There is a big temptation to see the coming general election as a contest between advocates of a Corbynite command economy and liberal champions of the market. The trouble with that narrative is that there are many forms of a market economy, and even ardent capitalists see that there are fundamental flaws in the prevailing system.
Currently there are two dominating business cultures: entrepreneurial and extractive. Only the former is compatible with a prosperous future for the UK. Entrepreneurial culture is about creating wealth by investing in productive assets and employing people to develop improved goods and services. Extractive business culture is very different and many commentators on both sides of the Atlantic have warned of its dangers.
One is Professor George Akerlof, winner of the Nobel prize for economics in 2001. He has said that organisations that rely on government guarantees in the event of losses have an incentive to ‘loot’, leading to a ‘topsy-turvy economics of maximising current extractable value’. Martin Wolf, chief economics commentator at the Financial Times, agrees. He argued in 2012 that the ‘core institution of contemporary capitalism’, the limited liability shareholder corporation has ‘inherent failings’, the most important of which is that companies are not effectively owned, which means they are vulnerable to ‘looting’ by executives.
Corporations are not ‘effectively owned’ when the vast majority of their shareholders have no real commitment to the company. They value shares primarily because they can easily be turned into cash. According to the Bank of England’s Andrew Haldane, the average duration of equity holdings in the UK fell from about five years in the mid-1960s to two years in the 1980s. By 2000 it was slightly over 12 months and just before the crash in 2008 it was nearer seven months. Now shares are often held for only a few seconds.
Corporations are also currently vulnerable to hostile takeovers and asset-stripping. David Stockman, Director of the Office of Management and Budget for President Ronald Reagan from 1981 to 1985, says ‘the companies most Americans work for have been strip-mined to the tune of trillions in order to fund financial engineering gambits like stock buybacks and M&A deals rather than productive investments in plant, equipment and technology.’
It is noticeable that the above critics do not want to abandon a market economy, and opponents of Corbynite economics should be careful not to fall into the obvious trap of becoming apologists for everything about the established order. Extractive business culture is not defensible, but the alternative to it is not collectivism.
Instead, there should be a revival of entrepreneurial business culture. The Kay review of UK equity markets and long-term decision making in 2012 said that ‘public equity markets currently encourage exit (the sale of shares) over voice (the exchange of views with the company) as a means of engagement, replacing the concerned investor with the anonymous trader.’ It found that UK companies were disproportionately subject to predators and that America had more safeguards for entrepreneurs.
The aim of America’s company laws (which vary from state to state) is to encourage personal responsibility in business and commerce. In particular, they provide companies with protections against hostile takeovers so that people with a long-term commitment to a business can continue without disruption by corporate raiders. Replacing the anonymous, ‘ownerless’ corporation with new legal structures is the best way to do this. Here are six ways it could be done.
First, corporate articles of association could be changed so executives could lawfully take into account interests other than those of shareholders, such as employees. Under the 2006 Companies Act the interests of shareholders are currently dominant. For example, Sir Roger Carr, the chairman of Cadbury during the takeover by Kraft, told the Kay review that his board believed it was under a legal obligation to accept the Kraft offer. In America, however, some states are now introducing a new type of corporation, the ‘benefit corporation’ or ‘B’ corporation. They are permitted to take into account the long-term prospects and interests of the company, its shareholders, employees, suppliers and customers, and even the communities in which the company operates.
Second we could use corporation tax rules to discourage arms-length shareholding and promote proprietorship. Since 1958 US companies have been able to register with the tax authorities as either a ‘C’ or an ‘S’ corporation. A ‘C’ corporation pays corporation tax, while an ‘S’ does not. In the latter case, all profits and losses ‘pass through’ to the shareholders. Ordinary income tax is paid when individual owners take money out of the company, for example when dividends are received. Profits retained in the company, however, are not taxed. To qualify, an ‘S’ corporation must have no more than 100 shareholders, which makes it more feasible for owners to have face-to-face relationships. Shares can only be sold privately.
Third, dual share classes could be permitted. They are currently frowned on by the London Stock Exchange but not in America. When some private companies decide to go public they issue A and B shares, with one class typically having ten times more votes than the other. This allows founders, or executives who are the custodians of the ideals of the company, to prevent hostile takeovers by companies run by asset strippers. When Google went public in 2004, it issued a second class of shares to allow the firm’s founders to keep control. In most cases, these enhanced voting shares are not publicly traded.
Fourth, companies should be able to use ‘poison pill’ strategies to discourage hostile takeovers. One example of a poison pill, a ‘flip-in’, allows existing shareholders to buy more shares at a discount when a takeover bidder reaches a certain threshold. By purchasing more shares at below market price the long-standing shareholders are rewarded for their loyalty, and simultaneously the shares held by the hostile acquirer are diluted.
Fifth, we could create companies which oblige directors to serve the interests of the locality, the workforce and the nation, as well as those of shareholders. In return for registering this way and accepting obligations to their workforce and the wider public, they would pay no corporation tax. Any profits taken out of the company would be taxed as individual income at normal rates, but earnings retained for investment would be tax free. Unlike American ‘S’ corporations, there would be no limit on the number of shareholders. Such companies would be more likely to see that their main business asset is the capability of their workforce. Faced with declining orders for one product, they would not dispense with some of their workforce as ‘surplus to requirements’. Instead, they would find new products that could be made with the skills they already have. It’s what good companies already do, but not those dominated by stock-market pressures.
Sixth, limited liability could be withheld from some businesses. It is a legal privilege that was for many years strongly resisted, until the Limited Liability Act was passed in 1855. We should ask whether all business activity is equally deserving of it. Sole proprietors do not have limited liability, nor do partners in traditional partnerships. A case can be made that investment in productive enterprise merits limited liability, but does pure arbitrage deserve special protection? Taking bets on whether a share will go up or down in price does not deserve the same protection as investing in an asset such as a factory or an office building in the expectation that it will produce an income. The alternative to granting limited liability is not prohibition. It is merely to expect its practitioners to take full responsibility for all losses. Nor is the intention to discourage risk taking. It would only mean that investors must take risks with their own money.
Brexit will open up vast new opportunities for progress on many fronts, but we must ensure that the culture of business works for everyone. Too many people who have held down an honest job rightly feel they have been left out. Reforms such as these would channel the energy of businesses into the kind of wealth creation in which all can share.
David Green is Director of Civitas