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Restoring the Crumbling Foundations of Corporate America

A U.S. flag hangs above an entrance to the New York Stock Exchange in 2015. (Lucas Jackson/Reuters)
'Stakeholder capitalism' undermines the foundational values of a free society.

Business management is about making value judgments. Is it more valuable to launch a new product or stay with the existing products? Is it profitable to initiate a new research and development project? These kinds of questions must be carefully appraised each day by corporate executives. Though often not recognized, the answers to these value judgments depend more on the executive’s philosophical foundations than on empirical analysis.

Paul Samuelson in his book Foundations of Economic Analysis (1947) laid the groundwork for economic study based solely on positive economic analysis. Positive economic analysis focuses on “what is” in contrast with normative economic analysis that focuses on “what ought to be.” When Samuelson’s book was published, the positive approach was tenable because it rested on the shared values of the post–World War II West. A shared belief in traditional values provided the foundation for property rights, the rule of law, and the preservation of a culture of trust.

Jürgen Habermas summarizes the West’s philosophical foundations: “Universalistic egalitarianism, from which sprang the ideals of freedom and a collective life in solidarity, the autonomous conduct of life and emancipation, the individual morality of conscience, human rights and democracy, is the direct legacy of the Judaic ethic of justice and the Christian ethic of love.”

Within this culture, Harry Markowitz in the 1950s proposed a purely mathematical means to build optimal investment portfolios, reducing the investment decision to a handful of statistical parameters. Implicit in his analysis was the assumption that company managers would adhere to the pillars of Western civilization.

The 1970s saw the explosion of deeply useful quantitative financial models along with technological advances. With emerging empirical insights, John Bogle created the Vanguard Company in 1974, based in part on the evidence related to passive investing. Academic and technological advances together provided wide-spread financial benefits. Examples include improved corporate decision-making leading to better products at lower cost, lower overall borrowing rates, and improved investment performance.

Many have noted that the shared traditional values are now starting to crumble. Even John Bogle notes, “There no longer can be any doubt that the creation of the first index mutual fund was the most successful innovation — especially for investors — in modern financial history. The question we need to ask ourselves now is: What happens if it becomes too successful for its own good?” One key issue he identified was the concentration of corporate voting rights in the hands of a few investment firms. This would not be a problem if these firms’ managers based their voting decisions on shared principles.

There is now clear evidence of conflict over these shared traditional values. Warren T. Brookes noted the problem back in 1982. “We are dealing, no less, with the basic conflict between two entirely different concepts of man and his universe, concepts that affect every aspect of our social and economic lives, one determinedly physical and finite and the other profoundly metaphysical and infinite; the one (collective socialism) rooted in fearful concern about visible resources, the other (market capitalism) springing from faith in spiritual reality.”

Fortunately, we still have the opportunity to express our creativity through the legal structure of corporations with assurance of clean ownership. Companies are owned by their shareholders and hence should be solely managed based on the fiduciary trust granted to managers. Operating a company on behalf of any other stakeholder is a breach of fiduciary duty. Obviously, treating employees, customers, and suppliers with integrity and respect is simply fulfilling managers’ fiduciary duty as it results in direct benefits to the shareholders. But shareholders should actively push back against managers who pursue ideological goals at the expense of their businesses, not only because it will hurt their wallets, but because it undermines the shared premises necessary to a functioning economy.

If the heft of large shareholders proves insurmountable in attempts to influence management, an alternative is to allocate capital toward only those businesses with a demonstrable commitment to shareholder primacy. The more power that Americans cede to ideologically driven asset managers, the more likely we are to sacrifice the tremendous gains in wealth and technology provided by traditional values.

Disclaimer: Robert Brooks serves on the Ratings Oversight Committee of 2ndVote and serves on the Advisory Board of 2ndVote Funds.

Robert Brooks, Ph.D., CFA is the founding partner of Blue Creek Investment Partners, LLC and president of Financial Risk Management, LLC. He is on the Oversight Committee for 2ndVote and the Advisory Board for 2ndVote Advisers.

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