10
New Citizens in Corporate Governance
The corporation is a human community, and like the
larger community of which it is a part, it is
best governed democratically.
We lack real alternatives to the stockholder-focused corporation because virtually all public corporations have that design. There’s a word for this style of structural design, one used by my friend Anne, who is an architectural historian. The word is vernacular. It describes buildings that aren’t so much designed as simply built. Like a barn. Everyone knows what a barn looks like, so that’s what they build: the barn in their head. The vernacular barn.
We in America live with the vernacular corporation. We seem to design public corporations in our sleep, following unconscious assumptions we rarely examine. If we can begin to wake up—dare to reconceptualize the public corporation as a semipublic government, designed in part to serve the public good—we can begin focusing on this issue of design: how to structure corporations to be accountable to a broader set of interests.
There are two sets of interests that need to be separately empowered, and those are employees and the community. In the community—that is to say, under the protection of government—I would include other interests, such as the environment or consumers. All such nonfinancial interests are often lumped together as “social” concerns. But there is in fact a key distinction among them: employees are internal to the corporation, while most other social interests are external.
The notion of internal and external stakeholders is important because corporate governance in its present form recognizes this division. Externally, corporate governance is regulated by state statutes and court interpretations. Internally, corporate governance is controlled by a board and management legally answerable to shareholders.
A COMPASS, NOT A MAP
Along these two dimensions, the direction of democratic change we need can be summarized in a simple way. Externally, corporations must move from being the private domain of shareholders to being responsible to the democratic order, as we saw in the last chapter. Internally, corporations must shift from exclusive governance by shareholders to joint governance by employees and shareholders. This internal shift is the focus of this chapter. Its primary aim is to make the case that employees deserve a legitimate voice as internal citizens of corporate society.
If our ultimate aim is a fully democratized corporate governance system, what this chapter offers is not a map of that territory but a compass pointing toward it. As management theorist D. K. Hurst wrote in Crisis and Renewal, “Maps, by definition, can help only in known worlds—worlds that have been charted before.” Compasses are helpful when one can gain “only a general sense of direction.”1
As both quantum theory and chaos theory teach us, the next state of the world is fundamentally not knowable. Our economy is too complex, changes too rapid, the political climate too hostile, and reform efforts too early for anyone to say what the end point of economic democracy can look like. What we can know, with precision, is the direction we need to take. That direction is as crystal clear as the direction America needed when Thomas Paine wrote Common Sense—a direction that at that time faced away from monarchy and toward political equality. Today our direction faces away from control by the financial aristocracy and toward control by ordinary people. In broad strokes, that means limiting the power of shareholders by putting real corporate governance power in the hands of employees and the community.
VOLUNTARY CHANGE IS NOT ENOUGH
Real power means legal power. In the long run, it won’t be enough to rely on voluntary initiatives, toothless codes of conduct, enlightened leadership, or reforms that proceed company by company. We must ultimately change the fundamental governing framework for all corporations in law. Ideas for doing so will be discussed in chapter 11, but a few words are needed here.
The necessity of legal change is too often unappreciated by corporate reformers. I have tracked reform efforts over fourteen years at Business Ethics, and have seen almost invariably how they focus on “enlightened management,” which is another way of saying “voluntary change.” The belief seems to be that if we put managers through ethics courses, write voluntary codes, teach environmental stewardship, and encourage stakeholder management, we can somehow counteract the overwhelming legal and structural power of shareholders. But we can’t.
Again and again I’ve seen the truth of it. Voluntary actions have no staying power. Voluntary codes, for example, are easily trumped by pressure for shareholder profits. As Neil Kearney of the International Textile, Garment and Leather Workers Federation has commented, “The companies say to the contractor, ‘Please allow for freedom of association, pay a decent wage,’ but then they say, ‘we will pay you 87 cents to produce each shirt.’”2
Enlightened founders have the most control, but their policies rarely survive into subsequent generations of management, particularly at public companies. Ben Cohen of Ben & Jerry’s discovered this in 2000 after he and his board “decided,” at the point of a gun, to sell B&J to the highest bidder, Unilever. Cohen and a group of social investors tried to buy the company, and the board might have been protected in selling to them at a lower price had it used Vermont’s stakeholder statute. But the board feared lawsuits and declined to test that law. So Cohen instead sought informal assurances about his continued influence at Unilever, but soon found those assurances hollow. At every turn, his enlightened leadership was outmatched by the structural forces arrayed against him.3
Similar disappointments have met other progressive company founders. In a study of eleven socially innovative business people in six countries, published in Beyond the Bottom Line: Socially Innovative Business, author Jack Quarter found that in every case social innovation was followed by a reversion, at least in part, to traditional practices.4 If the reader will permit an extreme example, our era is akin to the time when a few enlightened slaveholders voluntarily freed their slaves. Such moves were only a prelude to the ultimate step required, which was to eliminate slavery in law.
When a problem is supported by or caused by law, the solution must be in the law. Today, shareholder primacy is in our law. Certainly it’s the law as seen by the Delaware courts, which control most major corporations. And in any state—even those with stakeholder laws—directors who fail to maximize shareholder value can be sued. CEOs who fail to do so can be fired. The company itself can be subject to hostile takeover. These are legal mechanisms that hold shareholder primacy in place. And legal mechanisms can only be counteracted by other legal mechanisms.
Reformers are far from agreement on this point, but it’s a point that seems vital to me. And it is connected to a second point that I have raised earlier: in making legal changes, we should move beyond laws focusing on specific abuses—like environmental damage, low wages, or unsafe working conditions—and focus on structures for reallocating power. Democracy is fundamentally about structure: structures of voice, structures of decision making, structures of conflict resolution, structures of accountability.
As Abram Chayes remarked in The Corporation in Modern Society, it was the judgment of America’s constitutional convention “that limitations of structure rather than limitations of substance would best secure our liberties.” If the founding generation’s work has proved “effective, durable, adaptable,” economic reforms have proved less so. It is quite possible, Chayes wrote, “that the difference in approach contributed to the difference in the quality of the result.”5
We may have a patchwork of laws controlling various behaviors of corporations, but we lack any constitutional framework for these economic governments. The constitutional law of corporations has never been written—even the word corporation is absent from the Constitution. Elected representatives of the people have never met to draw up a democratic framework for corporate structures.
“The rise of the modern corporation has brought a concentration of economic power which can compete on equal terms with the modern state,” wrote Adolf Berle. Accordingly, he added, “the law of corporations … might well be considered as a potential constitutional law for the new economic state.”6
If we take this suggestion to heart, it does not mean we must proceed as America’s founders did—writing the entire Constitution at one time. Given the complexity of our economy, it may be more prudent to proceed as Britain did, allowing a constitution to evolve over time. Whichever path we take, the first step is eliciting principles we can agree on. And that work begins by asking simple questions, such as this: Who besides shareholders deserve to have their interests served by the corporation?
THE PROMISE (AND PERIL) OF STAKEHOLDER THEORY
In progressive parlance, there’s an emerging formulation that says that instead of serving stockholders alone, corporations should serve all stakeholders: those with a stake in the corporation. This is a concept developed by scholars like R. Edward Freeman and other business ethicists.7 It has intuitive appeal, perhaps because of the wordplay between “stockholder” and “stakeholder.” Theorists commonly draw the list of stakeholders to include customers, stockholders, employees, suppliers, creditors, the community, and the environment.
If this list seems so broad as to include the whole world, scholars are attempting to sort it out. One of the best efforts to do so can be found in a 1997 article by management scholars Ronald Mitchell, Bradley Agle, and Donna Wood, who suggest a typology based on three critical factors: power to influence the firm, legitimate standing, and urgent claim. But although useful conceptually, this typology in the end yielded an essentially shifting categorization, one in which different stakeholders can over time move in and out of legitimacy, or influence, or urgency.8
From an ethical perspective such observations are useful, but the more critical perspective is that of the law. And this is the perspective that stakeholder theory too often neglects, says John R. Boatright, professor of business ethics at Loyola University–Chicago. Because of the tendency to ignore existing financial and legal frameworks, stakeholder theory is “widely dismissed as irrelevant” by researchers in financial economics and corporate law, Boatright notes.9
This is unfortunate, because the theoretical skills of stakeholder scholars are sorely needed today. We need many good minds working on this issue of reforming corporate governance. And we need ways to rescue stakeholder theory from irrelevancy, because of the intuitive legitimacy it has in the popular mind. It was stakeholder theory, after all, that was imperfectly enacted into law with state stakeholder statutes.
But the weakness of those statutes may have something to do with the weakness of the theory itself. Indeed, its bagginess and shapelessness do seem fatal to its real usefulness. Rather than grappling with the core issue of institutional power—who has it, who should have it—stakeholder theory seems instead to rest on encouragement of management’s good intentions. As corporate governance theorist David Ellerman, an economist with the World Bank, has commented, “One sometimes has the suspicion that ‘stakeholder’ governance ideas are being floated by managers who know that, by being responsible to everyone, they will be accountable to no one.”10
If I were to suggest future avenues for stakeholder scholarship, I would say we need to give more attention to one basic issue: Who is external to the corporation, and who internal? In other words, whose interests should be protected as part of the larger, external democratic polity? And who deserves an internal voice in governance and a share in profits? All stakeholders do indeed deserve consideration. But that doesn’t mean all deserve internal standing.
EMPLOYEES AS MEMBERS OF THE FIRM
One group that does deserve internal standing is employees. Among the theorists who support that view is Ellerman. Stakeholder theorists commonly ask, Who is affected by the corporation? But Ellerman suggests that a more precise query is, Who is governed by the corporation? The answer is employees. “Many are affected, but few are governed,” he says, making analogy to the fact that foreigners are affected by U.S. actions, and their rights should be protected, but that doesn’t mean they deserve to vote in the United States.11
As Ellerman observes, when shareholders elect a CEO to govern the corporation, it is not shareholders who are being governed by that CEO. Employees are the ones whose actions are supervised, who must submit to drug tests or have their phones tapped and their e-mail monitored. They can be governed in the most invasive ways.
Employees are in essence a colonized people. As Ellerman notes, a stockholder board electing someone to govern employees is like the British Parliament electing a ruler to govern America.12 In corporate governance, he suggests, we need a shift from the master-servant paradigm to a partnership paradigm. Rather than being seen as servants lacking a legal voice, employees should be seen as full members of the enterprise.13
Current governance theory takes the opposite view, seeing employees as outsiders who merely sell their labor to the firm. Ellerman argues that this employment contract is illegitimate, for it involves giving up the right to self-control. And in his view, the right to self-control is like the right to self-govern. In a manner akin to the right to vote, it can never legitimately be sold, even voluntarily.14 He compares the employment contract to the ancient pactum subjectionis, the pact of subjection by which a people alienated their right to self-govern and turned it over to a king. If such contracts are no longer considered legitimate politically, they should cease being legitimate economically.15
Although Ellerman approaches this along a somewhat radical trajectory, others have arrived at the same point in more conventional ways. Consider Douglas McGregor’s famous Theory Y of management, as presented in The Human Side of Enterprise. Traditional management operates by Theory X, based on control of employees by authority, he wrote. But Theory Y replaces control with integration. As McGregor put it, “Theory Y assumes that people will exercise self-direction and self-control in the achievement of organizational objectives” when they are genuinely committed to those objectives. The only way to achieve that commitment—and thus to achieve organizational excellence—is to stop seeing employees as serving organizational goals, and instead to integrate them fully in setting goals and benefiting from their achievement.16
This is no longer a novel idea in management, for McGregor’s book has been a classic since 1960. The problem is that the concept of employee membership in the firm has yet to become more than a management theory; it has not crossed into corporate governance theory, much less into legal reality. Managers speak often of giving employees a sense of ownership. But real employee ownership is in most cases minuscule. So corporate membership, in any legal sense, remains elusive. As Corey Rosen of the National Center for Employee Ownership once said, giving employees a “sense” of ownership is like giving them a “sense” of dinner.
Still, McGregor’s theory is persuasive, for it makes the case that the democratically run corporation is in fact the more effective corporation. One can make other instrumental arguments—pointing, for example, to research showing that employee-owned firms generally financially outperform conventional firms. But such arguments seem unnecessary to me. Similar arguments were once used to justify the vote for women—arguments that said this step would improve society. Whether or not that has proved true, the argument today seems superfluous, even insulting. Women deserve a vote because they are full human beings like men. In like manner, employees deserve a role in governance because they are full members of the corporation, just as stockholders are.
Compelling support for this view is offered by democratic theorist Robert Dahl. In his book A Preface to Economic Democracy, he notes that the right to self-government is among the most fundamental of all human rights. And because it is an inalienable right—meaning it can never be given up or sold—it necessarily translates fully into the economic realm. As Dahl put it, “If democracy is justified in governing the state, then it must also be justified in governing economic enterprises.”17 In words similar to those used by Ellerman—and in some cases credited to Ellerman—Dahl argues, “Binding collective decisions ought to be made only by persons who are subject to the decisions….For laws cannot rightfully be imposed on others by persons who are not themselves obliged to obey those laws.”18
Noting the oft-cited conflict between self-governance rights and property rights, Dahl asserts that self-governance is the superior right. He notes, for example, that in Thomas Jefferson’s trilogy of rights—“life, liberty, and the pursuit of happiness”—the right to property is conspicuously absent. And Dahl adds that Jefferson viewed property rights as a late development in the growth of democracy. In Jefferson’s own words, “Stable ownership is the gift of social law, and is given late in the progress of society.” Others might argue that property rights are antecedent to government, but Jefferson saw them as “not so much prior to society as dependent on it.”19
Those who argued the opposite case—that property rights trump self-governance rights—included Chancellor Kent, whom Dahl also cites. At the New York Convention of 1821, Kent opposed universal (that is, white male) suffrage on the grounds that it would “jeopardize the rights of property.” He scoffed at the notion that “every man that works a day on the road, or serves an idle hour in the militia, is entitled as of right to an equal participation in the whole power of government.” In his view, this assertion was “most unreasonable” and with “no foundation of justice.” Kent, of course, lost that argument.20
Ultimately, Dahl argues, there need be no conflict between property rights and self-governance rights. For “if a right to property is understood in its fundamental moral sense as a right to acquire the personal resources necessary to political liberty and a decent existence,” he writes, “then self-governing enterprises would surely not, on balance, diminish the capacity of citizens to exercise that right.”21
It’s invigorating stuff, using democratic theory to justify worker self-governance rights. But there are other justifications as well—such as the arguments based on economic risk advanced by corporate governance theorist Margaret Blair.
In dominant corporate governance scholarship, as we have seen, the corporation today is viewed as a nexus of contracts. Stockholders alone are said to have a contract for control because they take residual risk—that is, they receive income that’s not fixed but variable, based on firm performance. But Blair argues that employees also bear residual risk when they develop skills that don’t easily translate to other firms. Thus when employees are laid off, they often take new jobs at substantially reduced pay and never fully recover their firm-specific investments.22
Developing this view in recent scholarship, Blair has joined Lynn Stout to argue in Virginia Law Review that corporate boards should be seen as “mediating hierarchies”—not serving shareholders alone, but instead balancing competing interests. The two base this view of board function on the economic theory of “team production.” Such a theory is appropriate in cases where productive activity requires the efforts of two or more groups and “output from the enterprise is nonseparable,” so it’s not clear how economic surpluses should be divided. In such circumstances, the board acts to protect the “enterprise-specific investments of all the members of the corporate ‘team,’” overseeing allocation of profits. Its role is to deter “shirking and rent-seeking among the various corporate ‘team members’”—which, as we have seen, is rampant today among stockholders.23
The team production theory, Blair and Stout argue, is more appropriate to public corporations than the prevailing theory, which views stockholders as principals and managers as their agents. In that view, the core problem of governance is one of controlling agency costs—keeping directors and managers loyal to stockholder interests. That view relies implicitly on the notion that stockholders own corporations, which is irrelevant in modern legal theory, since a nexus of contracts is not something anyone can actually own.24
There are many ways to justify an employee role in internal corporate governance. But the fact remains that many progressive thinkers fail to perceive the legitimacy of employee standing, which is disturbing. Among both stakeholder theorists and social investors, for example, the tendency is to cast employee concerns as social concerns, not fundamentally different from community or environmental concerns. In an unconscious way, these groups thus manifest discrimination against employees.
Imagine if we had taken a similar approach with discrimination against women. We might have begun by saying, yes, the patriarchal family is too focused on fathers. But we would then have recommended a new focus on children, grandparents, aunts, uncles, neighbors, and, oh yes, mothers. Discrimination against women would have remained intact. As women had once disappeared into their husbands (losing their property, losing their names, becoming simply Mrs. John Doe), women would later have disappeared into the world. They would have remained invisible, when their invisibility was itself the starting problem. The problem was an inability to see women as human beings equal to men.
Today, we too often fail to see employees as sovereign members of corporate society, equal to stockholders. The point is not that employees are the only stakeholder group that matters, but that they matter in a different way—an internal way. They live in the house, so to speak. Other stakeholders are like neighbors or cousins and aunts and uncles, related to the corporation but not part of the nuclear family.
There are instances in which other stakeholders could become internal—as with “captive” suppliers making products for one company alone, or franchisees dependent on the central franchise firm. Such stakeholders may at times deserve a role in internal governance. But employees are one group that always deserves such a role.
As for what shape an employee role in governance should take, one vital piece is of course representation. That immediately suggests employees on corporate boards, but it’s worth noting that with employee-owned firms this has not proven an enormously effective tool. As Edward Carberry of the National Center for Employee Ownership told me, “It’s not that it doesn’t do any good, it’s that in itself it doesn’t dramatically change how the corporation operates. They’re not being represented as employees but as shareholders.”25
A different approach might be to create a separate employee house—a bicameral legislature—modeled on the Works Councils of Germany, which are employee assemblies that must approve all major corporate decisions. As Lord Acton once wrote, democratic systems wisely restrain power by dividing it, and this division “affords the strongest basis for a second chamber, which has been found the essential security for freedom in every genuine democracy.”26
Whatever shape employee representation takes, ultimately this representation should be mandatory. Today we have optional employee voice through unions, but we must begin to recognize how inadequate this arrangement is. It’s like granting Republicans a permanent lock on voting power but permitting Democrats to vote only if they organize city by city. Unions can be conceived of as political parties representing the labor interest, counterbalancing the financial interest, which today runs corporations like one-party states. Unions are vital. But it may be equally vital for employees to have the vote. We must move toward a truly democratic economy, where employees are naturally seen as voting citizens of the corporation. Such a system should augment unions, not replace them.
But representation is only one tool of governance. If we look at stockholder governance of corporations, we find it uses a number of tools. There is hiring and firing the CEO, and setting his or her compensation. There is the right to vote on changes of control, and the right to bring derivative litigation if one’s interests are not served, relying on court protection of fiduciary duties. And finally, there is financial reporting focused on stockholder interests.
In any ultimate scheme of democratic governance, employees should have access to all the tools that stockholders now use—based on the principle of equal protection of the laws. This might mean Employee Income Statements, an employee right to impeach CEOs who pay themselves outrageous amounts, and a mandated duty of loyalty to employees.
HINTS, NOT PLANS
But let us not get too far out into utopian musings. We may find that the idea of employee governance never catches on, or that one or two governance tools in employee hands is sufficient to change how corporations operate. The future genuinely is unknowable.
The more practical question is how to craft a workable hook in law to begin pulling ourselves toward a democratic future, starting today. I would suggest a route proposed by Supreme Court Justice Louis D. Brandeis, who said that a single state could serve as a “laboratory” for a novel experiment, “without risk to the rest of the country.”27
One experiment we could try at the state level is to take a single stockholder tool—like voting on changes of control—and extend it to employees in law. Thus no merger, acquisition, or hostile takeover could be completed without approval by workers. Because such combinations generally lead to layoffs, employees might be roused to fight for the proposed law. Even lobbying for it would allow us to make the case that corporations really aren’t pieces of property but rather human communities, and employees are part of those communities. If it were to pass, such a law would spell the beginning of the end for shareholder primacy, because it would immunize corporations against hostile takeovers, a key enforcement tool for maximum shareholder gain.
As Thomas Paine once wrote, “I only presume to offer hints, not plans.”28 What I offer here is a rough draft of ideas for democratizing corporate governance, and if it encourages others to make better drafts, it has served its purpose.
The map is less important than the compass. The particular shape of employee role in governance is less vital than the general direction of employee citizenship. What we need today is not a blueprint, but the fire in the belly to get us moving—and it may be that talk of democratic self-governance rights can stoke that fire. Perhaps the spark is the realization that we need not live forever with the vernacular corporation.