains for low- and middle-income shareholders. This simple change would have the
benefit of recycling surplus into stronger economic growth, and it would also
build momentum towards greater worker-ownership plans and the full benefits of
democratic capitalism. Most wage earners would be pleased to put their money
into a plan that provided not only secure long-term appreciation but also large
annual dividends that could be spent or reinvested in more equity, both
stimulants to still greater economic growth.
Another change that
institutional investors could implement is to measure corporations by making
them accountable for management’s predictions for sales growth, cash flow, and
profits over a three-year period. Adoption of this measurement and
accountability combined with large, tax-free dividends, with no capital-gains
tax for the wage earner, control of the feeding frenzy in executive
compensation, and a change of auditors every five years (see chapter 9) would
move the economy towards the stronger, steadier growth of democratic capitalism,
and of away from the boom/bust cycle of ultra-capitalism that has done such
unnecessary economic and social damage.
After ultra-capitalism is
purged from the system in part by the voting power of the institutional
investors, and after democratic capitalism receives support from the American
culture and political structure, it will spread wealth throughout the world and
unite people in economic common purpose. The visible improvement in the lives of
hundreds of millions of people will then set the stage for a steady reduction
and eventual elimination of violence among people and nations. The United States
is positioned to lead towards this economic common purpose and its promise of
global social progress. That ideal prospect, including cooperation with the
United Nations in its mission to substitute law for violence, is the focus of
hypothesis #10.
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