Future of the Corporation 2020

Paper Series on Restoring the Primacy of the Real Economy JUNE 2009 AllEN WhitE, EditoR

New Principles for Corporate design 1. The purpose of the corporation is to 4. Corporations shall distribute their harness private interests to serve the wealth equitably among those who public interest. contribute to wealth creation. 2. Corporations shall accrue fair returns 5. Corporations shall be governed for shareholders, but not at the expense in a manner that is participatory, of the legitimate interests of other transparent, ethical, and accountable. stakeholders. 6. Corporations shall not infringe on 3. Corporations shall operate sustainably, the right of natural persons to govern meeting the needs of the present themselves, nor infringe on other generation without compromising the universal human rights. ability of future generations to meet their needs. For information on the development and context of these principles, www.corporation2020.org 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | ii

JUNE 2009 Dear Colleague: It is my pleasure to present you with a copy of this Paper Series in conjunction with the 2nd Summit on the Future of the Corporation: Restoring the Primacy of the Real Economy, Boston, June 9-10, 2009. The Paper Series and Summit mark the fifth anniversary of the launch of Corporation 20/20. The small core group that began this journey, comprising individuals from business, civil society, finance, labor, law and the media has grown into an international network of nearly 400 participants with a shared commitment to rethinking the fundamentals of the modern corporation. Through convenings, e-dialogues and research, Corporation 20/20 has continued to challenge the conventional notions regarding the design of the modern corporation, including its purpose, ownership, control, governance, capitalization and other components of the corporate form. Few of us involved in this journey could have imagined how relevant our work would be in light of the bubbles, busts and crises that have emerged in recent years. The topic of corporate purpose and structure has shifted from relative obscurity to front page headlines as all stakeholders grapple with the worst economic recession in decades. In particular, the role of the financial sector, a comparatively minor concern of Corporation 20/20 in its early years, has assumed a position of equal standing to the non-financial (“real economy”) sector on the agenda of the initiative. Reflecting this shift, the papers in this document and the 2nd Summit itself pay special attention to the purpose, regulation and restructuring of the financial sector at both the global and national levels. In the spirit of all Corporation 20/20 activities, paper authors challenge us to think “outside the box” and to open our minds to new ways of thinking about the nexus of capital and corporations. There is no issue of greater importance to achieving a just and sustainable economy in the decades ahead. We offer our sincerest appreciation to all authors for their contributions. Thanks also to the editorial team of David Wood, Faye Camardo and Nina Smolyar, and to Christina Williams for design of this document. We hope participants in the 2nd Summit as well as readers worldwide will find these papers both informative and provocative. Cordially, Allen L.White Director, Corporation 20/20 Senior Fellow, Tellus Institute 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | iii

table of Contents 1. Beyond the Crisis: Policies to Foster Long-Termism in Financial Markets . . . . . . . . . . . .1 Rebecca Darr and Judith Samuelson If a group of leaders with diverse perspectives but a common concern for reintroducing long-term orientation in business and markets were to brainstorm about public policy, what kind of recommendations would they make? This paper examines the range of public policy ideas that have emerged through dozens of conversations over several years that The Aspen Institute has facilitated among its Corporate Values Strategy Group—a network of business, investor, labor, and governance experts who are concerned about the problem of destructive short-termism. The paper lays out some of these policy suggestions toward the goal of getting to a better system. These ideas are particularly timely in the current moment of renewed interest in the regulation of the financial services sector in particular, and business in general. 2. Toward a Bretton Woods II: Aligning a New Global Financial Architecture with Sustainable Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Paul Epstein International efforts to reorder rules of engagement have often followed periods of social turbulence, pandemics, revolutions, depressions, and wars. The current global economic crisis presents such a moment for international finance. A new paradigm is urgent, one that shifts focus from protecting and enhancing capital interests to one geared to addressing the great challenges of sustainable development. Existing international finance institutions are ill-equipped to do this. New rules, incentives, funding mechanisms and governance that advance ecological protection and social well-being await invention, with a new climate regime arguably the most urgent among many pressing priorities. 3. Tomorrow’s Owners: Stewardship of Tomorrow’s Company . . . . . . . . . . . . . . . . . . . . . . 16 Mark Goyder Capitalism is in trouble because stewardship is failing. The world needs shareholders whose priorities and behaviors are aligned with the long-term interests of the company, and with the health of the soil in which it is being nourished. It needs boards and investors who exhibit a deeper understanding of the ingredients of success, and who have the tools of analysis by which they can advance this understanding. Shareholder value is a good measure but a bad master. No business will continue for long if it fails to meet a human need. We need investors, boards, rule-makers and civil society to combine in developing an agenda which puts stewardship and an inclusive approach at the heart of corporate life. This paper is intended to start the process of describing that agenda, with recommendations for: defined stewardship mandates for asset managers; changed independence criteria for board members; a cultural revolution in the management of behavioral risk; mandatory ethical audit and reporting; professional codes and disciplines covering the role of directors and capital market participants; changes in company law and governance codes to underpin the changes. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | iv

4. The Origins and Costs of Short-Term Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Kent Greenfield It is widely acknowledged that one problem facing American business is the fixation on the short term. Yet there is a puzzle: why does the capital market not punish companies for such short-termism? If short-termism truly hurts companies, why does the share price of those companies not go down, and the managers not get thrown out? It ought to be irrational for Wall Street analysts to require—and company management to make—decisions by the company that hurt the company in the long run but allow the companies to meet short- term earnings projections. Share price is a reflection of the company’s value. If decisions are being made to decrease the true value of the firm then the share price should reflect that. That is not what we observe, which is puzzling. This essay will provide some possible answers to this puzzle. 5. Not Just for Profit: Emerging Alternatives to the Shareholder-Centric Model . . . . . . . 34 Marjorie Kelly We introduce the concept of For-Benefit design, a new organizational archetype that is a hybrid that combines the traditional for-profit archetype, which has profit at its nucleus, and the non-profit archetype, which has social mission at its nucleus. For-Benefit designs have a blended purpose at their core: serving a living mission and making a profit in the process. These emerging designs represent an alternative to the shareholder-centric model that could help companies avoid ethical mishaps and elevate their contribution to meeting societal needs and expectations. The paper discusses various examples of such companies within a three-part typology: Stakeholder-Owned Companies, Mission-Controlled Companies, and Public-Private Hybrids. 6. Markets at Risk: The Limits of Modern Portfolio Theory . . . . . . . . . . . . . . . . . . . . . . . . . 42 Steve Lydenberg Modern Portfolio Theory (MPT) has done much to improve risk management at the portfolio level for institutional investors. Its emphasis on risk control within portfolios, however, has increased the demand for risky products in the broader marketplace and, ironically, made financial markets more risky and volatile as a whole. It has focused investors on “beating the market” and promoted the use of hedging and diversification techniques that, as more investors use them, can ultimately prove ineffective in extreme market conditions. Moreover, MPT ignores many of the social and environmental risks inherent in the investment process. The current economic crisis presents a rare opportunity to rethink the fundamental purpose of investing and to invent the tools that serve that purpose. The key to such rethinking is to define investments in each asset class as a means to socially purposeful outcomes, rather than a numbers game built on a narrow financial theory. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | v

7. How Should the Economy be Regulated?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Richard Rosen The current economic crisis provides a rare opportunity to re-think how the economy should be regulated in the coming decades. A key issue usually completely absent in such debates is how to democratize decisions pertaining to capital investments in basic industrial and service sectors. Achieving key social goals should be a criterion deeply embedded in such decisions. Two such goals are climate change mitigation and alignment of investments with sustainable development in general. Regulatory processes pertaining to capital investments in basic sectors should empower stakeholders whose lives are affected by such investments. Beyond capital allocation, future regulation should allow for stakeholder input in determining what kinds of products should be produced and what their prices should be in cases where markets are substantively non-competitive. U.S. Public Utility Commissions illustrate a powerful but underappreciated model of a proven regulatory approach that can and should be expanded to key sectors of the economy as a means to democratize decision- making. This would help correct the regulatory failures exposed during the economic crisis and enable a balance of public and private interests in shaping a form of managed capitalism for the future. 8. Work and Well-Being . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 John Stutz The principles of corporate redesign make clear the need to enhance the well-being of workers. Today this is addressed through increases in compensation made possible by growth. However, research on the determinants of physical and subjective (psychological) well-being shows that gains from growth will be marginal at best. What is needed are im- provements in working conditions. For the U.S., long hours and job insecurity are critical areas. While there are ways to address these concerns, the turbulent, competitive nature of the economy makes progress difficult. Fortunately, the current major economic disruption provides an opening for significant progressive change. Author Biographies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | vi

Beyond the commit to endeavors that may take years and, in some industries, decades, in order to realize both societal benefits and to make profits for their financial investors. The Crisis: unmitigated growth in short-term financial pressures that we have observed over the last several decades can greatly limit this potential to benefit society; indeed, it causes great harm.3 Policies to Foster Long-Termism A new administration in Washington and unprecedented public attention to business in Financial Markets1 and financial markets offers a unique opportunity for public-policy recommendations in pursuit of long-term wealth creation to gain visibility and, possibly, to obtain real traction. Rebecca DaRR aND JuDith SamuelSoN Given this direct link between the potential aSpeN iNStitute ceNteR foR of business to create value and the need for i buSiNeSS aND Society long-term perspective, CVSG takes the consequences of short-termism as the point of departure for its deliberations. Short-termism If a group of leaders wIth dIverse constrains the ability of business to do what perspectives but a common concern for it does best—create valuable goods and ser- reintroducing long-term orientation in vices, invest in innovation, take prudent risks, business and markets were to brainstorm develop human capital, and address issues of about public policy, what kind of social and environmental significance. Short- recommendations would they make? Since term financial metrics encourage companies 2004, The Aspen Institute’s Corporate Values to externalize costs on wider society. The Strategy Group (CVSG) has been facilitating internal incentives and market signals that dialogue among corporations, organized follow from short-termism drive the kind of labor and public pensions, with the hope of dysfunctional, value-destroying behavior we influencing federal and state policy when the have witnessed since the fall of Enron and, on window of opportunity opens. Organized a much grander scale, in the current financial around the pervasive and destructive crisis. Short-termism is not limited to the be- problem of market short-termism, CVSG havior of misguided individuals; it is system- aims to promote business and market wide, with contributions by and interdepen- practices that curb short-termism and dencies among companies, asset owners, asset refocus the relevant players on creating long- managers, and government. term value for all stakeholders, with special focus on augmenting the voice of long-term ASPEN PRINCIPlES AS THE PlATFORM oriented investors.2 The Aspen Principles on Long-Term Value The purpose of this paper is to explore Creation, released to the public in June 2007, a range of public policy prescriptions that served as a starting place for this dialogue on have emerged over dozens of conversations public policy. Drafted under the leadership and several years time, at a moment of of CVSG members including senior-level renewed interest in the regulation of the representatives from business, corporate financial services sector in particular, and governance, public pensions, and organized business in general. labor, the Principles represent a consensus FOUNdINg ASSUMPTIONS of “strange bedfellows” on actions that are The Aspen CVSG starts from the assump- aimed at counteracting short-term focus tion that corporations represent a vital and at the company level, and that may have influential institution in society. In order for broader ripple effects throughout the wider corporations to perform at their best, they market. The Principles urge companies to 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 1

define firm-specific metrics of long-term val- deeply concerned with the consequences of ue, and then use these metrics both to com- short-term thinking and acting, and who municate with investors around long-term thought change possible. This included people measures and activities, and to better align who were closely engaged with our work on executive compensation with the creation of short-termism and, thus, enjoyed a degree of long-term value.4 mutual trust, forged through the development Voluntary actions undertaken by indi- of the Aspen Principles of practice. We also vidual companies and boards are an excel- included participants who had a Washington lent starting place to make positive changes insider’s perspective on what was possible in in the market. But even before the economic the political sphere. In a search for common crisis became front-page news, it became ground, we began from the assumption that clear that in order to succeed in influenc- all input to the dialogue process was useful, ing the behavior of business and markets on regardless of political viewpoint or role.5 a wide scale, the principles of practice for long-term orientation must be bolstered by PRINCIPAl gOAlS system-wide incentives; that is, mandates The ideas we present below were developed and rules that comprise an integrated rede- through a series of five meetings held between sign of financial markets regulation. mid-2008 and March 2009, and have roots in conversation that began two years prior.6 APPROACH TO dIAlOgUE The June 2006 CVSG summit was based As Election Day 2008 approached, partici- around the idea of envisioning a better sys- pants in the CVSG acknowledged the poten- tem by the year 2015; participants identified tial for public-policy discussion aligned with characteristics of capital markets in which a the work on curbing short- better balance between short- and long-term THE BETTER SySTEM: 2015 termism. A working group horizons is achieved. (See box, “The Better convened around the follow- System: 2015” at right.)  Appropriate and trusted balance between ing assumptions and operating The recommendations that emerged from and alignment among government, principles: this visioning process largely prefigured business, investors, and society at large. Focus on the system and not those that would eventually comprise The  Greater understanding of how the just the corporation, recogniz- Aspen Principles, released in June 2007. different participants in the market (e.g., ing that a “complex dance,” In July 2008, CVSG defined its policy business, investors, and policy) relate to the system; and greater lines of sight involving both companies and discussion goal as follows: “Identify and regarding consequences of decisions and investors, drives the results we test constructs that provide an approach to behavior. have now. policy action that creates a more supportive  Businesses with clarity of purpose, Work toward developing a environment for companies and investors focusing on delivering excellent goods coherent package of ideas rath- concerned with creating long-term value and services, and creating sustainable er than a piecemeal approach, that is in the interest of the common good.” long-term value. and embrace all links in the Compared to two years prior, the July 2008  Transparency on issues that matter– investment chain. summit focused specifically on how public businesses providing information Seek the common ground policy could encourage long-term oriented that offers appropriate insight into among different market actors business and investor behavior. Recom- past performance, compensation and incentives, and indicators of future health. with an interest in extending mendations centered around five goals, with time horizons in the business accompanying suggestions about how those  Better sharing of wealth, based on more equitable evaluation of contributions. system, with the hope of creat- goals might be accomplished: ing a common platform. Encourage more patient capital and dis-  Public policy characterized by an appropriate balance between short-term As a result, rather than start courage investor churning: For example, in- and long-term business and investment the policy discussion with a stitute minimum holding or vesting periods incentives. re-examination of the corpora- as a prerequisite to the exercise of certain  Business leaders actively engaged in tion and its purpose, the focus shareholder rights; change capital gains and addressing long-term societal challenges of the dialogue was to work tax policy to reward long-term investment; that affect the business environment. with individuals and influen- and develop new long-term investment tial organizations who were products with restricted access to invested 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 2

capital for individual investors in retirement troversial/ difficult to achieve? and other long-term contributory schemes.  Are there any logical linkages between Discussants called for additional research by ideas? experts to test these ideas. Four of the five policy goals outlined during CVSG’s July 2008 summit ultimately Promote greater investor transparency: For were reflected in the final set of “building example, require more and better disclosure blocks” developed by this working group that of holdings by investors, intermediaries, and focused on policy outcomes from October agents on record dates and when acquiring 2008-March 2009.7 The policy discussion significant positions (short and long) in order and subsequent ideas (see Appendix) were to illuminate conflicts, discourage “empty” significantly clarified and galvanized by voting, and enable operating companies the growing financial and economic crisis. working to amplify the voice of long-term While the headlines have remained similar holders to know who owns their shares, and from July 2008 to now, what changed was an in what quantities. articulation of how the policy goals would be achieved—more specifics were included in Hold financial intermediaries to a higher some areas and a change in scope modified degree of accountability: Increase disclo- other goals. Two new areas for policy focus sures on compensation, incentives, trading, were discussed and were added to the mix: (1) and other such matters that would indicate the role of excessive risk-taking; and (2) the compatibility, or lack thereof, with the stated role of leverage in the current economic crisis. goals of the ultimate investors, such as pen- The building blocks outlined below rep- sioners and those saving for college. resent concepts that participants believed were critical to restoring trust and confidence Encourage corporate use of compensation in financial markets, the foundation of any and incentives that better align employee sustainable recovery.8 They believed these interests with the long-term health of concepts are also necessary to move the U.S. the company: For example, modify tax toward a smarter financial system, one that is treatment of options and tax rules on the focused on long-term societal health, not just deductibility of executive compensation as a until the next bonus is banked. These building corporate expense. blocks are supported by specific examples of actions (to be implemented by the U.S. De-emphasize the quarter: Refocus manag- government, state governments, and stock ers on long-term value creation and produc- exchanges), some of which are described in tive activity by encouraging the release of the next section and in the Appendix. broader performance metrics and strategies as a target for management discussion, and Create revenue and pricing incentives move the statutory requirement for U.S. to encourage more patient capital and company filings from quarterly to semi- discourage investor churning. In collabo- annually, as is done in other countries. ration with other OECD countries, the U.S. In October 2008, we began to facilitate a should develop tax-based mechanisms with small working group interested in public- a market-wide reach to encourage investors policy ideas and representative of diverse to hold stock over longer periods. These perspectives and organizational affiliations. could include a trading tax to discourage The following criteria were applied to the churning, changes in the capital gains tax search for the best ideas, and in order to to re-define “long term” and to reinstate triage a longer list of proposals presented for Clinton-era rates on holdings of between consideration by this small group: one and five years, and end the “2 and 20”  What is mission critical versus less critical loophole that allows fund managers to (higher versus lower priority)? claim capital gains tax treatment for their  What is less controversial/easier to do cut of the carried interest of their investors, (technically, politically) versus more con- thus avoiding paying income tax. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 3

Strengthen investor disclosures to promote disclosure requirements that are currently greater transparency about who owns what. applicable to operating companies. The current economic crisis has shown that a  Ensure that LT fund and index fund man- number of actors whose roles in the market agers are taking fundamental risk into ac- have far-reaching effects have been flying un- count when they invest their clients’ funds, der the radar of existing reporting and disclo- and are voicing concerns and engaging in sure requirements, often obscuring potential activism about risk in stocks within their interests and motivations. Greater disclosure portfolios assuming they cannot sell. about these entities’ transactions will lead to a  Ensure that LT fund managers vote and clarification of their roles in the market. This invest in ways that will promote prudent may be achieved by requiring more and better growth and that index fund managers also disclosure of holdings by investors, inter- vote their shares in a manner that reflects mediaries, and agents on record dates and the long-term orientation and actual hold- when acquiring significant positions (short, ings of the portfolio. long, and derivatives) in order to illuminate  Ensure that LT fund managers disclose conflicts and to enable operating companies, and explain excessive annual portfolio focused on the long-term, to know who owns turnover. their shares, and in what quantities. In ad-  Require public disclosure of proxy advi- dition, pension funds should be required to sors’ criteria for making voting recommen- disclose their share-lending policies and all dations to mutual and pension funds, and should be banned from voting by use of bor- prohibit pension, college savings, index, rowed shares. or 401(k) funds from relying on a proxy advisory service for voting advice unless Hold financial intermediaries to a higher that service gave voting advice based on degree of accountability—ensuring their the perspective of a long-term investor in interests are aligned with their ultimate the corporate issuer. investor—by requiring increased disclo-  Require public disclosure of the revenues sures on compensation, incentives, trading proxy advisors receive from public com- and other such matters that would indicate panies and institutional investors, and the compatibility, or lack thereof, with the stated nature of the work that generates those goals of the ultimate investors. In many revenues. ways, financial intermediaries, such as asset managers and portfolio managers, have De-emphasize the focus on the next quar- become divorced from the interests of those ter and refocus managers on long-term value who provided the capital in the first place; creation and productive activity by requiring these ultimate investors are often invest- that quarterly guidance may be given only in ing for long-term goals such as college and the context of a clear long-term growth plan. retirement, while the intermediaries manage In the past, the SEC has deemed information this money with a quarterly or annual hori- misleading when it is not placed in appropri- zon. As such, financial intermediaries should ate context. Only if short-term guidance is be held to a higher level of fiduciary duty, actually placed within this larger context is it taking greater care in their role as agents meaningful to a long-term investor, and even and acting in ways that are beneficial to the then it is of minimal utility to investors who ultimate investor. Through creation of new are invested for 10 to 15 years or longer. or clarification of existing federal laws or regulations, the following might be required: Better focus corporations on real risk and  Compensate the managers of long-term opportunity. To create a corporate culture oriented, tax-advantaged funds, such where greater attention is paid to the real as 401 (k) and college savings (a.k.a. LT risks and opportunities facing the com- funds), based upon the fund’s long-term pany, corporations should assign explicit performance. responsibility for such risk management to  Extend to mutual funds the compensation their boards and senior-level staff; specific 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 4

changes might be mandated through new passed by the “building blocks” described or revised federal legislation, regulation, above. Participants in the discussion prod- or stock exchange rules. Boards should be ded each other to think big, while simulta- encouraged to create a committee specifi- neously remaining aware of the little things cally focused on non-accounting risk, and that could improve matters incrementally. to rethink their operating models to set Nevertheless, there were several ideas that aside necessary time to devote to strate- dialogue participants considered, but which gic planning, management oversight, and failed to move forward due to insufficient compliance. Policymakers should consider support. These ideas may be relevant to those building on Sarbanes-Oxley requirements who are interested in creating a more just to mandate certification of companies’ risk and sustainable world, and for this reason management processes by top executives we share these ideas, in particular, and with and an outside auditor. greater specificity in the following pages.9 To address the goals of more patient capital Limit opportunities for excessive risk- and better investor transparency, two ad- taking that can translate into extensive ditional ideas emerged: value destruction. The current economic crisis shows the widespread destructive ef- Reform the use of rule 14a-8 to strike a fects that can result from investors’ efforts to balance more useful to long-term share- make short-term profits through excessive holders risk-taking or leverage. While these actions  The current challenge: Rule 14a-8 in may make profits for a handful of firms and the Securities Exchange Act of 1934 has individuals, they may ultimately inhibit real produced stockholder activism that is economic growth. These speculative prac- beneficial to investors.10 Nevertheless, the tices may give clout to short-timers with in- volume of activism also has substantial terests often adverse to long-term investors, costs: while filers bear a small filing cost, and may create excess volatility and risk in the number of proposals has mushroomed, the equity markets. Following are some ac- increasing the time that management tions that might begin to remedy the current devotes to proposals (and not to managing situation (see Appendix for additional ideas): the company). In addition, these propos-  Implement a leverage limit that should als may be brought by people who have include, at a minimum, investment funds not owned company stock for any period subject to the Investment Company Act of time, who only own a very small stake, of 1940 and any hedge fund that accepts and/or may be net short the company. At investments from pension funds, states, the same time, the SEC has kept Rule 14a- counties or other municipalities, and uni- 8 from being a tool for investors to have a versities. stronger voice and to be able to address, on  Regulate hedge funds as financial inter- a company-by-company basis, issues such mediaries. Up to 70% of securities trading as proxy access. is conducted through hedge funds whose  The proposed changes: The changes actions are not regulated; therefore, hedge described below would allow shareholders funds should be regulated and particular concerned about a company’s social and focus should be placed on their approach environmental practices to register their to risk, their use of leverage, and their concerns with relative ease, but would keep potential conflicts of interest. short-term investors and/or those with  Increase the reporting threshold for off- short positions from impacting company balance-sheet entities. behavior through the proxy process. •L eaveinplacethecurrentlowthresholds OFF THE TABlE BUT NOT FORgOTTEN for social proposals dealing with issues The policy discussions we facilitated began such as the environment, labor, and hu- with many wide-ranging ideas that were man rights, but require that the propo- gradually winnowed down to those encom- nent have owned shares at least a year. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 5

•R aisetheeligibilitycriteriaforusingRule a bylaw or seek books and records, to eq- 14a-8 to submit non-social proposals uity holders based on how long they have by requiring that proponents hold a sig- owned shares, and require those exercising nificant, net long stake for at least a year certain rights to have a net long position. before making a proposal and establish a To address the goal of focusing corporations reasonable filing fee for submitting non- more on the long-term creation of wealth social proposals. and real risks and opportunities, two addi- In order to address the concerns expressed tional disclosure-related ideas were proposed. by shareholders of all sizes about their in- Shareholders are not granted the protections ability to meaningfully push back against a of the corporation as a societal aim, in and board and its management when actions are of itself. Limited liability encourages share- taken which are contrary to the wishes of the holders to hand over their capital to corpora- shareholders: tions, which will engage in risky, but possibly •E liminatetheexclusionthatkeepselection profitable ventures. The desired, aggregate reform proposals from being presented outcome of this corporate risk-taking is the under Rule 14a-8 [Rule 14a-8(i)(8)]. This generation of financial profits and an increase would promote a private ordering solution in societal wealth. In the process of generating to issues like proxy access, “majority vot- financial profits, corporations have multiple ing,” and electoral expense reimbursement. incentives to employ and train workers, to •I naddition,stateslikeDelawareshould develop innovative products and services, and pass a statute, clarifying that bylaws allow- to engage in other activities that increase— ing for reimbursement of proxy expenses, not diminish—societal wealth. One might proxy access, and non-binding votes on expect to find an accounting of a company’s executive compensation (“say on pay”) are contribution to society in its voluntary ESG valid. States might require a form of proxy or CSR report; nevertheless, such reporting is access and expense reimbursement annual- voluntary and is limited in comparability even ly at companies with classified boards and by those using the Global Reporting Initia- every three years for board slates receiving tive’s G3 framework.11 more than 30% of votes. Improve corporate compensation disclo- Permit corporations to grant shareholder sure with context on societal impact voting and rights based on duration of  The current challenge: Over the last 25 holding years, executive compensation has grown  The current challenge: Shareholders who significantly, while the real income growth propose long-lasting corporate governance of the average U.S. worker has stagnated. changes or other fundamental alterations The SEC has a rather new Compensation in business strategy should have a substan- and Disclosure requirement; nevertheless, tial, long-term interest that signals their this requirement focuses only on the top motivation in wanting the corporation to executives and provides no context. prosper over the long haul. Currently, this  The proposed change: To give the public is not the case. One way of ensuring this is a better sense of companies’ impact on to allow only true “owners” of stock, and society via their workers, corporations not transient “renters,” to have a substan- should be required to disclose informative voice in a company. tion about the growth in pay and benefits  The proposed changes: Through a state to top executives over time in comparison law modification, corporations could grant to the median wage and benefits package voting and other rights through changes paid to other employees in the company. in their corporate charter. For example, Other useful information might include corporations could give more weight to the size of the corporation’s workforce; a the votes of long-term equity holders. In breakdown of full-time, part-time, and the same vein, corporations could grant temporary employees; the percentage of certain rights, such as the right to present employees provided with health insur- 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 6

ance; and a breakdown, by country, of the policy actions must look clearly and boldly at number of workers and revenues where a redefining fiduciary duty from a shareholder- company operates. centric orientation to broader, multi-stakeholder orientation. Companies that manage Mandate key disclosures on environmental to a single, financial objective will continue and social issues to miss important risks and fail to capture  The current challenge: A corporation is important opportunities to bring the talent of not merely an instrument of private wealth business to bear on problems that matter. creation; thus the public has a vested inter- A sustainable company must be one that est in the way in which such wealth is cre- not only achieves longevity, but longevity by ated. However, little disclosure is expected virtue of its attentiveness to the legitimate of U.S.-based or traded companies on the interests of those who both influence and are human impact of their operations, beyond influenced by its decisions and investments. specifics such as release of air pollutants. In this vein, one policy idea is to redefine Some European nations are now requiring the “license to operate” through a corporate corporations to make comprehensive dis- charter that must be renewed every 20 or so closures about the effect their policies have years. The renewal process would include on the nation, such as the environmental multiple voices answering such questions as: impact of their operations. One might 1) Is the company producing useful, valuable expect some of these data points to be in- products and services?; 2) Is the company a cluded in a company’s ESG or CSR report; good employer?; 3) Is the company a good however, the disclosure is voluntary. neighbor to its local community?; and 4) Is  The proposed change: Require publicly the company a good corporate citizen in the traded corporations in the U.S. to disclose eyes of government? information regarding their environmen- Second, more research is needed to under- tal and labor practices. This would give stand the corporate structures of companies the public and shareholders alike a better that have succeeded at long-term focus. understanding of companies’ real human Though not a new public policy prescription, impacts, and its effects on the environ- we believe that state laws already may offer ment. It would also help policymakers sufficient opportunity to structure ownership, identify industry participants who are ex- control, and voting rights in ways that could ternalizing costs to competitors or society advantage long-term orientation; yet, those at large, and policy areas where further examples are not well understood. Many ad- regulation is needed.12 vocates and academics are interested in new forms of corporate structure such as the For REFlECTIONS Benefit Corporation (“B Corp”) discussed in Our role in the ongoing dialogue has been complementary initiatives; it would be useful one of secretariat, facilitator, and process to build knowledge of commonplace voting cheerleader. The ideas shared above were not and ownership structures that advantage a developed by us. They emerged in multiple long-term view, and that can be accomplished meetings and have varying degrees of cur- under existing law.13 rency among participants; although there The process we have been facilitating strives is no consensus, and in the current envi- to offer a new vision for policy and regulation ronment of crisis and public distrust said which will vastly diminish the forces of short- consensus is increasingly hard to achieve. termism and drive behaviors that refocus on Given this opportunity offered by Corpora- the long term. We hope that these ideas— tion 20/20, we thought we would advance those that “survived” the autumn 2008-spring two policy-related ideas that have not been 2009 facilitation process, those that were voiced in any forum we’ve organized. discarded, and new ideas we suggest above— First, if companies are to focus on creat- can play a constructive role in the valuable ing and sustaining value into the long term dialogue on corporate design that Corpora- and fully account for their societal impacts, tion 20/20 continues to facilitate. n 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 7

APPENdIx: SUMMARy TABlE OF PUBlIC POlICy IdEAS MOdE OF ACTION Existing Rules legislation Regulation State law Exchange IdEA Federal Federal Action Clarify Rules Still on the Table for Discussion Implement a trading tax X* Modify capital gains rates X* End the “2 and 20” loophole X* X* Enforcement of fiduciary duty of fund managers to take into account fundamental risk when X investing Extend the compensation disclosure principles to mutual funds X X Create accountability on the part of proxy advisors X X Special rules for LT tax favored investments [college savings, 401(k)] X X Special voting rules for index funds X X X Enhance & make more timely the disclosure of economic interests of activist investors X X Limit leverage by funds/regulate hedge funds X X Ban voting of borrowed shares X X X Require investment funds to disclose share lending policies X X Limit certain rights to long-term, net holders X X Consider requiring issuers to disclose and update a long-term plan for the growth of corporate X X earnings if they wish to give quarterly earnings guidance Consider requiring that boards have a separate risk management committee to address non- X accounting risks Give boards more time to focus on the company’s business plan, the oversight of management X X and its performance, and the management of risk Consider requiring that an officer-level risk management process be the subject of certifications X X by the CEO, chief legal and financial officers, and outside auditor Increase reporting threshold for Off-Balance Sheet Entities X* X Permanently reinstate the uptick rule and outlaw naked short-selling X* Institute leverage limits and reinstate sensible margin limitations for financial institutions & X* X investment funds Regulate credit default swaps as securities X* X Impose capital and disclosure requirements on all parties writing credit insurance contracts and X* X credit default swaps Off the Table but Not Forgotten Reform the use of Rule 14a-8 to strike a balance more favorable to genuine, long-term investors X Clarify that long-term investors may pass bypass laws requiring reimbursement of proxy expenses, X proxy access, and a non-binding vote on executive compensation Improve disclosure of executive compensation by placing it in the context of other corporate X X policies and their effects on other corporate constituencies and societal interests Require corporations to disclose information regarding their environmental, labor, ethical, and X X worker safety practices * International coordination would be highly desirable 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 8

ENdNOTES substantive bases for exclusion.” Accessed 26 March 1 We wish to acknowledge David Langstaff, Damon 2009 from: http://sec.gov/interps/legal/cfslb14.htm Silvers, and Leo Strine, Jr. for their energy and 11 Developments in various countries suggest that intellectual contributions that shaped many of the ideas mandatory reporting is gradually emerging and may presented in this paper. Any error in representation is become far more common than it is today. For example: inadvertent, but it is ours. Sweden has mandated GRI reporting for state enterprises. 2 CVSG is a program of the Aspen Institute Business Denmark mandates CSR information in the annual and Society Program (Aspen BSP), which is dedicated reports of 1100 largest companies. The Johannesburg to developing leaders for a sustainable global society. Stock Exchange requires listed companies to comply with Aspen BSP engages with business leaders and business the King III Report on Corporate Governance which educators alike to help create a new vision of business includes sustainability reporting a key component of that incorporates stewardship of the environment and good governance. And China encourages state-owned society. companies to report on CSR activities. 3 CVSG’s focus on short-termism is rooted in the work 12 See COST-US (Consultation on Sustainability of The Conference Board’s Blue Ribbon Commission on and Transparency), a network of practitioners and Public Trust & Private Enterprise, formed in response academics advocating a major enhancement of non- to the fall of Enron. More at: http://www.conference- financial disclosure in U.S. financial markets. http:// board.org/knowledge/governCommission.cfm groups.google.com/group/cost-us/subscribe?note=1 4 Aspen Institute Business & Society Program, “Guiding 13 A teaching module, “What the Law Allows,” is Principles for Long-Term Value Creation,” June 2007. available from Aspen’s CasePlace.org. http://www. Accessible at: http://www.aspeninstitute.org/sites/ caseplace.org/d.asp?d=2811 (CasePlace.org registration is default/files/content/docs/pubs/Aspen_Principles_ required to access this module, but registration is free.) with_signers_April_09.pdf 5 The focus of the CVSG and policy dialogue has tended to avoid fundamental rethinking of the purpose of the firm; however, Aspen BSP believes that these fundamental questions are timely and relevant. Over the last decade, and more recently through our Center for Business Education, we have convened and supported the work of dozens of academics and others pursuing significant change in theory and business practice in pursuit of business’ contribution to society and sustainability. 6 A list of participants for the June 2006 and July 2008 summits can be found on http://www.aspeninstitute. org/policy-work/business-society/corporate-programs/ corporate-values-strategy-group/participant-list 7 Others expressing their opinions in mainstream publications in recent months have called attention to the many policy goals and related ideas, including compensation and quarterly reporting that were articulated during the July 2008 summit. 8 Aspen CVSG public policy working group papers, December 2008-March 2009. 9 Aspen CVSG public policy working group papers, December 2008 and February 2009. 10 What is rule 14a-8? Per the SEC: “Rule 14a-8 provides an opportunity for a shareholder owning a relatively small amount of a company’s securities to have his or her proposal placed alongside management’s proposals in that company’s proxy materials for presentation to a vote at an annual or special meeting of shareholders. It has become increasingly popular because it provides an avenue for communication between shareholders and companies, as well as among shareholders themselves. The rule generally requires the company to include the proposal unless the shareholder has not complied with the rule’s procedural requirements or the proposal falls within one of the 13 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 1 | 9

toward a Bretton output—global GDP or real wealth—is ~$40 trillion.) The paper money was lost in a game of limitless risk transfer; “securitization” that turned out to be anything but. Woods ii: With some wagering the bundles would fall ‘short’ and others betting stocks and bonds and currencies would rise, we may come to view this as one grand Ponzi scheme (decentralized and unwitting, perhaps, save Aligning a New Global Financial for the predatory lenders) that has left a trail of hardships, foreclosures, bankruptcies, Architecture with Sustainable layoffs and—the worst—the near collapse of whole economies such as Iceland, Ireland, Development and Spain. In the U.S., with housing values dropping and Detroit in its self-made sorry state, two major pillars of the U.S. economy have witnessed a precipitous paul R. epSteiN decline in output and market capitalization. t haRvaRD meDical School Today’s financial market disruption is mirrored by mounting climate instability and accelerating melt of the Earth’s ice cover. they say there are no atheIsts In a Meanwhile, plateauing crop yields and eco- foxhole; it seems there are no ‘free market’ nomic sinkholes threaten to drag asunder a fundamentalists in a recession. Yet, amidst growing list of nation states. Sometime soon, the most severe economic crisis since the the disharmonic convergence of economic, Great Depression, we are clinging to market energy, environmental, and political instabil- forces to bring about a recovery. Meanwhile, ities will drive us into a new world order. The the world faces escalating climate, food, and mantras of the Washington Consensus—de- water crises. A perfect storm on the one regulation, liberalization, privatization—led hand; a rare opportunity for integrated inter- us inexorably into the 2008 downward spiral, ventions and systemic change on the other. the end of an era of seemingly endless but On November 15, 2008 the leaders of 20 na- ultimately unsustainable growth. We need tions met in Washington, D.C., to address the a vision for the financial architecture and international financial crisis. France’s Presi- mechanisms that drive less and very differ- dent Sarkozy has called for another summit ent patterns of consumption. soon, and the 20 nations met in April 2009, The old rules of engagement are inad- with the Obama administration in place. equate for the task we face. We need a new With the financial collapse and rapidly set of regulations, performance and effi- devolving worldwide economy, calls for a ciency standards that oblige the economy, new Bretton Woods Agreement are be- once primed, to move steadily in the right coming audible. So much has happened in direction. Complementing the stimuli such a short time, the sense of urgency to needed for developed nations, UN Secretary restructure global finance has never been General Ban Ki-moon, this winter called greater. upon the G20 to establish a $1 trillion fund First, the financial mess: the abrupt to help developing nations deal with the evaporation of liquidity and lines of credit contraction in global investments and cope that has reverberated across the globe. with the social, environmental and political It wasn’t hard to see it coming, as ‘exotic fall-out. But realigning rules and rewards is derivatives’—speculative ‘side-bets’ on not sufficient: we also need an institution to highly-leveraged, bundled stocks and administer the funds and assure compliance bonds and swaps—rose from $900 billion with a new standards regime. A look back at in 2001 to $45.5 trillion in 2007! (World the evolution of the extant financial architec- 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 10

ture is instructive in relation to charting the accumulation (derived from colonies) and pathway forward toward meeting the great concentration of wealth were accompanied sustainability challenges of the 21st century. by large migrations, populist and labor movements, a failed revolution in 1905, the A BRIEF HISTORy OF WORld ORdERS First World War, the Russian Revolution of Conscious international efforts to reorder 1917, and the 1919 pandemic of influenza rules of engagement have often followed (killing an estimated 20 to 100 million), periods of social turbulence, pandemics, which together precipitated another attempt revolutions, depressions, and wars. In the to restructure international relations. late 18th and early 19th century, revolutions The victorious powers from World against the old order exploded in the War I—led by the U.S., U.K., and France Americas and France, and back to the (Woodrow Wilson, Lloyd George, and Americas. After his defeat in Haiti (which Georges Clemenceau)—met in Paris for a led to his capitulation of American territory peace conference in January 1919 that would with the Louisiana Purchase in 1803), last until June. The Treaty of Versailles and Napoleon marched across Europe and his the League of Nations (following Wilson’s ultimate defeat there led to the momentous “Fourteen Points” and principles of “self- Vienna Peace Conference of 1814. And determination”) kindled new hopes for a while international relations continued to be new order and a lasting peace. dominated by colonial pursuits, and internal But many critical problems were left conflicts between labor and business caught unsolved. Women’s participation and fire, the 1815 Treaty of Vienna marked women’s suffrage were rejected, reparations the beginning of prolonged peace among were exacted from the vanquished, and European nations. colonies were reshuffled into League By mid-19th century, urban crowding of Nation “mandates.” Without funds (the population of London rose sevenfold to reignite the global economy, it took from 1790 to 1850) overwhelmed water and six years for Europe to recover, and the sanitation systems. In the 1830s outbreaks cinders of future conflict smoldered. Rapid, of cholera, tuberculosis, and smallpox uncoordinated growth led to spirals of in London, New York and Boston (and speculation and, following the 1929 stock many other industrializing cities) affected market crash, the Bank for International city dwellers and sparked protests and Settlements (established in 1930) served as a revolutionary involvements demanding hint of what was to come following the Great change. Public health jumped to center stage Depression and yet another world war, more in national development agendas during devastating than the first. this period, and the resulting sanitary and environmental reforms had stemmed the BRETTON WOOdS tide of the infections by the 1870s, years In the summer of 1944, as the second of two before Robert Koch (1883) and Louis devastating world wars, interspersed by the Pasteur (1890s) isolated bacteria. While roaring ‘20s and Great Depression of the no concerted international developmental 30s, drew to a close, Western leaders met effort emerged during this period, the at the White Mountain resort in Bretton first international funds to coordinate Woods, New Hampshire to form a new communications were established to support world order. The old one was broke and the International Telegraph Union (1865) broken. John Maynard Keynes—a Lord, a and the Universal Postal System (1874). financial market trader (Bloomsbury group The next turning point came in 1884, when member with Virginia Woolf and Lytton colonial powers met in Berlin to consolidate Strachey, among others) and designer of the a new world order. After centuries of Lend Lease Agreement (by which the U.S. extracting gold, ivory, and slaves, colonial supported Great Britain in WWII)—was powers divided Africa into new dominions. the designated chair. Keynes’ 1936 salient During the subsequent decades, primary book had pointed towards a Third Way of 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 11

development, combining full employment tacked by others. The WTO has provided the and a market economy. umbrella for huge agricultural subsidies in Keynes figured out that you didn’t have to developed nations, while disallowing protec- figure it all out: you had to change the rules tive tariffs. The combination —swords al- that shape the system. The rules shape lowed, but shields denied—has undermined the body—the morphology of the global and, in many cases, eliminated profitable economy—and changes in it emerge from agriculture in many developing nations. changing the underlying rules. This complimentary combination of At Bretton Woods, western nations agreed a) sticks, b) carrots, and c) institutional to three rules: 1. free trade in goods, but infrastructure catapulted the post-war 2. fixed exchange rates, and 3. constraints recovery into several decades of prosperity on the international flow of capital. (The for some. In that post-war period, the third of these, whose violation in today’s Universal Declaration of Human Rights, capital markets can only be described as framed by Eleanor Roosevelt, was signed, “over-the-top,” followed Adam Smith’s and the United Nations was born out of admonition that healthy competition and the ashes of Wilson’s League of Nations. comparative advantage among nations It was truly a time of conscious transfor- would not hold if capital flowed freely and mation of world values and the world or- speculatively across borders.) der—new institutions followed a recognition Soon after, economic stimuli came in the that the destiny of the world’s nations and form of the Marshall Plan for European peoples were inextricably linked and that reconstruction and, in the U.S., the GI new governance mechanisms must be put Bill (priming housing, jobs, schools, and in place to both foster shared, core values as industries). And the international frame- well as to manage a globalizing economy. work to ensure stability was housed in the A major detour from this evolution newly-formed World Bank, the International occurred in 1971. With U.S. debt mounting Monetary Fund, and what was to become from Vietnam War expenditures, President the World Trade Organization (WTO). Nixon abandoned the Bretton Woods rules. Free trade in goods was now matched by THE WTO unhinged exchange rates and deregulation of The WTO, an international organization the international flow of investment capital. that deals with the rules of trade among The upward spirals soon began. In the nations, was established in 1995 to replace 1970s gold jumped from $38 an ounce to the General Agreement on Tariffs and Trade $300 (to >$900 today); oil rose ten-fold, (GATT). It extended trade policy from goods from $3 to $30 a barrel; and nations went to service industries through the General hat-in-hand to the World Bank to borrow Agreement on Trade in Services (GATS). The money to fuel their economies. By 1983, WTO was formed to ensure that internation- money flowing out of the developing al trade “flows as smoothly, predictably and world surpassed that entering in aid and freely as possible” and to “help producers of investment, and the debt crisis was born. goods and services, exporters, and importers By the end of the 1980s, unheard of conduct their business.” interest rates (18-19%) drove money Unlike the GATT, the WTO is backed by a into British banks and away from dispute settlement mechanism, or trade court, their productive economy, creating a wedge and compliance, based on the court’s find- between finance and industry. (This was ings, is mandatory for member governments. corrected in the early ‘90s with a transfer in Through the court, the WTO acts as an Great Britain from finance into industry— arbiter when members’ non-trade objectives and the British economy rebounded.) conflict with their free-trade undertakings. But the ‘90s saw the unbridled transfer The effectiveness of the WTO has been of speculative, ‘hot money’ (e.g., moving questioned by some, and the impacts of its quickly in and out of one Asian capital to policies on those most in need roundly at- another, not stopping to invest in long- 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 12

term projects). Currency transactions also Debt is the means by which some nations skyrocketed. In 1972, they amounted to exert control over others. Unpayable debts $16 billion daily. Today they are close to $2 must be forgiven. Debt forgiveness would trillion per day And today we witness the be a compensation for past inequities driven cliff over which the runaway split between by unequal terms of trade and centuries of the interests of finance and industry have wealth extraction. For example, debt-driven carried us. timber extraction and land clearing for mon- ocultures and biofuels will overwhelm even TOWARd A BRETTON WOOdS II well-funded measures for forest preservation. If global institutions are to be reconstructed But debt would re-accumulate rapidly to support inclusive, equitable, and unless the conditions that gave rise to it sustainable development, the deliberations are also changed. The most challenging must bring all nations to the table (not just issue is, thus, the terms of trade (TOTs): 20 chosen ones). And on the table are the the difference between the prices poor rules (the “sticks”), the financial incentives nations receive for their exports (e.g., (the “carrots”), and the international food) vs. the prices they pay for imports financial institutions: The World Bank, (e.g., tractors). Since the 1960s TOTs have the IMF and—of utmost importance—the steadily widened. Equalizing TOTs is most WTO. A new institution may be necessary— challenging because it means distributing the Global Environmental Facility is global wealth more equitably. TOTs must one possible model, being a granting (not a become more balanced, even from a banking and lending) agency, and includes Western, self-enlightened perspective, to the United Nations (UNEP and the UNDP). maintain purchasing power and global The GEF, which remains financially tethered markets. Equity is a prerequisite for trade in to the World Bank, must be democratized. goods that is free and fair, and for addressing A new global compact must realign international divisions among workers. the monetary rules, the regulations, and rewards that determine the shape of the Incentives and Funds. Perverse subsi- global economy in a way that aligns with the dies—such as those encouraging deforesta- higher purpose of sustainable development. tion and the extraction, mining, refining We will need a substantial fund to prime and combustion of coal and oil—must be the recovery, spark manufacture and eliminated. Subsidies and tax incentives international trade in new technologies and must be switched to stimulate producers and practices, and transform the international consumers of clean energy and energy-effi- finance institutions into bodies with a new cient technologies. New enterprises for solar, ethical foundation and new values that wind, geothermal, and other renewables will position finance into its appropriate role as generate jobs, enterprises, and trade. servant to the higher purpose of building a International agreements—such as sustainable future. the Kyoto Protocol and the (pending) Copenhagen Agreement, and the A NEW FINANCIAl ARCHITECTURE Biodiversity Convention—are hindered by In addressing a framework for a new 21st the lack of adequate financial resources. Century global financial architecture, we Instructive is the universal acceptance of can divide the components of financial the 1987 Montreal Protocol to phase out architecture into three sets: rules, incentives, stratospheric ozone-depleting chemicals and institutions. which was achieved when funds were allocated to technology transfer to poor Rules. New rules are needed to constrain nations (China, primarily; at the time poor). capital flows a) in order to prevent the Funds are needed to “jump-start” clean, volatile, destabilizing, speculative movement infant industries and to sustain them in of capital and b) to direct funds towards developed and developing nations. healthy development. A vast scaling up of funds is needed to sup- 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 13

port stewardship of what the private sector revisit Keynes’ proposal for an international will not protect—forests, wetlands, water- clearing house to international governance sheds, climate stability—in the face of the of transactions of goods and services. short-termism and relentless cost competition associated with a globalized economy. CONClUSION Potential sources for such Global Fund Our current mode of exhausting finite for Adaptation, for the program for resources and generating wastes beyond Reduced Emissions from Deforestation the capacity of biogeochemical systems to and Degradation, and Mitigation include recycle them is not sustainable. Worldviews, taxes on carbon, airline traffic, and like physical systems, are beginning to shift. Internet “cyberdollars.” A tax on currency And once things start to change, they can transactions—the “Tobin Tax” named after change fast. the Noble-prize winning Yale economist, The international tasks that lie ahead James Tobin—delivers a “two-fer”: it would loom large, for corporations must ultimately a) dampen the destabilizing influence of “hot realize rewards for promoting less, not money” transfers and b) generate significant more; a 180-degree turn away from the funds for stewardship of both non-renewable conventional model of driving unending and renewable resources. A quarter of a levels of consumption as the foundation cent levy on each of the $1.9 trillion traded for measuring success. The misalignment daily—far less than one pays a broker to buy of financial systems and new models of stocks—would not discourage long-term business is a disconnect that must be investments while yielding hundreds of rectified if timely, affordable, and patient billions of dollars annually. capital is to flow into sustainable enterprise. In all respects, we appear to be at the junc- Institutions. Formed in an era when ture of a packet of waves of different wave- resources were seemingly infinite and lengths, where the 30-year cycles and the modern environmentalism had yet to 60-year Kondratieff boom-and-bust cycles take shape, existing international financial have crashed along with a 500-year wave institutions are inadequate to the tasks we of western civilization. Suddenly, we face face today. critical turning points in social and natural A look at the Global Environmental systems. It is a critical moment to rethink Facility provides some guidelines for the and repurpose international finance institu- type of institution needed for enhanced tions such that they become the vanguard global governance. Established to coincide of the next wave of global change—change with the 1992 Rio Earth Summit and targeted at building sustainable societies of support both UN Climate and Biodiversity which finance shifts from an exercise risk Conventions, the GEF makes grants, gaming to one in which it becomes a core not loans, and involves two UN bodies driver of positive social change. (UNEP and UNDP). It has increased NGO A test of the political will and vision of participation. Though its funding is grossly world leaders for spurring such change will inadequate, its organizational model is far occur in December, 2009 when nations will better aligned with the critical sustainability meet in Copenhagen to create the post-Kyoto challenges than is the World Bank—by climate regime. These deliberations will in- definition, a lending institution. clude representatives from civil society, busi- Beyond funding a new form of ness, and the scientific sectors. This gathering development, a new global institution would of the global community to meet this global also have to absorb the functions of the challenge can be the vehicle that sets us on a WTO, forging new rules and enforcement path to reshape the financial architecture. mechanisms to redirect development We cannot afford to balk. In this nation toward more equitable outcomes than the we will need a Manhattan Project to study current pressures toward unfettered trade new technologies, a Marshall Plan to finance liberalization. In this context, we must them, an Apollo Plan to launch them and, a 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 14

new New Deal to sustain the transformation. Constructing a new economic order built on equity and conservation shaped by a regulatory, institutional, and financial framework, will require a “Bretton Woods II,” this time with government, corporate, scientist, labor, NGO, and civil society participation. Creating new governance architecture with adequate levels of funding and financial regulatory power can provide the scaffolding on which to construct and sustain healthy, ecologically-sound, and equitable global systems in the centuries before us. n 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 15

tomorrow’s and then according them deference that is usually reserved for magicians and rock stars. In RBS, dealmaking and expansion by acquisition were richly rewarded: owners: teamwork, loyalty and long-termism were not. Boards and investors failed to understand how large culture looms in the risk profile of a company. In Halifax Bank of Scotland (HBOS)—the other U.K. Stewardship solutions for a better bank that failed—one dominant corporate banker, Peter Cummings, took an equity- capitalism with-loans approach that left it with debts of over £7billion. In RBS no one on the board or among senior colleagues was strong enough to challenge Sir Fred Goodwin. In maRk GoyDeR HBOS Cummings was, we are told, held tomoRRow’S compaNy in awe and promoted to the board whose t job it was to challenge his strategy. Moving outside the U.K., the culture at UBS was so dysfunctional that senior sales-driven THE CASINO ECONOMy ANd THE executives simply overrode established FAIlURE OF STEWARdSHIP internal control policies forbidding them to flirt with further U.S. tax schemes London. 8 October 2008. It was a day of The London Financial Times of 8 October reckoning for the casino economy. On that contained another news item on the theme day, the U.K. government announced that of ownership and stewardship. This was the it had taken ownership stakes in the major denouement of a long-running involvement banks, Lloyds TSB and Royal Bank of Scot- of the activist speculative investor, Robert land. This led to the resignation of Sir Fred Tchenguiz, and the pubs and hotel company, Goodwin, CEO of RBS, who had led them M&B. For some time Tchenguiz (a well- through a number of successful acquisitions known client of Peter Cummings of HBOS) before becoming one of the most energetic had been trying to use his investment collectors of toxic assets. in the company to force it to sell off its It was only some months later that the property into a joint venture with one of his British public, who are now paying for the companies. This in itself was not unusual. bank’s misjudgements, learned that the RBS What did seem strange was that he was board had used its discretion to protect his able to get the company to treat him like a pre-retirement pension with the effect of major shareholder—to the extent that he was giving him a taxpayer-funded pension of granted the right to nominate two directors £700,000 a year from the age of 48. to the board—when he did not actually The original failure to challenge a powerful hold any shares at all. What he had was an CEO, and thereby manage the banks’ risk, option to purchase shares called a contract is an obvious failure of stewardship. The for difference (CFD)—a derivative—that board’s positive decision to reward failure in meant that at any time he could convert a this way suggests a staggering insensitivity to derivative into a holding worth 25 percent of the expectations that society has of business. the company. Shareholders were expressing unease about The company eventually acceded to his Sir Fred’s management style and acquisitive demands; but then, because of the credit habits as early as 2005. The scale and nature crunch, the funding for the deal fell away of Sir Fred’s remuneration reflects flawed and the company was left with a loss of over thinking about the whole nature of success £300m on hedging arrangements it had and reward in business—appointing stars made in conjunction with the deal. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 3 | 16

As the market continued to fall Tchenguiz While it impossible and undesirable to roll then found himself being cornered by back many of the forces that have created traders who were now short-selling M&B the casino economy, we can reinforce and driving down the value of his potential stewardship, and we can also rediscover holding. In order to short-sell you have to the ingredients of success to which good borrow the shares. Tchenguiz decided to stewards must always turn their attention. convert his derivative holding into a real Which brings us to the third news item for holding, not so much because he wanted 8 October—the publication of a new report to be a real shareholder as to prevent other on the nature of ownership. (Tomorrow’s people short-selling the stock on which he Company 2008) had bet! This report starts by making a distinction Now he was a real owner: at least he fully between the real economy—producing owned the shares he had paid for. But that goods and services that meet human needs was still not the end of the story! The end and the banks and investors that support the came on 8 October when it was revealed real economy—and the casino economy— that, because Tchenguiz had borrowed the activities which are removed from the money to buy these shares from an Icelandic production of goods and services and bank, he had now been forced to sell his where prices may have little relation to the holding at a discount. M&B were at least free underlying value of what is being traded. from the attentions of an “owner” who had The report dissects the concept of little interest in its long-term success, and the ownership. Companies are separate legal company is now trying to find its way back entities which own their own assets. to its previous course, nursing hedging losses Ownership consists of a ”bundle of caused by this deal which exceed £300m. rights” which are exercised to a degree by Meanwhile, Tchenguiz is now embroiled in shareholders and to a degree by directors legal disputes with his Icelandic bankers. and by others. This is a parable of the casino economy. The report argues that shareholders have An investor who is not interested in the four main ownership-related roles, of which long-term health of the company can, stewardship is the most important: effectively, use a derivative to put his tanks  Member—setting the rules, voting , at- on the company’s lawn without formally tending the AGM; owning shares in the company. It prompts  Analyst, or scrutineer—assessing the the question: should a company have to treat company’s potential and ability to de- all investors the same, even where some liver; of those investors are less interested in its  Financier—providing equity funding in long-term health than in forcing break-up or an IPO or rights issue; disposal for their speculative gain?  Steward—promoting sustainable, long- term, performance. WHy STEWARdSHIP MATTERS The rights and duties of shareholders give Capitalism is in trouble because them a stewardship role alongside that of stewardship is failing. Some of the reasons directors in protecting the long-term health for this failure are global: they relate of the company and promoting the long-term to the depersonalization of ownership, value of the investment. Directors are en- the explosion of derivatives, and the trusted by shareholders with the management introduction into financial services of of the company on a day-to-day basis and are new layers of intermediation which erode accountable to—and can be influenced by— personal responsibility. But, as will be shareholders. Thus, the core responsibility for argued later in this paper, stewardship is also stewardship is shared between shareholders failing because of a flawed understanding and directors—a vital point. of the relationships and dependencies that The report goes on to define stewardship: underpin corporate success. “In Tomorrow’s Company we see stewardship as the process through which 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 3 | 17

our shareholders, directors or others seek  the ’real economy’—producing goods to influence companies in the direction and services that meet human needs. of long term, sustainable performance  the ‘financial economy’—banks, inves- that derives from contributing to human tors and intermediaries which support progress and the wellbeing of the the ‘real economy.’ environment and society.”  the ‘casino economy’—activities of those linked to the ‘financial economy’ which THREE CONNECTEd SySTEMS are removed from the production of So is stewardship in retreat and, if so, why? goods and services and where prices set Even before the recent financial crisis may have little relation to the underlying profound changes were evident in the values of what is being traded. patterns of company share ownership, both in the structure of companies and the nature THE RISE OF INSTITUTIONAl of their shareholders. INvESTMENT Globalization and technology have According to one study, at least 310 million facilitated the emergence of new financial people in 59 countries (24 developed and institutions and derivative instruments. At 35 emerging-market nations) own stock the end of 2007 the Bank of International directly. Nearly 173 million of these investors Settlements estimated the notional amounts live in countries with developed stock of all “over-the-counter” (OTC) contracts markets, and the remaining 137 million as $596 trillion—or $88,000 worth of reside in countries with emerging stock derivatives for every man, woman, or child markets. At least 503 million individuals in on the planet! 64 countries own stock indirectly through Companies depend for their success on pension-fund holdings. (Grout et al. 2009) the health of three connected systems—the Within the listed company sector, there has natural environment, the social and been a shift in many developed economies political system, and the global economy. from individuals to institutions. In the This interdependence for companies was U.S., according to John Bogle, institutional described in Tomorrow’s Global Company. ownership has grown from 8 percent in 1945 (Tomorrow’s Company 2007). to 75 percent today. (Bogle 2008) If we break down the global economy, we Individuals held over half of U.K. shares in can see it as consisting of three inter-related 1963. By 2008 they held around an eighth. sub-systems (Figure 1). There has also been a rapid increase in foreign shareholders. For example, in the figure 1 U.K., foreign investors held less than a sixth of the shares in 1993 but, by 2007, the U.K. glOBAl ECONOMy Treasury was reporting that foreign owner- 3 inter-related sub-systems ship of the U.K. quoted corporate sector had reached approximately 50 percent. Domestic institutions such as pension funds and insur- the natural the social and ance companies held over half of U.K. shares environment political system around 1993. Today their share has slipped back to about a quarter. the global PENSION FUNdS REMAIN dOMINANT economy In spite of the attention given to hedge the ‘real’ the ‘financial’ funds, sovereign wealth funds, and private economy economy equity, these new entities are overwhelmed by a factor of ten by the world’s pension the ‘casino’ funds, mutual funds, and insurance funds. economy Although institutional investors are often seen as having a contrasting approach 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 18

to alternative investment vehicles, they sharpness of market judgements and identify are increasingly investing part of their corporate weaknesses long before “patient” portfolios in private equity and hedge funds. institutional investors. Derivatives can help On average, shares also are being held for to lubricate markets even though some of shorter periods, although this could arise them, for example contracts for difference, from some shareholders churning shares have been used to undermine stewardship. faster and faster while others maintain long- The best of the continental European term ownership. “block” investors enhance stewardship while the worst abuse the rights of minority THE lISTEd COMPANy IS THE shareholders. It is a question of balance, ExCEPTION, NOT THE RUlE and if the casino economy marginalizes While the retreat of stewardship is most obvi- stewardship to the detriment of the well- ous in the listed company sector, it is impor- being of real economy and, beyond that, tant to keep a sense of proportion. The listed society and the environment, then corrective company with widely dispersed shareholders action is needed. may be dominant in the U.K. and U.S., but it is not the worldwide norm. For example INgREdIENTS OF SUCCESS companies with “block holders”—where a So stewardship is being undermined. This single owner has more than 20 percent of is the first flaw in current capitalism, and the shares—account for 60 percent of market we need to take steps to reassert it across all capitalization in Germany, France, and Italy. types of ownership Worldwide, most companies are unlisted. But whatever your form of ownership, There also is a shift in the balance of power stewardship will be ineffective if it is based from developed to emerging economies, with on a restricted understanding of what an increase in the number of acquisitions of drives long-term success in a company. It is companies in the OECD countries by those hard to focus on the long term if you have from emerging economies. no effective means of assessing long-term figure 2 progress and prospects. THE STEWARdSHIP The second flaw in contemporary SHAREHOldERS STEWARdSHIP SPECTRUM capitalism derives from our neglect of SPECTRUM Tomorrow’s Company has plotted the true sources of enduring success in high different types of shareholders companies. Our investment and governance and their propensity for methodologies lack rigor. They fail to reflect founders stewardship (Figure 2). a deep understanding of the drivers of This stewardship spectrum long-term business success—leadership, families/trusts/ indicates the likely position of values, relationships, culture, and behaviors. foundations a type of shareholder. At one Because we do not recognize these factors Degree of stewardship end of the spectrum, founders we do not have the tools or the language or employees or founding families tend to be the measurement frameworks to evaluate the very strong in their stewardship company’s potential for longer-term success, engaged shareholders attributes while, at the other or properly to manage its risk. listed in company (direct or through intermediary) end, speculators exercise no And that is exactly what has gone wrong. stewardship responsibilities For an illustration of this flaw, we need unengaged shareholders listed in company whatsoever. look no further than value destruction that (direct or through intermediary) It is impossible to categorize has just occurred in the complex chain whole types of investor or that linked mortgage lending, through trader investment as either ”good” securitization, and collateralized debt or ”bad.”’ At its best private obligations to the ultimate creation of Speculator equity is the epitome of strong toxic assets. In financial services, unlike in stewardship, jointly exercised other sectors more exposed to the public low by investors and managers. gaze, managers surrendered to the idea Hedge funds can enhance the that success is pursued by making as much 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 3 | 19

money as the law allowed without regard if everybody did it? Not our problem! to how it was made. The complexity and Where is the bank or insurance company opaqueness of their production processes board member who stopped to challenge has allowed something that the public their company by asking exactly what was stopped tolerating long ago in other, less the human origin of the debt they were so complex, industries. happily repackaging? Take footwear as an example. Thirty years Now we are paying the price in trillions of ago, retailers would be quite content to source dollars for that imprudent attitude. the shoes they wanted to sell as cheaply as possible. The working conditions of those SHAREHOldER vAlUE—A gOOd who produced them were not their concern. MEASURE BUT A BAd MASTER Then headlines and protests developed. The natural laws of capitalism to which we Society started to hold them responsible need to return, would start with the idea for previously invisible working conditions. that shareholder value is a good measure Companies such as Nike went through a but a bad master. The natural starting point transformation. They realized that they for a business is meeting a human need. were polluting their brand. Global sourcing And no business will continue for long became visible. It was no longer viable to if it fails to meet a human need. There is define success simply in terms of buying at nothing wrong with constructing economic the lowest price and selling at the highest. models on the assumption that everyone Financial services and investment are has the same profit-maximizing ambitions. today where footwear was 30 years ago. I was Such caricatures are very helpful in the talking recently to a very senior investment construction of theoretical models of banker, whose firm was exceptional in the behavior. The danger lies in taking what is ethical controls that it exercised over its simply a set of assumptions and elevating product development. In spite of this, he told them into a set of natural laws which all me that, repeatedly, new product ideas had business people are expected to obey. “Let us been put in front of him without any prior assume this is how everyone behaves,” has in thought about their ethical content. The some minds become: “This is how everyone product developers simply did not make the behaves all the time,” or even “This is how connection between innovation and ethics, people in business ought to behave....” and ethics and risk. His business—one with The problems arise when half-truths a strong family involvement—survived are claimed as whole truths, and exclusive the crisis because there was a process of statements of purpose replace inclusive stewardship which applied ethical brakes to ones. “We are here to create value for our this process. Others did not. shareholders” quickly becomes corrupted Consider the building up of huge into: “We are here only to create value for portfolios of loans to poor people in U.S. our shareholders,” and ultimately into “never trailer parks. These loans were authorized mind the future—give us the money now.” without proper scrutiny of the circumstances Exclusive messages are bound to end up as of the borrowers. Somebody else then dishonest messages, because the company deemed them fit to be securitized…and so itself has to contradict them in its battle to on through credit default swaps and the rest win the loyalty and trust of whole human without anyone seeing the transaction in beings who divide their time between their terms of its ultimate human origin. roles as customers, employees, shareholders, Each of the decision-makers thought it and members of communities. okay to act like the thoughtless footwear This is the underlying flaw that has buyer of the 1970s. The price was attractive. hollowed out trust from our banking There was money to make on the deal. Was system—at the wheel have been fast-driving it responsible? Irrelevant! It was legal, and CEOs with no stewardship brakes. Following others were making money that way. And on behind are unquestioning slaves of the consequences for the banking system a fee-driven culture where long-term 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 20

relationships and the responsible assessment and services they buy to perform well of human impacts are sacrificed to greed and technically, and be good value for money, selfishness. but they also want to feel good about The two failures of capitalism reinforce consuming them, and in most situations each other. If we had a clear metric for they are prepared to pay more for this separating companies with wholesome emotional component. cultures from companies with flawed This is why it makes sense to think of cultures, it would be easier for investors to companies as living organisms, and as exercise stewardship. If investors or their associations of human beings rather than proxies were more interested in stewardship, economic machines. Companies are started there would be more demand by companies by entrepreneurs. They are all different. As for such metrics, and managers would they grow, their wealth-creating capacity behave better. We have to find a way, short depends on maintaining a combination of of Sarbanes-Oxley-style prescription, of entrepreneurial spark and constant values creating the pressures whereby metrics in all their relationships. They stand or will reinforce the stewardship and the fall by their reputation. How they behave stewardship will reinforce the metrics. will ultimately determine how much value they create. Successful companies are those An Inclusive Approach which are most effective at serving human purposes, and human needs. (Tomorrow’s How do we think of companies? On Company 1995) the one hand there are people, like many Companies which allow a gap to grow of those employed in financial services, up between the needs of society and the who have thought of companies as needs of their shareholders are, ultimately, box 1 machines—as impersonal, plotting their own downfall, as the U.S. TOMORROW’S COMPANy: ruthless, wealth-maximizing car industry can testify. It can sometimes AN INClUSIvE APPROACH TO engines, a bundle of contracts, take decades, as in the case of the tobacco BUSINESS SUCCESS all pointed in the general companies, but eventually the pressures of Tomorrow’s Company direction of maximizing society do make themselves felt. While soci-  Clearly defines its purpose and values, value for shareholders. Their ety must set rules and limits, the real key to and communicates them in a consistent thinking is based on a one- enduring success is to promote and reward manner to all those important to the dimensional view of human high-quality business leadership, and to set company’s success; motivation, and they have companies free to fulfill their potential in  Uses its stated purpose and values, and no way of explaining why bringing out the best in human beings and its understanding of the importance of some companies engage contributing the most to society. each relationship, to develop its own their people more; why some success model from which it can generate a meaningful framework for performance achieve higher prices through ANd THE PRACTICAl TOOlS measurement; the value of their brands; why We now need more than just a commitment some derive more help and to restore stewardship: we need the tools  Values reciprocal relationships, understanding that by focusing on and innovation throughout their that underpin it. As I argued in Lessons from learning from all those who contribute supply chain, and are given the Enron we need to develop a methodology for to the business, it will best be able to benefit of the doubt by local assessing the health of a company’s culture, improve returns to shareholders; authorities and regulators. the robustness of its values, the strength and  Works actively to build reciprocal consistency of the leadership and behaviors relationships with customers, suppliers, The answer lies in values that will drive its reputation and its brand and other key stakeholders, through a and behaviors (Box 1). value and, so, in the longer term, its share partnership approach; and Employees look for more than price and its underlying economic value.  Expects its relationships to overlap and wages from their work. They (Goyder 2002) The know-how exists in acts, with others where necessary, to look for meaning and a sense each relationship: I know at least one HR maintain a strong “license to operate.” of belonging to something consultant who has already developed his From RSA Inquiry Tomorrow’s Company 1995 p1 bigger than themselves. own “Killer HR questions that every investor Customers want the goods should be asking of companies.” 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 21

lEgISlATORS CAN PROMOTE (an inclusive approach). Hence the duty INClUSIvE BEHAvIORS imposed by the 2006 Act for directors to In the past, I have characterized the first have regard to the interests of customers, group of people as people who think employees, suppliers, the community, and “firm” and the second as those who think the environment in pursuing the success “company.” Why? Because the origins in of the company. This offers a pattern that the word “firma” are in the Italian for the should and will in time be adopted in other stamp that seals a contract. The origins of jurisdictions. “company” on the other hand are first a You cannot make companies into charities military grouping of soldiers but, ultimately, or civil society organizations. Their profit- the group of people with whom you share seeking nature is essential to their success. your bread. (Goyder 1997) What you can do is create the limits within The divide between those who think “firm” which leaders pursue that success, and and those who think “company” applies also use the rules of good governance, as much to debates about how to regulate transparency, and accountability to allow business as to how it is led and governed. society to satisfy itself that companies are If you see the company as a relentless, im- being run in a trustworthy way. personal machine, rather as Joel Bakan does There are other precedents. When I first in “The Corporation,” then the company is worked in a manufacturing business as the problem. The only answer is to exercise a young personnel officer in the 1970s, I restraint from the outside, either by seizing found myself being put in charge of health the shareholder citadel so companies are and safety in an engineering factory which forced to obey different shareholder orders, employed 1000 people. It was shortly or by imposing societal rules. after the introduction of the Health & If, on the other hand, you think “company” Safety at Work Act of 1974. This was, in rather than “firm,” you adopt a different set my experience, a very effective piece of of principles by which to design regulation. It legislation. It devolved onto each business leads you to conclude that society needs en- the duty to say how exactly that business trepreneurial businesses—but if it is to benefit defined health and safety. Each company from their creative potential it needs them to had to write its own safety policy. And, operate in a context of self-discipline, so that to ensure that it was held accountable for regulation is left to create a broad framework implementing the policy, the legislation not a straitjacket for their activity. And this required the creation of Safety Committees is where good stewardship comes in—as and, in the case of factors with trade the custodian of responsible behavior which union recognition, there was the added makes trust and flexibility possible. Good accountability of trade-union-appointed stewardship paves the way for an enterprise- safety representatives. friendly climate. The betrayal of stewardship The act set out a framework and principles brings with it the loss of public confidence but left the individual company with and the backlash of rigid regulation. freedom to apply those principles in ways Significantly, an inclusive approach that were appropriate to local circumstances. already has been taken up by lawmakers This is the spirit in which all participants in the UK. The new definition of directors should work to re-establish stewardship and duties, enshrined in the Companies Act of the inclusive approach. 2006, is an inclusive definition of the duties of directors—in other words, its starting STEWARdSHIP ANd INClUSIvENESS IS point is the proposition that the future EvERyBOdy’S BUSINESS success of companies lies in the quality Building and sustaining inclusive organiza- of their leadership and the health of their tions is a multi-faceted challenge that de- relationships, and it is on these elements mands the commitment and skills of all stake- that sound governance and reporting should holders within and outside the organization. focus alongside the immediate financials Examples of the roles of each player 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 22

illustrate the range of contributions challenge it on these issues and make it that collectively build high-performing, clear that it is central to your concerns as enduring, and socially-purposeful an investor—not a fringe concern for the companies. socially responsible investor alone. 3. Empower the ultimate beneficial inves- Chairman, CEO and Board Members tors to express their preferences through 1. Ensure that a culture of challenge the investment system. Step up your re- operates in your company: have a clear search into the priorities and expectations method of profiling that culture and of your clients, whether these are govern- review it regularly. Insist that values and ments, pension funds, or individual cli- behaviors command as much attention ents, and show them how they can make from the CEO and executives as do choices and have influence. Ask them, for financial performance. example, whether they would like you to 2. Make the culture of the company, and place more value upon well-led, well- its leadership style and principles, a key governed companies in the way that you part of the induction of every new board already have started to emphasize their member, and of its risk management attitudes to environmental sustainability. processes. (Tomorrow’s Company 2004) 3. Insist that the board receive a report at 4. Become signatories of the (UN) Prin- last twice a year on the company’s values ciples of Responsible Investment and and behaviors, and that these are the ba- report publicly against them. sis for the induction of board members. 5. Encourage learning and spread account- 4. Ensure that your company has its finger ability across different forms of invest- on the pulse of the relationships that ment. Create new tools and frameworks will determine its future success. Satisfy that can be used across all. For example, yourself that the company’s measure- it makes no sense for a private equity ment scorecard and the numbers and in- owner, intent on transforming a com- dicators regularly reported to the board pany’s fortunes, to ignore reputational include relevant material on the percep- risk in doing so. Institutional investors tion of your company by, and the health can learn from private equity and fam- of its relationship with, its customers, ily businesses in holding managers to suppliers, employees, community, and account and making sure remuneration shareholders. is well-judged and not excessive. When 5. Never fall into the trap of relegating val- pension funds and other institutional ues to a ghetto called corporate respon- investors invest in hedge funds—or sibility or, even worse still as happens in indeed private equity—they should set some companies, “CR values.” mandates which hold those investment vehicles to account. Institutions should Pension Funds and Asset Managers, ensure that the methods used by those Private Equity, Hedge Funds and Sovereign they invest in do not contradict their Wealth Funds own purposes as custodians of their 1. Review your valuation methods and members’ savings. They should also ask your risk management methodol- whether their stock lending is justified ogy. Understand the contribution of a in the light of their overall objectives. company’s culture to its reputation and brand values. Draw on the know-how NGOs, Stakeholder Organizations, Trade of experts in leadership, risk manage- Unions, Commentators and Journalists ment, and in employee and all other 1. Be clear in your own mind what good stakeholder relationships so that you can stewardship means to you and how you improve your profile of the well-led and define a well-led company. well- governed company. 2. As well as condemning and exposing the 2. In your dialogues with the company weak, focus on and celebrate the excellent. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 23

Lawmakers and Regulators ence. Neither percentage should be as 1. Take an inclusive approach to company high as 100 percent. Boards need the law—see U.K. companies Act and King feisty NGO head who may never have III Report on Corporate Governance in worked in the industry: they also need South Africa. the experienced former executive who 2. Professionalize financial practice: bind all cannot be said to be independent. those who handle our money to profes- 5. Report on ethical and culture risks. The sional codes which spell out the obliga- time has come for ethical audits with tions they must fulfill to society and their teeth—for a rigorous process in which customer in exchange for their continuing independent observers check the gaps license to practice. Would-be investment between the stated values of the business bankers, dealers, fund managers, and and its actual behaviors—and the board investment consultants would be required are forced to confront this because the to swear their own version of the Hippo- results will be published. In the U.K. con- cratic Oath, the promise to “do no harm.” text this is best done by bringing back the Those found guilty of scams, insider mandatory Operating Financial Review trading, misrepresentation, or putting (OFR), which the government developed their own interests before the interests of and then watered down. To this would their customers or of society could face be added a discussion of risk manage- disciplinary investigation and ultimately ment, and a section dealing with the suspension from their profession. company’s values and behaviors, with an 3. Professionalize the board—executives and independent external auditor’s comment non-executives alike. (At least under U.K. alongside the boards’ own commentary. company law, they all have the same du- The Chairman would then be required to ties to the company.) Most countries have report on this in a separate agenda item at a professional qualification for directors: the Annual General Meeting. in the U.K. it is called Chartered Direc- 6. Rebalance remuneration. Remuneration tor status, and Tomorrow’s Company has needs to be rebalanced so that it rewards proposed that government should impose performance over the whole cycle, with upon listed companies the requirement provisions for deferral and claw back, that by, say, 2015 a minimum of half of all and a balance between teamwork and their listed company board members are individual achievement. The Remunera- professionally qualified. With professional tion Committee should be required to qualifications should then come that explain whether remuneration policy same ethical obligation to do no harm to promotes desired or undesirable behav- shareholders, customers, stakeholders, iors. There should be a clear description and future generations in the same way of the ratio between the lowest and high- as medical professionals are bound to do est paid, and a published explanation no harm. of the need for these differentials. Don’t 4. Resolve the conflict between indepen- limit the quantum, but use transparency dence and expertise. In the recent past to force boards to explain it. there has been too much emphasis on 7. Empower long-term approaches and ensuring board member independence. penalize speculation where it gets in the Now people are asking if it isn’t more way of this. This is easier said than done. important to have people on a bank But there are a number of circumstances board who know about banking. The where governments and regulators will answer is to be found in a split approach: need to intervene to help create the cli- a percentage of board members need to mate for stewardship. Here are examples be able to demonstrate independence. of situations in which careful thought A percentage need to be able to demon- will be needed: strate the deepest levels of industry and a. whenever the provisions that allow even company know-how and experi- market liquidity spill over into 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 24

rewarding speculation at the expense the law already allows this, then the of long-term ownership—as in the focus shifts to education. But if there is Robert Tchenguiz example. any doubt about the law, then the first b. Whenever the tax system appears step is to change the law. to favor derivative forms of shareholding over real shareholding CONClUSION (as in Contracts for Difference). The world needs shareholders whose pri- c. Whenever competition law gets in orities and behaviors are aligned with the the way of companies collaborating long-term interests of the company, and with each other to create a more with the health of the soil in which it’s being sustainable “level playing field” of nourished. It needs boards and investors responsible practices. who exhibit a deeper understanding of the d. Whenever market participants ingredients of success, and who have the promote their own interests at the tools of analysis by which they can advance expense of the health of the system this understanding. As with most complex as a whole—for example, invest- problems of this century, the solution does ment consultants who make most of not lie with any one group. We need inves- their income by encouraging their tors, boards, rule-makers and civil society to pension fund clients to “churn” as- work together to develop an agenda which set managers instead of developing puts stewardship and an inclusive approach longer-term mandates, incumbent at the heart of corporate life. boards which use their position as insiders to engineer buy-outs on REFERENCES lucrative terms, or other fee arrange- Bogle, John. 2008. Interviewed in Advisor ments or collateralized debt obliga- Perspectives. December. http://www. tions which create systemic risk. advisorperspectives.com/pdfs/John_Bogle_ e. Whenever companies need protec- on_Leadership_Asset_Allocation_and_the_ tion to develop deeper dialogue Outlook_for_2009.pdf. with their longer-term investors and are unwilling to accord the same Goyder, Mark. 2002. Lessons from Enron. privileges to investors who they do not judge to have their long-term Goyder, Mark. 1997. Living Tomorrow’s interest at heart. Why should a CEO Company. Gower/Tomorrow’s Company. extend the same time and co-operation to an investor who is seeking to Grout, Paul A., William L. Megginson and profit by movements in the com- Ania Zalewska. 2009. One Half-Billion pany’s share price as a long-term Shareholders and Counting—Determinants intrinsic investor? of Individual Share Ownership Around the 7. Fiduciary Duty and Sustainability. In World. March 18. Available at SSRN: http:// some jurisdictions, the shift towards ssrn.com/abstract=1364765. stewardship behaviors may need changes in the law. It is now clear Tomorrow’s Company. 2008. Tomorrow’s that fiduciary duty extends beyond Owners – Stewardship of Tomorrow’s Company. pursuing immediate financial returns to beneficiaries. It covers responsibility Tomorrow’s Company. 2007. Tomorrow’s for enhancing the operation of the Global Company: Challenges and Choices. investment process so as to ensure that those financial results can continue Tomorrow’s Company. 2004. Restoring Trust: to be delivered in the future. Pension Investment in the Twenty-first Century trustees, and all those who handle savers’ money need to build this Tomorrow’s Company. 1995. The Role of understanding into their approach. If Business in a Changing World. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 2 | 25

The origins fortunes based on increasingly risky and dubious financial products. Those in this exclusive market made bets with billions of dollars of capital gathered from regular folks, and Costs of and when they lost their bets the rest of us were dragged down with them. Stewart’s description is certainly not complete, but it certainly captures the sense Short-term that many of us have in the midst of the current crisis, that the financial markets have taken us as chumps. For most of us with investments, we’re worse off than if we Management had put our cash in our mattresses for the last decade. And this is not even to mention that those of us who depend primarily on wages for our income—as opposed to investments—are no better off in real terms than our parents were in the early 1970s. keNt GReeNfielD The causes of the financial fiasco are boStoN colleGe School of law W many, and scholars already are beginning to tell coherent stories about the numerous reasons why we find ourselves where we why Is a fIxatIon on the short term are. The over-dependence on derivatives, a problem for American businesses? One the overuse of leverage, the culture of greed might hasten to answer that management and entitlement in the finance industry, is compensated for short-term successes. the pervasive assumption of an ever-rising Another answer might be that some housing market, and the emphasis on investors—particularly professional finance as the economy’s driver rather than investors—value only the short term and production all deserve attention. manipulate the market in a particular stock There is another cause for the economic so they can profit on the movement. These downtown that deserves study—the focus on answers undoubtedly are part of the answer. the short term within corporate governance. But a puzzle remains: why does the market If managers, officers, and directors had not punish such short-termism? This essay taken a more long-term view of the health will present a possible answer. of their own companies and the fortunes of their investors, we might not have seen JIM CRAMER, JON STEWART, WAll the other problems come to such a head. STREET, ANd MAIN STREET The addiction to leverage, derivatives, and Jon Stewart expressed the outrage of many greed that caused the market to become a when he recently called CNBC’s Jim Cramer casino would only have been possible in a onto the carpet for cheerleading the greedy, business culture where short-term gains are risk-addicted, finance-driven economy of the prioritized over long-term costs. last decade.1 Stewart decried the existence And what’s worse, the short-term gains of “two markets,” one for regular folks who went to a handful of corporate executives, put their money away for the long term, financiers, hedge and private equity funds, relying on the assurances of Cramer and his and banks, while the costs are now being ilk that the stock market was a safe, long- borne by everyone. And what might have term investment for their retirement savings. been assumed to be costs that would be The other market, according to Stewart, suffered in the long term—sometime in was where those in the know used capital the future—are being absorbed now. John accumulated from pension investments and Maynard Keynes was wrong on this point: in small- scale, retail investors to build personal the long run, we’re not all dead. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 26

What caused Wall Street’s fixation on the to decrease the true value of the firm then short term? The answer is indeed complex, the share price should reflect that. and this essay will not attempt to provide a To offer a concrete example: let’s say a comprehensive answer. The focus here is to company chooses to adjust its accounting provide some comments on one aspect of treatment in such a way as to accelerate the question; namely, why is there a short- earnings and delay costs for the current term problem at all? And should Main quarter. This will give the appearance of a Street care? greater profit in the current period, perhaps allowing the company to report to Wall THE SHORT-TERM PUzzlE Street analysts that the company has met Many analysts of the corporate world have its earnings expectations. But no rational, long remarked that a fundamental problem informed investor would pay a higher price with the way corporations are managed is the for shares in such a company since the phenomenon of “short-terminism.” Despite company’s value has not changed in reality. some naysayers,2 the problem is very real. They are still making the same products or Shareholders hold their stocks, on average, providing the same service. Their long- for less than a year, and even less for small term prospects have not changed for the companies.3 Institutional investors have better and may have changed for the worse, been said to be particularly bad on this front, if the management has been spending acting “more as traders, seeking short-term its energy on accounting rather than gain.”4 Managers admit that they make deci- productive pursuits. sions that harm the company in the long Indeed, if the company is in fact being term in order to meet short-term earnings managed for the short term at the expense expectations.5 In 2006, the Conference Board of the long term, then the share price and the Business Roundtable, two of the na- should fall dramatically and consistently. tion’s most prominent business organizations, The rational buyer would not be willing to both issued reports “decrying the short-term pay any more for each share than the sum focus of the stock market and its dominance of the total dividend payments coming over American business behavior.”6 to her in the future on the basis of that Short-termism is fairly well documented, share (discounted to present value). And if but its existence is befuddling and its impli- shareholders know that the company has cations unclear. Why, for example, would a made future dividends less likely because of company benefit from short-term manage- management’s short-term orientation, then ment? Why would share prices be inflated the market price of the stock will reflect this for such a company, rather than depressed? even if the short-term earnings are inflated. Consider that any shareholder who sells Indeed, share price should be expected to her stock in order to profit in the short term fall consistently over the period of such is selling to someone else, who by definition managerial strategy. Again, to make the believes that the stock is selling for less point concrete: if managers intentionally than it is worth. Share turnover is not by manage a company to accelerate all profit definition a problem, then, since for every and earnings into the next five-year period seller there is a buyer. Moreover, it ought and then go bankrupt, no informed to be irrational for Wall Street analysts to shareholder should purchase shares of that require—and company management to company at the current price. The shares make—decisions by the company that hurt will be worthless in five years, and fall the company in the long run but allow the dramatically in value between now and then. companies to meet short-term earnings All this is to ask: Why is short-termism a projections. In such situations the share problem? Why does the stock market not pun- price should fall rather than increase or stay ish companies managed for the short term? steady. The reason is that, in an efficient market, share price is a reflection of the SHORT-TERM STRATEgIES company’s value. If decisions are being made In figuring out this puzzle, allow me to make 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 27

an assumption that will simplify the analysis  A greater dependence on debt to finance as we go. Allow me to assume that there are company expenses and projects, which two kinds of companies: one that manages increases the company’s leverage, inflating for the short term and one for the long term. returns on equity as long as the company is The short-term company seeks to maximize doing well and the market is trending up, profits and earnings in the near future, with but at a cost of increased risk of insolvency disregard for the long term. If decisions can if the market goes down; be made to transfer value from the future  The use of executive compensation into the present day, the management will schemes that prioritize the satisfaction of do so, even if it will decrease the total value short-term financial goals, incentivizing of the firm aggregated over time. (We’ll set management to look only a few steps aside for the moment why management ahead; would do this.) Long-term-oriented compa-  Breaches in implicit or explicit contracts nies will make decisions that seek to maxi- and understandings with company mize the value of the company over time. If stakeholders, which allow the company decisions can be made in the short term that to seize the value of past investments by cost the company money but will pay returns such stakeholders without paying them in the future, then the company will do so, their expected returns (an example of this even if in so doing the company will be un- would be a change in company policy away able to recognize profits in the near future. from a commitment to providing stable In a company whose management team is employment and toward an increasing use oriented toward the long term, one would of short-term, low-wage employment); expect to see a greater-than-usual dedication  Cuts in employment generally, since to sustaining the company as a going savings in labor costs occur in the short concern over time; a larger commitment to term and costs to the company arising maintaining the loyalty of those who have from a decrease in employee loyalty and made investments in the company, whether specific human capital valuable to the by way of capital, infrastructure, or work; a company are incurred in the longer term; dedication to the development of products  A disregard for latent risks in the or services that will pay off in the future; company’s products or services, whether a diversification of firm endeavors and such risks be environmental (the risk of investments to guard against short-term global warming brought about by the shocks in the financial or consumer markets; use of SUVs, for example), social (the and so on. social cost of violent media, for example), On the other hand, a company focusing or financial (the risk of financial crisis on the short term will also have a number brought about by the overuse of risky of strategies at its disposal. Here is an financial derivatives); illustrative list, hardly exhaustive:  Stock buy-backs, which increase share  Cuts in research and development, in order price in the short term but deplete the to use the capital that would be spent for company’s capital that could be used for a R&D to increase dividends or retained more productive purpose; and earnings temporarily, at a cost to the long-  A focus on share price rather than the term health of the company; corporation’s value as a whole or the  Accounting adjustments (either legal or value of the corporation to its non-equity illegal) to accelerate recognition of revenue shareholders. and delay recognition of expenses, inflating Each of these short-term strategies will likely current earnings at the cost of deflating impose long-term costs onto the firm but future earnings; have short-term benefits to the company, the  The sale of profitable divisions or management, or certain shareholders. There subsidiaries for cash, realizing future may be situations in which such long-term earnings of the division as a cash payment costs are worth the short-term gain—for in the present, usually at a discount; example, when the company needs to satisfy 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 28

some short-term financial obligation (to why the market does not consistently punish pay a legal judgment, say) and can only do such behavior. If managers make decisions so if R&D expenditures are put off. But by that will hurt the company in the long term definition most of these strategies will be bad for selfish reasons, why does the share price decisions for the firm in the long run. not fall? One answer might be that some I do not intend to say no company investors, too, focus on the short term, so managed for the long term ever fails. that they buy up stock of companies so Managers make mistakes, and some oriented. But that, too, does not answer the mistakes are quite costly. Moreover, to the question, since short-term-oriented share- extent that a company’s time horizon is long, holders should not be able to realize any it may be more difficult to know whether a benefit from owning shares in a short-term- long-term strategy pays off than if a short- oriented company. If dividends are inflated term strategy pays off. Also, a long-term in the short term at the cost of the long-term strategy is more difficult: not only must a fortunes of the company, whatever benefit company’s management make decisions that realized from the short-term dividends will are focused on success five or ten or twenty be more than set off by the decline in the years out, it must also make short-term, stock price brought about by the decline in tactical decisions that work as well. A part of the real value of the company. a company’s long-term strategy must always In other words, if a company’s short-term be to survive in the short term. strategy is known to the investing public, As a public policy matter, it is important then the future drop in the value of the com- to encourage long-term management, since pany will be “baked in” to the current price. the economy as a whole benefits when No benefit should be gained from such a companies have a long-term strategy. The strategy if indeed it is known to the investing economy is a summation of the fortunes of public. As the costs of the short-term strategy the millions of companies and individuals become clearer, the stock price will plum- that make it up; if most companies make met, and those holding the shares of such a decisions that prioritize the short term at the company will find fewer willing buyers. expense of the long term then we all suffer. A As for companies with long-term strategies, nation’s wealth grows more over time when the future earnings will be baked in as well, so companies invest for the future, maintain that the stock price will be trading at a fairly their viability as a going concern, and engage high price-to-earnings ratio. (The value of the in business practices that are sustainable future earnings will not be fully captured by environmentally, socially, and financially. the current share price, however, since investors will discount future earnings in relation BACk TO THE PUzzlE to the time value of money and will also likely So here we get to the nub of the problem: impose a “risk discount” in connection with if short-termism is costly to companies the probability that the company will not in the long run (by definition) and to the actually realize the benefits of the long-term economy as a whole (because the economy strategy.) All in all, in a perfectly informed is a summation of the well-being of all of market, the value of long-term oriented com- us) then why do we see the short-term panies will tend to be recognized as such, and management tactics described above? their share values will so reflect. Part of the answer lies in the fact that companies are controlled by managers, and THE INFORMATION FAllACy some managers intend to be at the company Of course this argument depends on an un- for a long period of time and therefore look reasonable and simplistic assumption—that toward the long term; some managers want the market is informed. In fact, investors are to make their money and get out. not perfectly informed, and it is often costly So this might explain why some manag- or impossible to determine whether com- ers would want to manage their companies panies are being managed for the long or for the short term. But it does not explain short term. It is often costly or impossible to 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 29

determine whether an increase in quarterly That is, there will be a lag between the earnings is evidence of a short-term orienta- implementation of short-term management tion that will be costly to the company in the and when the chickens come home to roost, long term, or the realization of returns from in that it may take some time for the capital a successful long-term strategy. market to price the shares correctly. This fact poses a significant difficulty The other side of the story should be for public policy. Profits and earnings for told as well: it will often be difficult and a long-term-oriented company may be costly to distinguish between a company indistinguishable from profits and earnings that is showing a low level of short-term for a short-term-oriented company. It is easy profits and earnings because of the costs of to show the numbers; it is difficult for most implementing a long-term strategy and a investors to determine the reason for such company suffering a low level of profits and numbers. In fact, a company that is utilizing earnings because of poor management or a some of the short-term managerial strategies failure of strategy. So the share price of the listed above may show profits and earnings company that is actually being well managed that are greater than companies with a long- for the long term—but showing no signs of term focus. And the capital market may not success as of yet—will trade falsely low. “punish” such short-term management if it is The existence and extent of this lag time not clear that the inflated earnings are based between the establishment of a long or on strategies that are costly in the long term. short time horizon and the recognition of When a company’s management strategy the costs or benefits thereof in the stock is not known, or is not widely known, a price will depend on a number of factors. company which is being managed for the The most prominent of these will be how short term may have a share price that is obvious the strategy is to investors in the inflated, falling only when the strategy market. The more obvious the strategy, becomes clear and earnings begin to fall. the more efficient the capital markets will Those investors holding this stock at the be in “pricing” the securities issued by the time of the fall will suffer the financial loss. company. If a company that is pursuing a A windfall will be gained by those who are short-term strategy is able to camouflage it holding the stock during the run-up of the as a long-term strategy, the stock price will stock price and who are fortunate enough be falsely inflated until the strategy becomes to sell before the drop. Also, a windfall will sufficiently clear to the investing public that inure to managers who time their departure they recognize that it is overpriced. Only before the drop. then will the share price fall to a level that As for long-term-oriented companies, correctly reflects the company’s value. the depressed short-term earnings brought Most investors will not invest the about by the long-term strategy will not be time to distinguish between the long- easy to distinguish from depressed earnings term companies that are not yet making caused by bad management or a short-term money and the companies that are simply strategy that has run its course. The stock floundering. Instead, they will look toward price will also be discounted because it will companies that are showing profits and be unclear to investors what the true strategy earnings. The problem there is that some of really is. This, in turn, makes the company these—investors will assume—are realizing ripe for takeovers. the benefits of successful long-term strategies So in a world in which (1) short-term and some are simply exchanging long-term management can result in short-term benefits for short-term profits at the cost of bumps in profits and earnings, and (2) such the company’s long-term prospects. earnings and profits are indistinguishable (or costly to distinguish) from those coming SOPHISTICATEd INvESTORS IN A from long-term-oriented companies, then UNINFORMEd MARkET (3) the market will be slow in punishing Note that nothing I have said so far will short-term-oriented management. be unknown to sophisticated investors. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 30

They know that earnings and profits in the need only look at the numbers. The risk of short term do not necessarily translate into the second strategy is holding too long. If long-term success. They also know that a a stock’s inflated value becomes obvious to failure to show short-term earnings does the market, the stock price will plummet. In not necessarily mean that the company is other words, the key to the second strategy destined to fail. But they also know that it is is timing. Get in, ride the wave, and get costly to figure out which is which, and what out before it crashes down. Then take your counts to them is the value of their portfolio money and find another investment in the as a whole over time, not the profits from a short-term market. single investment. Note a key fact about the second strategy: So in maximizing the value of their A short-term investment strategy will portfolio, sophisticated investors face a become even more successful if the investor variety of choices. If such an investor has can control the timing of the investment’s a short-term focus, perhaps because their withdrawal, to capture as many of the short- own time horizon is short due to imminent term gains as possible before the inevitable retirement or the like, then they have no downgrade in stock price. incentive to try to pick the long-term Most investors do not have any way to successes and hold for the long term. They do that. They can only try to stay ahead will, rather, look for companies whose stocks of the curve by trading often and quickly, will pay off in the short term, whether such usually on the slightest sign of downturn in pay-off comes as a result of short-term a stock. This makes the market as a whole strategies with long-term consequences or more volatile, since small upticks in stock companies that are realizing the pay-offs of price will attract a host of short-termers long-term strategies. looking for a place to put short-term money As for long-term investors—individuals and small downturns will cause many planning for retirement years in the future, short-termers to flee in fear that the small or investment funds that hold accounts for downturn is the beginning of something such people—one might expect that they worse. But such a strategy is highly risky, would tend to “buy and hold” investments in and unlikely to maximize gains over companies that appear to be strong for the time (witness that very few mutual funds long term, even if short- term earnings are outperform index funds over time). disappointing or foregone. That is certainly true for some long-term investors, but MAkINg A SHORT-TERM STRATEgy certainly not all. Such long-term investors, WORk IN AN UNINFORMEd MARkET whether individuals or institutions, face What if an investor could time their a choice: they can (1) try to identify investments? The gains from the short-term companies that have successful long-term strategy could be immense. The long-term strategies but have undervalued stock at value of their portfolios would be the present; or (2) identify companies with high summation of a series of above-market, earnings and profits in the short term. Some short-term gains. And the strategy could of the latter group will be truly successful be maintained as long as there are enough companies; some will be companies that are investment opportunities available that the utilizing strategies to emphasize short-term money investors pull out of one company gain at the expense of long-term gain. can find a place to land elsewhere. Both strategies are in fact followed by But how could such timing be long-term investors. Both have their risks accomplished? and costs. Under the first strategy, the risk Let us imagine a situation in which is that the investments chosen will not investors—whether individual or in fact pay off, and the major cost is the institutional—can affect the time horizon expense of discovering such undervalued of a company, to accelerate earnings and companies. The cost of research under the capture as much of the company’s future second strategy is much less—an investor value as possible in the near term. Let us 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 31

also imagine a situation where they could When this is true, then they can manipulate keep that information camouflaged from the the company using the strategies described market generally. How would they do that? above to maximize their own short-term The answer is by taking over management of gain at the expense of the long-term health the company or by buying up enough stock of the company, and time their departure in a company that the management is forced before the company falls back to earth. to listen to you. Obviously, such a tactic would be available WHAT TO ExPECT IN A SHORT-TERM only to investors with significant capital MARkET to invest. But if investors are successful So that’s the story of how short-term- in doing so—buying off management or oriented investors could collude with or buying off companies— then the company become short-term-oriented management can be caused to do the things that shift to cause businesses to manage for the short future company value to the present. For term without being punished by the market example, the company can buy back stock, in the short term. Such a strategy will hurt increasing immediate returns to investors; the company in the long term and impose pay management exorbitant compensation, external costs onto company stakeholders in effect taking present and future earnings with long-term interests, as well as society of the company as individual compensation; and the economy in general. But such costs sell off portions of the company for cash, will not be borne in the short term by the distributing the cash as a dividend; they can investors or managers. As long as they “get leverage the company highly, multiplying the out” in time, they will be able to enjoy above- return on equity at the cost of increased risk market returns in the meantime. And as for the firm in the long term. long as they can continue to find companies Moreover, while the investors themselves that are susceptible to the same strategy, are managing the company in such a way, they can maintain above-market returns they need not make the true implications of for the duration. But of course such returns their decisions clear to the investing public. are not truly a reflection of anything other One mechanism for taking control of than being a winner in a zero-sum game. companies in this way is private equity. In The returns are not a reflection of excellent fact, private equity funds are defined as this: management, or product innovation, or they take over companies and manage them the creation of value. They are only, in as private corporations, free from many of economists’ terminology, the “extraction the reporting obligations required of public of rents,” the shifting of financial gain from companies. (Private equity as an investment someone who is losing at least as much. The sector earned almost 36% in 2005, 24% in fact that those who are losing live in the 2004, and 23% in 2003.) Also, certain hedge future does not make the losses any less real. funds have such large amounts of capital to One last thing to recognize: in a market throw around that they may be able to get where companies are being increasingly similar results from management without managed for the short term, the typical actually taking over the companies. “Main Street” investor will not stay in the And note that many managers may want to dark forever. Investors who do not have maximize short-term earnings at the expense the access or capital of the hedge funds of the long term. Managers find it advanta- and private equity funds will eventually geous to use short-term strategies as well. It recognize what is happening. So they, too, is much easier to meet next quarter’s Wall will start investing with a view toward the Street earnings expectations, by hook or by short term, and be extremely sensitive to crook, than it is to guide a company toward downticks in stock price that might be a long-term goal. And if their compensation signs of a more serious downturn. This will consists primarily of stock and stock op- in turn make the market as a whole more tions, then they have incentives to consider volatile. And as volatility increases, the entire themselves investors rather than managers. market will become less secure. More and 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 32

more investors will either lose their shirts or simply leave the market and put their money elsewhere. And, eventually, the costs of short-term management will be such that the entire economy will suffer. The chickens will eventually come home to roost. If you have read a newspaper over the last year or so, this story should sound familiar. n ENdNOTES 1 See http://www.huffingtonpost.com/2009/03/12/jim- cramer-on-daily-show-_n_174503.html. 2 See Dent, George W., Jr. 2009. Stakeholder Governance: A Bad Idea Getting Worse, 58 Case W. Res. L Rev. ___, ___ (denying a problem with short-termism exists). 3 Mitchell, Lawrence E.. 2007. The Speculation Economy: How Finance Triumphed Over Industry 277-78 . 4 Kuttner, Robert. 2007. The Squandering of America 144. 5 Mitchell, supra, at 1. 6 Id. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 4 | 33

Not Just Yunus suggested the revolutionary joint venture and proposed that a new structure be invented for it, a hybrid between nonprofit and for-profit. for Profit: Like a conventional business, Grameen Danone must recover its full costs from operations. Yet, like a non-profit, it is driven by a cause rather than by profit. If all goes well, investors will receive only a Emerging Alternatives to the token 1 percent annual dividend, with all other profits being plowed back into the Shareholder-Centric Model1 business. The venture’s primary aim is to create social benefits for those whose lives the company touches. For example, the first maRJoRie kelly Grameen Danone factory, which opened W telluS iNStitute in November 2006, was deliberately built small, as a prototype for more community- based plants that would provide jobs across when mohammad yunus and the Bangladesh. “It’s just a tiny little plant, but Grameen Bank received the Nobel Peace it has a big message,” said Yunus in a speech Prize in October 2006, one endeavor to Global Alliance for Improved Nutrition, lifted into the limelight was Grameen the nonprofit organization brought in to Danone Foods. This was a path-breaking monitor the company’s impact on local collaborative enterprise, launched that year health. “While we make money, we can as a 50/50 joint venture between Groupe also do good.” Riboud adds, “I’m deeply Danone—the US$16 billion multinational convinced that [humanity’s] future relies yogurt maker—and the Grameen companies on our ability to explore and invent new Yunus had cofounded. Yunus called the business models and new types of business joint venture a “social business,” which he corporations.” said could be a pioneering new model for Yunus and Riboud are not alone in a more humane form of capitalism. As he seeing the critical importance of instilling explained in his book Creating a World a purpose other than short-term profits Without Poverty: Social Business and the at the core of corporate designs. In a Future of Capitalism (Yunus 2007), a social celebrated January 2008 speech at the World business is a profit-making company driven Economic Forum, Bill Gates called for a new by a larger mission. It carries the energy and form of “creative capitalism.” And around entrepreneurship of the private sector, raises the world—largely beneath the radar of capital through the market economy, and mainstream awareness—alternative designs deals with “products, services, customers, are being developed that, like Grameen markets, expenses, and revenues—but with Danone, seamlessly blend a central social the profit-maximization principle replaced mission with profitable operation. These by the social-benefit principle.” include the burgeoning microfinance The mission of Grameen Danone industry, emerging hybrids like nonprofit Foods is to bring affordable nutrition to venture capital firms, new architectures malnourished children in Bangladesh with such as Google.org that embody “for-profit a fortified yogurt, under the brand name philanthropy,” dual-class shareholding “Shokti Doi” (which means “yogurt for structures, employee-owned companies, the power” in Bengali, the country’s language). foundation-owned corporations of northern It began in October 2005, when Franck Europe, and a variety of cooperatives Riboud, the CEO of Groupe Danone, took on every continent. These models vary Yunus to lunch in Paris. “We would like to enormously in size and mission, but they find ways to help feed the poor,” said Riboud. are significant for the same reason: together, 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 34

they represent an evolutionary step in the meltdown (or other business abuses), it’s development of corporate structure. because the prevailing form of corporate design is generally taken as a given. Under THE SOUl OF A NEW dESIgN the law of most countries, it’s difficult for For years, critics of the corporation corporations to adopt any other form. But have argued that the prevailing design against the odds, tender green shoots of of publicly held corporations is innately new company designs are emerging today, flawed. That design involves a board that and existing alternatives are being adapted. is elected by shareholders—with votes Some emerging models are as likely to allocated proportionately to the number show profitability as more conventional of shares held—whose members then companies, and all are more adept at appoint a semi-autonomous CEO as the pursuing goals that conventional for-profit shareholders’ agent, who in turn delegates companies usually fail to reach: treating authority down through the ranks. In customers fairly, protecting the environment, many ways, this has been a highly effective creating a healthy workplace, and supporting model. The “managerial hierarchy” the communities in which they operate. structure, as corporate historian Alfred D. Richard Nelson, an economics professor Chandler, Jr. called it, has accomplished at Columbia University who co-founded the more in a short time than any other form field of evolutionary economics, observes the world has known. that social systems evolve because of two But this shareholder-centric model has also kinds of innovation: advances in physical contributed over the years to what former technologies (such as new environmental Citigroup CEO John Reed has called the and energy technologies), and advances in “iron triangle of short-term pressures,”— social technologies (such as new forms of hedge funds, stock options, and stock organization). While a good deal of public analysts—that keeps companies narrowly attention is focused on physical technologies, focused on quarterly profits.. social technologies are equally as important. The financial meltdown of 2008 was a The two must co-evolve. direct result of the pursuit of immediate As these two types of innovation influence profit by investment bankers and mortgage each other, the governance models that brokers who disregarded the impact of emerge—such as microfinance-related their actions on customers, on the larger structures—take their place alongside older, economy, and indeed on stockholders more established alternative models, such and the company itself in the long term. as cooperatives, employee-owned firms, and Those who wanted to operate with integrity government-sponsored enterprises. These found it difficult. They were constrained designs can be thought of as emergent new by a corporate design that reinforced the organizational species, occupying a new need to “make the numbers” by any means sector of society that is a greenhouse of possible—a design that bestowed the design experimentation in which the future greatest governance power on short-term of our economy may be growing. shareholders, the stakeholders with the least One helpful way of thinking about these interest in long-term performance or the designs is as representing a hybrid between external community. Conventional methods the traditional for-profit archetype, which for preventing abuses, such as regulation and has profit at its nucleus, and the traditional criminalizing egregious behavior, are only nonprofit archetype, which has social partially effective. In the long run, the best mission at its nucleus. This type of hybrid way to get to the root of the problem will has been dubbed the “for-benefit enterprise” be for corporate ownership and governance by Heerad Sabeti, CEO of the TransForms design itself to evolve. Corporation—a North Carolina-based If the idea of creating alternative forms manufacturer of wall decorations with about of corporate ownership and governance $2 million in revenues, which routinely is unfamiliar in conversations about the employs people with disabilities and invests 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 35

heavily in developing its workforce. Sabeti exist yet. We may be entering a new era is one of a number of people who have of design biodiversity, in which different begun to explore the parameters of this new designs serve different functions. Today, archetype. (Another source of exploration is at least three broad approaches to for- the Corporation 20/20 initiative, organized benefit architecture offer promising models: by Allen White and me at the Tellus Stakeholder-Owned Companies, which put Institute in Boston.) In a synthesis of the ownership in the hands of non-financial best of this thinking, we can conceive of the stakeholders; Mission-Controlled Companies, new type of organization with a blended which separate ownership and profits from purpose at the core: serving a living mission control and organizational direction; and and making a profit in the process. The Public-Private Hybrids, where profit-driven essential framework of such a company—its and mission-driven design elements are ownership, governance, capitalization, and combined to create unique structures. compensation structures—is designed to support this dual mission. And it is this STAkEHOldER-OWNEd COMPANIES design that enables companies to escape The cooperative model of ownership, which the pressure to maximize short-term profits dates to the mid-19th century, was conceived and instead to fulfill a more fundamental as an alternative to the shareholder-based purpose of economic activity: to meet ownership model that developed at roughly human needs and be of benefit to life. the same time. The defining feature of the Future experimentation is inevitable: cooperative model is that these companies the fully realized for-benefit corporate are owned and controlled by the members design—with all the right elements, a they serve. Members might be customers (as design that’s capable of replacing the in a credit union), producers (as in a farmers dominant model of today—may not cooperative), homeowners (as in a housing co-op), employees, or the community. (There THREE ORgANIzATIONAl ARCHTyPES is some overlap between cooperatives and employee-owned companies, but they are not the same; employees can own corporate shares either through cooperatives or in more conventional business structures through such measures as employee stock ownership plans.) Cooperatives are a globe-spanning phenomenon, with membership now at 800 million people— more than double the total from three decades ago. In Colombia, SaludCoop provides health care services to a quarter of the population. In Spain, the Mondragon Corporacion Cooperativa is the nation’s seventh largest industrial concern. More Americans hold memberships in co-ops than hold stock in the stock market. When they are successful, these stakeholder- owned firms can be extraordinarily long- lived, with remarkable business and social ILLUSTRATION By NICOLE GORkO impact: Rabobank in the Netherlands The top circles represent old organizational models, not flexible enough for our current era. and the Springfield Remanufacturing The bottom circle shows an alternative: the “for-benefit enterprise,” where companies have a Corporation in the Missouri Ozarks are two dual purpose at their core—serving a mission and making a profit—which is supported by structural aspects of enterprise design, such as ownership, governance, capitalization, and examples of companies that have prospered compensation. by drawing on the commitment and engagement of their shareholder-customers 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 36

and shareholder-employees, respectively. The council also influences policy and holds The success of firms owned and governed management to account, since it has the by stakeholders shows that, contrary formal power to dismiss the chairman. to some economic assumptions, there’s nothing innately better about independent MISSION-CONTROllEd COMPANIES shareholders or directors. But stakeholder A little-appreciated but powerful for-benefit ownership also has its flaws. Cooperatives model can be found among companies that have failed to match the growth of manage to be publicly traded while keeping shareholder-owned companies because control in mission-oriented hands. Take they lack access to capital (laws governing Interface Inc., for example. This Fortune cooperatives often put restrictions on capital 1000 flooring company, with 2007 revenues returns), and they can fail to retain leaders of $1.1 billion, is well on its way to meeting who perceive less chance of accumulating its ambitious 2008 pledge of “Mission Zero personal wealth. On the other hand, when by 2020”—a pledge to have zero negative employee ownership is matched with impact on the environment within 12 involvement, businesses can achieve results years. This means eliminating waste and that would be considered near-impossible in switching entirely to renewable energy, as conventional companies. part of the company’s larger vision of being The Cooperative Regions of Organic the first company that, as founder-CEO Producers Pool (CROPP), better known Ray Anderson puts it, “shows the entire by its brand name Organic Valley, is a industrial world what sustainability is in all producer-owned marketing cooperative in its dimensions.” La Farge, Wisc. CROPP is owned by the Other publicly traded companies have 1,200 organic family farms that produce tried to make this kind of long-term the dairy, eggs, and meat it distributes. The commitment, but have had to soften the company’s mission is to save the family farm, goal through the ups and downs of the stock which means paying as much as possible to market. What supports Interface’s mission farmers. “We don’t have any need for profits is a rarely mentioned but vital element in much over 2 percent,” says CEO George its social architecture: a dual-class share Siemon. “We’d just pay taxes on it. We’d structure that puts super-voting shares in rather give it to the farmers.” Though growth the hands of Anderson and a few other top has slowed in recent months, for years the executives, giving them control of 72 percent company grew 30 to 40 percent per year. of votes for the board, although they own With 2007 revenues of $433 million, Organic far less than a majority of publicly traded Valley stewards one of the nation’s four shares. Super-voting shares are generally largest organic brands. unavailable to the public, which insulates the Similarly, the John Lewis Partnership company from hostile takeovers. In effect, it PLC, with £6.8 billion (about US$10 billion) allows Interface to be a mission-controlled in revenues in 2007, has a stated purpose enterprise, one whose governance structure of serving the happiness of its employee- reflects both the need for ongoing sufficient partners. It is the largest department profit and a broader social priority. store chain in the U.K., and also owns 200 Mission control allows capital to trade Waitrose supermarkets. It is 100 percent freely, even as it ensures that the mission is owned by its 69,000 staff members, among not for sale. It allows leaders to focus the whom most profits are shared each year. company so that mission becomes the focal It is overseen by an unusual bicameral point while profits are energetically pursued. governance structure. The company has a There are other companies with publicly traditional board of directors as well as a traded stock and revenues over $1 billion second employee-based governing body, that are similarly mission controlled. the partnership council, directly elected by They include the family-controlled New employees. The partnership council in turn York Times, with its mission of serving an elects five of the twelve board members. informed electorate; foundation-controlled 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 37

Novo Nordisk, a Danish pharmaceutical the Upstream 21 Corporation, a socially company with a mission of defeating responsible holding company launched diabetes; and trust-controlled Grupo Nueva by the social investing firm Portfolio 21 SA, headquartered in Chile, with a mission Investments in Portland, Oregon. This of contributing to a sustainable Latin holding company was set up explicitly America. Perhaps the most notable recent to buy local companies, in order to build example of mission-controlled architecture natural, social, and economic capital within is Google, which adopted a two-tier stock the region. Oregon stakeholder law says configuration, vesting power with its directors may consider the interests of founders, when it went public in 2004. many stakeholders, not just stockholders, in In the best of these designs, the mission’s making decisions, and Upstream’s articles control of voting shares is strengthened of incorporation adopt language saying by an explicit commitment to mission in directors shall do so. The Upstream design the company charter and in the design of also reconfigures voting rights, giving greater governance procedures. Novo Nordisk, for power to hands-on owners (including example, has adopted an ambitious charter employees) and diminished power to that spells out the company’s values and absentee owners. commitments, including a commitment The “directors’ duty” aspect of this design to ensuring that all products and services has since been replicated by more than “make a significant difference in improving 130 companies signing on to become B the way people live and work.” Each year corporations, or beneficial corporations. the company board must report to the This model is being promoted by Jay Coen foundation board on how it is ensuring Gilbert and his colleagues at the non-profit that operations are “economically viable, B Lab in Philadelphia, who aim to create a environmentally sound, and socially unified marketing presence and certification fair.” The foundation board includes an process for B Corporations. Unfortunately, electrician, scientists, a physician, and a lab they did not replicate Upstream’s redesign technician, so that participants represent of voting rights in their model. Because many relevant points of view. Without virtually all B Corporations today are design elements like these that keep mission founder controlled, these firms may be in focus, super-voting share structures run vulnerable to losing their mission when the the risk of creating company monarchs founders depart. But as the B Corporation unanswerable to anything but their own model becomes more widely adopted, a whims—which may or may not remain community of practice could emerge— benign over the long run. similar to the communities of employee- Mission-control architecture can offer owned companies and cooperatives, a solution to the challenge that socially with their networks of attorneys and responsible companies face as they struggle consultants—that could help in the ongoing to keep social mission alive after founders evolution of this promising new model. depart or sell their shares. It is rarely sustainable for the mission of a company to PUBlIC-PRIvATE HyBRIdS be embodied in the personality of a single A third school of for-benefit design involves individual, no matter how charismatic or company architectures that deliberately blur well-intentioned that individual is. Research the lines between for-profit and non-profit shows that once founders depart, company modes of operation—Grameen Danone. mission often shifts—and in the absence of One powerful model here is being termed thoughtful for-benefit design, the pressure “for-profit philanthropy,” and it is famously of mainstream cultural norms and financial embodied by Google.org, a boundary- practice makes it easiest to revert to short- spanning entity created by Google. Google. term results as the primary goal. org currently manages a philanthropic One of the companies that is most explicit budget of $2 billion; the amount is based in using design to achieve a mission is on Google’s initial public offering, which 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 38

announced the company’s intention to for-profit and non-profit organizations that contribute 1 percent of equity and 1 percent deliver affordable housing, energy, and clean of profits to charity. water in South Asia and Africa. As Brooklyn Law School Professor Dana Brakman Reiser observed in a recent PRINCIPlES BEyONd PROPERTy paper, Google.org is not a traditional There is now enough experience with these foundation but a division of Google, three basic schools of design—Stakeholder- standing alongside the engineering, Owned Companies, Mission-Controlled sales, and finance functions, yet tasked Companies, and Public-Private Hybrids—to with addressing climate change, disease begin to identify some broad principles of pandemics, and poverty. By eschewing tax- design at work. Deeply embedded in them exempt status, it gains the running room is the aim of delivering human or ecological to combine investments with grants as it benefits. A company might be a producer pursues its ambitious goals—drawing fully cooperative designed to save the family farm, on Google’s staff, technology, and products a pharmaceutical company aiming to defeat in the process. As Reiser wrote, “Google. disease, an employee-owned firm making the org’s use of an integrated for-profit division workplace into a community, a microfinance inaugurates a new model: ‘for-profit institution seeking to end poverty, a philanthropy.’” The director of Google.org is development corporation revitalizing the Larry Brilliant, known both for his business inner city, or a public company laying a path acumen (he co-founded the Whole Earth to sustainability. In tangible ways, all aim to ‘Lectric Link [WELL] computer network) benefit life. Social issues are not relegated and for his medical philanthropy (he was to an ethics office in room 201 or left to the a primary figure in the World Health whims of particular leaders, however noble Organization’s eradication of smallpox they may be. and cofounder of Seva, a foundation that All the successful examples embody a brought eyesight to more than 2 million view of enterprises as living systems. Most blind people). economists and law professors still view Another cross-sector governance model companies primarily as pieces of property, involves nonprofit companies that create owned through their shares. But for-benefit for-profit subsidiaries—being deemed “social design starts with the assumption that enterprises.” The Great Neighborhoods! companies are organically evolving entities, Development Corporation (GNDC) living social systems—in other words, in Minneapolis—where I serve on the human communities. And their design board—has ushered in a renaissance in the reflects that view. once-blighted Phillips neighborhood by These designs also reflect the added driving out disreputable bars, drug dealers, complexity of the for-benefit sphere, and and prostitutes and bringing in a business the need to encourage innovation while incubator, health clinic, grocery store, and safeguarding against potential abuses. The retail shops. Although GNDC is a nonprofit track record in the microfinance sector organization, its real estate projects are shows why safeguards are needed, and designed to operate in the black. “We’re in why trumpeting good intentions, in itself, the business of changing the lives of the isn’t enough. The original Grameen Bank poor, and we’re using real estate business business model pioneered by Mohammad development to do it,” says Chief Executive Yunus —alleviating poverty by lending small Officer Theresa Carr. amounts of money to micro-entrepreneurs Yet another model in the hybrid category who then become depositors, allowing would be “nonprofit venture capital” funds, communities to recirculate capital—led such as the Acumen Fund, which raises to dramatic success in Bangladesh. It also charitable funds to serve the poor but takes inspired an international microfinance an investing rather than grant-making industry, which today has its own rating approach, offering equity and loans to both agencies, consultants, conferences, institutes, 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 39

and billions upon billions of dollars in non-financial stakeholders. At Organic international lending. Central Asia alone is Valley, for example, governance by a central now home to more than 1,000 microfinance board is supplemented by a network of institutions. In India, the number of regional farmer pools, each with staff microfinance clients grew ten-fold over four support. In still other cases, for instance, years to surpass 10 million at the end of with cooperatives, governance design is 2007. As this industry grew, the mission of shaped by laws that stipulate a policy of one the original model was sometimes lost. New person, one vote, as contrasted with one microfinance banks dispensed with critical share, one vote. Diversity is the hallmark of governance features, such as training local these governance innovations. For if capital lending officers to work closely with teams is the only group with a seat at the table, of borrowers. Instead, they simply lent at the capital’s view of the corporation is likely to highest rates possible. The result has been a prevail: the company will be seen as a piece new set of abuses. Banco Compartamos SA of property whose worth is measured by – a Mexican microbank portraying itself as a stock price. gentler lender to the poor—hugely enriched its initial investors when it went public in MEETINg THE MAINSTREAM 2007. Yet it reportedly made that fortune in Leaders of traditional firms may recognize the part by charging almost 100 percent annual opportunities in these new forms. They can interest rates to illiterate Mexican mothers. achieve a broader array of goals by adopting Some may wonder if these alternative a for-profit philanthropic division, as Google designs are intended to promote or lead has, or attempt a social business joint venture, to socialism, but in fact the concept of along the lines of Grameen Danone Foods. private ownership is deeply intrinsic to They can rapidly improve their operational them. Instead of doing away with private excellence through the engagement ownership, these firms redesign it. It has inherent in employee ownership, as founder been clear since the days of Adolf Berle and CEO Jack Stack has at Springfield and Gardiner Means—who published Remanufacturing. A few may even attempt to their breakthrough book, The Modern transition to a mission-controlled design, like Corporation and Private Property, in 1932— that employed by Interface. that business ownership is often separated Such models will have to overcome from its most vital element, control. These long-standing, deeply imbedded cultural designs go further by concentrating control traditions and legal imperatives. But as in a deliberately chosen group, selected nascent alternatives to the conventional as stewards of the firm’s living mission. structure quietly succeed, options may Ownership shares can be bought and sold continue to open in coming years, like property, but controlling shares represent particularly among business startups. “It is a living essence that is not for sale—or for the entrepreneurial spirit that has always sale only under restricted conditions. led the evolution from one age to the next,” In the case of Grupo Nueva, control is said Mike Thomas, a former executive with vested in the VIVA Trust, which is charged Granite Construction Company who is now in perpetuity with protecting the vision and a senior partner at the Monterey Institute for values of the firm. In describing the value of Social Architecture in Monterey, California. the trust, founder Stephan Schmidheiny said, In certain cases, alternative enterprises “Now there is an ownership structure that is best serve their social mission by keeping permanent, reliable, and committed to the profits low. On the other hand, some long term, and that will not be a victim of alternative models can be very economically speculation or personal whims, or the lack of competitive. Studies have shown, for preparedness of a successor; all this reduces example, that employee-owned firms risks for the investor.” modestly outperform their peers, and that In other cases, mission is preserved when these companies have high employee through governance designs that feature involvement, they do even better. In a 2002 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 40

paper, Steen Thomsen and Caspar Rose of Offers concrete, specific ideas on how to the Copenhagen Business School found structure plans and get employees involved that foundation-owned firms—common in decisions. throughout northern Europe—perform no worse and even slightly better than The Power of Unreasonable People: How traditional firms. The critical difference is Social Entrepreneurs Create Markets That that these companies do not set making Change the World, by John Elkington and money apart from other goals; there is no Pamela Hartigan, Boston: Harvard Business false choice between making money and Press, 2008. A guide to at promising social fulfilling other missions. The design of the enterprises around the world. company is aimed at accomplishing multiple goals at once. Dana Brakman Reiser. 2008. “For-Profit We live in an age when short-term Philanthropy”: http://works.bepress.com/ pressures have allowed speculation to dana_brakman_reiser/14: Includes an overtake the more traditional, human analysis of Google’s boundary-breaking functions of business. Alternatively designed innovations in for-profit philanthropy. companies offer important lessons in how corporate ownership and governance can www.FourthSector.net – Outlines Heerad evolve differently. And they’re important in Sabeti’s concept of for-benefit organizations. their own right as well, for they are likely to prove better adapted to the cultural and www.NCEO.org – Website of The National ecological demands of the 21st century than Center for Employee Ownership, the the industrial age models they might one single best source of accurate, unbiased day replace. Such businesses may seem like information on employee stock ownership anomalies today. But they more closely plans (ESOPs), equity compensation plans, reflect the priorities that engendered the and ownership culture. longest-lasting businesses throughout human history. n www.NCBA.coop – Website of the National Cooperative Business Association, with a RESOURCES mission to develop, advance and protect Art Kleiner, Jack Stack’s Story is an cooperative enterprise. Open Book, s+b: Profile of the founder and “creative mind” for one of the most www.Corporation2020.org – The website successful cooperatives, Springfield for Corporation 20/20, a multi-stakeholder Remanufacturing Corporation. initiative co-founded by author Marjorie Kelly, which aims to develop and disseminate A Cooperative Solution, s+b Summer 2006: corporate designs in which social purpose Some of the most successful companies in moves from the periphery to the core of the Europe, including Rabobank and Italy’s CoOp organization. supermarket chain, are stakeholder-owned. Marjorie Kelly and Allen White, “Corporate Muhammad Yunus, Creating a World Design: The Missing Business and Public Without Poverty: Social Business and the Policy Issue of Our Time,” Tellus Institute, Future of Capitalism, New York: Public November 2007, www.corporation2020. Affairs, 2007. Tells the story of the founding org: A set of principles for the next wave of Grameen Danone Foods and outlines his of corporate architecture accountable to concept of social business. broader societal interests. Ownership Management: Building a culture ENdNOTES of lasting innovation, by Corey Rosen and 1 Originally published in Strategy and Business Ed Carberry, The National Center for magazine, Issue 54, Spring 2009. Employee Ownership, Oakland, CA, 2002. http://www.strategy-business.com/magazine. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 5 | 41

Markets at Risk: modest returns from buying and holding triple-A bonds to maturity were more than enough reward. Modern Portfolio Theory, or MPT as it is most often referred to, has been a crucial The Limits of Modern element in the unleashing of this recent wave of demand for risk. It may not be Portfolio Theory difficult to understand how MPT, with its sophistication, elegance, and complexities, has succeeded in persuading investors that large risks can be controlled. Putting the Steve lyDeNbeRG genie of MPT back in the bottle, however, DomiNi Social iNveStmeNtS will be a more difficult task. Fixing MPT, i correcting its flaws, is not sufficient to this task. We will need an entirely new theory to underpin investment practice if we hope to In the face of one of the greatest tame this powerful force that has been set financial and economic crises of the past 100 free in the financial world. years, legislators and regulators are deciding Even the most casual, unsophisticated what new steps need to be taken to keep the observer can intuitively understand that abuses that have provoked such situations financially risky products are at the heart of from recurring. They are, understandably, today’s financial crisis. It is easy to see that focusing on the supply side: the host of new, it was a $450 billion bet on credit default highly risky financial products and practices swaps that brought down AIG, the largest around the world that need to be reined in insurance company in the world; that highly and brought under control. risky subprime mortgages broke the back of Unfortunately, not as much attention Washington Mutual, one of the fast growing is directed at the demand side: the regional banks in the United States; that out- apparently insatiable demand for risky of-control hedge managers bankrupted Bear products coming from our largest and most Stearns; and that highly leveraged real estate sophisticated institutional investors. Those deals contributed to the downfall of Lehman demanding these risky products have been Brothers. Risk-taking has devastated as responsible for their spread around the financial institutions around the world and world as have those providing the supply. brought whole national economies—Iceland Regulating that demand—tempering it, is the most dramatic example—to the brink restraining it, controlling it—is as likely to of fiscal collapse. prevent the recurrence of future financial These risky products purveyed by reckless crises as is trying to prevent super-smart financial institutions existed in part because money managers from finding fancy ways to there was a willing market—and institutional package risk in today’s marketplace. investors bound by fiduciary principles of Not more than forty or fifty years ago this prudence to their beneficiaries were part demand was easily controlled. Fiduciaries— and parcel of that market. These institutions the largest institutional investors of today: are among the largest investors in the world. pension funds, mutual funds, and trust Pension funds around the world control officers—were by and large limited in their some $25 trillion in assets. (Watson Wyatt abilities to invest in stocks because they were 2008) In the United States, endowments of too risky, not to mention mortgage-backed universities alone exceeded $400 billion in securities, synthetic collateralized debt assets as of 2008. (NACUBO 2009) Some obligations, credit default swaps, double- of the most technically expert investment barrier foreign exchange options and their professionals in the world clearly thought the like. A true fiduciary did not take risks with investments they were making were prudent, other people’s money. The security and and the reason they thought so was MPT. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 42

To understand the front-page headlines developing a theoretical rationale for the about today’s financial crises we must step “prudent man” to invest in stocks. MPT behind the scenes to understand some of provided that theoretical framework. those fundamental precepts of MPT that (Bernstein 2005) It demonstrated that the have been so influential. Although a full risks inherent in investing in stocks could be exposition of MPT—its origins, its primary measured and controlled at a portfolio level elements, and the debates about its various during normal market conditions. hypotheses—is not attempted here, the The origins of MPT can be traced to the following highlights a number of its most seminal work of Harry Markowitz. In a 1952 important contentions and theories and article in the Journal of Finance, Markowitz examines their implications for investment pioneered the concept of controlling risk practices today. at a portfolio level through diversification. Markowitz’s work was revolutionary because ORIgINS OF MOdERN PORTFOlIO it viewed risk as a portfolio problem, not THEORy a problem in individual security selection. The progenitors of MPT were academics Investing in countercyclical stocks was who, starting in the 1950s, set out to solve the key to controlling risk. If companies a relatively simple problem: how to justify involved in home repair thrive when those investing in risky stocks. In the late 19th that build new houses struggle, then a and early 20th centuries, stocks were an portfolio of the stocks of both companies unregulated, highly risky, speculative will be less risky than investments in either investment prone to boom and bust—and company alone. Investing in one risky stock consequently were off limits to prudent might be unwise, but investing in two risky investors. The risks of investing in stocks stocks—each risky in its own way—can be were made painfully clear during the crash prudent. (Markowitz 1952, 1959) of 1929 when the stock market lost almost Increasing the opportunities to invest 90% of its value over three years. in risky securities is crucial to investment Initial attempts to legitimize investing managers today because the greater the in the stock market were made during the risks the greater the potential rewards. By depths of the Great Depression. Among the diversifying risk throughout a portfolio, most important were increased transparency managers can achieve greater portfolio and government regulation. The Securities returns without taking greater overall and Exchange Commission was created in portfolio risks. Diversification techniques are 1933 and 1934 and directed to oversee the what Peter Bernstein calls “the closest thing stock markets. Companies were, for the first to a free lunch” that there is in investing. time, required to disclose audited financial (Bernstein 2005) statements. Also in 1934, Benjamin Graham In the 1960s Eugene Fama, Sidney and David Dodd published their still Alexander, and others developed a second popular classic Securities Analysis: Principles mainstay of MPT: the efficient market and Techniques, which laid out convincingly hypothesis. In its various forms this principles for purchasing stocks at hypothesis asserts that the stock market reasonable prices. (Mitchell forthcoming) essentially reflects all available information This combination of regulatory initiatives at any given time. This implies that stocks and academic advice helped legitimize are appropriately—or “efficiently”—priced. investing in stocks, but essentially wasn’t In addition, this theory implies that a sufficient to justify fiduciaries taking the money manager cannot beat the market—at plunge into the equities markets because it least not all the time—because the market provided no theoretical reason why stocks knows more and is “smarter” than any one should be viewed as safe. individual. (Fama 1970) It wasn’t until the mid-1950s, when the A crucial variation on this theme was stock market once again reached its 1929 necessary as well to account for the fact that highs, that academics tackled the task of markets bounce around irrationally day 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 43

to day. MPT concedes that stocks can be MOdERN PORTFOlIO THEORy IN temporarily mispriced. These momentary PRACTICE lapses in the otherwise efficient markets give Thus, all the elements of MPT were better-informed investors an opportunity effectively in place by the mid-1970s, but to take advantage of temporary market it took some twenty years for its basic anomalies and, brief as these anomalies precepts to be widely disseminated and might be, to buy or sell stocks before they accepted among institutional investors. The revert to their true mean. conservative investor of the 1970s and 1980s, Simultaneously, William Sharpe, James who had been told time and time again that Tobin and others were developing the Capital one of the primary duties of a fiduciary was Asset Pricing Model, which provides a means to avoid undue risk initially greeted MPT’s of measuring expected returns on any given brilliant academic proponents with doubt investment of a particular level of risk. This and skepticism. (Bernstein 2007) formula—and it is an algebraic formula— The tide turned gradually in the 1980s allows investors to measure the success of and early 1990s, as the proponents of this their investments. That is to say, it allows theory received increasingly widespread them to assess whether they have achieved an recognition—many were eventually awarded appropriate level of return for the level of risk a Nobel Prize in Economics1—and as the they have taken. (Sharpe 1970) technology and practical tools for measuring Crucial to this theory is the definition and controlling risk in investment portfolios of risk as the volatility of a stock’s returns were developed. But it wasn’t until the late relative to the market. A stock is risky if its 1990s that the floodgates truly opened price goes up or down more than the price and fiduciaries in charge of institutional of its peers. This simple, narrow definition investments embraced MPT wholesale. has led to the creation of innumerable Not only did MPT free fiduciaries to benchmarks that define the markets against invest in blue-chip stocks formerly deemed which investment success can be measured. excessively risky, but it has further led to More important, once this definition of the embrace of the even more risky stocks success is accepted, it leads to the logical of small firms and in the stocks on the conclusion that the duty—the fiduciary exchanges of emerging markets around the duty—of an investor is to “beat the market,” world. Other asset classes, whatever their that is, to achieve returns that are better apparent risk, have also become fair game. than a benchmark given comparable levels Private equity, hedge funds, real estate, of risk—or at least, to match the market’s commodities, currencies—virtually any performance while minimizing expenses. investment for which there is a market—are The final piece of the MPT theory was now not only available to fiduciaries, provided by Fischer Black and Myron but frequently promoted as a necessary Scholes when in 1973 they developed the investment if they are to keep up with their formula—the Black-Scholes Model—to price peers and “beat the market.” Previously, the options and other derivatives. This formula thought of investing in these asset classes is crucial because it enabled investors to use was inconceivable—they were seen as derivatives in their portfolios for hedging— reckless and imprudent—now they are a and hedging is the simplest means to control necessary tool for the sophisticated investor. risk. This model made risk control, if not Once investors accept these four principles necessarily child’s play for mere mortals, at of MPT—1) that greater returns come from least child’s play for the highly quantitative securities with greater risks; 2) that the risks mathematicians and scientists hired by Wall of individual securities can be diversified Street to show institutional investors how away at the portfolio level; 3) that returns are risk can be controlled. Derivatives are viewed most meaningfully measured against market as so foolproof a method of controlling risk benchmarks; and 4) that derivatives can be that they are often referred to as “insurance.” meaningfully priced—then fiduciaries are (Black and Scholes 1973) virtually forced to seek out risky products in 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 44

order to maximize their returns relative to  The more investors control financial risks, their peers. That is why MPT has changed the greater the societal and environmental the face of investment. That is why investing risks. today inevitably and dramatically increases  The more investors hedge their portfolio the demand for risky products in the bets, the more likely markets are to go bust. financial markets. The more convinced investors are that they can control risk, the easier they are to con. lIMITATIONS OF MOdERN PORTFOlIO While it may seem intuitively self-evident THEORy that the more risky products investors Despite its current wide acceptance in the demand, the more risky financial markets marketplace, MPT has severe limitations will become, MPT’s assertion that risk can that are recognized by many mainstream be controlled cannot be casually dismissed. investors. Here, for example, is what Gao It is not by accident that MPT has become Xiqing, president of the China Investment a fundamental and powerful principle of Corporation, one of the largest sovereign investment today. Its virtues must be fully wealth funds in the world with some $200 appreciated and acknowledged before its billion under management has to say about weaknesses can be accurately analyzed. derivatives—one of the keystones of MPT. MPT needs to be treated with respect When James Fallows, interviewing him for not simply because many of its progenitors The Atlantic, asked what he thought about are Nobel Prize recipients—although that these risky products, he answered:. certainly commands respect— but because “If you look at every one of these it has been so widely embraced by so many [derivative] products, they make sense. But in powerful positions. Its virtues need to in aggregate, they are bullshit. They are crap. be understood not simply because it has They serve to cheat people.” (Fallows 2008) contributed valuable insights to the art of This is a remarkably concise statement investing, but because it has made many of three crucial and somewhat surprising rich. Its weaknesses need to be carefully points. First is the recognition that MPT analyzed not simply because they are when applied “locally”—that is, at the apparently inadequately recognized, but portfolio level (it is, after all, called Modern because it will take an alternative theory Portfolio Theory)—works. The second to replace this theory and reform current assertion, however, is counterintuitive: when financial practices. Understanding where the tools of MPT are widely used—that MPT is strong and where it is weak is the is to say, when these theories are put first step toward building a new theory. systematically into practice—they break Let’s be clear. MPT is an elegant, highly down. Not only do these tools break down, sophisticated set of principles and practices but they can have a destructive impact on that accomplishes exactly what it sets out financial markets as a whole. to do—control risk at a portfolio level. It The third assertion is even more surprising. can identify and measure risk (defined When Xiqing says derivatives “cheat” people, most simply as volatility) within a portfolio. I believe he means that those who sell these It can adjust the level of that risk up or products to institutional investors know full down throughout portfolios through a well that they don’t work if everyone uses variety of sophisticated techniques. It can them. They are not quite Ponzi schemes. They compare risks taken to returns achieved are not outright fraud. They are not illegal. and determine if the returns are appropriate But at crucial times they are ineffective, unre- to that level of risk. It can measure and liable, and ultimately dangerous. compare the capabilities of different  The assertion that the specifics of MPT managers with different investment styles in when applied generally are dangerous can be achieving these risk-adjusted returns. What’s put several different ways. more, it can apply these principles not just  The more investors control portfolio risks, to stocks, but to virtually any asset class for the greater the market risks. which there is a developed market. In its 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 45

own terms, within the limited boundaries of a security relative to a benchmark index. it sets for itself, MPT is a wonderful and By limiting the definition of risk to price undeniable success.2 volatility, MPT ignores the possibility that Controlling risk at a portfolio level allows investments can either pose social and investors to hold an increased number of environmental risks or, because reward is the risky securities. The importance of this flip side of the risk coin, that investments can concept cannot be overstated. It is the create social and environmental benefits. path that leads to greater portfolio returns Addressing this limitation forces us to without greater portfolio risks. It is a theory recognize that the act of investing—the and a practice that sound too good to be allocation of assets to specific institutions true. And unfortunately, at a market level, for specific purposes—creates products and that is precisely the case. services that impact society. This may sound Within the context of the financial like a self-evident truth, but it is one that markets, two things happen when substantial is ignored by MPT. When investors pour numbers of investors put this theory into money into the fossil fuel industry because practice. The first is that, as the demand a skyrocketing price of oil makes these for risky products increases, the overall companies momentarily profitable, MPT quantity of risky products in the marketplace is of great help in measuring their financial increases. The dangers of this increase returns versus their financial risks, but its are obscured by the fact that the risk of formulas are of no help when it comes to, for each portfolio, when viewed individually, example, the risks of climate change. On the is apparently negligible. (In Gao Xiquin’s flip side—that of measuring rewards—when words, “If you look at every one of these investors allocate dollars to microlending products, they make sense.”) programs that enhance the abilities of large At a portfolio level, risk can be diversified segments of the world’s population who away by purchasing securities or asset classes have not previously had access to financial with countercyclical risks; by securitizing services to take at least tentative steps out and redistributing risky securities to others, of poverty, MPT has no calculus for these as in the case of speculative mortgages or benefits to society. commercial real estate loans; or by hedging In addition, for every investment made against risks through the purchases of there is not only a potential societal risk and derivatives. Hedging in particular is the most reward, but there is an opportunity cost for elegant and most immediately effective way which there is no place in MPT’s equations. to deal with risk. That is why the notional Every dollar invested in oil companies is value of derivatives in the marketplace stood a dollar not invested in alternative energy. at $683 trillion as of June 2008. (Bank for Every decision to invest in the development International Settlements 2008) of high-cost and high-margin drugs to treat Risky products designed to control the chronic ills of the developed world is a risk—and risky debt (or, as it is often decision not to invest in cures for malaria, referred to in the financial community, sleeping-sickness, tuberculosis, AIDS, and “leverage”) used to multiply the returns from other scourges of the developing world, not these risky products—now dominate the to mention vaccines. investment landscape. When they start to Furthermore, MPT’s ignorance of the fail, they fail spectacularly—as the current societal and environmental implications financial crises that have brought the largest, of investment decisions also short-circuits most sophisticated financial institutions in debates about government’s role in the the world to their knees amply demonstrate. creation of public goods. By focusing the (“But in the aggregate, they are bullshit. They concept of investment narrowly on market- are crap.”) based returns, MPT distracts attention A second limitation of MPT is that its from the contribution of investments definition of risk is purely financial—that is provided through the governmental, to say, purely related to the price volatility quasigovernmental, and nonprofit sectors 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 46

in such areas as infrastructure, education, it would fail in exceptional circumstances. health care, housing, security, and other (Bernstein 2005; Bookstaber 2007) public goods. These goods are provided by The same is true for other derivatives. non-market-based institutions precisely For example, credit default swaps (CDSs) because the profit-motive is too short- are often billed as a form of insurance. This sighted to allocate assets efficiently to these esoteric product, developed within the past endeavors. decade to help lenders control the riskiness of Put most simply—MPT fails to grapple their loans, had become so popular that as of with the complicated task of valuing the 2008 some $65 billion in notional assets were societal and environmental implications so insured. Here’s one example of how a CDS of investments, or even to give them the might work. A bank lending $10 million to a minimal respect of a passing glance. major U.S. corporation can enter into a credit The third weakness of MPT is that it fails default swap with a hedge fund. The hedge to account for the possibility that markets fund agrees to pay the bank the $10 million if may be in practice more dishonest and the corporation defaults on this loan any time dangerous than they appear in theory. within the next five years. In consideration Nassim Nicholas Taleb, in his recent rant for this service, the bank pays an “insurance” against current financial practices, tells a premium to the hedge fund each year, fictional tale about asking a professor what nominal if the chances of the corporation the odds of a coin that has been flipped defaulting are minimal, or greater if the 99 times and comes up heads each time corporation is in financial difficulty. would be of coming up heads again on the If I’m a speculative and profit-minded hundredth flip. The professor’s answer is banker, however, I might decide to enter 50-50, because odds do not change simply into two or three CDSs for this loan, instead because of chance variations. When he asks of just the one. After all, if the corporation the same question to his street-wise friend defaults I am now not only protected against Fat Tony, however, he gets a very different a loss, but stand to make a tidy profit. In answer. Fat Tony would give you only a one- fact, the next time that corporation comes in-a-hundred odds of heads coming up the to me for a loan, I might be willing to make next time. Why? Because “The coin is clearly one that is more risky at a higher interest rigged. It can’t be a fair game.” (Taleb 2007) rate because, using CDSs, I can make more The point of this story is that, while many money whether the loan is paid off or not. of the risk-control techniques that have The problem with this scenario—which one been sold to the financial community as might view as a win/win for both the corpo- insurance are theoretically sound, they rate community and the bank (corporations don’t work when widely used. What’s worse, have access to risky loans, the banks are pro- they can actually increase the chances of tected against default)—is that as more and systemic collapse. For example, a set of more investors take out CDSs on risky loans hedging techniques were developed by two the less likely the hedge funds or other third academics from the University of California, parties are to be able to pay if these corpora- and widely marketed to the financial tions actually default. (Sarra 2008) community in the early 1980s as “portfolio Michael Lewis has said of the credit insurance.” By early 1987, some $70 billion default swap, “Call it insurance if you like, in assets were theoretically insured against but it’s not insurance most people know. market declines of theoretically predictable It’s more like buying fire insurance on your magnitude. However, during the precipitous neighbor’s house, possibly for many times stock market crash of October of that year, the value of that house—from a company these insurance policies not only failed to that probably doesn’t have any real ability protect investors against large losses, but to pay you if someone sets fire to the whole even contributed to the size and speed of neighborhood.” (Lewis and Einhorn 2009) the crash. The more investors used this This is true of many hedging techniques insurance technique, the greater the chance in the financial world. They are sold as 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 47

insurance, but they are no such thing. They isn’t that these investors need a better system work only if limited numbers of investors use or even a better casino. What they need them. As more investors pile onto the risk is a better theory of what to do with their control techniques that have been developed investment funds to begin with. to implement MPT, the more likely they are In order to develop a theory that will not to work. This is why Gao Xiquin says compete successfully with the allures of they “cheat people.” MPT, the definition of the goal of investing must be changed. As long as success in IT TAkES AN AlTERNATIvE THEORy investing is defined as controlling risk and MPT’s assertions about risk control are in beating price-based benchmarks, risk-taking many senses too good to be true. It is this and speculation will become irresistible to attractiveness—the promise of a free lunch— investors at some point and the markets will that has made them so popular within the again find a way to fill that demand. institutional investment community. A theory of investment that can stand Investors always have a difficult time up to MPT will, I believe, relate success in saying no to a good deal. Those that invested investing to the social and environmental in an outright fraud, such as the Ponzi purposes for which particular investment scheme run by Bernard Madoff, should asset classes were created. have known better, should have done their After all, banks were not created so that due diligence more thoroughly, and should depositors could earn interest. They were have seen that the promise of an unbroken created to help support family-owned series of positive returns could not be businesses and local economies. The purpose kept. The remedy for this kind of abuse is of issuing bonds is not to help citizens straightforward —as a fiduciary, do your job, make money, but to fund the creation of don’t be seduced by fraud. public goods by governments acting in the The problem posed by a world of public interest. Stock markets didn’t come institutional investors exercising their into being so that investors could beat fiduciary duties under the precepts of MPT benchmarks, but to fund large-scale business is more complicated. MPT is progress in enterprises providing useful products and the sense that it works for some investors all profits for a community of stakeholders. A the time, and all investors some of the time, conception of success in investing solely but it doesn’t work for all investors all the as achieving better returns than those of time—and it cannot. It cannot because it is your neighbor, no matter what the asset the right answer to the wrong problem. class in which you are investing, is limited, The question responsible investors should impoverished, and anemic. be asking themselves is not “How can risk An alternative to MPT and current be controlled at the portfolio level?” A better financial practices needs to be built on a question for MPT to have addressed might foundation of investments that maximize have been “How can risk be controlled at the societal goods they are best at creating. the market level?” But even that question This necessitates understanding the risks isn’t the right one—because risk cannot be involved—risks certainly cannot be ignored. controlled. Risk and speculation are part More importantly, however, it involves of the investment process and they can no understanding the specific needs that more be eliminated from it than death can investments fill, the specific goods they create, be eliminated from life. and the specific rewards they bring to the It is as if fiduciaries were persuaded to society and environment in which we live. enter a casino by some smart people with Successful, effective investment is as promises of a system to beat the house. Their much about particular rewards as it is initial allocation of assets to slot machines about generalized returns. Understanding and the roulette wheel paid off handsomely, how investments relate to the asset classes but now everyone seems to be using the through which they are made will promote system and it is breaking down. The problem a world of lesser risks—financial, societal, 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 48

and environmental—and greater long-term Lewis, Michael and Einhorn, D. 2009. “The rewards. Defining the purpose of investment End of the Financial World As We Know It,” as achieving these ends is a short, quick New York Times January 4:WK9. road to creating the demand that will help Markowitz, Harry M. 1952. “Portfolio stabilize financial markets and sustain long- Selection,” Journal of Finance Vol. 7, No. term societal wealth. 1:77-91. The current economic crisis is a rare moment of opportunity to rethink the Markowitz, Harry M. 1959. Portfolio fundamental purpose of investing and to Selection: Efficient Diversification of invent the tools that serve this purpose. Investment. New Haven, Connecticut: Yale The key to such rethinking is to define University Press. investment as a means to socially purposeful outcomes rather than a numbers game built Mitchell, Lawrence. Forthcoming. “The on a societally inadequate theory. n Morals of the Marketplace: A Cautionary Tale of Our Time.” Forthcoming in Stanford REFERENCES Law & Policy Review. Bank for International Settlements. June 2008. “Amounts Outstanding for Over-the- NACUBo. 2009. “2008 NACUBO Counter Derivatives.” Available at http:// Endowment Study.” Available at http:// www.bis.org/statistics/otcder/dt1920a.pdf. www.nacubo.org/Research/NACUBO_ Last visited May 10, 2009. Endowment_Study.html. Last visited May 10, 2009. Bernstein, Peter L. 2005. Capital Ideas: The Improbable Origins of Modern Wall Street. Sarra, Janis. 2008. “Credit Derivatives, Hoboken, New Jersey: John Wiley & Sons, Inc. Market Design Creating Fairness and Sustainability.” Available on the Social Bernstein, Peter L. 2007. Capital Ideas Sciences Research Network at http:// Evolving Hoboken, New Jersey: John Wiley papers.ssrn.com/sol3/papers.cfm?abstract_ & Sons, Inc. id=1399630. Last visited May 10, 2009. Black, Fishcer and Myron Scholes. 1972. Sharpe, William F. 1970. Portfolio Theory and “The Valuation of Option Contracts and Capital Markets. New York: McGraw-Hill. Corporate Liabilities,” Journal of Political Economy Vol. 81: 637-654/. Taleb, Nassim Nicholas. 2007. The Black Swan: The Impact of the Highly Improbable. Bookstaber, Richard. 2007. A Demon of Our New York: Random House. Own Devising: Markets, Hedge Funds, and the Perils of Modern Financial Innovation. Watson Wyatt. 2008. “Global Pension Fund Hoboken, New Jersey: John Wiley & Sons, Inc. Assets Rise and Fall.” Press Release, January 31. Available at http://www.watsonwyatt. Fallows, James. 2008. “Be Nice to the com/news/press.asp?ID=18579. Last visited Countries that Lend You Money,” The May 10, 2009. Atlantic, December: 62-65. ENdNOTES Fama, Eugene F. 1970. “Efficient Capital 1 What is frequently referred to as the Nobel Prize in Markets: A Review of Theory and Empirical Economics is technically the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, which Work,” Journal of Finance: Vol. 25, No. 2: has been awarded annually since 1968 by the Swedish 383-417. national bank. The Nobel Prizes for achievements in physics, chemistry, medicine, literature and for peace Graham, Benjamin and Dodd, D.L. 1934. have been awarded by the Nobel Foundation since 1901. Security Analysis: Principles and Techniques. 2 MPT has also succeeded in converting investing New York: McGraw Hill. from an art into a science, in the sense that investing 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 49

according to MPT has become a highly complicated, rigorously quantitative exercise for which physicists and mathematicians at the highest levels (the proverbial rocket scientists) are necessary. In making this conversion, MPT has achieved an underlying goal of taking personal preference and politics out of the investment process. The assertion that the personal and political should have no role in investment is not simply a practical consequence of MPT’s rules, it is a dogmatic belief fundamental to its religion. This making over of investment into an impersonal science has the virtue of restraining conflicts of interest and opening up the investment world to merit and skills that are independent of class and entrenched power. Discussing the strengths and weaknesses of this other aspect of MPT, unrelated to its attitudes toward risk, is a separate topic not dealt with here. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 6 | 50

how Should capital investment. Unfortunately, the world cannot rely on traditional capital markets alone to properly prioritize the future need for capital among key industries. If we the Economy could continue to rely on capital markets to properly allocate capital investment, we would not be facing the multiple crises that are now upon us. At the very least, we need be Regulated? a strong form of “managed capitalism” to guide corporate bodies toward socially- beneficial decision-making. Regulating the “economy” means regulating all economic sectors of society broadly speaking, not just the financial RichaRD a. RoSeN sector which is most in the public eye W telluS iNStitute today. This means inclusion of almost all areas of society where money or services change hands, including, in theory, the when thInkIng about how the government itself Listing some of the economy should be regulated we need to obvious institutional forms comprising make a totally fresh start. This is because the economy, we have: for-profit public very little creative thinking about this critical corporations, for-profit private corporations, subject has occurred for several decades. non-profit institutions of many stripes Specifically, the current economic crisis is a such as hospitals and universities, small stark reminder of how outmoded regulatory businesses with a single owner, worker- structures are in relation to the current owned corporations, and cooperative structure and function of the financial societies. The economic sectors that require industry, though problems of the financial varying degrees of regulation include: retail, industry are not the sole or even main cause wholesale, financial services, manufacturing, of the broader economic crisis. But even mining, farming, education, health care, and in the absence of a crisis, rethinking the housing, among other sectors. fundamentals of economic regulation would Given all the permutations and combina- be long overdue. tions of these types of corporate entities, Patching a generally broken regulatory and these sectors of the economy, we have a system is not enough in the U.S., or very wide range of situations that need to be internationally. We need new principles on regulated in order to advance broad social which to base a new approach to regulation, goals. For each combination of corporate principles that help guide corporate form and economic sector, one key question investment decision-making and business is how much and what kind of regulation is management toward practices and outcomes needed, and who should regulate? that are much better aligned with the great social and environmental challenges that ACTORS ANd AgENTS lie ahead. Fortunately, the six principles In beginning to think about how to regulate that the Corporation 20/20 project has the economy, first consider all relevant already developed for corporate design are relationships between the “big three”: also highly relevant to thinking about new businesses/non-profits, government, and regulatory designs and processes.1 As these civil society. In particular, the proper role principles make clear, the world’s critical that civil society should play in regulation social, economic, and ideological challenges, has generally been neglected, in part often lumped under the rubric of how to because even most proponents of strong achieve “sustainable development,” demand regulatory processes have not recognized the more targeted and directed use of new the important pro-democratic benefits that 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 51

can flow from the more active involvement last 20 years might have prevented some or of civil society in regulatory processes. Since most of the serious damage to corporations the economy, in the broad sense, comprises and investors linked to the current financial many different kinds of institutions, many crisis. More broadly, new forms of regulation of which are only partially participants in are needed to help ensure that necessary markets, the appropriate mode of regulation principles of corporate design such as the needs to be very different from industry to Corporation 20/20 principles are, in fact, industry, and from type of market to type followed. These principles require that of market. In addition, “regulation” does private interests serve the public interest, and not necessarily just mean regulation by that as part of serving the public interest all government agencies, even though most stakeholders should receive a fair share of regulation probably should be overseen, all the wealth that corporations create. (See in a legal sense, by a government or quasi- Corporation 20/20 principles #1 and #2 at government agency or commission. And, of www.corporation2020.org.) Thus, achieving course, government functions themselves the public interest in all its aspects must can be divided into executive, legislative, always be the core rationale of regulation. and judiciary branches, which further The second important relationship complicates the picture. between regulation and money arises when In addition, there are external factors investment decision of all sorts are made. that affect the optimal regulation of various The need for regulatory mechanisms to sectors of the economy. For example, foster more democratic control over a corporations that have a major social and/ broad range of investment decisions, even or environmental impact clearly need those of private for-profit corporations, is more regulation than small businesses greatly under-appreciated. Without greater that have much less impact. The potential democratic control over the full range of for systemic impacts and risks should relevant investment decisions, the public also be a justification for more strict and interest cannot be achieved. The majority comprehensive regulation. Thus, financial of the investments that society makes institutions have to be regulated in ways that cannot be allowed to be controlled solely the manufacturers of common household by private interests. To do so would most items do not. After all, the bankruptcy of likely mean that neither corporations, nor even a major manufacturer of dishes, for thereby society, would function sustainably, example, would have little systemic impact nor would the wealth and other benefits on the economy. Furthermore, issues of generated by new investments be equitably potential market power (quasi-monopoly) distributed. (See, especially, Corporation also have to be taken into account when 20/20 principles #3, #4, and #5 in this regard assessing the appropriate level of regulation. at www.corporation2020.org.) Then, again, there is a wide variety of labor, Another type of problem which regulation wage and salary, pension, health insurance, addresses is the problem of the exercise of and health and safety issues to take into market power in various types of markets. account In short, the picture that emerges If markets are not reasonably competitive, is clear—no one size or type of regulatory then either temporary or permanent approach fits all sectors of the economy. regulation of those markets is justified to ensure enhancement of the public interest WHy REgUlATE? by achieving the fair pricing of products and In a capitalist market economy, what is the services in those markets. Fair pricing also core rationale for regulation? To begin, would help ensure that Corporation 20/20 sound regulation should attempt to prevent principles #2 and #4 were implemented; a wide range of problems from occurring, namely, that the wealth and value generated including, and this is new, the misallocation by business would be distributed fairly of financial resources. Obviously, more among relevant stakeholders, especially regulation of new financial products over the consumers in this case. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 52

Regulation can, then, have a profound A second argument against regulation is effect on how society spends or invests that it is often too expensive relative to its its financial resources, and what it pays potential benefits. This argument is clearly for its products and services. Markets do related to the economic efficiency argument not necessarily yield optimal, aggregate above, because doing a cost/benefit analysis investment patterns owing to information of regulation is part of measuring economic shortcomings, their failure to account for efficiency. Of course, this argument is often externalities and multiple social goals, and a disingenuous because the risks of proceeding lack of ethical considerations which would with unregulated processes are usually help direct the flow of capital to socially not fully (or even partially) accounted for desirable ends. in such a cost/benefit analysis. Partly this Finally, as noted previously, regulation can happens because the analysts artificially and should be an instrument to ensure more segregate what they call public and private democratic decision-making. This occurs, costs, as if private financial losses are not both by allowing greater public review of social costs as well, and vice versa. decisions and issues being regulated, by Finally, some attack regulation on the facilitating greater transparency and public grounds that it reduces the freedom of disclosure of the information on which certain economic actors, such as business decisions being regulated are made, and owners, to act in ways that they claim as by providing a platform for a wider range an entitlement. The presumption behind of stakeholder input into, and power over, this argument seems to be that people relevant regulatory decisions, including have certain “rights” to carry out their investment decisions. (See Corporation business without regard to their impacts, 20/20 principle #6 which supports the right as if such activities exist in outer space. of natural persons to govern themselves, This argument tends to ignore the fact which should include their right to that without the existence of many social democratically decide how society’s financial institutions—not the least of which are the resources should be invested to achieve courts, regulatory agencies, and the rule of social goals.) law—doing business would be impossible. In contrast to these reasons for regulating Of course, pro-business ideology tends to institutions, markets, services, and strongly emphasize the need for the rule products, there are common arguments of law to protect their property, but it is against doing so. One main claim is that less enthusiastic about relying on the rule regulation is not economically efficient in of law to protect the rest of society from many situations. Implicit in this claim, of the negative consequences of business course, is the view that economic efficiency enterprises themselves. is the most important factor to take into account when considering how to regulate BETTER REgUlATORy PROCESSES the economy. In fact, economic efficiency What new regulatory institutions and is but one criterion by which to judge the processes should be created to advance the performance of an economy and a society. public interest while enabling responsible The degree of democratic decision-making enterprises to prosper? One group that is another, perhaps more important should be considered for a much more criterion. And, no one approach to making active role in future regulatory bodies is civil investment decisions is going to lead to society, defined as all those organizations perfect outcomes, since no approach can consisting of voluntary groups of citizens achieve perfect foresight. Thus, having more that form around a set of issues. Usually, democratic input to decision-making should these organizations are non-profits. They help blunt criticism when some investments, could be faith-based, unions, environmental in fact, turn out to be underperformers, as groups, or PTAs, among others. is inevitable under any set of regulatory or We also need to remind ourselves that market structures. regulation often works by regulating the 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 53

activities of people, in addition to the doing so commits the electric ratepayers to institutions for which they work. This paying for coal, and not natural gas as the is often the case for workers whom we fuel, for the entire life of the power plant, consider “professionals.” Various types of which could be 50 years or more. This professionals are often regulated by licensing decision obviously has many environmental standards aimed at strengthening the quality and economic impacts over the long term. and safety of the services they provide. One of the most attractive features of This approach to regulation applies to both well-functioning state PUCs (there is doctors and public accountants, among no exact federal counterpart) is that all many others. Probably other professionals decisions are based on evidence, as best should be more highly regulated as well, the commissioners that serve on these such as financial sector workers of various commissions can determine the evidence. types. Of course, just because accountants Evidence is gathered on all issues that the must be licensed as individuals, does not PUC is obligated to decide by holding mean that accounting firms that consist formal hearings that must comply with of many licensed accountants should also administrative legal processes. Because not have their operations regulated. But administrative law is followed throughout clearly there is an efficiency-related trade- the PUC hearing process, the decisions off illustrated by this example between the of PUCs can also be appealed to relevant efficacy of regulating individual employees, courts. The evidence is supplied to PUC and the regulation of the institutions in commissioners by witnesses who testify which they work. under oath in the hearings. The witnesses in a case are often experts in technical fields THE PUBlIC UTIlITy COMMISSION relevant to the issues being considered, but MOdEl non-experts are often allowed to testify as At least one somewhat obscure but poten- well in order to get a broader range of public tially powerful model exists for a regulatory input into all decisions, many of which process that could regulate much of the are basic policy decisions. Importantly, all economy in which medium-size and large witnesses can be cross-examined by the corporations are the main actors. This is the lawyers of the legal parties to the case to try American model of public utility commis- to further determine the weight that should sions (PUCs). PUCs are best known for rate- be given to their testimony, just as occurs in setting with respect to energy, telecommuni- most courts. cations and water. But even more important In PUC proceedings, all parties to each case is their little-known role in approving all are allowed to ask formal discovery questions major utility investments, and all utility prod- (make information requests) of the business ucts for which they set rates. It is the fact that being regulated, so that reliable and complete PUCs have the authority to approve invest- information can be relied on by each party ments that makes PUCs particularly power- to the case. Because of the discovery process, ful. They are given this authority to approve the information advantage that unregulated investments because a large part of the cost corporations usually have relative to the of all utility services provided to the public is general public when it tries to comprehend the cost of paying off capital investments in corporate decisions is greatly reduced. plant and equipment. Importantly, a wide range of types of orga- In addition, the kind of investments nizations, corporate, governmental or civil approved by PUCs often determines many society, can be legal parties in PUC cases. of the other costs of providing services to Thus, widely diverse opinions and positions customers over a very long time period for are represented, and usually supported by any given type of utility service. For example, legal counsel. Sometimes the PUC orders the if a PUC approves a major investment in a regulated company in a case to pay for the new coal-fired electric power plant instead legal and expert witness costs of representa- of in a new natural-gas-fired power plant, tion for stakeholders who do not have suf- 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 54

ficient income to pay these costs themselves. industry-specific expertise. Depending This element of the PUC process ensures the on the regulatory needs of that particular fair and relatively equal representation of all industry, each such IRB would have stakeholders. Finally, the PUC commission- somewhat different responsibilities and ers and staff members themselves should be types of authority to cover different sets of chosen from a diverse set of stakeholders, so issues, as needed, to promote the public that democratic decision-making could be interest. The scope and depth of regulation even further enhanced. would vary with the scope and depth of each One implication of applying this PUC industry with respect to environmental and model to non-utilities is that regulatory social impacts. Diverse stakeholder interests decision-making processes would become would be represented at all levels of the IRB far more transparent and publically regulatory process. accessible than is typically the case. For The focus of each IRB should be to ensure example, currently, many federal regulatory that appropriate financial investments are bodies merely allow comments on made by each industry in a way that mutu- proposed rules to be submitted, but open ally reinforces the need to achieve key social public evidentiary hearings are not held so and environmental goals over the coming as to open up the internal decision-making decades, with mitigating climate change process. (This includes the Security and chief among these goals. In fact, given how Exchange Commission, the Environmental little time the world has to mitigate climate Protection Agency, the Federal Energy change, water shortages, and the associated Regulatory Commission, and the Federal human dislocation, among other problems, Communications Commission, among it is inconceivable how unregulated and others). Undemocratic “back-room” undirected corporate investment decisions deal-making would be a lot more difficult could even come close to putting the world under a PUC-like regime because PUCs on a reasonably safe and certain trajectory also have to write formal orders explaining towards climate stabilization, and sustainable exactly what their decisions are, and the development in general. basis for them, as rooted in the evidence The IRB/PUC model would work in the presented in each case. Of course, no following way. Whenever a business of regulatory process can ever guarantee significant size wanted to invest more than that the regulatory decision-makers will a specified minimum sum of money (e.g., balance all relevant arguments and societal $10 million) in a new production facility for interests in a reasonable way consistent an existing product type, or to create a new with the evidence presented to arrive at the product or service, they would apply to their true “public interest.” But such fallibility industry IRB for approval of this investment. pertains even more so to private corporate The IRB would seek further information decision-making by Boards of Directors regarding the investment, as it deemed and executives of corporations wherein necessary. If the investment proposed was balanced stakeholder input is rarely the relatively small and non-controversial, case even for decisions with long-term the IRB would have the authority to issue social and environmental consequences for an order approving and/or modifying the the public-at-large. investment without a formal hearing, but informal input would still be solicited Industrial Regulatory Boards and from relevant stakeholders. If the applicant democratic control of investment. In an accepted the order, the investment could earlier paper I have proposed that Industrial go forward. However, if the investment Regulatory Boards (IRBs) be established proposal was large and/or controversial, in each major industry along the lines of then the IRB would determine that formal the PUC regulatory model as described hearings should be held. This would involve above.2 Each IRB would be composed of a full-scale review of the evidentiary and commissioners and technical staff with policy issues relevant to whether or not 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 55

the proposal should be approved, with or U.S., has the authority to take the impact of without modification. expensive patented seeds on the finances of It is important to note here that generally farmers into account as a basis for restricting the initiative to invest would come from the production or creation of new seed either the relevant private or public types. Yet new patented seeds have stirred corporation, and not from the regulatory tremendous controversy both here and body or the government. Thus, typically, no abroad, with regard to their social impacts as agency of the government would require well as biological impacts. that any new investment be made by If an Industrial Regulatory Board existed corporations. However, in other situations, for the agriculture industry, the Board would a particular industry IRB might have certain also have to investigate the relationship legal responsibilities to achieve certain social between a company patenting certain seeds goals, such as keeping the electricity system and the price they could charge for them. reliable. In such a case, the IRB might need After all, patented seeds greatly reduce to find either an existing public or private the possibility of competition among seed corporation that would be willing to make producers, and thus the possible exercise the relevant investments needed to achieve of market power has to be reviewed. Thus, that social goal. If no existing corporation patented seeds might have to be price was willing to do so, a new public controlled, so that only a fair rate of return corporation might need to be established on the relevant investments could be with governmental financial support to charged to customers. Also, of course, the enable this social goal to be achieved. An social and environmental disruption that example of where such a need might often patented seeds might cause would have to be arise is the need for more affordable housing considered before such an IRB could approve for the poor and lower middle class. any new seed products. Thus, the core motivation for the enhanced (or new) regulation of key corporate (and 2. Chemicals: In contrast to the fact government) investment decisions is to that there are thousands of chemicals ensure that society’s scarce capital is not mis- manufactured in the U.S. that have never directed, especially during the coming criti- been tested for safety, a chemical industry cal decades during which a massive “green” IRB would prevent such a situation from New Deal, among other investment pro- ever arising. The IRB could ensure this since grams, will be required to meet the world’s it would have the power to disapprove any pressing social and environmental goals. new chemical product if it were not in the public interest. Furthermore, since most Different impacts, different regulatory existing chemicals are made from fossil fuels regimes. As discussed above, each industry and other minerals, such an IRB could force is unique in structure, technology and producers to back off these raw materials in impacts on society and the environment. order to move towards renewable sources This reality is the foundation for developing of energy and chemical feedstock such a range of regulatory “intensity” to meet as biomass. Many, if not most, organic society’s sustainability goals. To illustrate, chemicals can, in fact, be made from consider the four industries below: biomass feedstocks. In addition, chemicals made from unsustainable minerals could be 1. Agriculture (patented seeds): In the U.S., phased out if other chemicals deriving from the full range of social and environmental more sustainable feedstock would suffice in impacts of new patented seeds has not their place. been deliberated in an open PUC-like, A chemical industry IRB should also set methodical process, even though such up a cycle of hearings in order to review issues have occasioned widespread concern whether or not the production of each and criticism in the NGO community. For existing chemical product should be allowed example, no regulatory body, at least in the to be continued based on new evidence of its 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 56

environmental impacts as they emerge. The nor the Justice Department currently ability to recycle or reclaim various chemical makes such determinations as to the need agents would also be a consideration in the for price controls for pharmaceuticals Board’s deliberations. Presumably, such under U.S. anti-trust statutes. (Or, at least, a Board would adhere to a precautionary such determinations are extremely rare.) principle approach to such matters. Again, Similarly, in situations where government as with patented seeds, if a new chemical research funds helped facilitate the discovery product were both patented and so unique as of a new drug, then a pharmaceutical to lead to the likelihood of a quasi-monopoly industry IRB could force the relevant in the market for such a product, then its manufacturer to share its profits from selling price would have to be regulated, as well. that drug with the government. Certainly, a chemical industry IRB would 4. Financial services: In the wake of the carefully regulate the location environmental economic crisis, a broad-based consensus impact of any new chemical factories or has emerged calling for revamping financial refineries. Finally, a chemical IRB could services regulation. But beyond that general review national production levels of all point, agreement on a detailed set of chemicals in order to determine the need for regulatory structures has yet to materialize. all the chemicals currently produced. For example, almost no one is advocating bringing more transparent and democratic 3. Pharmaceuticals: Even though the U.S. procedures to the deliberations of the currently regulates drugs through the Food Security and Exchange Commission, the and Drug Administration (FDA), there are Federal Reserve Board, or the Treasury many weaknesses in the FDA’s operations Department. In fact, those agencies are relative to how a full-fledged pharmaceutical notorious for depending on fairly secret industry IRB would function. First of all, an back-room deliberations and negotiations IRB could prohibit patented copycat drugs for making policy, with only certain where substitutable generic drugs would industry insiders being consulted. That suffice, in order to reduce wasted investment type of process must be replaced with open within the industry. Also, the review hearings where both expert and non-expert and approval procedures for each new input is garnered. Financial regulation is no drug could be significantly democratized more or less worthy of being based upon through the public hearing process that transparent and accountable processes all Boards would be required to utilize in than any other type of regulation, except, most cases. This would allow citizen and perhaps, during periods of extreme crisis civil society input into all decisions in a which, hopefully, better regulation will help way that currently is impossible when drug avoid. The potential social impacts must also applications are reviewed. Thus, citizen be accounted for when a financial industry groups could call their own expert witnesses IRB decides which financial products are to testify in such hearings along with safe enough to allow, and the risk profile of industry and agency staff witnesses. This each product should be made well known would help break the current dependency of to all industry actors. Furthermore, as agencies such as the FDA on scientists whose with any other IRB, a financial industry work is funded directly by the industry that IRB should be staffed with a wide variety the FDA is attempting to regulate, a topic of of industry experts, representing the full much recent controversy. range of policy positions on relevant issues. And again, if the likelihood of a company The same should be true for the financial having market power for any given product industry IRB commissioners themselves. The could be demonstrated due to its unique Board commissioners should not be limited features, then the new IRB would regulate to financial industry insiders based on the the price of this product, which is something implicit assumption that other stakeholders the FDA has no current power to do. could not possibly understand the relevant Neither the Federal Trade Commission issues. Furthermore, federal-level financial 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 57

regulation would have to be synchronized appropriate moment in time to complement with state- and local-level regulations in damage control with proactive, positive this industry or, in the case of the insurance regulatory principles that are designed industry, federalized altogether. to achieve specific public purposes. With a broad spectrum of urgent social, CONClUSION economic, and environmental problems The structure and function of all existing upon us, enhanced regulatory structures and future regulatory bodies needs to be re- and processes stand as a key opportunity thought from a clean slate. Most regulatory to mobilize all our social resources toward bodies should be more strictly restructured solving such problems, while at the same around specific industries or commercial time enhancing democratic process and services, so that those bodies can focus on consciousness. It is this balanced blend of developing the right centers of expertise to damage control and proactive principles for better inform their decision-making. But all achieving society’s goals that should shape basic industries and sectors of the economy, the purpose and structure of regulation in including government agencies, should be the coming decades. n covered by enhanced regulatory processes. With rare exceptions, all regulatory ENdNOTES board proceedings and deliberations 1 Please see www.corporation2020.org. should be completely public, based on 2 Rosen and Schweickart. 2006. “Visions of Regional evidence collected broadly from all relevant Economies in a Great Transition World.” Great stakeholders under the powerful mechanism Transition Initiative Paper Series. Boston, MA: Tellus Institute. of administrative law. Generally, regulatory bodies should react to applications from public and private corporations for investment and/or new product approval. Civil society participants should be eligible for funding mechanisms in order to help ensure a diverse range of such participation. This implies that industrial (commercial) regulatory boards might also have to regulate the prices for many products and services, as well as the environmental and social impacts of such products and services, if market power is found to exist in certain industries. This is because technological change and industry structure may allow certain providers of these products and services to be able to exercise market power in relevant markets, so that the pricing of goods and services could not be competitive. Finally, whether or not major new investments or new products and services are broadly in the “public interest” should be the guiding “bottom-line” criterion on which all regulatory decisions are ultimately based. Regulation has long been defined in terms of maximizing damage control—namely, to limit the negative behaviors of business to ensure protection of the public interest. While to some degree this damage control mindset should be maintained, now is an 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 7 | 58

Work and these measures overall Well-Being (WB) is quantified using the following formula: WB = (HLE x SWB) / 10 Well-Being The division by 10 is an adjustment made so that the values of WB lie in the same numerical range as human life spans. WB has a simple meaning. It is the satisfaction- JohN Stutz adjusted healthy life span. telluS iNStitute There is a tendency to think that well- i being as just defined fails to reflect many aspects of life because they are absent from the WB equation. In fact, that isn’t the case In an economy focused on growth because of the way the survey question used and individual gain, it is difficult to question to assess SWB is framed. The question asks the primacy of compensation among the how satisfied is the respondent is with life as indicators of welfare and create space a whole. Thus, in principle, all aspects of life for a broad discussion of the factors that are taken into account. contribute to well-being. Yet doing so is Physical and subjective well-being are essential to corporate redesign. Earnings separate but overlapping areas of scholarly in- are but one contribution to a worker’s terest. The section of the Measure of America well-being. A long and satisfying work (Burd-Sharps et al. 2008) captioned, “A Long experience, rich in opportunity and and Healthy Life,” provides a good introduc- fulfillment, depends on a host of tangible tion to physical well-being. The recent book, and intangible factors. The current economic Happiness – Lessons from a New Science crisis provides a rare opening for rethinking (Layard 2005), provides an introduction and the linkage between well-being and work. overview of major results concerning SWB. Doing so is long overdue. This paper aims to The construction of an overall well-being get the discussion rolling. index as the product of physical and subjective well-being is discussed in the paper by WHAT IS WEll-BEINg? Nic Marks on the Happy Planet Index. (Marks The study of well-being focuses on an 2006) Use of the product is the idea of Ruut individual’s prospects for a long, healthy, Veenhoven, a well-known expert on well- and satisfying life. It provides a framework being, who argues that it provides the best within which quantitative assessments can overall measure available. When other refer- be developed. Like the acreage of a field, ences are not provided, results on physical well-being is quantified based on its “length” and subjective well-being can be assumed to and breadth.” The preferred measure of come from Burd-Sharps et al. and Layard. length is the World Health Organization’s Well-being, as just described, is an individ- Healthy Life Expectancy (HLE) at birth. This ual attribute. Both of its components—HLE is the number of years of healthy life a new- and SWB—are in part genetic. However, un- born can expect given current patterns of like hair and eye color, economic and social illness and death. Because it reflects current conditions have important effects on each of patterns not their evolution over the infant’s them. It is these effects which are relevant to life, HLE provides an indicator of physical the exploration of the linkage between work well-being for the current population. and well-being. The measure for breadth, referred to as Subjective Well-Being (SWB), is the average HOW MUCH dOES COMPENSATION level of life satisfaction determined on the MATTER? basis of a standard survey question scored Compensation—consisting of wages and on a scale of one to ten. (Layard 2005) Using benefits as well as bonuses, profit sharing 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 8 | 59

and stock options—is assumed to provide Historical studies show that the develop- the most important linkage between work ments that led to gains in lifespan were quite and well-being. This view is reflected in diverse. The studies reveal neither a “general the efforts of individuals and households mechanism” nor even a common role for to “get ahead,” and in negotiations between income. Instead, what they show is that gains labor and management. If, however, gains in lifespan depend on the existence of na- for some are not to be offset by losses for tion-specific social structures and relation- others or eaten up by inflation, then income, ships which are utilized to produce chang- defined as the average real Gross Domestic es—more frequent hand-washing, human Product per capita, needs to grow. Thus, it waste disposal away from drinking water, is growth in income that is the focus in na- acceptance of immunization, etc.—which in tional and multi-national economic policy. turn increased lifespan. (Riley 2008) The focus on income growth reflects a Insight into the relationship between in- broad consensus that the way to increase come and HLE can be gained by considering well-being is to have vigorous income the situation in the U.S. The U.S. has a sig- growth which permits real growth in nificantly higher income and spends much compensation. In the face of this consensus, more per capita on health care than Japan the results obtained from the study of well- or the nations of Western Europe but has a being are somewhat surprising: lower HLE than either. HLE varies across the  Historical analysis shows that while states in the U.S. as does income. Statistical increases in income have accompanied analysis shows that only 12 percent of the gains in lifespan, they are not the cause variation in HLE is explained by the differ- of such gains and indeed have played a ences in income. What explains the other 88 modest role in producing them. percent? The answer is a variety of factors.  It remains an open question whether Some are things one would expect, such as increases in SWB accompany gains in the extent of health insurance coverage. income over time. The importance of relative income and adaption suggest that SWB ANd INCOME gROWTH – any effect of income growth on SWB will, A WEAk RElATIONSHIP AT BEST at most, be modest. Unlike lifespan, there is very little long- term historical data on SWB. The best data HlE ANd INCOME gROWTH – available is for the U.S., Western Europe, and CORRElATION BUT NOT CAUSATION Japan. It covers only the period from 1950 The historical record shows a clear to the present. During this period the gains association between income and lifespan. in income for these three nations ranged This has led historians to investigate the role from roughly three- to ten-fold. (Maddison of income growth in causing the increase 2007) For the U.S., experts have been unable in lifespan. Medical scientists, for whom to find any evidence of accompanying gains distinguishing causal relationships from in the average level of SWB. For Western mere statistical associations can be an issue Europe and Japan researchers have recently of life or death, have developed standard found some evidence of very modest criteria to apply in such investigations. The increases in SWB. However, this finding is only mandatory criterion is “temporality”— controversial. There is no explanation why the cause must precede the effect. Careful Japan and Western Europe would behave historical studies show that, for a number of differently than the U.S. Nor is there the type nations, increases in lifespan have occurred of historical analysis required to explain with only minor gains in income. Further, the role that income gains play in causing for the rich nations which currently enjoy increases in SWB. the longest lifespans, much of the increase in Why massive gains in income were lifespan took place while income was low. not associated with clear, substantial Medical scientists also look for a general increases in SWB has been the subject of mechanism which links cause and effect. much research. The results highlight the 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 8 | 60

importance of relative income and adaption corporations must look beyond income in limiting change in SWB. To appreciate growth and consider working conditions. the importance of relative income in Occupational health and safety regulations determining SWB, a well-known research are found in virtually all nations, rich result will be helpful: and poor, though enforcement of course  College students in the U.S. were asked varies widely. However, the focus of those to imagine two different outcomes when regulations is generally quite narrow. If the they entered the work force. Either they design of future corporations is to effectively would earn $50,000 while their classmates foster worker well-being, a broader focus is would average $25,000 or they would earn essential. Two key aspects are hours worked $100,000 while the others would average and job security. Both have a significant twice that. The students were asked which effect on both SWB and physical well-being outcome they would prefer. Most chose in the U.S., and lesser effects elsewhere. the first. In the U.S., between 1970 and 2000 the The preference expressed by the students is percentage of men working 50 hours per typical. In determining SWB relative income week or more increased significantly. For generally matters quite a bit. As a result a women the percentage more than doubled. large increase or decrease in income over Toward the end of the period a survey was time that leaves the income distribution conducted in which participants were asked relatively unchanged has little effect on the to compare their ideal and actual hours of average level of SWB. work. Roughly 60 percent said the ideal Adaption leading to growing expectations was lower, while less than 20 percent said it also helps to explain how massive shifts in was higher. 28 percent said their ideal was income may be accompanied by little or no at least 20 hours less than actual. It is fairly change in SWB. Here again consideration of a easy to understand how working more than bit of research conducted in the U.S. is useful. one considers ideal might adversely affect  Between 1955 and 1985 the Gallup Poll SWB. (Jacobs and Gerson 2004) Outside the asked respondents to indicate the smallest U.S. work time is less of an issue. However, amount of income a family of four needed the increasing intensity of work is a concern to get along in their community. The both within and outside the U.S. (Green required real income rose, tracking the 2007). In general, this increase has the same growth in actual real income. adverse impact on SWB as long hours. What this result shows is that simply Job insecurity, or simply a significant having the “necessities of life” was seen increase in the unemployment rate, has to require substantial income growth. Of been shown to have a significant adverse course, had income growth been lower, impact on SWB. Here much more than expectations would likely have remained concern about a drop in income is involved. lower, and adverse impacts on well-being Employment provides an important part would have been avoided. Thus, through of an individual’s identity and sense of adaption, changes in SWB decouple from self-worth. In rich nations other than the changes in income over time. U.S. there is generally greater job security. However, it is often more difficult for those lOOkINg BEyONd INCOME gROWTH entering the job market, initially or after a Research on well-being shows that income job loss, to find employment. This is simply growth has, at best, a limited impact on well- a different sort of “job insecurity,” with the being. This is not a reason to ignore income same adverse impacts on SWB. gains, and particularly the workers’ share of There are a variety of connections them. Indeed, standard economic theories between long hours and insecurity and of wage determination stress the importance workers physical well-being. Some, such of perceived fairness in setting wage levels. as the adverse impact of long hours on (Akerlof and Shiller 2009) Rather, the point time available for exercise, are relatively here is that to adequately address well-being, direct. Others are more subtle. Long hours 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 8 | 61

and insecurity are sources of stress which, leads to a discussion of the desirability of in turn, have adverse physical effects. such an economy. However, even accepting In addition, working more hours than the highly competitive global economy as a desired or worrying about job security can given, there are measures that corporations, make individuals less able to maintain a acting individually and collectively, could satisfactory marriage and friendships, both undertake to enhance worker well-being. of which contribute to physical well-being, Doing so is not a matter of altruism; in part by helping the individual cope with such measures arguably have positive the impacts of stress. (Helman 2007) consequences for productivity and long- term prosperity of the organization. REdESIgN RAISES THE WEll-BEINg In the U.S, working “long hours” (i.e., 50 ISSUE or more hours per week) is most common The principles developed by Corporation among highly educated management or 20/20 begin with the observation that the technical personnel in whom a firm has a purpose of the corporation should be to substantial investment. The corporation harness private interests to serve the public pays the costs in absences from work and interest. After addressing fair returns, turnover associated with the hours they sustainability, equity, and governance, the work. Similar costs are associated in general principles conclude with the requirement with intensity of work. that the corporation not infringe on univer- Job insecurity is also due in part to sal human rights. Well-being is certainly part structural features of the modern economy. of the public interest. The right to pursue it is Consider for a moment the pace of change. arguably a universal human right. In the U.S., between 1990 and 2003, the net Redesign is the principal strategic ap- change in the number of jobs was modest, proach put forward by the Corporation averaging growth of .3 percent per quarter in 20/20 project. The mission statement for the the private sector. However, that .3 percent project makes it clear that Corporate Rede- was the difference between job destruction sign is to shift the focus from the produc- of 7.7 percent per quarter and job creation tion of goods and services to the nature of of 8.0 percent. (Cahuc and Zylberberg 2006) the corporation, particularly its purpose, its With such turbulence, job insecurity will, of character, and its architecture. (Corporation necessity, be a continuing worry. 20/20) This framing of redesign raises two Workers’ concern about possible job questions related to well-being: loss is increased by typical labor practices.  Purpose. Should part of the corporate Faced with a downturn, employers typically purpose be to help workers maximize their choose layoffs rather than reductions in well-being? hours and wages spread across most or all  Character and Architecture. How does segments of the workforce. The rationale the current character and architecture of is that, while both have adverse effects on the corporation need to change in order workplace morale, with layoffs most of the to fulfill its legitimate purposes relative to problem goes “out the door.” If the well- workers’ well-being? being of workers is a concern, reductions in The Corporation 20/20 principles show hours would be the preferable option. If the that the answer to the first question is “yes.” reductions were made and conveyed in a Turning to the second, the issue is how and way that increased worker security, well- to what extent the current character and being would likely be enhanced. architecture of the corporation be changed. Individual firms can assess what actions to reduce hours and increase job security WHAT IS THE SCOPE FOR ACTION? might be cost-effective and feasible for them. Long hours in the U.S. and the more general The ability to take such actions is, of course, increases in the intensity of work reflect the limited by the behavior of competitors. increasingly competitive nature of the global Here, following the model established by the economy. Dealing fully with these issues Global Reporting Initiative (GRI), it may be 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 8 | 62

possible for the firms in various industries to REFERENCES come together and jointly adopt standards Akerlof, George A. and Robert J. Shiller. or practices which, if adopted individually, 2009. Animal Spirits – How Human would lead to a competitive disadvantage. Psychology Drives the Economy, and Why it Matters for Global Capitalism. Princeton and IS THIS THE TIME FOR CHANgE? Oxford: Princeton University Press. To the extent that well-being is addressed in the corporate world today, the focus is on Burd-Sharps, Sarah, Kristen Lewis, and increases in compensation for the workers, Eduardo Borges Martins (eds). 2008. The returns and appreciation for the “owners,” Measure of America – American Human and benefits in the form of enhanced Development Report 2008-2009. 2008. Social product quality and diversity as well as Science Research Council and Columbia declining unit costs for customers. This University Press. approach reflects a tacit judgment that, if the corporation is contributing to the growth in Cahuc, Pierre and André Zylberberg. 2006. income, it is doing what it can (and should) The Natural Survival of Work: Job Creation to foster well-being. Workers and those who and Job Destruction in a Growing Economy. represent them may question the sharing of Cambridge, MA/London, England: The MIT gains with the owners, but they generally do Press. not question the importance of increasing the incomes available for division. Corporation 20/20. The results on income and well-being www.corporation2020.org discussed in this paper put all of this in question. Given the weak role of income Elliott, Larry et al. 2008. A Green New Deal in fostering well-being, the emphasis on – Joined-up policies to solve the triple crunch growth is misplaced. A shift, based on an of the credit crisis, climate change and high understanding of the ways the corporation oil prices. London, UK: New Economics affects the complex web of mechanisms and Foundation. relationships which determine well-being is needed. In the U.S. hours of work and Friedman, Benjamin M. 2005. The Moral job insecurity must be addressed if a more Consequences of Economic Growth. New effective approach to well-being is to be York: Alfred A. Knopf. embedded in future corporate forms. . While the challenge of addressing working GRI. Global Reporting Initiative. www. conditions through corporate redesign is globalreporting.org. significant, the current financial turmoil may make action easier. There is a long history Green, Francis. 2007. Demanding Work – of social progress during times of financial The Paradox of Job Quality in the Affluent crisis. The best-known example is the U.S. Economy. Princeton and Oxford: Princeton New Deal that changed key elements of the University Press. relationship between labor and management. (Friedman 2005) A more recent example Helman, Cecil G. 2007. Culture, Health and is the work of Green New Deal Group in Illness. London: Hodder Arnold. the U.K., which links progress on energy and climate issues to the resolution of the Jacobs, Jerry A. and Kathleen Gerson. 2004. current financial crisis. (Elliott et al. 2008) The Time Divide: Work, Family, and Gender Changes that under normal circumstances Inequality. Cambridge, MA/London, UK: may appear to be impossible may be moved Harvard University Press. into the realm of plausibility when economic distress is widespread and business and Layard, Richard. 2005. Happiness – Lessons political leadership are forced to re-examine from a New Science. Penguin Books. the conventional wisdom. n 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 8 | 63

Maddison, Angus. 2007. Contours of the World Economy, 1-2030 AD. Oxford, UK: Oxford University Press. Marks, Nic. 2006. The Happy Planet Index. London, UK: New Economics Foundation. Riley, James C. 2008. Low Income, Social Growth, and Good Health – A History of Twelve Countries. University of California Press and Milbank Memorial Fund. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | PAPER NO. 8 | 64

Biographies REBECCA k. dARR Rebecca K. Darr is the Senior Fellow of Corporate Programs at The Aspen Institute's Business & Society Program (BSP). She joined Aspen BSP in December 2007 in a newly created role to advance outreach to the business and investor communities on the Aspen Principles for Long-Term Value Creation and other work of the Corporate Values Strategy Group. As an independent consultant, Rebecca helps clients in North America and Asia with sustainability strategy development and operations improvement; clients include start-up and long-running businesses from multiple industries, social enterprises and NGOs. Rebecca was part of the first corporate responsibility team at Deloitte Touche Tohmatsu from 2004-2006 and was a management consultant with Deloitte Consulting from 1996-2004. Rebecca holds a B.A. from Rice University, received her M.B.A. from the University of Michigan, and completed a post- graduate certificate in cross-sector partnerships at the University of Cambridge, England. PAUl R. EPSTEIN Dr. Paul Epstein is Associate Director for the Center for Health and the Global Environment, Harvard Medical School (http://chge.med.harvard.edu) and is a medical doctor trained in tropical public health. He has worked in medical and teaching capacities in Africa, Asia, and Latin America, and has worked with the IPCC, the NAS, NOAA, and NASA to assess the health impacts of climate change. Dr. Epstein coordinated Climate Change Futures: Health, Ecological and Economic Dimensions, with Swiss Re and the UNDP, assessing the risks and opportunities from climate change, and prepared the report Healthy Solutions for the Low Carbon Economy: Guidelines for Investors, Insurers and Policy Makers that examines energy options through the environmental health lens; supported by the Wells Fargo Foundation and the Global Roundtable on Climate Change (Earth Institute, Columbia University). Dr. Epstein received recognition for his contributions to the work of the IPCC, and was awarded the Nobel Peace Prize in 2007. MARk gOydER Mark Goyder is Founder Director of Tomorrow’s Company, a business-led think-tank which engages business leaders in difficult issues for the future. Current projects are Tomorrow’s Owners – stewardship of tomorrow’s company, Tomorrow’s Green Economy, and Tomorrow’s Global Talent. Previous reports include “Tomorrow’s Global Company – challenges and choices” (2007), “Sooner, Sharper, Simpler - on the agenda for integrated company reporting and UK reporting reforms (1998)”, “Redefining CSR” (2002) and “Restoring Trust: investment in the twenty-first century” (2004). Mark initiated the Tomorrow's Company inquiry into ‘the role of business in a changing world’ in 1993. For 15 years he was a manager in paper, printing and electronics. He has had advisory roles with British Airways, British Telecommunications, Camelot, and Co-operative Financial Services. Mark writes and broadcasts regularly and speaks to business audiences all over the world. He won the Institute of Management Studies (IMS) Tillers Millennium Trophy for best speaker. He was Director Magazine’s Director of the Month in June 2004. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | 65

kENT gREENFIEld Kent Greenfield is Professor of Law and Law Fund Research Scholar at Boston College Law School and is the author of the book “The Failure of Corporate Law,” published by University of Chicago Press. His published articles are widely cited, and he has been called “the leading figure” and “the most creative thinker” in the progressive, stakeholder school of corporate law scholarship. He is the Chair-Elect of the Section on Business Associations of the American Association of Law Schools. He also blogs for the Huffington Post. Before joining the BC faculty, Mr. Greenfield served as a law clerk to Justice David H. Souter, worked at the law firm of Covington & Burling, in Washington, D.C., and served as a specialist on corporate social responsibility at Levi Strauss & Co., in San Francisco. Mr. Greenfield is a graduate of the University of Chicago Law School and of Brown University, where he studied economics and history. MARJORIE kElly Marjorie Kelly is a business journalist at Boston’s Tellus Institute, where she is a specialist in issues of alternative enterprise design and co-founder of Corporation 20/20. She is currently working with the Ford Foundation on a project on shared ownership and community wealth control designs for rural areas. She is author of The Divine Right of Capital (Berrett-Koehler, 2001), named by Library Journal one of the best business books of the year and translated into three languages. Kelly was co-founder and president for 20 years of the company publishing Business Ethics magazine. Her writings and op-eds have appeared in publications such as Harvard Business Review, Chief Executive, Tikkun, Strategy and Business, San Francisco Chronicle, Boston Globe, Denver Post, St. Louis Post-Dispatch, and elsewhere. Ms. Kelly is at work on a new book about alternative enterprise design. She is a director of the Great Neighborhoods! Development Corp. in Minneapolis, a social enterprise revitalizing neglected neighborhoods. STEvEN d. lydENBERg Steven Lydenberg is Chief Investment Officer for Domini Social Investments LLC. He has been active in social investing for 30 years as Director of Corporate Accountability Research with the Council on Economic Priorities; Investment Associate with Franklin Research and Development Corporation (now Trillium Asset Management); and Director of Research with Kinder, Lydenberg, Domini & Co. (now KLD Research & Analytics). Mr. Lydenberg is the co-author of Rating America’s Corporate Conscience (Addison- Wesley Publishing, 1986) and Investing for Good (Harper Collins, 1993), a guide for socially responsible investors; and co-editor of The Social Investment Almanac (Henry Holt & Co., 1992). He is the author of Corporations and the Public Interest: Guiding the Invisible Hand, published by Berrett-Koehler in early 2005. He holds degrees from Columbia College and Cornell University and is a Chartered Financial Analyst (CFA). 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | 66

RICHARd ROSEN Dr. Richard Rosen is Executive Vice-President and a founding member of Tellus Institute. He has thirty years of experience in energy-sector resource planning and management and environmental compliance. In recent years, Dr. Rosen’s research has focused on the economics and feasibility of restructuring the electricity utility industry. In a variety of regulatory and public planning settings, he has presented detailed analyses of alternative supply options, renewable resources, environmental impacts, conservation, and integrated power plans in both market and regulated contexts. Dr. Rosen’s current research focus is on alternative economic visions and models for the global economy, including new approaches to capital markets, regulation, and design of the production unit. He is also active on these issues through the Great Transition Initiative and Corporation 20/20 networks of Tellus Institute. JUdITH SAMUElSON In 1998, Judy Samuelson created the Aspen Institute Business and Society Program (Aspen BSP), which employs research and dialogue among business leaders to build a sustainable global society. Aspen BSP targets innovators and works with business managers at all levels, from MBA students to Fortune 500 CEOs. Among its signature programs are Beyond Grey Pinstripes (a global data base and report card on MBA business education), and the Corporate Values Strategy Group (a forum for business leaders to promote change in policy and business practice in pursuit of long-term value creation). Judy recently helped spearhead the creation of the Aspen Principles, a set of guidelines for long-term value creation for companies and institutional investors. From 1989 to 1996, Judy led the Ford Foundation’s office of Program Related-Investments. From 1982-1989 Judy managed a sales and lending team at Bankers Trust Company. From 1974-1980 she worked in Sacramento as a lobbyist and legislative aid on California state health and education issues and in the Governor’s office of Planning and Research. JOHN STUTz Dr. Stutz is Vice-President of Tellus Institute, a non-profit organization which provides research and consulting services, primarily to clients in the public sector, in the areas of energy, environmental policy and sustainable development. Dr. Stutz has worked for the United States Environmental Protection Agency and the Organization for Economic Cooperation and Development, as well as various U.S. state and Canadian provincial agencies, on issues of regulatory, economic and environmental policy. Since 2000, he has also worked extensively on issues of well-being and sustainability. Dr. Stutz received a B.S. in mathematics from the State University of New York at Stony Brook and a Ph.D. from Princeton University. He then taught and did research at the Massachusetts Institute of Technology, the State University of New York at Albany where he received tenure, and Fordham University where he was associate professor of mathematics and co-director of the program in mathematics and economics. He left Fordham in 1976 to help found the Tellus Institute. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | 67

AllEN l. WHITE Allen L. White is Vice President and Senior Fellow, at the Tellus Institute in Boston, and directs the Institute’s corporate redesign program. Dr. White co-founded the Global Reporting Initiative in 1997 and served as its Chief Executive through 2002. In 2004, he co-founded and now directs Corporation 20/20, an initiative focused on designing future corporations to sustain social purpose. He advises multilaterals, foundations, corporations, and NGOs on corporate responsibility and sustainability strategy, policy and practice. He has held faculty and research positions at the University of Connecticut, Clark University, Tufts University, and Battelle Laboratories; is a former Fulbright Scholar in Peru; and served with the Peace Corps in Nicaragua. Dr. White has served on advisory boards and committees of the International Corporate Governance Network, ISO, Civic Capital, and Instituto Ethos (Brazil). He is Chair of iScale, a non-profit dedicated to building capacity and the movement in support of global, multi-stakeholder organizations. Dr. White is a member of the Steering Committee of the Institute for Responsible Investment, Boston College Center for Corporate Citizenship and, since 2004, has served as Senior Advisor to Business for Social Responsibility. He has published and spoken widely on corporate responsibility, corporate governance, and business- society relations. 2009 SUMMIT ON THE FUTURE OF THE CORPORATION | 68

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CoRPoRAtioN 20/20 | c/o tEllUS iNStitUtE 11 ARliNgtoN StREEt | BoStoN, MA 02116 | tEl: 617.266.5400 | fAx: 617.266.8303

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