The unintended consequences of good ideas
Tuesday, October 9, 2012/
To drive through Europe, as I did this summer, is to see history recorded in city skylines. Their buildings reflect the transfer of power through the centuries, beginning with the old castles (now museums and grand hotels). Below them, in the city centres, are the parliamentary palaces of the people. These, in turn, are dwarfed by the towers of the corporate world, where the real power now lies.
They’re full of paradoxes, those towers. Built of glass, they are impossible to see into. The names emblazoned on their doors and rooftops are, as often as not, words or initials that convey no meaning. To most passers-by, these are anonymous organisations, run by anonymous people, who are the appointed agents of anonymous investors. The economic engines of democratic societies, they are as centrally controlled as any monarchy and squat in the midst of democracies like islands unto themselves. No wonder there’s a growing perception that their power has escaped popular control – and that the concerns of wider society are being ignored.
Why have these business organisations acquired so much power? Because two good ideas of the 19th century – both sanctioned by British law and rapidly copied around the world – have had unintended consequences. One was the joint stock company, and the other was limited liability.
These two social inventions spurred unprecedented economic innovation and growth, but they also put us on a dangerous course. By effectively separating the theoretical ownership of a company from its management, the first turned shareholders into something more like punters at a racecourse. Using shares as betting slips on the nags of their choice, they behave like neither trainers nor owners. As a result of the second, limited liability, managers gained their own licence to gamble, at no personal cost.
It was to correct those flaws that, in the 1970s, another good idea was suggested, this time by two academics in an obscure economics journal. Michael Jensen and William Meckling argued that managers were effectively the agents of shareholders and should work for them. To reinforce this principle, the thinking went, managers’ rewards should be linked to those of the shareholders.
Managers were quick to see their opportunity in this idea. Stock options and later bonuses tied to share prices became their compensation of choice, and not unnaturally, many massaged those share prices in their own interests, all too often to the longer-term detriment of the business. Thus another good idea has been undone by its unexpected consequences: while the earnings of managers have soared, those of shareholders have generally declined.
In the midst of all this, people forgot (or never realised) that shareholders do not actually own the company; they own only its stock. This entitles them to get the residual assets of the company upon its breakup and to vote on resolutions at annual meetings and on the appointment of directors, but not to tell the firm what to do. A company is in law an independent person, and its directors have a fiduciary duty to the company as a whole – that is, to its workers and customers as well as its investors.
Perhaps, then, the next good idea would be to require directors to obey the law and to put the long-term interests of the company as a whole before those of themselves or their shareholders. They might well discover that all of the above were better served. And many years later, as a consequence (not unintended), we might find companies to be less opaque, anonymous and ominous to the people passing by.
Charles Handy is a long-time contributor to Harvard Business Review and the author of more than a dozen books, including ‘The Age of Unreason’.