Marjorie Kelly’s The Divine Right of Capital is one of those mind-bending books that deserves to be read by a large audience. It tells a behind-the-scenes story of capitalism that we don’t often hear; one that shows how our preoccupation with shareholder “primacy” distorts capitalism in ways that generate serious harm for society and the planet. Kelly shows how our current problems with capitalism are not necessarily intrinsic to market forces or even capitalism itself, but to the particular version of it that we have today.
In this brave book, Kelly highlights the historical roots of our current system and its ties to feudalism, and then lays out a set of prescriptions for rethinking how corporations actually could work.
To help me digest this important book, I summarized each chapter, and in the hope of encouraging readers of this blog to read the book yourselves, I’m sharing these chapter-by-chapter overviews here on my blog – with the permission of the author.
Chapter 1: The Sacred Texts
The Principle of Worldview:
In the worldview of corporate financial statements, the aim is to pay stockholders as much as possible, and employees as little as possible.
All societies have world views, the “unconscious mental habits” we use to make sense of the world – so deep, so pervasive as to be invisible. Aristocratic society in feudal times based its membership on property ownership. Back then, it was land. Today it’s wealth, or financial assets. Throughout the book, Kelly draws a connection between feudal aristocracy and our modern aristocracy, the wealthy shareholder.
Today, our worldview has a bias – that stockholders are to be paid as much as possible, while employees are to be paid as little as possible. “Income for one group is declared good, and income for another group is declared bad.” Nowhere is this more clear than in our financial statements. Here’s the basic formula you’ll find on financial statements:
Capital Income + Retained earnings = Revenue – (Employee income + Cost of materials)
Kelly uses some simple algebra to show that this formula could just as easily be re-written as:
Employee income + Retained earnings = Revenue – (Capital income + Cost of materials)
In other words, the company could just as easily be optimized to maximize employee income. All it takes is a perspective shift. Kelly then talks about the fact that employees don’t even show up on the corporate balance sheet. That’s because employees are seen as an expense, not an asset, despite the common phrase “our employees are our greatest assets.” This is because employees are essentially treated as “outsiders” in the narrative of corporate financial statements. Kelly proposes shifting this, so that labor and capital both become considered “insiders” – full-fledged members of the corporate society, each with a claim on its profits.
The last section in chapter 1 covers how companies externalize costs and how that translates into social and environmental degradation.
Chapter 2: Lords of the Earth
The Principle of Privilege:
Stockholders claim wealth they do little to create, much as nobles claimed privilege they did not earn.
“If equality under the law is the hallmark of democracy, privilege sanctioned by law is the hallmark of aristocracy.” Just as feudal lords extracted wealth from serfs on their lands, today’s aristocracy does the same with corporations. Privilege – the right of the aristocracy – is “a right to income detached from productivity.” After the fall of the Roman empire, the feudal lords emerged as a source of order. They played a valuable role in bringing social stability, but over time this role and its associated responsibilities faded – and the benefits did not. The same has happened with stockholders today.
Look closely at the stock market and it betrays some fundamental assumptions about the creation of wealth in today’s markets. Only 1% of the total value of equity on Wall Street is actual investment in the sense of new money going into firms. The remaining 99% is speculation – people buying and selling existing stock in the aftermarket of equity. In the preface of the book, Kelly makes the good analogy of buying a car. When you buy a new car, the money goes to Ford. But when you buy a used car, it all goes to the previous car owner – Ford doesn’t get a cent. Stocks are the same – and the vast majority of money sloshing around is just trading hands and not actually being invested in firms.
What’s more, companies go to great pains to buy back stock, to take it off the market in order to shore up their stock price. When you take these stock buybacks into account, not only does all that 1% of new investment disappear, it actually goes negative. That’s right, “new equity sales were a negative source of funding in fifteen out of the twenty years from 1981 to 2000.” So in reality, investors aren’t really investing at all. They are extracting wealth and they’re speculating.
One role that investors do actually play is ensuring the liquidity of the stock. While Kelly acknowledged this, she seems to underplay the significance of this role somewhat throughout the book. Anyone who invests in a firm (whether it’s founders, stockholders or employees) will want to convert their equity into cash at some point, and liquidity is essential for that, so it actually is a pretty important job.
Shareholders at one time had some managerial responsibilities that they held with the firm. This was eventually shed, as eventually was their legal liability. The last responsibility to be shed was actually providing capital, as the above figures illustrate. So, much like aristocrats of old, shareholders today have shed all the responsibilities while retaining (and growing) all the benefits. This is the modern notion of privilege.
Meanwhile, over the last decade (since this book was written in 2001) employees have increased their productivity three times the rise in compensation that they received. Kelly makes the case that this is where we need to look to find the new peasant class now paying for the privilege of today’s aristocrats.
Chapter 3: The Corporation as Feudal Estate
The Principle of Property:
Like a feudal estate, a corporation is considered a piece of property — not a human community — so it can be owned and sold by the propertied class.
The source of stockholder privilege is ownership. Today we assume that 1) the corporation is an object that can be owned; 2) that stockholders are the sole masters of that object; and 3) they can do as they like with their “object.”
Social standing used to be based on “real” property – i.e. land. It led to three categories of persons: property owners with full rights; slaves, who were property themselves and had no rights; and a mixed category of right-bearing subjects who were the property of another. A man’s wife and servants fell into this last category. This ownership created a lopsided loyalty, where servant was loyal to master but not the other way around. This relationship has been extended to today’s property – the corporation, where common law duty of loyalty to the corporation is still dominant, but duty to employees is minimal. At marriage, women “disappeared” into their husband upon marriage. Only men were permitted to have property. Employees similarly disappear into the corporation, with the property passing to shareholders.
Corporations create wealth in two ways as the property of shareholders. There is a stream of income in the form of dividends. What’s left is retained by the firm as retained earnings, which is booked as stockholder equity. The earnings are therefore one part of the stockholder property and the second is the value of the corporation – its market cap. It’s like owning a house and getting rent off of it. The original investment contributed is the equity and retained earnings is the profits that accrete on top of that each year, even though shareholders may never contribute another cent.
The book value of a firm is the value of all its tangible assets, but that’s usually just a quarter of the typical firm’s actual valuation. Most of its value is intangible – things like patents, reputation, and people. In owning intangible value, stockholders essentially own employees. Our law doesn’t support the buying and selling persons, but we can own certain types of property that are “in” others. Intellectual property of employees is one example. If one owns the firm, then one owns everything created on top of those assets – even if that thing is an idea that is inside someone’s head. This is very feudal, similar to the idea that lords own the fruits of everything done on top of their asset, the land. But under democratic law, we’ve adopted the notion that “future improvements” to property should be left to the developer – which is at odds with how corporations are run today.
Kelly provides a great example of the St. Luke’s ad agency and what happens to the value of a firm when employees simply leave.
We’ve accepted the unconscious assumption that corporations are objects, not human communities.
Chapter 4: Only the Propertied Class Votes
The Principle of Governance:
Corporations function with an aristocratic governance structure, where members of the propertied class alone may vote.
Stockholders reign supreme in corporate governance. In theory, the boards of directors are elected by shareholders, but in reality they are handpicked by the CEO and the existing board. There isn’t much actual governance going on in most cases, aside from ensuring allegiance with the prime directive of maximizing returns for shareholders.
Corporations did not start with shareholder primacy as their prime directive. It is primarily something that’s evolved out of common law – the law as interpreted by the courts – and common law can be overturned by legislation. The 1919 “Dodge v. Ford Motor Co.” Supreme Court case was the precedent setter on shareholder primacy.
There are three tools through which shareholder primacy is enforced: hostile takeovers, stock options for the CEO and firing the CEO.
Until the 1980’s, most corporate boards were a pretty sleepy place. But then, in the wake of Reagan’s deregulation, corporate raiders started knocking on boardroom doors, forcing boards to sell underperforming companies to the highest bidder or be sued by stockholders. Most of us think that was just the 80s, but the trend has since accelerated. It’s just that in most cases, boards simply stopped fighting the takeovers and started embracing them.
To ward off the threat of hostile takeovers, boards soon became more activist, heaping stock options on CEOs who caused nice increases in the share price, and firing those who did not. Most of this happened in the 90’s and accounts for the steep incline in CEO compensation we saw then. This was also a time a huge cost-cutting, most of which was born by employees though governments contributed their share too in the form of massive corporate tax cuts. It was during those two decades that we saw the passage from an era of managerial capitalism to a new era of investor capitalism.
Public corporations function like monarchies after England’s Glorious Revolution – when the king’s power was superseded by Parliament, the seats of the aristocracy. In the case of the corporation, the CEO is king but it is shareholders who hold the real power behind the throne. Instead of the divine right of kings, today we have the divine right of capital – a notion so important, Kelly made it the title of her book.
Stock options are often seen as a way to inject employees back into the ownership equation, but they are limited in their effectiveness. They’ve only been extended to non-management employees in 7% of companies, and it’s really the tech sector that makes by far the largest use of them. Even when average employees do own options, it’s usually only a very small amount; not a large enough number of shares to experience much financial upside relative to base salary. When salaries are suppressed to drive up the stock price, stock options simply don’t help most employees because they don’t have enough shares to offset the salary declines.
In closed societies, the fate of society is equated with the fate of the ruling class. These societies create taboos to take certain topics out of the realm of debate and discussion, and blending natural laws (like gravity) with normative laws (a societal norm, like the divine right of kings). Today we have confused the idea that “the only responsibility of the corporation is to make a profit” with a natural law, when in fact, it is just expresses a norm or set of behaviors that we currently practice. This is one of our taboos. Another taboo is that shareholders govern the corporation and employees do not. That is because we are still stuck in the frame of the corporation as a piece of property, a thing that’s yours to do with as you see fit if you are the one who owns it.
Kelly closes chapter four with an exploration of “wealth discrimination.” At America’s founding, the right to vote was limited based on race, sex and wealth. As a society, we have recognized the harms of racism and sexism, but we have yet to truly address wealthism.
Wealth bias is typically rolled into our notions of class, but class can be embedded in our family of origin, dress, schools, mode of dress and other factors. All these factors matter when it comes to social status, but political and economic power, where Kelly makes the case that it is more precise to focus on wealth rather than class. She tells the story of Thomas Dorr and the Dorr Rebellion of 1842, which focused on extending the right to vote to all white males, regardless of whether they owned property. Dorr was imprisoned for life, and still remains a relatively unknown name in history even though universal suffrage was extended to all non-property owning white males across the United States as a result of his efforts.
Chapter 5: Liberty for Me, Not for Thee
The Principle of Liberty:
Corporate capitalism embraces a pre-democratic concept of liberty reserved for property holders, which thrives by restricting the liberty of employees and the community.
When wealth interests seek government protection, we’re told that property rights are vital to a free market. When the community or employees seek government protection, we’re told about the danger of infringing on the free market. Privilege tied to property is one of the bedrocks of our current system and the second is “freedom of contract” or the free market.
Property and liberty.
With freedom of contract, we’re all free to contract with whom we choose and the government is there to make the contracts legally binding. It’s in the Constitution in Article 1, Section 10 which says that no state shall make any law “impairing the Obligation of Contracts.” With regard to corporations, legal scholars no longer view shareholders as actually “owning” a corporation. Instead, they’ve transferred the rights of ownership to a conceptual framework of the corporation as a “nexus of contracts.” These same scholars note that the reason to remain focused on the interests of shareholders is that they are the last in line to receive compensation in the result of a liquidation of the company, even though in practice this rarely happens because troubled companies are usually allowed to be raided and sold at the hight viable share price.
Even with this “nexus of contracts” notion, it’s been hard to shake the idea that the corporation is actually owned and has owners. It is the common perception and the nexus of contracts slight of hand provides a legal framework for connecting shareholder rights to the Constitutional stipulation that the state not impair obligation of contracts.
The notion of the free market goes back before Adam Smith’s invisible hand to a pre-economic focus by Leibniz who talked about a “hidden hand” that led to “a basic harmony of interest among men in the long run.” Some might call it faith. But, Kelly notes, The Wealth of Nations was written long before the rise of the modern corporation and industrialization and what has developed is the “two nations” effect due to capitalism’s tendency to uplift some even as it degrades others.
Liberty stops at the corporate doors. Employee surveillance occurs at nearly three-quarters of major companies and 86 percent do drug testing. Employees have no due process, no right to privacy, no protection against unreasonable search and seizure, no representatives to take their side, no say in governance, no free speech, no jury to hear their case. In the corporation, we are obsessed with the notion of liberty of property which originates from feudal norms. With the birth of our democracy, we shifted to a new focus on liberty of persons. But where liberty of property is allowed to run rampant, there is no room for liberty of persons.
The World Trade Organization’s restrictions on countries’ ability to democratically determine their own laws is an example of this on a macro-level, where free markets trump democracy. We’ve also started to shift the way we talk about these forces, increasingly replacing the term “capitalism” with “market systems” – which shields wealth holders from the spotlight and gives them functional anonymity.
“While employees and the community are left to the protection of the invisible hand, wealth is protected by the visible hand of government and corporation.” Kelly closes chapter five with a fascinating vision of a world where labor rights are enthroned in law and property rights are left to the invisible hand.
Chapter 6: Wealth Reigns
The Principle of Sovereignty:
Corporations assert that they are private and the free market will self-regulate, much as feudal barons asserted a sovereignty independent of the Crown.
Economic sovereignty trumps political sovereignty in the corporation. Stockholders are sovereign because they believe they are the corporation, much as King Louis XIV believed he was the state (“L’etat, c’est moi“). This leads to the conclusion that the only legitimate, legally protected rights related to the property that is the corporation, belong to the shareholders.
The history of democracy is the history of people repeatedly and successfully challenging various forms of property rights. The king was once thought to be sovereign over the entire nation, because he owned it, thus intertwining political and economic sovereignty. The Magna Carta limited the king’s ability to take other’s property and was a seminal moment in the history of democracy. With the Glorious Revolution, property and sovereignty were still linked but were devolved from the king to the aristocracy. The American colonies were originally property of companies chartered by the British Crown. The king dechartered these companies and converted them to royal colonies before they were in turn taken by Americans and converted into a new United States of America.
Economic property is today centered on property because this was once true for all sovereignty – economic and political. It is only in the age of democracy that the two were split asunder. The property that provided people with sovereignty was originally just land. Over time, this property evolved to include other forms of wealth – including companies.
Political sovereignty evolved from the king to the aristocracy, to propertied white males, to unpropertied white males, to black males and finally to women. Economic sovereignty has not similarly evolved. It never made it past the financial aristocracy of shareholders. Assuming this is an inviolate law is just as absurd as assuming that political sovereignty should have been similarly stopped in its evolution.
Economic sovereignty has an internal and external aspect to it. Internally, stockholders are sovereign because the corporation is said to be private and hence out of bounds from external interference. Externally, stockholders are sovereign because the free market must be allowed to self-regulate. Internally, rising shareholder income is good, while rising income for employees is not. Externally, a rising stock market is good while rising wages is considered inflationary and bad. It’s really a question of whose interests are considered one with the health of the economy – shareholders’ or employees’.
With political sovereignty, each person has an equal vote, but not so with economic sovereignty where the wealthy have more votes. The wealthiest 10% of households own about half of all stock and since the bulk of our GDP is corporate revenues, running corporations to serve shareholders equates to running our economy to serve shareholder
s. Corporate profits for shareholders have been growing at 10% a year, while GDP grew at only 3%. When one group’s slice of the pie grows three times faster than the pie itself, other people are going to lose their portions of the pie.
Economic sovereignty was ceded to the wealthy through a series of legal fictions, the prime one equating the corporation with absentee stockholders rather than the community of people engaged in the actual work of the firm. Another important legal fiction is that the corporation is a person, an individual just like you or me competing for its own self-interest in the free market. This would have been a valid notion long ago when companies were not much more than the individual entrepreneurs who ran them, but as major corporations evolved, economists simply substituted the word firm for entrepreneur and pretended nothing fundamental changed.
In 1886, the Supreme Court ruled in Santa Clara County v. Southern Pacific Railroad that the corporation is a person, with the same Constitutional protections afforded actual citizens, such as free speech and the right to participate directly in the political process through lobbying and political contributions. This ruling has been upheld despite the fact that corporations are immortal and stretch across the national borders that still bind actual citizens.
Hundreds of years ago, to explain the apparent contradiction of the king being both divine and human, theorist developed the notion that the king had two bodies. The Body natural was the physical body, subject to mortal afflictions. The Body politic was imortal and lived on forever, transferring from one king to the next upon death. Stockholders today have assumed the mantel of the body politic. Much like the divine king, thanks to limited liability, they can do no wrong.
Chapter 7: Waking Up
The Principle of Enlightenment:
Because all persons are created equal, the economic rights of employees and the community are equal to those of capital owners.
We have an old model of the corporation that equates it with a tangible object like a railroad or factory. This was more true in capitalism’s early days. Today corporations are far less tangible, though our models remain tied to the old view of them as physical property. When we allow shifting groups of speculators to control a community of people from afar as we do with corporations today, it is conceptually similar to the kind of control England maintained over the American colonies before the American Revolution.
Enlightenment is seeing old customs with new eyes and questioning traditions. It is time to recognize that all human beings have equal economic rights. This shouldn’t take away the economic rights of shareholders; property rights of shareholders can remain in some measure, but need to now accomodate the property rights of employees and the community.
Immanuel Kant once wrote that we must treat all humanity “never simply as a means, but always at the same time as an end” and in this sense, employees and the community are not simply means through which to generate wealth for others. For this reason, Corporate Social Responsibility is not enough when it says “treat employees well because then stockholders will prosper.” Employees and community are each ends in and of themselves, not simply a means to better stock prices. Even socially screened funds like Domini Social Index have the implicit assumption that investor returns are the paramount measure. Ultimately, we must assert that other measures of prosperity matter too.
Ultimately it comes down to one problem: the power of wealth. Feminism benefited from agreement on the power of men as its central issue. Today’s social problems similarly need to focus on the root problem of wealth discrimination.
This is not to say that the wealthy are the enemy. They are, for the most part, no more evil or greedy than others. The goal is not to demonize, but to open eyes.
Respect for the right to attain wealth is integral to the American psyche. Most people want to acuire wealth someday – and the possibility should remain open. Our focus now must be on opening real opportunities for wealth generation to a broader spectrum of society and reducing the tendency for wealth to concentrate in just a few hands. The solution is not communism. Communism aimed for equality of outcome, when the more proper remedy is equality of opportunity. By seeking to eliminate private property altogether, it eliminated incentive, which is why it didn’t work. The goal isn’t to do away with wealth, but to redesign a system that gives illegitimate power to wealth.
The language we use matters. Calling stockholders “owners” gives them a claim of sovereignty. Calling them “investors” is a bit more accurate, although as Kelly outlines earlier, “speculators” may be an even more appropriate term. Phrases like “employees are our greatest assets” also play into the same old feudal mindset of stockholders owning employees, just as lords once owned serfs.
Financial statements are the most powerful “language” we have. Today employee income is scattered across our financial statements as various cost items. It would be useful to develop a supplemental “employee income statement” to aggregate all financial flows to employees. With this in hand, it would be much easier to compare employee compensation to employee productivity to better ensure fair compensation.
Just as we look to employee productivity, we might also develop a clearer understanding of stockholder productivity by summarizing all income to shareholders in a way that more accurately shows the tremendous outflow to investors each year in things like dividends and stock repurchases. This kind of report might help boards reconceptualize shareholders as investors, rather than owners, and help them reassess what is a reasonable rate of return to them. By better surfacing outflows to investors and employees, it might help boards question whether it makes sense to continue booking all retained earnings as stockholder equity or whether some portion of it might be set aside for a new entry: employee equity. Similarly, a community income statement would show corporate taxes, jobs created and other benefits weighed against the firm’s costs in infrastructure, subsidies and externalized costs.
Kelly then looks at alternative measures of prosperity such as the Calvert-Henderson Quality of Life Indicators and the Genuine Progress Indicator. She also looks at efforts to encourage more standardized corporate disclosures on environmental and social impact such as the Global Reporting Initiative and efforts like the Corporate Sunshine Working Group, aimed at enforcing mandatory disclosures.
Information is a critical step to exposing problems in a new light – and seeing things in a new light is what the enlightenment is about.
Chapter 8: Emerging Property Rights
The Principle of Equality:
Under market principles, wealth does not legitimately belong only to stockholders. Corporate wealth belongs to those who create it, and community wealth belongs to all.
Thomas Paine’s Common Sense is widely credited with building public resolve for America’s independence from England. Pain started that famous document by noting that “a long habit of not thinking of a thing wrong, gives it a superficial appearance of being right, and raises at first a formidable outrcry in defence of custom. But the tumult soon subsides. Time makes more converts than reason.”
These words apply equally to our current assumptions about shareholder primacy and the idea that corporate profits should accrue exclusively to shareholders. In the knowledge era, much of the value created by the firm comes from the minds of employees. As the foundation of wealth has changed, so too should its allocation. It’s a simple principle that efficiency is best served when gains go to those who create the wealth. Rewards should be tied to contributions. Since shareholder contributions have declined over the years, so too should their compensation. Instead of allocating wealth only to wealth, it is better allocated to merit.
American courts early on established the idea that the value of property improvements accrue to their developer – that wealth belongs to its creator. Corporate law today does not comport to these principles. Instead, it maintains that stockholders own all the firm’s assets – and everything created on top of those assets. It is time to divest ourselves of these assumptions. Employees have a right to much of the value they help create. Stockholders should abide by the free market and be willing to set aside protectionist legal barriers guaranteeing them special rights to the firm’s profits. If their value-add warrants it, they will naturally be compensated.
In our best political and economic traditions, it is labor that creates the right to property in the first place. John Locke wrote that “justice gives every Man a Title to the product of his honest Industry.” Adam Smith later echoed these sentiments by writing “The property which every man has in his own labour…is the original foundation of all other property.” Similar ideas can be found in Thomas Paine’s writings, as well as those of Thomas Jefferson and Abraham Lincoln, who once noted: “Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.”
Thomas Paine, in his Rights of Man, notes that the citizen deposits his rights and capabilities “in the common stock of society, and takes the arm of society, of which is a part.” “Society grants him nothing. Every man is a proprietor in society, and draws on the capital as a matter of right.” Similarly, every employee is the natural owner of the corporation, by way of his or her contributions to the wealth they create through the firm. This is not something the firm can grant the employee – it is a matter of right based on the merit of contribution.
Founders are like the original warrior kings who conquered their territory, but when those rights are passed on to descendants or speculators, the merit of contribution is not earned.
John Locke is often ascribed as the champion of property rights, but actually he voiced strong contempt for “the idle, unproductive, and Court-dominated property owners,” who lived off their property but no longer worked it. Property rights advocates often cite Locke’s line that government “has no other end but the preservation of Property.” But Locke did not exalt property in general; he favored only those rights stemming from honest industry. Locke’s core message was that productive members of society ought to unite against “an idle and wasteful land-owning aristocracy.”
Locke was a founding theorist of democracy, and we can no longer afford to allow him to be used by wealth-rights absolutists. The same is true for Adam Smith, who believed that profits should naturally be low and that profits are “always highest in the countries which are going fastest to ruin.” He also noted that “by raising their profits above what they naturally would be” wealth holders in effect “levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens.”
Economists often dismissively refer to the notions of increased sharing of wealth with employees as the “labor theory of value” and like to say it has been discredited by lumping it in with Marx who claimed that labor was the only source of economic value. This is clearly not the case; human capital is greatly enhanced by financial capital. Today we embrace a “financial theory of value” which assigns money as the true source of all value. The reality is that corporate wealth is a joint creation of both capital and labor.
American economist John Bates Clark makes the claim that the distribution of income in society is controlled by a natural law, which in a world without friction, would naturally allocate wealth based on merit. The problem is that friction does exist, in the form of laws based on feudal traditions of privilege which assign primacy to stockholder claims to corporate profits. Kelly gives an interesting counter example from Brazil, where the publication La Prensa compensates its stockholders based on a wage or salary for providing capital. Employees are similarly compensated. Any remaining profits are then split 50-50 between shareholders and employees.
Employee ownership is a good solution to the above issues. One example is San Diego-based, Science Applications International Corp. (SAIC), which is 90% employee-owned. Employee ownership is not without its flaws, which include: 1) that it retains the notion that economic sovereignty is still tied to ownership; and 2) that it still ignores the economic rights of the community. That said, employee ownership is good in general because it taps the right incentives in helping people to work more efficiently. It is most effective when coupled with management techniques aimed at distributing decision making in the firm. Employee ownership can also defer or eliminate taxes for founders who sell to employees, thus passing on the firm to its rightful heirs – those who continue in its value-creation processes.
The time may now be right for policies aimed at increasing employee ownership through removing tax barriers and removing current regulations that require firms to buy back employee shares when employees leave the firm. Some firms like SAIC get around this problem through an internal market that allows employees and retirees to trade amongst themselves, but there may be policies for opening this up to others in ways that might also increase liquidity and help employees diversify their holdings.
Stock options are another route to employee ownership, but there are a few problems here. First, employees generally have no voting rights with stock options. Second, options tend to be given to only a few employees and in cases where it is given more broadly, it is typically only a small number of shares, which offers little in the way of real financial growth. Employees also need to buy some portion of the shares when they exercise options, which leads to 9-out-of-10 employees simply selling the options as soon as they are exercised. There are tax incentives and other policies which could be adopted to counter some of these problems, however. Existing shareholders are likely to be upset over dilution of their stake in the company, but it is a time-honored principle of capitalism that new capital dilutes old capital.
Ownership transfer is another route to employee ownership. Laws requiring indigenous ownership of foreign-owned firms provides similar incentives on a macro level. A more radical approach is simply limiting the amount of time that equity investments are allowed to create returns for investors – much like the expiration of a patent term.
When employees simply walk out and refuse to work for the firm any more, as was the case with London-based St. Luke’s advertising, it provides a rare opportunity for valuation specialists to develop a true assessment of the firm without its employees – and by contrast, the value of the employees to the firm. This valuation could form the new basis for their fair stake in the firm. Takeovers and corporate mergers are particularly ripe moments for this. If it just happened in one highly visible firm, it could start a wave of similar shifts across the corporate landscape.
Kelly closes the chapter with a look at community property rights through examples like Alaska’s Permanent Fund, compensation from a tanker company to California residents for soiling their beaches, and giving citizens a stake in things like the airwave frequency spectrum and other natural resources, though she notes the risks here in the temptation that such financial compensation might bring by encouraging citizens to allow these natural resources to be depleted.
Chapter 9: Protecting the Common Welfare
The Principle of the Public Good:
As semipublic governments, public corporations are more than pieces of property or private contracts. They have a responsibility to the public good.
Publicly traded corporations have their hands tied when it comes to truly acting in accordance with the public good. Concern for the public good is built into the very structure of our democracy. It’s built into the system, not simply through broad voting rights but also by the protection of individual rights enshrined in our Constitution. Democracies acknowledge the importance of self-interest and how to harness it. A democratic economy must do the same, as self interest is often the engine of prosperity. But self interest has its limits, places where the government needs to fill in.
We need a new economic principle that says that public companies have a responsibility to the public good. We had this once upon a time at our founding as a nation, when corporations were chartered by individual states only to serve the public good. This tradition was gradually eroded by the courts right around the time of the Robber Barrons. The original intention behind the corporation in America’s early years, however, was definitely serving the public good – the “polar star” of the American Revolution.
Shareholder primacy emerged out of common law in the mid-nineteenth century, right around the same time stockholders’ agents developed our modern financial statements as a way to keep tabs on how well their principles’ investments were doing. These reports were never intended to represent the corporations overall performance. They were simply the slice that stockholders cared about – and that’s the part that we are stuck with today, and something all companies are legally required to produce on an ongoing basis.
The other idea that emerged from this time is the notion that companies are private entities – that they are the result of private contracts rather than public charter. This shift stemmed from the Supreme Court’s 1819 Dartmouth College decision, which found that a grant of incorporation was a contract that could not subsequently be altered by government.
The notion that corporations are private is the legal lynchpin of stockholder primacy, but it stretches the notion of private beyond recognition. The original term was reserved for the household or to one’s body or to an intimate group of persons apart from the general community. The notion that corporations are like households or these intimate groupings does not fit with entities whose very ownership is traded in huge volumes by a faceless public every day. The power of corporations today is so great, in fact, that they function like small, semipublic governments. This is not a new notion and it has been made by many followers of corporate organizational theory over the years. As private governments, corporations today represent the private realm swollen so large as to threaten the public realm – and there is a historic precedent for this; it’s called feudalism.
America went through a period of feudalization at the time of Robber Barrons, when men like Rockefeller, Morgan, and Carnegie ruled the land like feudal princes. Kelly makes a mistake here, wrongly attributing the Homestead strike to Rockefeller rather than Carnegie. Our dedication to free markets provides a kind of cover to the actions of these corporate leaders by claiming that their collective actions will result in the best outcome for all. This clearly was not the case with the Depression, during which time our country recognized the market’s inability to always self-regulate in alignment with the public good. These lessons were lost in the post-war era, however, through the teachings of Milton Friedman and the revived enthusiasm for free market fundamentalism of the Reagan presidency.
The problem is that despite all these changes, we’ve never really changed the corporate structures and rules left to us by the Robber Barrons. Shareholder primacy is one of the big assumptions left unchallenged. As Thomas Paine once argued in The Rights of Man, “Every age and generation must be as free to act for itself, in all cases, …Man has no property in man; neither has any generation a property in the generations which are to follow.” We are free to challenge assumptions of the past.
State courts continue to act helpless as though constrained by legal requirements to maximize shareholder returns, but actually there is more room for maneuvering than is typically imagined. Much of our current restraints are based on common law, which can be easily overturned with legislation. Expanding fiduciary duties beyond shareholders to stakeholders would be one set of policy objectives that would go a long way toward ensuring the public good. Thirty-two states had already enacted some form of stakeholder statutes at the time the book was written (1991). These laws give boards broad legal cover to take stakeholder needs into account in the event of hostile takeovers, but they are still rarely used in practice. It is mostly the critics of these laws who have noticed their potential for real impact.
Kelly closes the chapter with the following: “We may picture the public corporation as a rational tool of accountants, but it is not. It is the brainchild of brutal men in a brutal age, hell-bent on amassing for themselves untold wealth, and leading a feudal revolt against the notion that corporations must serve the public good.”
Chapter 10: New Citizens in Corporate Governance
The Principle of Democracy:
The corporation is a human community, and like the larger community of which it is a part, it is best governed democratically.
In rethinking the corporation to be accountable to a broader set of stakeholders, it is important to note that employees are internal to the corporation while the community is external to it. Externally, corporate governance is regulated by state statues and court decisions. This must shift to be increasingly supportive of the broader democratic order. Internally, corporate governance is controlled by a board and management that legally answers to shareholders. This must shift by extending governance rights to employees as well as shareholders. This latter shift is the focus of this chapter.
Voluntary efforts to change the corporation lack staying power and are easily trumped by pressure from shareholders. Shareholder primacy is enforced through the threat of lawsuits and takeovers, both enforced through legal mechanisms. Ultimately, any lasting solution will need to be legal in nature in order to counteract these mechanisms.
Democracy is fundamentally about structures – structures of voice, decision making, conflict resolution and accountability. Our political system has structures to secure our liberties. Separation of powers is one example. We lack a similar set of structures to protect people’s liberties within the corporation.
Stakeholder theory expands the notion of who is served by the corporation from its exclusive focus today on shareholders, by opening it to include customers, stockholders, employees, suppliers, creditors, the community and the environment. Most of the focus thus far in stakeholder theory has been on ethics rather than grounding it in solid legal theory, which has weakened the theory’s applicability and left widely dismissed as irrelevant by researchers in finance and corporate law. Some of this weakness in stakeholder theory may rest on a deeper set of issues stemming from a lack of clarity over who actually should have a voice in the company’s governance.
Stakeholder theorists often ask who is affected by the corporation, but corporate governance theorist David Ellerman suggests a more relevant question is who is governed by the corporation? He makes the analogy that many foreigners are affected by US actions and that their rights should be protected, but that that doesn’t mean they should have a right to vote in the US. When shareholders elect a CEO for the corporation, it is not the shareholders who are governed by that CEO. It is the employees who are. Current governance theory sees employees as outsiders who merely sell their labor to the firm. Employment contracts are illegitimate in the sense that they preclude employees’ ability to self-govern. Democracy scholar Robert Dahl notes that the right to self govern is amongst the most fundamental of all human rights and that laws cannot rightfully be imposed on others by persons who are not subject to those laws themselves. Just as with the right to vote, the right to self governance is not a right that can be sold, even voluntarily.
Some management theory, such as Theory Y, gives employees more autonomy and control, but this thinking has not yet crossed into mainstream governance theory. One exception is Margaret Blair who argues that if stockholders’ assumption of “residual risk” (being last in line for compensation after creditors) grants them governance, employees bear just as much residual risk and hence should also be granted governance rights. Another exception is Lynn Stout, who builds on the notion of “team production” to argue that the contributions of labor and capital are non-separable and that governing boards can help oversee the proper allocation of profits between labor and capital to ensure behavior from both sides that contributes to the long-term, ongoing health of the firm.
With stakeholder theory, many progressives lump employee concerns in with other social concerns, which in many ways undermines the legitimacy of employees claims to governance of the firm. There are instances when other stakeholders may become “captive” by the firm and in those cases governance roles may be appropriate. But employees are the one group that always deserves such a role.
One approach to opening up employee governance is the creation of a separate employee legislative house. The Works Councils of Germany follow this approach. This kind of an approach would relies on the wisdom of the separation of powers found in the US government.
However it is structured, employee representation needs to be mandatory. This is not the same as unions. Kelly’s point here seemed a bit off the mark to me, perhaps because she does not want to undermine the role of unions. She notes that unions may be thought of as a kind of political party, representing the interests of workers, but representation should be the default assumption in all companies regardless of whether or not they have been organized. She feels that the two could exist side-by-side, but I’m not sure the need for unions would be quite as strong with the kind of representation she’s painting here.
Chapter 11: Corporations Are Not Persons
The Principle of Justice:
In keeping with equal treatment of persons before the law, the wealthy may not claim greater rights than others, and corporations may not claim the rights of persons.
Implementing economic democracy will require working through the political and judicial process in order to free our legal machinery from the grip of corporations and wealth. When corporations assert aristocratic privilege, they do so by co-opting our democratic institutions in claiming that corporations have the same constitutional rights as real people.
In 1976, the Supreme Court decided in Buckley v. Valeo that money is equivalent to political speech, thereby harnessing our constitutional rights to free speech as a way of guaranteeing corporations’ the right to contribute to political campaigns.
The issue of corporate personhood has deep roots. When Thomas Jefferson ran for president in 1800, his Federalist opponents spoke freely about the need for the “steadying hand of the ‘rich, the able, and the well-born'” in running the country. Jefferson developed populist sentiment to the point where these assumptions could no longer be stated explicitly in politics at the national or state level. Wealth privilege was thereafter forced to take on a more subtle disguise.
It took decades before this new guise finally appeared in the ingenious shape of corporate personhood. Wealth was then shifting from land to corporations, which were still chartered by individual states. But the Supreme Court changed all this in 1886 through its Santa Clara County v. Southern Pacific Railroad decision, which found that corporations are natural persons, and therefore protected by the Constitution. Supreme Court Justice William O. Douglas commented years later that there was “no history, logic, or reason given to support that view.” The Fourteenth Amendment, which is the cornerstone of this finding was originally intended to protect the rights of recently freed slaves, but as Justice Hugo Black later noted in 1938, “less than one-half of 1 percent [of cases] invoked it in protection of the Negro race, and more than 50 percent asked that its benefits be extended to corporations.”
Our legal system has no coherent theory of the corporation. At the beginning of our country, we did; corporations were established for the public good. Over the intervening decades, we have cobbled together a collection of piecemeal regulations that leave us with nothing but a conceptual haze.
One solution would be to initiate a national dialog to clarify our intentions with regard to the corporation. Amending the Constitution to codify this understanding would be very difficult and sure to face stiff opposition. One approach to such an amendment is simply to state that “a corporation is not a natural person under the U.S. Constitution.” Other approaches to define what corporations actually are would be more difficult. Kelly proposes a combination of public and private ends; that the corporation be required to serve the public interest and to make a profit. She suggests some possible language:
“In keeping with equal treatment of persons before the law, the wealthy may not claim greater rights than other persons, and corporations may not claim the rights of persons. The public corporation is a semipublic body, composed of both property and persons, and these persons include employees. The public corporation is to be chartered by states to serve both public and private interests and is to be governed internally by democratic processes.”
In the end, we may not even need a constitutional amendment because the Fourteenth Amendment says that states may not “abridge the privileges or immunities” of any citizen, nor deny to any person “the equal protection of the laws.” This phrase itself might well cover race, sex and wealth discrimination already. This point of attack may not convince the Supreme Court, but it could be a good way to frame overall efforts for reform. Kelly notes that Article I, Section 9 of the Constitution also specifically states “No title of Nobility shall be granted by the United States” and makes the argument that this too could be used as part of the conceptual frame, especially in fighting for more aggressive estate taxes.
Chapter 12: A Little Rebellion
The Principle of (r)Evolution:
As it is the right of the people to alter or abolish government, it is the right of the people to alter or abolish corporations that now govern the world.
Thomas Jefferson once wrote, “A little rebellion now and then is a good thing, & as necessary in the political world as storms in the physical.” The aim here is not an overthrow of the whole edifice, as in the abolition of stockholder rights – but the expansion of these rights to include others. We must return to America’s founding ideals; among these include:
- the liberty of states to control corporations
- the liberty of casting a vote that has substance
- the liberty of enjoying the fruits of our own labor
- the liberty of individuals to enjoy equality under the law
It all begins with enlightenment, with public acts that raise the public consciousness. The American Revolution, as serious as it became, started as a prankster’s revolt – dressing in native garb and throwing tea off ships was just one of the stunts. Early leaders also made heavy use of communications through “Committees of Correspondence” throughout the colonies. The revolutionaries had gained widespread support for the ideas behind the revolution years well before wrangling actually began over the Constitution.
The American people’s right to abolish corporations is not imagined. It is still present in all state constitutions as the right to revoke charters. Writing limitations into these charters is another potential instrument of the people’s power. Charter revocation has not been used with success. It is a bludgeon, not something you pick up often – but a potential tool for rebellion. Charter revocation may be thought of more as a warning shot across the bow, but there are other tools as well.
Through the organizing work of Thomas Linzey of the Community Environmental Defense League, two townships in Pennsylvania passed ordinances prohibiting corporate ownership of farms. Wayne Township in Pennsylvania adopted a “three-stikes-and-you’re-out” ordinance to give them control over corporations with a history of repeated bad behavior. Author William Greider suggests that we must “raise the bottom line cost of lawlessness” with corporations. At the federal level, we might, for example, establish a “felonious status for ‘corporate citizens'” that would bar them from campaign financing and lobbying, the same we we deny these rights to human felons.
Kelly then breaks down the rest of the chapter with specific recommendations for rebellion for different groups:
Employees: running for the board of directors, demonstrations, refusal en-masse to agree to employee drug testing, challenging ownership over their intellectual property.
Business students: challenging the frames taught today in business school, academic research into the topics in this book.
Investors: socially responsible mutual funds, lobbying for greater SEC social disclosure.
CEOs: pioneer true models of economic democracy, rewriting corporate bylaws, testing state statutes to protect stakeholders rather than buckling to takeover raiders.
Activists: develop schools for revolutionaries, national days of action.
Unions: shift focus from protecting certain categories of workers to a broader focus on economic democracy, focus on wage data transparency.
Generating public discussion is critical to building public resolve. This was the focus in the early days of the American Revolution. We need new organizations to step forward in the cause for economic democracy.
As Joel Barlow suggested in 1792, what separates the free from the unfree of the world is merely a “habit of thinking.” Change begins in the mind, but unfolds into the reality of historic moments – moments of crisis like what we saw in the 1930s.
Kelly closes the chapter with the following:
“Corporations today are governments of the propertied class, exercising power over Americans that is greater than the power exercised by kings. They are governments that have become destructive of our inalienable rights as a people. We can end their illegitimate reign and institute a new economic government, laying its foundation on such principles as seem most likely to effect our safety and happiness. We can one day complete the design in the economic realm that the framers began in the political realm, the design of novus ordo seclorum – a new order of the ages.”
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