Has Managerial Capitalism Peaked?
Summing Up. Professor Jim Heskett considers his reader's comments on the growing imbalance between what John Bogle terms managerial capitalism and owners' capitalism.
The clear consensus of those responding to this month's column is that managerial capitalism, as John Bogle terms it, has peaked. But what will follow it is less clear.
Many doubt that the form of owners' capitalism represented by private equity is the answer. C. J. Cullinane expressed his concerns by saying, "Our capitalism has evolved into a financial pyramid scheme and not industry building."
One piece of evidence that something is wrong with managerial capitalism was presented by B. V. Krishnamurthy, who cited the results of a study of 300 listed companies that found that "firm performance and top management compensation are inversely related." And this may not have taken into account the large severance payments made to those being asked to leave their leadership jobs because of mediocre performance.
But a debate arose over whether the establishment of direct oversight of management by owners—an important element of owners' capitalism—through the vehicle of private equity ownership is the answer. Adrian Grigoriu maintains that "A private ownership will tend to hold more control over and involvement in the board and CEO performance." Jacoline Loewen agreed, saying that "private equity partnerships have a vested interest in the growth of the company and hence see it as a living, growing, evolving organism that they can help."
A contrary view was put forth by K. Subramanian, who asserted, "The so-called merits of private equity management were oversold … companies taken over by private equity groups have been stripped of their assets … and hold unsustainable debt burdens." Gerald Nanninga, in lamenting the decline of "emotional investment" among managers, pointed out that "the owners are no better. Be it mutual funds or hedge funds, these so-called owners have virtually no emotional investment in the companies (they own)." B. D. Majuqwana comments that "the biggest drawback for PE is that it … does not aim to create new companies." Cheri Thomas says, "We need to worry about hedge fund managers and private equity managers raking in billions while decimating companies and destabilizing markets more than we worry about whether the CEO of Ford took home a few paltry millions while actually running a company that is open to shareholder control."
In looking forward, several suggested that the next era of capitalism, an answer to both managers' and owners' capitalism, may be something we may call entrepreneurial capitalism. Paul Hudnut, who suggested the term, offered a prediction: "Just as many of our largest companies/industries did not exist 30 years ago, my bet is that 2037 will be very different as well. And this will be due to entrepreneurs, not private equity funds or public company boards." This may be linked, as D. R. Elliott suggested, to the rise in the "knowledge economy" where "thanks to cheap computing capacity and the Internet, it doesn't take a billion dollar R&D platform to discover the next technology platform." Jim Winkelmann agreed, but with a caveat: "The rebirth as always (will) be in the entrepreneurial sector … creating opportunities for the next hijackers to come in and plunder the corporate treasuries for their self enrichment."
To what degree will entrepreneurial capitalism be the antidote to both managers' and owners' capitalism? Are we about to see a rebirth of Schumpeter and his belief in the power of entrepreneurial behavior in the economic process? If so, what can we do to foster the process? What do you think?
There is a growing call for a redress of the imbalance between what John Bogle terms managerial capitalism and owners' capitalism. In his 2005 book, The Battle for the Soul of Capitalism, Bogle describes owners' capitalism as "an enormous transfer of wealth from public investors to the hands of business leaders, corporate insiders, and financial intermediaries."
Headlines remind us of very large payouts to CEOs, regardless of their performance. (In fact, it could be argued that in many cases payouts are inverse to success, since many have been occasioned by the firing of the recipients.) Some critics contend that managers have received a disproportionate share of the fruits of corporate success, leaving too little for workers or owners. Even hedge funds have been derided as better management compensation devices than investment vehicles.
What's the reason for these phenomena? According to one report, Michael Jensen and Kevin Murphy, in a book to be published in the next several months, CEO Pay and What to Do About It, lay much of the blame at the feet of boards of directors. They claim that CEOs in public companies should be answerable to directors for poor performance but in fact are not. Directors, representing an indirect form of governance, are poor representatives of owners. They are far too lax in influencing employment contracts and management incentives. The options they grant are too generous and fail to take into account the cost of capital employed during the term of the option. The severance payment arrangements to which they agree are too lavish, regardless of the reasons for severance.
Jensen and Murphy's antidote is private equity fund ownership, in which owners (as directors) have direct oversight over managers, ways in which compensation is pegged to performance, and ways in which value is increased in either the short or the long term. Many maintain that the accumulation of huge pools of money in private equity funds will bring a more sophisticated investor to the table, one capable of countering the power of the executive and exercising better governance in companies even as large as Chrysler.
Another phenomenon may provide a different kind of response to the challenge. Flush with more cash than good ideas, many large public companies are buying back their stock (which may be undervalued because they have more cash than good ideas) at a remarkable rate. If it continues, it will be a short step to take some of these firms private through the vehicle of a leveraged buyout. In this case, managers as owners will be held directly accountable for their performance.
Who will be the beneficiaries of the possible rebirth of owners' capitalism? Will the use of capital be improved through the leveraging of underleveraged assets by owners who can bring superior financial engineering to the game? Will this foster growth and jobs? Or will this just saddle acquired organizations with too much debt, requiring significant cost reductions and related layoffs?
As a result of these developments, will CEOs and the power of the executive be brought back into balance with that of owners? Or is this just the latest development in an era in which financial engineers have gained the upper hand? Has managerial capitalism and the power of the executive peaked? What do you think?
To read more:
John C. Bogle, The Battle for the Soul of Capitalism (New Haven: Yale University Press, 2005).
Michael C. Jensen and Kevin J. Murphy, CEO Pay and What to Do About It (Boston: Harvard Business School Press, forthcoming) as reported in Louis Uchitelle, "Revising a Boardroom Legacy," The New York Times, September 28, 2007, pp. C1 and C5.