Most Valuable Payer
Has corporate America changed direction?
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Hey Trustees!
Last week, the Business Roundtable (BRT), a group of CEOs from major corporations across the U.S. economy, issued a statement announcing it now believes that executives should “lead their companies for the benefit of all stakeholders — customers, employees, suppliers, communities and shareholders.”
Since 1997, BRT has taken the position that a public corporation’s executives are first and foremost beholden to its owners — that is, shareholders — a philosophy called “shareholder primacy.” So, at least on paper, the announcement seemed to mark a major shift in corporate America’s thinking.
The reactions have been intense, with some supporting BRT’s new direction, some critical of it and others arguing it’s not really a new direction at all. That’s because the resulting debate cuts at the core of people’s economic and political beliefs and, in many cases, is one in which they have an enormous financial stake.
While BRT’s statement doesn’t directly mention the technology sector, its thinking reflects changing attitudes — among executives, consumers, employees, communities, shareholders and lawmakers — about how business leaders should behave, and those changes have often involved or been in response to the actions of tech companies. Take, for example, the Google employee walkouts, #DeleteUber and Amazon’s efforts to expand its presence in New York City. Additionally, this debate will significantly impact lawmakers’ approach to both technology and economic policy moving forward.
BRT’s statement touches on topics that are far too large to fully discuss here. Still, I want to unpack a few key underlying forces that seem to have motivated its pivot.
But first, some new developments in two stories that I discussed back in the first issue of Trusty:
Librexit
Article: Hannah Murphy + Shannon Bond / Financial Times
What happened: two original backers of Facebook’s cryptocurrency project, Libra, told FT reporters they were considering backing out, with another saying it didn’t want to support the project publicly for fear of attracting its own regulatory scrutiny.
Why it matters: while Facebook will develop the proposed currency, it also plans to share control with other financial and tech companies, each of which has pledged $10 million to get a seat at the table. However, the project has faced intense scrutiny from lawmakers in the U.S. and European Union since Facebook announced it, and this news suggests some backers may be getting cold feet.
What’s next: part of the draw of cryptocurrencies is that they’re decentralized — no central bank (or company) can screw over its currency’s users by inflating the price (see: Venezuela). Facebook’s third party backers, in theory, help it make the case that control over Libra is distributed, but that case could fall apart if backers begin fleeing the project.
Face the Bern
Article: Shirin Ghaffary / Recode
What happened: Bernie Sanders announced his plan to “ban the use of facial recognition software for policing” as part of a broader effort to reform the criminal justice system.
Why it matters: While Kamala Harris, Elizabeth Warren, and Cory Booker have all expressed criticism of law enforcement’s use of facial recognition technology, Sanders is the first Democratic primary candidate to take an official position in favor of an outright ban.
What’s next: it remains to be seen whether the announcement leads others to follow suit or merely sets Sanders apart from the field on this issue.
And now, let’s break down the Business Roundtable’s latest news...
Most Valuable Payer
Incent-sitive
If you’re a regular reader of Trusty, you’ve likely heard me talk before about the power of incentive structures. Here’s one way to define the concept:
Incentives aim to motivate groups of people to behave in certain ways by assigning value to those behaviors through punishments and/or rewards.
In an economic context, a company may offer its employees free dinner starting at 6 p.m. to encourage them to work later or a government may levy a tax on carbon emissions to discourage companies from harming the environment.
When I want to better understand any complicated system, I try to identify the strongest incentive acting on people within it. There may be exceptions, but that underlying incentive still offers a solid predictor of most people’s actions in most situations — and thus the system as a whole.
Why does that matter here?
At the most basic level, BRT’s statement is a reflection of an effort to change the incentive structure for corporate executives, investors and other individuals within the free-market system.
If you ain’t first, you’re last
BRT was founded in 1972. For its first 25 years, the group actually endorsed a similar incentive structure to the one it announced last week. Its 1981 “Statement on Corporate Responsibility” argued that:
“Balancing different constituent interests — in the context of both near-term and long-term effects — must be an integral part of the corporation’s decision-making and management process.”
Among those constituencies, BRT included employees, communities, society at large, suppliers and, lastly, shareholders. It wanted executives to take into account the short-term and long-term interests of each of those groups when making decisions. However, BRT also acknowledged that it would be “impossible to assure that all will be satisfied because competing claims may be mutually exclusive.” In other words, executives sometimes encounter zero-sum situations and must choose who wins and who loses.
Let’s imagine you’re an Amazon executive faced with a warehouse that has become problematically inefficient. Do you...
shutter the warehouse, hurting the local community and employees who had grown dependendent on those jobs but benefiting shareholders whose shares become more valuable as other investors flock to a company that just improved its margins?
automate the whole operation and pass along the benefits to consumers in the form of lower prices and shorter delivery times?
build a new, but expensive, carbon-neutral warehouse, valuing the long-term health of the environment over short-term profits?
During its early years, BRT didn’t issue guidance on which of those groups executives should prioritize. But, in 1997, it took a stand: shareholders come first, everyone else comes last. Rick Wartzman, director of the Drucker Institute’s KH Moon Center for a Functioning Society, described the move as:
A significant marker in the evolution of corporate America — both a reflection and reinforcement of an ideology that has thrilled investors, gripped executives, and knocked out a more enlightened form of capitalism that had emerged in the era after World War II.
So began the era of shareholder primacy.
What to expect when you’re expecting
Historically, investors in public companies have focused on one indicator above all others: quarterly earnings. Specifically, they judge a company’s quarterly numbers against analyst expectations: predictions of a company’s financial performance, issued by (typically) independent experts with intimate knowledge of that company and industry.
If a company “beats” expectations, it signals to investors that a company is doing well — or at least doing better than its current share price reflects. So, investors buy more shares. That increased demand drives up the price, meaning investors’ existing shares become worth more than they paid originally — that is, they make a return on their investment. This encourages executives to ensure their company beats expectations each quarter.
Clinton-era tax policies (among other factors) have also led executive compensation packages to become increasingly comprised of stock and bonuses, in what’s known as “performance pay.” Whereas most employees get paid the same hourly wage or salary regardless of how the company’s stock performs, executives make more or less depending on the share price.
As a result of these two factors, executives’ financial incentives have become closely intertwined with those of investors: the more they can beat analyst expectations, the more money they — and investors — make on their shares.
However, that preoccupation with short-term profits has often resulted in executives acting irresponsibly or corruptly — and with few consequences for cutting corners. Enron, the 2008 financial crisis, Wells Fargo, and Boeing offer just a few examples. As two professors wrote in Harvard Business Review in 2016:
“Studies have shown that paying CEOs based on stock options significantly increases the likelihood of earnings manipulations, shareholder lawsuits, and product safety problems. When people’s remuneration depends strongly on a financial measure, they are going to maximize their performance on that measure; no matter how.”
In light of the growing evidence that “short-termism” leads to negative financial results over time, it’s not surprising that 181 of the 188 chief executives belonging to BRT would want to realign the incentive structure toward creating long-term value. In fact, many companies — most notably Amazon — have already been approaching strategic decisions this way for years.
According to the data, that’s a smart business move.
Do executives also hope to regain the trust of a younger generation that feels more positive about socialism than capitalism; convince lawmakers there’s no need for stricter regulation of business; or give themselves some wiggle room when the next recession hits and share prices drop?
Likely, the answer is yes to all the above. And by taking those risks into account, executives are also doing what’s in the interest of their companies — by definition, another smart business move.
But there’s one aspect of this equation that we haven’t discussed so far. Suppose executives follow BRT’s guidance and the strategy works and these corporations do well financially. Who benefits as a result?
While corporations are considered people legally, they’re not literally. People manage, work at, work with, invest in and share the environment with these corporations, and executives have an enormous say in how the winnings are divided up among those stakeholders.
This is where much of the disagreement over the BRT statement starts.
Sharehoarders
The BRT statement comes at a time when both income and wealth inequality have reached levels not seen since the run-up to the Great Depression. This chart from the World Inequality Lab’s 2018 World Inequality Report shows how things have gotten worse in recent decades:
Share of US National Income Going to Top 1% and Bottom 50%, 1980–2016
Source: WID.world (2017)
This chart is essentially saying that, when the United States earns new money (i.e. national income), that economic pie is increasingly going to those at the top.
That’s on top of the current status quo, which many people already feel is massively out of balance. A 2011 survey showed how the economic pie is currently divided versus Americans’ perceived and ideal distributions:
Chart from Mother Jones
Proponents of shareholder primacy argue — as the Council of Institutional Investors did — that, because Americans own shares of companies through mutual funds, retirement accounts and pension plans, they’re shareholders too. So, when shareholders win, everyone does.
The problem is that not all shareholders are created equal. Economist Edward Wolff found that, in 2016:
“Despite the fact that almost half of all [U.S.] households owned stock shares either directly or indirectly through mutual funds, trusts, or various pension accounts, the richest 10 percent of households controlled 84 percent of the total value of these stocks.”
In other words, when executives prioritize making money for shareholders, they’re disproportionately making money for those at the top — themselves included. The stock market pays based on how much stock you hold, and wealthy Americans hold by far the most stock (while many at the bottom own little or none).
Opportunity for all
In 1975, BRT co-founder John Harper argued that:
“Business must take an active, aggressive role in developing understanding of and support for the free-market system by reestablishing the public’s confidence in business. Without question, we have our work cut out for us.”
While BRT’s latest statement seemed to indicate a change in its policy on who corporations should benefit, the organization did not abandon its support for free-market capitalism, opening the statement with:
“Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. We believe the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.”
However, Americans are increasingly skeptical that the free market — over which executives and major shareholders have disproportionate influence — is actually providing said opportunity for all. To quantify that skepticism:
Americans aged 18-29 now view socialism more positively than capitalism (Gallup)
55% of Americans believe poverty is a result of circumstances outside of an individual’s control, compared with 44% who attribute it to that person’s own efforts (American Enterprise Institute)
74% of Americans don’t believe CEOs are paid the correct amount relative to the average worker (Stanford GSB) — the current ratio is 278:1 (Economic Policy Institute)
Like in 1975, executives once again have their work cut out for them if they hope to regain the public’s trust.
The takeaway
It’s one thing for BRT to say that executives should consider the long-term interests of all stakeholders rather than automatically prioritizing shareholders’ short-term returns. But this seems to miss the thrust of the American public’s frustration. A better way to frame the debate might be: when push comes to shove, will executives make decisions that actually share the fruits of labor more equitably among those stakeholders?
Those decisions aren’t always easy, and there are undoubtedly gray areas around who will benefit from any given decision. But there are also cases where it seems more clear who the winners and losers will be. Here are a few examples:
When the GOP tax bill lowered corporate tax rates, companies claimed workers would benefit because executives would raise wages. Instead, most companies spent that money on stock buybacks, which disproportionately benefit stockholders (i.e. wealthy individuals).
Tech and media companies lobbied against a bill that would bring transparency to the gender pay gap.
Trade groups representing major corporations have lobbied to maintain tax havens, which are used disproportionately by the ultra-wealthy to evade taxes.
So, if the 181 executives who signed onto the BRT statement (who, it’s worth noting, are overwhelmingly white and male) did so simply because they think this will further enrich themselves and top shareholders relative to other groups, it’s unlikely they’ll reverse their companies’ policies or lobbying stances on issues that might make capital markets more equitable.
But, if their aim is truly to address the concerns of the American public, which appear to be more centered on the distribution of wealth and income, then we should look for executives to take very different stands than they have in the past. Anand Giridharadas, author of Winner Take All, offered a few examples of where we might hope to see those reversals:
In many cases, this would require executives to act against their own personal financial interests — in other words, to go against the strongest incentive in the system of capitalism. Whether they will remains to be seen.
Tech Tip of the Week
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Thanks for reading this week’s issue! Trusty will be off next week for the Labor Day holiday, but tune in the following week as I break down the 2020 Democratic primary candidates’ positions on tech policy.
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