Corporate America is governed by boards of directors who are appointed to represent the interests of the owners (investors) by hiring the firm’s top management. This arrangement has created in what economists Michael Jensen and William Meckling called the principal-agent problem. In essence, the separation of the owners from the managers can lead to a conflict when managers are perceived as pursuing an agenda that is at odds with the interests of the owners. The concept of the principal-agent problem can be expanded to include situations where corporate actions are also at odds with the public’s economic interests. Examples of this are easy to find.
As environmental concerns increased, companies responded by only locating toxic operations in poorer communities. The assumption is that poor communities do not have the enough political power to complain. Efforts to place a wind farm near Martha’s Vineyard met with such resistance that the project was shelved, proof that wealthy communities can avoid the plight of poorer ones.
American Airlines in 2012 filed for bankruptcy and asked the Pension Benefit Guarantee Corporation’s permission to dump their underfunded pensions, even though other airlines who sought bankruptcy protection managed to maintain worker pensions. This action from a firm in an industry that used 90 percent of their profits over the past decade to engage in stock buy backs as opposed to shoring up their underfunded pensions.
In 2008, President Bush signed the $700 billion bank bailout bill. Treasury Secretary Henry Paulson had asked Congress to approve $700 billion in expenditures to buy mortgage-backed securities that were in danger of defaulting thus saving many of our largest banks. The assumption of government officials in the Obama administration was that the banks would voluntarily renegotiate the subprime mortgage loans they pushed as the housing bubble was growing ever larger. Instead, one of the worst loan servicing abuses was “robo-signing.” Banks and mortgage servicing companies used false affidavits in the hundreds of thousands of foreclosure cases. According to RealtyTrac, in September of 2012, 345,000 households, which are one out of every 248 households in the United States received a foreclosure notice.
The solution to this dysfunctional system of corporate governance is to reform boards of directors by having them include representatives from the various segments of society, such as, consumer advocacy groups, employees, environmental representatives. The criticism of this proposal would be that none of these groups are the owners of the firm, and technically that is true. But it’s my contention that current “owners/shareholders” (except for first time buyers of equity shares) are not true investors.
Today’s “so-called” investors are in reality not investing in the company, but speculating on the possibility of future capital gains. Today’s Fortune 500 companies should be thought of as social institutions and not just private enterprises. It’s for this reason that various segments of society should have a seat at the table when it comes to corporate decision making.
Under normal circumstances, reforming corporate boards would be monumental tasks, both legally and politically. But in today’s economic environment where the government will be asked to bailout large numbers of firms, we are being presented with an easy opportunity to achieve these reforms. Bailouts can come in the form of low interest loans, grants, or stock purchases. The government spent $80 billion bailing out the auto industry in 2008. The Treasury Department lent money and bought stock ownership in GM and Chrysler, in effect the government nationalized these firms. In 2014, the Treasury Department ended the bailout selling it last remaining shares back to the private sector, but they missed an opportunity reform the governance boards of these companies in a way that would have made them more socially responsible. Five years after being bailed out GM closed the Lordstown Ohio plant moving its production to Mexico.
The coming recession and accompanying bailouts will give us an opportunity to add representatives from public interest groups to these governing boards. Grants are gifts of money that need not be repaid. We can achieve the same effect by bailing out firms through government stock purchases, and in turn gifting these newly acquired shares of stock to the various groups, such as employees, environmental groups, and consumer advocacy organizations.
The last two decades have seen firms focused on maximizing shareholder equity, to accomplish this firms outsourced production, held wages down, eliminated pensions and other benefits, to the detriment of American workers. Thankfully the maximizing shareholder equity concept is dying, and it needs to be replaced with a more expansive view of corporate responsibility to society, a view that can be effectively articulated by a reformed governance board that more fully represents the needs of all segments of society.