Enlightened Enterprise Newsletter 02/22

FEATURE ARTICLE

In this newsletter I want to continue making the case for the urgent need to shift from the current form of capitalism to what I call Equitable Capitalism. I first published “A Call for Equitable Capitalism: Taking us Beyond ESG ,” Then “Unlocking the Value of Equitable Capitalism: Following the Money and Embracing Critical Systems Thinking ”

Here I want to start exploring what makes the current form of capitalism so unfair i.e., inequitable, and the damage being done. The negative consequences are serious if we don’t fix the problems. It will be the first in a series on the causes of unfairness with the others being covered in future newsletters.

The first cause of unfairness I will deal with is the rise in income inequality. At the outset let’s be clear, we are not talking about 'earnings'. They have to be earned. All the evidence indicates the massive increases in income received by top executives has not been earned. And I will argue there is no legitimate justification for them; that they are unfair and “ill-gotten gains,” the product of the corruption of capitalism. ???

I am not the first to make these arguments, of course. The problem was identified at least thirty years ago. But it has not been resolved. In fact, it has become much worse.

To be clear, I am making the arguments because I believe in capitalism, but not in its current form. I make my arguments in support of my view, that capitalism needs to evolve again, just as it has many times before.

Addressing this problem again is important because those with the power to bring about the change, have been unwilling to do so. They need to be made aware of the consequences of their inaction. So far, calls for “equity” in the “Diversity, Equity and Inclusion” (DEI) agenda have been mild. They will get stronger. More importantly, it is a major contributor to the lost legitimacy of capitalism in the eyes of many citizens, even in America.

As research by the Pew Institute in America makes clear, income inequality is closely related to wealth inequality and perceptions about whether the system as a whole is fair or not. On this issue, and on the matter of what to do about it, it is unsurprising to know that they find America is divided, But the majority agree things have gone too far. The consequences, including political polarisation and a breakdown in social cohesion; already visible and serious, are likely to get far worse.

Anne-Robert Jacques Turgot (1727-81) a contemporary of Adam Smith, is said to have understood and approved of capitalism, free-trade and Laissez-faire. As Intendant of Limoges, one of the poorest districts of France at the time. He was a reformer. In 1774 Louis XVI called Turgot to the Council of Ministers, and soon after made him Comptroller-General. He continued to be a reformer removing immunity from taxation enjoyed by the privileged classes, and the removal of the privileges [restrictive practices] of trade corporations. These were efforts towards a more economical, efficient, and equitable administration. Vested interests pressured Louis XVI into dismissing him after only 20 months, and “France drifted rapidly into the catastrophe of 1789” wrote Sir Kenneth Jupp in his translation of Turgot’s “The Formation and Distribution of Wealth: Reflections on Capitalism.”

Jupp goes on to note, “After 1789 many of his [Turgot’s] opponents will have paid the price of their intransigence under the guillotine.” And he says, “Whatever caused the French Revolution is a matter of much debate among historians. But whatever part in it was played by the poverty, the inequality, and the ill-treatment of the peasantry would have been considerably allayed, had Louis XVI insisted on retaining Turgot’s reforms, and resisted the court intrigue which led him to dismiss such an able minister.”

Our leaders today need not fear the guillotine, but events January 6th, 2021, in the US Capital, should be viewed as a warning; that capitalism in its current form, the institutions that perpetuate it, and the consequences of it, are losing capitalism it's legitimacy among large sections of society – close to 50% of those who bothered to vote in the last presidential election.

They might also ask themselves, what part did poverty, inequality and the ill-treatment of large sections of society play in that? And to avoid drifting further towards catastrophe, they ought to consider radical reforms towards the realisation of economical, efficient and equitable administration?

In this context, addressing the issue of income inequality is a good place to start. Why? Because “Chairmen and Chief executives are keenly aware of the criticisms regarding executive pay. Well Publicised instances of abuse and excess have served to call attention to the subject and raise concern that executive pay is ‘out of control.’” This was the view of Nigel Dyckhoff, leader of the Remuneration Practice at Spencer Stuart, London, in “Pay at the Top” (1994). This was “A Confidential Report” published “For private circulation only.” But I picked up a copy in a second-hand book shop.

“Out of control” executive pay in 1994 meant, the typical American CEO was earning 120 times more than the average manufacturing worker and 150 times more than the average manufacturing and service industry worker.” That compared with 34 times in 1974 in the case of the average manufacturing worker.

And what of CEO pay today? A 2019 Institute for Policy Studies report estimates that 80% of S&P 500 companies pay their CEO over 100 times more than they pay their median worker. Whilst, in 2020, CEOs of the top 350 firms in the U.S. made $24.2 million, on average — 351 times more than a typical worker.

These figures are not comparable on a like-for like basis. The first considers workers compared to CEOs in the economy in general. The second compares them within the same company. So, another statistic from The Economic Policy Institute (EPI) is perhaps more telling and more relevant. It estimates CEO compensation has grown 1,322% since 1978, while typical worker compensation has risen just 18%.

It is safe to conclude, “Out of control” executive pay has not been resolved since the problem was written about almost thirty years ago and is probably far worse. This is consistent with other data measuring the “shrinking middle-class.”

Nearly thirty years ago, Dyckhoff also documented concerns about “paying for failure, whereby senior executives are given huge compensation packages when they are forced to leave their companies.” He noted, “To the outside observer, it appears that senior executives are engineering no-lose situations for themselves,” and “while lip-service is paid to the principles of pay for performance, there is little evidence of a real correlation between what senior executives are paid and company performance.”

Dyckhoff concludes, “On all the evidence available, critics maintain, it appears that senior executives are writing their own pay cheques and that the amounts bear scant relationship to the performance they deliver or the value they create for shareholders.” This quote illustrates that shareholder value maximisation was dominating thinking then, as it still does today, but they were certainly not considering stakeholders either. The only beneficiaries were themselves.

Pay at the Top makes fascinating reading, explaining the problem and the consequences, whilst also offering solutions which were, clearly, ignored. Here is not the place for me to go into detail; I am making a higher-level argument for a shift to Equitable Capitalism. But I will refer to this book again in future articles.

Let me now turn to the evidence supporting the argument, that the massive fortunes made by CEOs are unearned. And let me strengthen the argument that the income rises bear little, if any, relationship to their performance.

In “How the Wealth Was Won,” a research paper by the US National Bureau of Economic Research, the authors state, “while real corporate net value added grew at a robust average rate of 3.9% per annum from 1966 to 1988 amid anaemic stock returns, it averaged much lower growth of only 2.6% from 1989 to 2017 even as the stock market was booming.”

In other words, the factors that boost economic growth and increase share prices, according to textbook economic theories, are no longer the drivers. The market value of companies is not being driven by real value added. So, what are they being driven by?

The authors of the paper note that from 1989-2017, $34 trillion of real equity wealth was created by the U.S. corporate sector. And they estimate 44% was attributed to a reallocation of rewards to shareholders in a decelerating economy, primarily at the expense of labour compensation. Economic growth accounted for just 25%, followed by a lower risk price (18%), and lower investment rates (14%). In contrast “The period 1952 to 1988 experienced less than one third of the growth in market equity, but economic growth accounted for more than 100% of it.” ?

In other words, companies are not creating real economic growth for themselves or the economy, their focus is on managing the market value of their shares at the expense of employees and through financial engineering such as share buybacks. This, “presents a difficult challenge to theories in which economic growth is the key long-run determinant of market returns.” It must also make us question how well firms are honouring their social contract. And it makes clear, the unjustified incomes being enjoyed by CEOs are not being earned, as we would expect them to be. They are the result of perverse incentives leading to behaviours which are corrupting capitalism.

Earlier I cited the views of Sir Kenneth Jupp, that ignoring the call for sensible reforms by Turgot in the 18th Century, almost certainly contributed to the French Revolution as a result of corruption and the abuse of privilege which perpetuated poverty, inequality, and ill treatment of the peasantry. Less dramatic, but equally important warnings are offered by Thomas Picketty in the first line of his Introduction to Capital and Ideology (2020).

Picketty says, “Every human society must justify its inequalities: unless reasons for them are found, the whole political and social edifice stands in danger of collapse.” There are already plenty of influential voices calling for post-capitalism, socialism and other alternatives to capitalism. Picketty’s more recent book is titled “Time For Socialism” for example. Commenting on this later book Robert Kuttner of the New York Times says, "What makes this manifesto noteworthy is that it comes from...and economist who gained his reputation as a researcher with vaguely left-of-center sensibilities but was far from a radical. Yet the times are such...that even honest moderates are driven to radical remedies."

The point I will conclude with is this argument; capitalists need to accept that capitalism must evolve, to Equitable Capitalism I hope. If those who have recently argued that it needs to shift from shareholder to stakeholder capitalism are serious about change, making the treatment of stakeholders equitable is not going to be such a stretch. But they must also accept reforms that demonstrate they are serious, starting with control on executive pay and in the reform of perverse incentives.

STARTING SOON

The first course for executives in "Critical Systems Thinking and the Management of Complexity" will now begin on May 10th.

The course is designed to help executives understand and and address their own systems thinking capabilities gap, and that which exists in their organisation and among their leadership team.

It will be presented by Dr Michael C Jackson OBE, author of a book by the same title and the former Dean of Hull University Business School. And I will be joining him in presenting the program.

It is offered online to reach a global audience, and twice on each of the dates to give access to people in both northern and southern hemisphere time zones. FULL DETAILS

RECENTLY PUBLISHED

The Enlightened Enterprise Academy is currently developing a multi-media publishing platform designed to disseminate thought leadership linked to the goal of the Academy, and Enlightened Enterprise Media has recently published the first book.

The Yin and Yang of Reputation Management was published in December and launched with events in New York and Boston. Plans are currently being developed for a European book launch tour to commence in April/May this year.

The book is available as an eBook, Paperback or Hardback on Amazon

You can also view the recording of the first event we ran in New York via the video recording available on YouTube.

RECENT ARTICLES

My recent articles dive into many of these issues. You can?read them all ?here LinkedIn.

NEXT ISSUE

In the next issues, on Monday next week, I will do what I initially planned to do this week, I will review the ideas of Paul Polman, former CEO of Unilever, and Andrew Winston, as sustainable strategy thought leader. Together they co-authored Net Positive (Oct 2021). I will relate them to the view of the Enlightened Enterprise Academy.?Don't Forget To Subscribe

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