Monday, February 23, 2015

 

Corporate Governance and Shared Governance


This should be a much bigger story.

IHE ran a story by Ry Rivard that should have set sociologists and economists running wild. It’s about several non-profit colleges, including one community college, that have made policy changes affecting students at the behest of bondholders.  

It’s one of those seemingly trivial or technical articles that signals a sea change.  It’s a discernible parallel to what happened to the private sector in the 1980’s, and it may well lead in a similar direction.  Whether pro or con, ignore it at your peril.  And I say this as someone not disposed to alarmism.

I’ll back up.

The corporate behemoths of mid-twentieth-century America were able to take the form they did because of a quirk in the financial system.  As Adolf Berle and Gardiner Means famously noted in the 1930’s, relatively widely dispersed ownership of stock -- that is, the literal ownership of companies -- meant that company management had unprecedented autonomy relative to investors.  What Berle and Means called “the separation of ownership from control” gave management -- as distinct from stockholders -- wide discretion to pursue relatively long-range projects.  

Because stockholders were all over the country, communication technology was crude, and the laws were the way they were, stockholders fell victim -- if you like -- to a version of Madison’s problem of “factions” in Federalist paper ten.  With stockholders everywhere, paying varying degrees of attention, pursuing different agendas, and lacking the effective ability to combine forces, they largely canceled each other out.  Management was able to run companies more in the interest of management than in the interest of stockholders.  This was the golden age of “The Organization Man.”  Combine autonomy from ownership with some pretty powerful economic tailwinds, and you had management cultures largely insulated from the market.  

It’s easy to read that as sinister, and in some ways, it was.  But this was also the golden age of private sector unionization, and I don’t think that’s a coincidence.  Managers were willing, and able, to sacrifice some short-term profit in the name of labor peace.  Shareholders were too fragmented to force much discipline on them.  Paradoxically, management salaries relative to labor were much lower then; again, a premium on peace brought some circumspection.

In the 1980’s, though, some tiny changes in financial regulations led to the rapid and unanticipated emergence of “institutional investors,” as opposed to individual investors.  Millions of shareholders each holding a few shares of a company had zero effective power over it.  But millions combined into a single mutual fund had considerable power.  Soon an ideology formed around the quest for “shareholder value,” in which shareholder value was “trapped” by management and needed to be “unlocked” by activist -- that is, organized -- investors.  In Berle and Means’ terms, ownership and control came back together.  

With a new locus of power came a new agenda.  Labor peace suddenly became a much lower priority, as did any sort of circumspection around inequality.  Previously patient capital became impatient capital.

As a result, the entire world of corporate governance has changed.  Outside of a few elite companies that are so wealthy that they can afford the long view -- Apple and Google leap to mind -- most have to attend to the short term.  Management obeys because it has to, and because the rewards for obeying effectively have grown.

Higher education largely sat out those changes, except to the extent that TIAA-CREF grew.  Endowments are the textbook version of “patient capital,” and publics with small endowments often had (barely) enough public funding to move forward on operations.  

But the mixed blessing of relative autonomy from market forces wasn’t necessarily sustainable.  Baumol’s cost disease is real, state disinvestment is real, and the pressure to be all things to all people is unrelenting.  Over time, cracks appeared.  The for-profit sector of higher ed, which used to be confined to small and undesirable niches, became a major player.  Colleges started replacing full-time faculty positions with adjunct positions, using the savings to put off larger changes.  Some colleges started making double-or-nothing bets out of desperation, issuing bonds -- that is, borrowing money -- for expansions that they hoped would generate new revenue.  When those don’t work, the lenders want a say in what happens next.

Which is where a financial issue becomes a governance issue.  Suddenly, “shared” governance isn’t just shared with people on campus, or in the legislature.  Now it’s shared with bondholders, and those bondholders have different priorities and varying degrees of patience.  Unlike the other participants in shared governance, they may not have any particular obligation to the other parties at hand.  It might not be worth their while to go for the quick kill, but that’s prudence, rather than deference.  They aren’t big on deference, as a group.

On the very same day, IHE ran a story about Alliant international University changing its status from non-profit to a “public benefit corporation.”  The idea is to maintain the mission-driven nature of a non-profit, while gaining access to the private investment capital that drives for-profits.

I don’t know if the hybrid will work.  It asks capital to be patient, in the manner of midcentury investors, but midcentury investors often had no choice.  Now they do.  I’m not sure what the mechanism is in a “public benefit corporation” to stop it from behaving like any other corporation, or how long it can hold when the force of economic gravity keeps pushing in the same direction.  But I’m intrigued, and I wish AIU well.  If it works, many of us may have something to learn from it.

The stories in IHE yesterday didn’t occasion much comment, and weren’t explicitly linked.  But then, back in the 1980’s, section 401(k) of the tax code was obscure, too.  Sometimes great changes start inconspicuously.  This may be one of those times.

Comments:
Very interesting analysis. I expect your conclusions are correct.

However, I believe that it wasn't the institutional investors (which I understand to be pension funds, foundations and endowments) that unlocked shareholder value in the 1980s, it was the corporate raiders, individuals backed by private equity funds. They would wrest control through hostile takeovers and "liberate" shareholder value through leveraged buyouts.

To bring the interests of shareholders and management into better alignment, compensation increases were made dependent upon increases in share prices. Giving management stock options advances that goal. Management prospers when shareholders do.

At the start of the Clinton administration, the tax deduction for compensation paid to an employee of a publicly traded company was capped at $1 million. However, "performance-based" compensation was specifically exempted, making stock options an even more attractive compensation alternative. As more and more compensation became linked to share prices, capital became less and less patient, as you observe.

An unintended consequence, I suspect.
 
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