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17 Feb 2020

18/2/20 - Raphaële Chappe, Open Society Fellow

We need a new corporate governance that empowers communities and workers - instead of focusing on short-term profits

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This article is part of our Rethinking Corporate Governance blog series

Corporate governance and ownership are critical human rights issues, writes Amelia Evans in this series. At the heart of the problem lies the ascendancy of “shareholder value” as a mode of corporate governance, in which firms operate to maximize shareholder value.

Corporate profits and valuations of US firms have soared despite slowing economic growth. High rates of return were maintained through the rise of “financialization” – a term which has been used ubiquitously to describe the economy since the late 1970s and can also be thought of as a number of profit-boosting market trends.

The majority of workers have experienced long-term wage stagnation. Had wages risen in line with productivity, an American earning around $40,000 today would be making close to $61,000. Decades of stagnation combined with soaring incomes for those at the very top has fuelled rising inequality and financial instability, as households turned to debt to maintain their standards of living.

Returns to shareholders increased as industries became more concentrated and intangible-intensive, leading to the domination of a few “superstar firms” across a range of sectors. Growing productivity differentials between firms are exacerbating inequality by furthering wage differentials as well as driving down the labor share, the portion of national income that goes to workers’ compensation.

In my Open Society Fellowship project I am studying how these trends have shifted economic risk from corporations onto individuals. More “creative destruction” in the economy has increased the volatility of firm-level performance, which has been passed onto workers in the form of wage volatility. Substantial income fluctuations have become the norm for American households. Firms are outsourcing other forms of risk to workers, from retirement plan portfolio fluctuations to skill obsolescence.

With market concentration comes market power – as William Lazonick describes for the pharmaceutical sector in this series, large leaders in “financialization” have resorted to extreme price gouging (high mark-ups), acquiring existing blockbuster drugs to squeeze them for revenue rather than innovating in-house. This has curtailed innovation.

Investment has been low even in sectors with the highest growth and valuations – some speak of an “investment gap”. Many firms choose to distribute profits to shareholders (e.g. via stock buybacks or dividends) rather than reinvest in their productive capabilities or the workforce.

Last but not least, many industries haven’t properly accounted for “externalities”, that is the impact of business activities on human health and the environment. Pollution has devastated entire ecosystems and communities. Imani Brown reminds us of what fossil fuel companies have done to the US state of Louisiana, a “sacrifice zone in the Global North”.

One way to interpret financialization is the financial sector turning to value extraction rather than value creation as a source of profit (what economists call “rent seeking”). The detrimental and destabilizing impacts on society and the environment have become abundantly clear. This is unsustainable.

Investors are beginning to appreciate this. The recent progress of environmental, social and governance (ESG) investment criteria, now being endorsed by some of the world’s largest asset managers, can be interpreted in this light.

The Business Roundtable’s recent commitment to all stakeholders can be viewed as an endorsement of ESG considerations, with corporate leaders finally “seeing the light” on these matters, though belatedly. As The Economist recently pointed out, CEOs who want to raise wages need some kind of a cover. A broader corporate purpose could provide it.

Yet Paul Rissman warns us that letting go of the primacy of shareholder value may well undermine corporate accountability to shareholders on these matters. Companies may be “virtue-signaling” (otherwise known as “purpose washing”) at little to no financial cost to themselves, without concrete concessions that would grant stakeholders actual leverage.

Multi-stakeholder governance is a balancing act that requires the weighing and assessment of various constituents’ conflicting interests to engage in potentially difficult trade-offs. In this series Bama Athreya and Amelia Evans have described the many reasons why executives shouldn’t be entrusted as sole stewards for this exercise – if only because they are often divorced from the human rights impacts of their business operations.

Bama Athreya makes the case why workers’ input is critical to steering corporations in the right direction. One approach is a radical rethinking of governance to build stakeholder-control mechanisms directly into corporate processes for decision-making and even, as Nathan Schneider suggests, in financing structures.

Amelia Evans advocates for two guiding criteria as we move forward: The first is legal and operational accountability to workers and communities, for example through workers or community representation on boards, or specific fiduciary duties. The second is profit-sharing that is better aligned with value created by workers and externalities absorbed by communities.

Another approach is to strategically leverage “the power of the share”, to use Paul Rissman’s vibrant image, as responsible investors may be well-positioned to push companies. Delilah Rothenberg has flagged the issues of how to bridge a trust gap between investors and labour and civil society groups as well as improve ESG metrics to account for stakeholder concerns that aren’t currently captured.

To that end, Rights CoLab and Predistribution Initiative are focused on building consensus by encouraging and facilitating constructive dialogue to advance common interests.

A new type of corporate governance that empowers communities and workers is the only way to move beyond the focus on short-term profitability that is endangering our collective future.

Corporate Governance von Grund auf überdenken

Should we consider fossil fuel extraction an unjust enterprise?

11/2/20 - Imani Jacqueline Brown, Economic Inequality Fellow with Open Society Foundations 10 Feb 2020

Here's how stakeholders can engage effectively to build a new corporate model

3/2/20 - Delilah Rothenberg, Founder and Executive Director, Predistribution Initiative 3 Feb 2020

Worried about US inequality? Ban stock buybacks to end the looting of corporations

28/1/20 - William Lazonick, Open Society Fellow 28 Jan 2020

View Full Series