It is an article of faith among mainstream economists and other defenders of the existing world order that the mainspring of economic advancement and welfare, from the perspective of the public as a whole, is the pursuit of maximum profit by private individuals or enterprises acting in their own individual interests or that of their shareholders. Most, however, would probably also recognise that such a simple proposition – corresponding to Adam Smith’s famous metaphor of the beneficent working of the Hidden Hand – needs to be severely qualified in any analysis of how the real world actually works.
In particular, the dynamics of private corporate enterprise, as it has evolved in the West since the 19th century, have revealed a powerful tendency for it to permit – or even encourage – the emergence of damaging conflicts of interest both a) within enterprises and b) between enterprises (individually or collectively) and the wider public. While such conflicts stem in large part from the inherent tendency of human beings to prioritise the pursuit of their individual self-interest, they have unquestionably been exacerbated by the institutional structures put in place since Victorian times with the supposed purpose of enhancing the benefits of the system to the public.
Corporate governance. The inherent conflict created by the often inevitable separation of ownership and control of an enterprise has long been understood to be a fundamental flaw in the theoretical equation. Indeed it is a little known fact that Adam Smith himself was broadly opposed to the idea of joint-stock (i.e. shareholder) companies because of the risks involved in individuals entrusting others with the management of their assets. Despite this objection, however, the dominant “capitalist” system has evolved since his time in ways that failed to address this “agency problem”. So far from that indeed efforts have focused on persuading those who might otherwise shy away from putting their capital at risk to do just that, notably by the granting of the automatic right of enterprises to limited liability (embodied in the original UK Companies Acts of 1854-55), which indemnifies shareholders against any potential loss beyond the amount of their shareholding in any given company. Implicitly the justification for extending this privilege to all was the need to attract far more investment capital at a time when it was still scarce in the face of growing demand for it as the industrial revolution was continuing to spread across the world.
In fact, as a result of this tendency, companies have been enabled to evolve in such a way that management – in the shape of the board of directors – is able to exercise effective total control of the company without any meaningful accountability to shareholders. For although shareholders nominally appoint the board and have the power to replace any of its members (though not in the United States), they often find it difficult to exercise that power, principally because of a) the multiplicity of shareholders rendering it hard to mobilise a majority in support of any resolution opposed by the board, and b) their limited access to information on the company’s affairs compared with that enjoyed by the board. The impotence of shareholders has been further demonstrated during recent attempts in the UK and elsewhere to try and limit the exorbitant remuneration packages that company boards routinely vote themselves and top executives even in the wake of poor results. Thus for example at Royal Dutch Shell shareholders actually passed a resolution to cut the executive pay increases proposed by the Board, only to find that the rules meant their vote could only be advisory and the final decision would rest with the Board in any case.
Corporate vs. public interests. Such abuses of corporate accountability, we might think, are precisely what Adam Smith would have expected given his hostility to joint-stock companies. What he might not have foreseen is that in an age of globalised production and distribution such huge and unaccountable corporate power could have been allowed to be concentrated in so few hands on a world scale. Still less might he have imagined that this concentrated corporate power could have enabled them to exercise correspondingly disproportionate political power by deploying their huge financial resources and lobbying power to distort the actions of supposedly democratic governments contrary to the popular will and the public interest.
In fact this implicit conflict of interest between the owners / shareholders and management of companies under the existing régime of corporate governance (particularly in the Anglo-Saxon countries) is at the root of the fundamental negation of democracy which is inherent in the existing global economic order. Moreover, it is compounded by the absence of any serious restraint on corporate donations to political parties, exemplified at the extreme by the notorious Citizens United judgement of the US Supreme Court (2010), which effectively ruled that any attempt to impose legal limits on companies giving financial support to political parties was a violation of the constitutional right to freedom of speech. The net result is that our supposedly democratic body politic is effectively under the control of a tiny number of corporate directors who cannot even claim to be representative of their own shareholders, never mind the rest of the population.
For most people it is of course nothing new to find that corporate interests have a large, if not decisive, influence over elected governments and their policies. Yet perhaps relatively few are aware of the extent to which this influence is exercised in ways contrary to the public interest, often at huge social and economic cost. Of the innumerable examples of its malign impact that could be cited two major ones may serve to illustrate the point.
The food industry and public health.
Although after decades of bitter struggle governments have managed to impose some limited restraints on the marketing of tobacco – whose lethal impact on public health has been known since the1950s – the same cannot be said of the hardly less harmful alcohol and food processing industries. The cost to the public of excess consumption of these – particularly of such ingredients as sugar – is reflected not only in the reduced well-being of individuals but of the cost to the public of remedying the resulting damage – such as the billions spent annually by Britain’s National Health Service in treating the ravages of diabetes. Meanwhile attempts to force the food industry to accept legal restrictions on excessive sugar content in their products run up against the malign power of the food lobby to prevent effective action.
Energy production and consumption
For at least the last 30 years there has been growing evidence that global warming and climate change are very real phenomena and that they are to a large extent a function of the steadily rising use of fossil fuels (hydrocarbons and coal) to meet the energy needs of a growing world economy and population. In face of this evidence – and the growing recognition that this trend is likely over time to pose a serious threat to the welfare, if not the survival, of large sections of the human race – there have been a number of highly vocal and politically influential campaigns devoted to disputing the evidence and claiming that consequently there is no need to moderate, let alone eliminate, our dependence on energy derived from fossil fuels. What is most significant about such organised denial – whether of the reality of climate change or of the role of human activity in causing it – is that it is largely financed and orchestrated by the major oil companies, notably Exxon Mobil, although this fact is often not reported in coverage of the issue in the mainstream media. It is thus fair to say that the failure of the international community hitherto to halt the growth in carbon emissions and thus the rise in global warming, notwithstanding numerous international conferences and agreements starting with the Rio Convention of 1992, owes much to the concerted efforts of the corporate-dominated lobby of climate change deniers, although it is also right to point out that until very recently they had strong allies among major Third World states such as China, which regarded efforts to impose limits on emissions as unfair discrimination against poor countries, which had historically contributed little to global warming compared with the industrialised nations.
It is of course true that under any market system individual private economic actors will inevitably tend to advance their own interests at the expense of others unless restrained by official regulation backed by law. What is especially pernicious about the dominant “Anglo-Saxon” model , as described above, is that it effectively compels company boards to pursue the maximisation of private profit as their overriding policy goal, to which all other corporate priorities – such as enhancing the welfare of their employees or supporting local communities – must be subordinated. This is because company law a) requires that the interests of shareholders (the owners) be given priority over those of all other “stakeholders” – such as employees or the general public – while b) owing to the large number of shareholders in many companies and the impossibility of consulting all of them on corporate strategy and management issues the board of directors will inevitably tend to interpret their mandate according to the lowest common denominator – i.e. maximisation of (short-term) profit. Moreover, their propensity to do so is further enhanced by the competitive pressures of the capital markets, which tend to mean that chief executives who fail to achieve a return on capital at least as high as that of the average of other companies are liable to be ousted from their highly paid positions.
These pressures on corporate management have intensified during the present “neo-liberal” phase of capitalism – i.e. since around 1980 – as market growth has progressively faltered and opportunities for productive investment have dwindled in the face of a cyclical downturn compounded by the more long-term negative impact of technological change. As a result there has been a growing tendency for corporate bosses not merely to give lower priority to the public interest and social considerations but to engage in blatantly criminal actions in pursuit of extra profit. Although the Enron fraud scandal shocked the world when it broke in 2001, it might until quite recently have seemed an “outlier” in that few, if any, other cases of major corporate fraud hit the headlines in the years before the start of the global financial crisis (GFC) in 2008. Since then, however, such scandals have flowed thick and fast – from the massive criminal manipulation of currency and other financial markets by the world’s major banks to systematic accounting fraud at major Japanese industrial corporations such as Olympus and Toshiba and now, most stunning of all, the Volkswagen emissions fraud at the heart of German industry.
An additional flaw in the system is that the dynamics of corporate power, as described above, allow the directors to structure management policy in such a way as to link it to their own personal interests. This commonly results in structures of executive remuneration that incentivise the short-term maximisation of the share price – such that this triggers huge bonuses for a few individuals at the top, even though it may well have an adverse impact on the company’s well-being in the longer run. Such self-serving behaviour of management is further encouraged, it should be noted, by their capacity to manipulate the share price by buying back their own shares, a practice that had been effectively outlawed for 50 years up to the 1980s – precisely because it was seen to have led to distorting price manipulation prior to the Wall Street Crash. Equally it is hard to imagine that such wide-scale perversion could have occurred if the same dynamics had not worked to put governments so deeply in thrall to corporate power.
The key: limiting limited liability
It can scarcely be denied that the huge dysfunctionality of the modern economic system, as described above, has resulted in large part from elevating the pursuit of profit maximisation to the status of a supreme social virtue. If we are to create structures less prone to this tendency – which permeate every sector and level of our ever more commercialised and privatised economy, from public utilities to professional sport, as well as those dominated by large corporates – we must be prepared to consider institutional reform at a fundamental level.
While a number of enquiries into how to improve corporate governance have been conducted in the UK since the 1990s – typically in response to some conspicuous failure of the system – none has resulted in the introduction of effective restraints on management. Indeed the abject failure of the authorities hitherto to initiate any criminal prosecutions against senior executives responsible for the multiple abuses associated with the banking crisis of 2007-8 has engendered enormous public cynicism as to the integrity of the regulatory structures in place.
Meanwhile awareness is growing, except among those with vested interest in preserving the status quo, that restricting the right to limited liability will be a crucial step in ensuring that corporate management serves the public interest better. The primary justification for such a reversal of this market-distorting provision of company law is that, in contrast to the position in the 1850s when it was first introduced, there is no longer any real scarcity of finance capital (rather the opposite) and therefore no need artificially to stimulate inflows of it into the market. Indeed it is becoming increasingly clear that such incentives to unnecessary investment are resulting in ever greater misallocation of resources. Well known examples in Britain are the building of the hugely wasteful High Speed 2 rail project and other white elephants such as the massively expensive London Olympic Park, built for the 2012 games but devoid of any real utility after that brief event. The damaging consequences of such follies is put in even sharper relief by the fact that they cannot be undertaken without the help of subsidies from the public purse, often open-ended, to the profitability of the private corporate sector – which appear all the more perverse at a time when vital forms of public spending, such as on health and social welfare, are being sacrificed in the name of fiscal rectitude.
It would thus be a very logical first step in any reform programme aimed at rebalancing the role of the corporate sector to make the right of any enterprise to the privilege of limited liability conditional on its accepting the inclusion in its articles of association a requirement that it be made formally accountable to the state (whether at national or local level). This would need to involve scrutiny mechanisms and rights of effective public veto on board decisions concerning significant change in the allocation of value added – e.g. major investments, pricing, remuneration of employees and management. While entrepreneurs would still be free to pursue an independent strategy without the protection of limited liability, it can hardly be doubted that the net effect of such a shift in the balance of power over the management of businesses would be a reduction in the level of private investment. But given that, as we have suggested, the volume of fixed capital investment is now excessive in relation to genuine, undistorted market demand, such a reduction would be no bad thing from a public interest perspective. But self-evidently the ultimate implications for the survival of capitalism would be dire.