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A Clockwork State

A Clockwork State
A Clockwork State
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Mr Burgess, author of A Clockwork Orange, writes about the power of the state to shape individual behavior in a recent New Yorker article. He worries that politicians can promote wrong policies for wrong reasons, which feature most prominently their desire for power, and cautions that “We probably have no duty to like Beethoven or hate Coca-Cola, but it is at least conceivable that we have a duty to distrust the state. Thoreau wrote of the duty of civil disobedience; Whitman said ‘Resist much, obey little’.”

Mr Burgess’s cautioning has implications beyond individuals: corporations are affected by the state as well. In fact, the state, a term I use loosely to designate any form of government, often has ties to corporations.

The state can own or partly own corporations, which is the case for Air Canada and for utilities like Hydro Québec. Ties also arise because of regulations promulgated and enforced by various state bodies, such as corporate and tax law. Corporations themselves influence regulations by partaking in political lobbying. On June 19 2012, Mr Dimon, CEO of JP Morgan Chase, came under intense questioning at a hearing of the United States House of Financial Services Committee regarding JP Morgan Chase’s extensive lobbying, which meant to tone down the proposed Volcker rule that would prevent banks from betting with their own money.

What to make of these ties between the state and corporations? Is caution advised, as suggested by Mr Burgess? The jury is still out on this question, as illustrated by two competing views that characterize the ties between state and corporations:

  • Proponents of the Public Interest Theory argue that these ties promote the greater good of everyone and aim at advancing our common as well as individual wellbeing. The Public Interest Theory views the state as a benevolent entity directed by good intentions for its citizens.
  • Proponents of the Interest Group Theory take a less rosy stance on the state’s ties to corporate life. They view the state’s decisions as being dictated by regulators’ and politicians’ craving for power, much as Mr Burgess does. Regulators and politicians cater to individuals and groups most likely to help them attain or maintain power. The demands of these individuals and groups end up substantially influencing regulations, laws, policies and state decisions.

A case in point is Say on Pay. In 2011, the U.S. implemented mandatory Say on Pay, which requires companies to have a shareholder vote on executive pay at least once every three years. The role of executive pay in the 2007-2009 financial crisis remains to this day vivaciously debated in academic and professional circles, and largely unresolved. Following the financial crisis, various groups, including institutional investors (such as the Council of Institutional Investors) and corporate governance watchdogs, called for a shareholder vote on executive pay. The reasoning was that a shareholder vote on executive pay would rid the world of excessive compensation packages for executives who do little good for their firm and its shareholders.

In an article in the Academy of Management Perspectives, I caution that Say on Pay can worsen problems with excessive executive pay. Why? Excessive executive pay is often caused by powerful CEOs with conflicts of interests who look out more for their own pay than for the firm and its shareholders. Say on Pay does not remove these CEOs from power. Rather, Say on Pay may relocate the cause of executive pay problems, from powerful CEOs with conflicts of interests to powerful shareholders with conflicts of interests.

Shareholders can indeed have conflicts of interests because of business ties with the firm. Academic research has cautioned that institutional shareholders such as pension funds can be afflicted by such conflicts of interests. Consider a pension fund that not only is a shareholder in Firm X but that also manages the pension plans of Firm X. To keep its pension business with Firm X, the pension fund, in its role as a shareholder, may monitor the firm’s CEO pay less intensely. Worse, the pension fund may give in to pressure for excessive executive pay. Giving a vote to shareholders when they have conflicts of interest, will thus not solve executive pay problems.

Why then does the U.S. mandate Say on Pay? Interest group theory cautions that groups with a vested interest in Say on Pay would push for this regulation and that regulators would cater to these groups. Doing so would allow regulators to attain or maintain power, since it makes them be seen, by the voting public, as addressing the pressing problem of excessive executive pay. Institutional investors would in turn benefit from Say on Pay because it provides them with additional power to push through compensation policies aligned with their own goals. Whether interest group theory is right on U.S. Say on Pay regulation is an open question that merits further debate. As Mr Burgess would suggest, a healthy dose of distrust is in order.

Your thoughts?

Reference

Anthony Burgess, The Clockwork Condition, The New Yorker June 4 &11 2012.

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