The scandals, the stock markets and corporate law: it's the barrel, stupid, not the apples!
The immediate cause of today's anxieties for capitalists in our part of the world is not corruption per se. Instead, it is the contradiction between the role of the corporation as a productive unit and its role as a vehicle for financial speculation. More specifically, it is the ability of some capitalists to exploit financial markets only loosely connected to the corporations whose productive activities they notionally exist to finance. This contradiction -- arising from the legal structure and nature of the Anglo American corporation -- always has the potential to create a crisis. It also serves to explain the continued existence of corruption.
In the distant past, it was common for the entrepreneur to be both industrial and financial capitalist. However, these functions have been split by the advent of the modern corporation. It is now completely feasible to make money without too much regard for the productive activities of the corporation whose financial instruments are being traded. For financial capitalists, the corporation provides the substratum for the trading of shares and IOUs and for the exponential growth of the parasitic classes that feed on the rich scraps that fall off the table. Naturally, the well-being of the corporation as the unit of production does matter, but this can take a long time to make itself evident. The consequence of this situation is that, as long as it remains possible to be able to make money without regard for production, there will be room for speculative markets that take off, fly high for a rime, and then crash land in spectacular fashion.
It is most unlikely that the current pre-occupation with devising remedies aimed at fixing false accounting and self-dealing by directors and managers will do much to prevent the future promotion of bubble markers. Indeed, the promoters of bubble markets have created an ideal situation where their fellow class members are able to plunder them. This is an intra-class problem among capitalists, one spawned by the legal structure and actual operation of corporations.
Corp orations, Corporate Law, Shareholders
The basic elements of corporate law have remained unchanged for the last 160 years, and they bring into view some of the underlying reasons for the recurrent malfunctioning of corporate capitalism. A corporation is a large, publicly traded company registered under a special statute, exercising separate legal personhood. The company has a legal existence separate from the contributors of its operating capital. Subscribers to that company get a certificate as proof of their contribution. The certificate entitles them to any such dividend as the corporation may declare as a result of the deployment of the contributed capital, which is now the property of the corporation as a distinct legal person.
Contrary to today's popular lore, shareholders are not the legal owners of the corporation. Indeed, as shareholders, they play no part in its daily operations. Instead, they are simply entitled to a share of the profits. In addition, shareholders also have the right to participate in the election and termination of the corporation's board of directors. It is the board of directors, together with the managers it employs, that is actually responsible for maximizing the return on the corporation's capital. Finally, shareholders also have some rights to attend and participate in corporate meetings and to share in any property left over after a corporate failure and the payment of all its debts.
Shareholders, then, are the quintessential capitalist exploiters. And, as it behooves capitalist law, law has made them virtually riskless exploiters. For example, to get individual wealth owners to contribute their capital to a corporation, incentives are offered. Not only will they nor be held legally responsible for the acts of the legally autonomous corporation, shareholders will not be responsible for making any more contributions should the corporation fall on hard times. Instead, shareholder risks are set, once and for all, when they make the decision to contribute X dollars. Then and there, their risk is limited to X dollars. More: since shareholders in large, publicly traded corporations are entitled to sell their shares to other willing buyers on the stock market, they are not bound to stay invested in any one corporate enterprise.
The Callous Cash Nexus
The relationship between individual contributors of capital is an impersonal one. It is based on money. This helps to explain why the only common goal of individual shareholders is to ensure that the corporation's business is conducted so as to increase the market value of the shares they hold. Having limited the personal liability of the shareholders, corporate law has ensured their financial liability for any harms inflicted and any wrongs done by the corporation in the pursuit of greater shareholder value is virtually nonexistent. This explains the systemic bias that impels this class of people to rake no interest in how their agents -- the directors and their managers -- seek profits. In other words, it is in order to make the share markets happy that we have had, and will continue to have, Westrays, Bhopals, Love Canals and lay-offs.
Legally and functionally, shareholders have given up their control over the deployment of the contributed capitals. Instead, directors and their managers have it. Of course, the discretion necessarily vested in directors and managers does present a threat to shareholders. It is always possible that they will use that discretion to advance their own interests at the expense of the welfare of shareholders. For example, it is always possible for them to try to reward themselves more than the intensity and effectiveness of their work warrants. In the corporate literature, this is termed the potential for "looting" and "shirking." Another example is directors and managers who resist a takeover/merger that would lead to their dislodgment even while paying shareholders a premium. Much of corporate and securities law revolves around this problem. In corporate law, there is pressure from shareholders and bondholders to put on boards directors who are independent of the existing management cadres. They do this in order to oversee these cadres, thus inhibiting the shirking and looting that capitalists expect from each other. It is for this reason, too, that securities legislation is by far and away the most elaborate consumer legislation we have.
Shareholders are to get information about any factors that might affect the market's valuation of their shares; no shareholders are to be preferred to any others because all capitalists ought to be treated even-handedly; and there are very sophisticated rules about what directors can do when takeover/merger bids are made. All of this amounts to the fact that shareholder value augmentation should be the focus of management decision-making. Still, this legislative TLC has not been enough. In the last 20 years, financial capitalists have gone even more out of their way better to align the goals of the corporations managers with those of shareholders. Through options and fancy bonus schemes, directors and managers have been paid more if they improve share values.
And Its Consequences
However, the consequences of establishing this kind of payment regime for people selected for their unalloyed commitment to greed and self-advancement are inevitable. This regime explains why corporations now book transactions as sales when there are no enforceable sales contracts -- Adeiphia, WorldCom and, allegedly, Nortel; this is why they resist booking the outstanding obligation of their corporation to make good on the options they have extracted from it as an expense the corporation has incurred, a manoeuvre that has allowed the profitable corporations on Barron's list to report one third more profit than they have actually been earning, misleading the marker into grossly overvaluing their shares; this is why corporate executives concentrate on short-term profit registration, even at the expense of long-term downside risks: it leads to a better share valuation; this is one of the reasons behind the explosion of takeovers and mergers: it turns corporations into what the market analysts call "growth" companies whose shares are highly prized, even though the empirical evidence indicates that these takeovers and mergers rarely achieve any of the synergeti c efficiencies they promise, the only cost-savings being attained by mass layoffs. All this was inevitable: such people were bound to bend the rules to make sure that the share market valuations went up and up.
The Role of Professionals
To enable them to engineer these shady dealings, corporate executives need the help of a raft of professionals. These professionals must not only know how to execute shady deals but also to give the manipulations legitimacy. "Legitimacy," here, simply means a stamp of approval by professionals who proclaim that their primary obligation is to serve the public weal. In a world built on greed and sleight-of-hand, there is never a shortage of professionals willing to "interpret" the rules designed to serve the public good in the interest of their masters -- particularly since this is also in their own interest. Enter Arthur Andersen, Merrill Lynch, Deloitte & Touche, PwC, and the lawyers. These people offer advice on how to engineer takeovers, help set up golden parachutes for mismanaging managers and the deliverance of poison pills, and offer opinions on when to shred incriminating documents. Now, very little -- apart from some new technical wrinkles -- is novel about any of this. Lying about the state of the co rporation, its prospects and expenses, have been part of the corporate world ever since it became possible to make money by trading shares, rather than just by relying on the profitability of the enterprise. Nevertheless, it remains true that, while some of these shenanigans were notorious at the time (Savings and Loans, Milken, Boesky, Bre-X, Baring, Royal Trust, Livent, Northland Bank), they did not create the kind of alarm that exists today.
Today's scandals are particularly serious because they are occurring in the midst of the bursting of a vastly inflated stoc- market bubble. This problem, which arises from the structured division between the raising of capital for the corporation and the day-today productive activity of the corporation, is embedded in, and has been perfected by, the modern corporate form. Of course, in the history of capitalism, there have been many manias followed by panics, but in today's corporate world, there exists an intensified potential to herd people into speculative madness.
Much of the hot air in this bubble was the talking-it-up big of the new technologies. Coming at the moment of the collapse of the Soviet Bloc and the "conversion" of China, it enhanced the spin doctors' message that a New Economy, one in which the old truths about the need for material wealth creation, the keeping up of demand, and the like, no longer held. Get into the market, clamoured the analysts tied to the brokerages and underwriters. Buy stocks in corporations that have no profitable operations, no recognized brand, but do have a concept. It is bound to be all right.
Governments also played their part. They bought into, and disseminated, the propaganda that government pensions, social funds, such as unemployment and worker's compensation, would be broke soon, and that people should provide privately for their own needs and security. Governments urged people to buy stock, through registered retirement savings plans -- for which the government gave generous tax breaks -- and private insurance schemes. Governments encouraged people to invest their savings in mutual funds, institutions that would prudentially and effectively -- because they invested expertly and diversifiedly (for large fees, of course) -- make these savings grow.
The wealth of the institutional investment houses, of course, is immediately tied to their market share. In turn, this is directly tied to how well they perform, quarter by quarter in the stock market. Their interests are aligned with the short-term share-value inflation pursued by the corporate executives whose prestige and wealth depends on their stock-market performance. A neat logical circle in which all the intermediaries are acting with one purpose has been drawn.
All of this was cheered by politicians, business media and the parasitic professions. As stock prices rose -- and with them options and bonuses -- a veritable stampede was set loose. Everyone was encouraged and manipulated into being a share-market player. The technology that was the catalyst for this latest outbreak of herd-like behaviour was used by individual profit seekers to invest on-line, with the minimum of data available to them. For instance, they were not party to the briefings that large banks and institutions got on an on-going basis from the corporations that sought their dollars. Ayn Rand's most famous disciple, Alan Greenspan, whilst warning against irrational exuberance, actually helped. the manic investment movement along. He persistently drove down interest rates, inhibiting investors from putting their monies in safer harbours, such as government bonds.
As the markets totter, rotten apples are being blamed by the contemporary dominant fraction of capitalism. However, while related to the current mess, this rottenness is nor the cause of the bubble bursting. There will be reforms on the auditing, monitoring of the executives and corporate-governance front to rein in the unruly servants of capitalism's dominant class. We have had these kinds of reforms before, for similar reasons. Now, as then, the basic corporate productive/capital-raising contradictory relations are not being changed.
For the Left, it is wise not to get too caught up in this somewhat amusing discomfort of the rich .and powerful. As trust in the corporate financial markets dissipates, it seems preferable to try to turn ordinary people's anxieties to gain a minor reformist advantage. For example, there may also be an opportunity to advocate a re-establishment of the public sectors as the best guarantors of health and income security. But let us nor let minor reforms and compensation dampen our hunger for real change.
Harry Glasbeek recently retired from Osgoode Hall Law School. His new book, Wealth By Stealth: Corporate Crime, Corporate Law and the Preversion of Democracy, is to be published by Between the Lines in the fall of 2002.
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|Title Annotation:||financial capitalism|
|Date:||Sep 1, 2002|
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