Aug. 21, 2001

FROM THE AIRWAVES
Creating and Exporting Irresponsibility

From the Airwaves is a transcript of “The GW Washington Forum,” the weekly public affairs radio program produced by GW, hosted by Richard Sheehe, and broadcast on WWRC-AM 1260 in Washington. This conversation with Lawrence Mitchell, professor of law, comes from a recent program. His new book, “Corporate Irresponsibility: America’s Newest Export,” is due to hit bookstores in the fall. His book is a survey of what happens when companies focus too much on the short term bottom line and why this attitude is being picked up by other countries now.


Richard Sheehe: What is corporate irresponsibility?

Lawrence Mitchell: The way we’ve structured American corporations and the markets in which they are situated, corporations literally don’t have to be responsible for their behavior. The way we’ve done this is by creating a corporate structure in law in which all the power is held by the managers or directors and the stockholders. None of the other groups, which is all of us that major corporations affect, have any say in the way the corporation is run except to the extent they may have contractual dealings with the company. What I mean by irresponsibility is that by creating a structure in which the power is so centrally limited, and situated in a market in which we expect the corporation to be maximizing its stock price, we’ve literally created a situation in which the corporations only responsibility, as we all see it, is to maximize stock price. It is, in effect, a moral excuse not to be responsible or accountable to anyone else. My argument is that corporations ought to be morally accountable in the same way that any one else is. It doesn’t necessarily mean that every corporation is going to behave well.

RS: How is this picture different from 30 or 40 years ago?

LM: Technically it’s not. We have the same basic structure of the American corporation that we’ve always had. What’s different is two things. The first is the structure of stock holding in America. The second is what I would call American social ethics. The structure of stock holding over the last 30 years has been this concentration in the hands of institutional investors. Previously, stock was dispersed among a relatively small segment of the population, but not a segment that was going to be concerned about anything other than wealth creation. They were investing, for the most part, over the long term. As more wealth has been generated, as more Americans have become beneficiaries of pension funds, as the stock market has heated up and cooled down and become subject to public interest, more Americans have invested through the rise of mutual funds and pension funds. Thirty years ago, mutual funds barely existed. The result has been that all of the money gets funneled indirectly in through these intermediaries, creating a concentration of wealth in the hands of institutional investors. In some big companies, as much as 90 percent of the stock, and I think Coke is an example, is held by institutional investors. Not five institutional investors, maybe 100, but a small enough group so that should they choose to, they could exert pressure.

RS: Does all of this focusing on the bottom line change depending on whether we’re looking at a good economy or a rough economy?

LM: It’s hard to say because the dominance in this way of thinking is really only the product of the last 10 years or so. And during those last 10 years, with the exception of the first Bush recession, we had a very good economy up until now. It’s hard to say whether a bad economy wakes people up. But I think you’re going to see lots of layoffs, in part to keep the businesses running, but in part to keep the stock prices up, as well.

RS: I was looking at the description of your book and part of it reads, “Corporations are so often focused on making short-term profits for their stockholders that they behave in ways that adversely affect their employees, the environment, consumers, American politics and even the long-term well-being of the corporation.” What is this behavior doing to the corporation? If you’re boosting your stock price, how can that be bad?

LM: Well, it can be bad if you’re boosting your stock price at the expense of long-term investment. Most managers would argue that investing in R&D, which we under-invest in dramatically compared with other developed countries, is something that is good for the long-term well-being of the corporation, even though it’s a current expense. It’s going to adversely affect your earnings report. Our current market environment, where analysts and stockholders jump on earnings reports and devour them like rabid dogs and then drop the stock price, is bad for the corporation. The focus on what the stock is worth today is very much a short-term focus and does not incorporate the long-term. Nobody’s asking what they are planning for the future or how are they planning to deal with whatever business problems come up.

RS: It sounds as though Americans, at least those in charge of the financial world, just don’t have as long of an attention span as their predecessors.

LM: No, they don’t. But I don’t think, for the most part, that it’s the managers’ fault. I think it’s our fault. It’s our fault that we have this short-term, self-centered focus on immediate gain. And depending on which set of statistics you look at, the peak earning capacity of a money manager comes at about the age of 40. But if that’s what you’re working for and that’s your peak earning capacity, then you’re going to be pushing to make as much money as you can before that time hits when you’re getting old. There may be something, also, to a short-term focus in general in our society. But there’s also been, and it think it’s a phenomenon that’s developed over 20 years, an ethic of instant self-gratification.

RS: A major point of your book is that this view is being exported and other countries are starting to adopt this perspective. Can you explain this?

LM: This is a phenomenon that’s related to globalization in a very particular way, an American way. I think you’ll find there’s an excess of investment capital in the United States. During the early and mid 1990s, American investment bankers had so much money that they needed new investment opportunities. Well, they took those investment opportunities abroad. American investment bankers, who needed to make more money, went over and started selling deals, which is what mergers and acquisitions investment bankers do. They would look and say, ‘well, if we take over this one, you can unlock X value and that’s going to increase the stock price, and entice the Europeans into beginning this process of Americanization first through hostile takeovers, but secondly, through investment.’ Mutual funds and pension funds have invested very heavily in European companies and investing in European companies began to bring pressure on management to develop American-style ways of structuring their corporation...I’m all for corporate capitalism, but there are different ways of doing corporate capitalism and I think the way we do it has become, particularly in the long term, highly destructive of our own system and these European systems.

RS: Where do you start looking for solutions?

LM: The problems that I’ve been talking about are fairly complex. I don’t pretend for a minute that there’s any one particular cause. These are the causes I’ve identified as being most significant. Nor is there any one particular solution. If the problem is centrally a real short-term pressure in the market caused by structure, and a market that really is unregulated, then we have to overcome that by, in effect, disciplining ourselves. One of the ways of doing that is that the financial reporting system in this country is wrong. It’s much too short term. There’s no reason for corporations to have to issue quarterly reports. Warren Buffett claims he doesn’t look at them. He says, ‘what’s going to happen in a quarter that I’m going to care about?’ Yet, corporations are required under the securities laws to issue quarterly reports. It seems to me that one thing we can do is lengthen financial reporting periods. I suggest a year in the book, maybe it’s longer than that. That’s not to say a corporation couldn’t voluntarily release information in the interim, but then it risks being perceived as a corporation with a short-term focus. The default rule ought to be longer times between reporting periods. One of the phenomena that you see, that’s diminished somewhat, but as of a year ago, is that 15 percent of the market volume everyday was daytrader volume. Daytraders don’t know squat. They are trading solely on price. One possibility is to reexamine at the capital gains structure and have punitive capital gains taxes for really short-term trading. Obviously, there would have to be exceptions for market specialists. But there’s no excuse for people to turn over stocks everyday.

RS: The past couple of years, we’ve seen more vocal protests at global meetings in Genoa, Washington, and Seattle. What’s your take on that? Are you glad to see a more vocal opposition to some of this globalization? Are they on the mark in your view, or should they be focusing on some of the things you’ve mentioned?

LM: I don’t think they are particularly focused and that’s the problem. Yes, I’m glad to see the protests because, if nothing else, even if they’re unfocused, the protests do make global leaders aware that there are serious problems that need to be addressed. What I would prefer to see is some centralization to the protests. I have received a major grant from the Ford Foundation and created the International Institute for Corporate Governance and Accountability, which now numbers among its members people around the world — academics, policy makers and the like — for the purpose of trying to come up with a centralized form. We’ve got a Web site up now — www.law.gwu.edu/iicga. We’re going to have publications. This may not be the only solution and it may not be the best one, but there need to be focused discussions. There needs to be a centralized, serious, non-violent, not-on-the-streets forum for the opposition.

RS: You’ve been a law professor here at GW for 11 years. Before that, you were in mergers and acquisitions. Did that motivate you to start thinking more along these lines and writing books?

LM: It’s hard to say what motivated me. Part of my motivation to leave that and go into teaching was the realization that my mother didn’t raise me to make investment bankers rich, which was basically the job I had. Yes, I saw lots and lots of deals that were non-economic deals, or if they were economic, they were economic because of tax considerations. And they weren’t adding value. They were just making investment bankers rich. I didn’t want to devote what talent I may have to that process.

 

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