Banks and automakers who accepted bailout stimulus money are living the truth behind the proverb, “when you pick up a stick, you get both ends.” Banks are realizing that dipping their hand in the taxpayer till may turn out to be a honey pot that they should run—not walk—away from. Stories like this, this, and this, begin to paint the picture of banks looking to escape the strings attached to bailout money. It looks like at least some of these firms are shaking their heads asking, “what have we done?”
Banks, however, seemed a little quicker on the uptake than the automakers, who may still not fully realize their plight. In Stakeholder Capitalism and Chrysler, Harvard Business Review editor, John T. Landry exposes two significant trends fueled by the Administration’s approach with Chrysler. First, there’s a new precedent of legal priority caves to political expediency. Second, there is an underlying movement to supplant shareholder value as the primary goal and purpose of a business with the similar-sounding, but very different meaning stakeholder value.
What do I mean about the legal stuff? I’m talking about U.S. bankruptcy law. (For a more apologetic and detailed angle, read Who is Screwing With Bankruptcy Law? It isn’t my purpose to delve into the nitty gritty of the Chrysler deal, just to hold it up as an example of a shifting macro-opinion.) Typically, companies raise money by issuing various types of debt and equity. Each of these exchanges represents a promise of repayment, and that promise is called a security. In a bankruptcy liquidation, there is often not enough money available to pay everyone back, so these various securities represent the priority of who gets paid back first. Bonds are debt securities, while shares of stock are equity securities. Typically the pecking order from first to last is, bondholders > preferred stockholders > common stockholders.
However, in Chrysler’s case, the President’s offer gave a better deal to the UAW than it did to bondholders. Bondholders made a statement that to the effect that they felt they had an obligation to their shareholders to defend the rights of their more senior position. The President’s opinion is clearly that workers (read stakeholders) are more important than shareholders. President Obama‘s words (abridged) were:
Now, while many stakeholders made sacrifices and worked constructively, I have to tell you, some did not. In particular, a group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout.
They were hoping that everybody else would make sacrifices and they would have to make none. Some demanded twice the return that other lenders were getting.
I don’t stand with them. I stand with Chrysler’s employees and their families and communities. I don’t stand with those who held out when everybody else is making sacrifices.
Because of the fact that the UAW and many of the banks, the biggest stakeholders in this whole process have already aligned, have already agreed, this process will be quick, it will be efficient. It’s designed to deal with those last few holdouts, and it will be controlled.
It’s a process that has the full support of Chrysler’s key stakeholders and the full backing of the United States government.
What about the second point, that Obama’s opinion represents a more widespread and significant trend shift toward stakeholder value supplanting shareholder value as the corporate mandate. A more overt treatise is available from Harvard Business Review editor Michael Yaziji in his frightening article, Time to Rethink Capitalism.
My intention is that with the recent surge in popularity of anti-capitalist sentiment both in the U.S. and abroad, I think it’s time capitalism received a defense, however inadequate in the context of the shareholder/stakeholder question.
I contend that companies exist to create value for two groups: customers and shareholders, both of whom voluntarily fund the company with cash in exchange for the value the company creates for them. When the company is successful creating value for these two groups, it is able to use the cash they provide to pay employees and value chain partners in order to grow and increase its capacity to create even more value. Without this funding, companies have no resources to allocate to community reinvestment, corporate giving, philanthropy, and corporate citizenship.
Mr. Yaziji contends that between employees and shareholders, employees take greater risk. His logic is that the scope of individual risk represents the ethical grounds for earning a return. He concludes that since the economics of today’s capital markets produce shareholders that individually have a very small stake in the company, in fact may not even know that they own the stock if the purchase was part of a manged fund, that shareholders individually carry much less risk than do individual employees and that laborism, the notion that employees should make most of the decisions and be the primary recipients of returns, is justified.
What!?! Let’s consider a few problems with this argument. For starters, the individual scope of participation by shareholders does not change the essential nature of the function they provide, or the relationship they have with the company. In other words, just because the capital markets have evolved a mechanism that allows more investors to participate (in line with their risk tolerance), and thereby more money to be made available for companies seeking to raise it, doesn’t mean that the function of their investment is different than if it were a single “deep pockets” investor. Just because an employee’s compensation package may constitute a larger dollar amount than the size of the average shareholder’s investment, doesn’t change the fact that employees have one relationship and shareholders another.
Looking at the relationship in investment terms, we see that employees invest “sweat equity”, they deliver their labor. Although the potential for value exists within that labor, it does not automatically translate directly into value for the company.* It is possible for any amount of labor to end up wasted and worthless. (For instance the labor invested in producing Chrylser automobiles that customers are not willing to buy.) In exchange for that labor, employees receive a paycheck every pay period. As investors, we might say that the risk employees face of losing their original invested capital only lasts as long as the time between paychecks. The only thing at risk for employees is potential returns in the future—employees risk only Return on Invested Capital (ROIC), but practically never risk Return of Capital.
Investors on the other hand risk both their invested capital and their potential returns. But, some say, employee compensation represents much more than simply a paycheck. What about benefits like health insurance, retirement accounts, and options?
Well, the employer portion of insurance is typically paid each pay period, so employees receive that benefit immediately. Retirement accounts and options typically vest over time, so there is the potential for employees to lose some of that value which could be considered part of their invested capital. However, these instruments typically create an opportunity for employees to participate as investors. To the extent that these benefits function as investments, the participants should really be regarded as shareholders and not employees.
As Kirby Cochran argued in What About Those Pesky Shareholders?, when companies focus on shareholder value, all other stakeholders are taken care of. It’s a win-win. However, the opposite is not true. A scenario where stakeholder value is preferred over shareholder value, the cart is before the horse and a win-lose scenario results.
*Note that Karl Marx’s notion that the value of a product was equal to the sum total of all the labor that went into its production is undeniably false. Just look at the current housing market. The labor value could be summed up as the “replacement cost.” Houses are selling below replacement cost. That’s because value is established by the customer, not the worker.