How to Save Capitalism - Part 2

ABOLISH STOCK OPTIONS
by Barry C. Lynn

Barry C. Lynn is a senior fellow at the New America Foundation and author of End of the Line: The Rise and Coming Fall of the Global Corporation. His last article for Harper’s Magazine, “Breaking the Chain: The Antitrust Case Against Wal-Mart,” appeared in the July 2006 issue.

What is the purpose of a corporation? In America today we generally believe that corporations exist to generate profits for their shareholders, who “own” them. Indeed, we have structured much of our economy—and often staked our retirements—on this idea.

Not many years ago, though, most Americans would have found such thinking absurd. From the nation’s earliest days until the 1970s, Americans saw the business corporation mainly as a practical tool of development. The aim might be to build a bridge, or to manufacture steel, or to transport people from one city to another. The private corporation was simply the institution best suited—usually, but not always—to organize and govern such work. Profits were a part of the system. After all, the only way to attract capital is to pay for it. But the manufacture of cash was a distinctly secondary goal.

Our society lives with many fictions, and most do us little harm. But there is a big problem with viewing corporations as private sources of paper “wealth” rather than as public sources of goods and services. It’s not that the former idea is technically wrong, though American law is very clear that the business corporation is not a property and cannot be “owned.” The problem is that our efforts to extract cash from these corporations leads us increasingly to degrade—and in some cases to destroy—some of our most important production and service systems at the very moment we should be making them more robust and open to new ideas.

I thought of this problem recently when investors pushed General Electric CEO Jeffrey Immelt to put up for sale his firm’s Consumer & Industrial Division, the heart of GE’s business since 1892. I don’t own GE stock, but if I did I would wonder which best served my interests—for the company to sell its 125 years of expertise in electrical systems to some lesser firm, and thereby to direct a few dollars into my accounts; or for GE to retain that know-how, perhaps depressing its stock price in the near term but enriching us all through the improved efficiency of our refrigerators, transformers, and light bulbs.

In fact, I’ve been forced to think about the destructive powers of shareholder “activists” all too often over the past year or so, as fund managers claiming to be “owners” (or agents for “owners”) have busted into the decisionmaking processes at all sorts of firms on which we depend—Motorola, General Motors, Yahoo!, Boeing, The New York Times, Hertz, and Freescale Semiconductor, among others. The problem is not change: every enterprise must adapt to its day. The problem is who decides what to change, and what motivates them. Firms such as Google and Toyota and machine-tool maker Mazak still do a great job of delivering better products and services. But these enterprises are run by managers who figured out how to insulate their executive suites and R&D operations from rapacious fund-runners. In a growing number of industrial firms, the scientists and engineers and machinists we rely on to devise and build what we need tomorrow lack the power to do so. Those who have power—be it billionaire investor Carl Icahn or California’s pension fund—know little about the systems they control. So like any absentee landlord, they blithely demand more than soil or serf can yield.

There is one easy way to get the managers of our corporations to focus more on making nextgeneration products and less on piling up cash for themselves and the fund managers they serve. And that is to eliminate, or at the very least to alter radically, the stock options that since the early 1990s have become such a huge part of executive pay packages. Back then, options were promoted as a way to bring the selfinterest of managers more in line with that of shareholders. This is exactly the problem. The old antagonism between “professional” managers inside the firm and the masters of capital outside it helped ensure a balance between acts of creation and acts of destruction.

In America, the modern manager emerged during the late nineteenth century in tandem with the limited-liability corporation. As these private governments grew bigger, so too did fears that a largely self-selecting corporate elite would abuse their authority, economically and politically. The New Dealers’ aggressive use of the IRS, antitrust law, and other state powers seemed to solve this problem, and by the 1950s managers were wont to present themselves as “corporate stewards” whose job was to serve “stockholders, employees, customers, and the public at large.” These managers knew their companies intimately: in 1950 nearly 40 percent of CEOs had forty or more years of experience with their firms. And they had an incentive to ensure the long-term health of the activities entrusted to their care, because the best way to keep the plush office and perks was to invest in the people and ideas necessary for the company to grow.

This balance was upset by two actions. The Reagan Administration’s overthrow of antitrust law in 1981 freed investors and managers to create larger firms less regulated by horizontal competition and hence less compelled to refine their products and systems. The explosion of options and the linking of earnings to short-term stock-price fluctuations completed the transformation of the CEO from tribune of the industrial arts to Shareholder #1.

It would be wrong to view the old way as perfect. The New Dealers, like the progressive-era reformers before them, failed to resolve the huge constitutional questions posed by the often necessary concentration of immense power within industrial corporations. But the ad-hoc balances they achieved were far safer than the one-sided dictatorship we see today. We should not allow investors to scatter the people, machines, and ideas entrusted to our great industrial firms any more than we would allow them to shutter or sell off the physics departments at MIT and Caltech. The time is long past to shift control over these vital activities away from the massed mindless appetites of Wall Street and entrust them instead to teams of human beings freed to use their powers of reason, and rewarded for doing so.