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More builders and fewer traders: A growth strategy for the American economy

A trader works on the floor of the New York Stock Exchange shortly before the end of the day's trading in New York July 31, 2013. REUTERS/Lucas Jackson

In a new paper, William Galston and Elaine Kamarck argue that the laws and rules that shape corporate and investor behavior today must be changed. They argue that Wall Street today is trapped in an incentive system that results in delivering quarterly profits and earnings at the expense of long-term investment.

As Galston and Kamarck see it, there’s nothing wrong with paying investors handsome returns, and a vibrant stock market is something to strive for. But when the very few can move stock prices in the short term and simultaneously reap handsome rewards for themselves, not their companies, and when this cycle becomes standard operating procedure, crowding out investments that boost productivity and wage increases that boost consumption, the long-term consequences for the economy are debilitating.

Galston and Kamarck argue that a set of incentives has evolved that favors short-term gains over long-term growth. These damaging incentives include:

  • The proliferation of stock buybacks and dividends
  • The increase in non-cash compensation
  • The fixation on quarterly earnings
  • The rise of activist Investors

These micro-incentives are so powerful that once they became pervasive in the private sector, they have broad effects, Galston and Kamarck write. Taken together, they have contributed significantly to economy-wide problems such as: (1) Rising inequality, (2) A shrinking middle class, (3) An increasing wedge between productivity & compensation, (4) Less business investment, and (5) Excessive financialization of the U.S. economy.

So what should be done? Galston and Kamarck propose reining in both share repurchases and the use of stock awards and options to compensate managers as well as refocusing corporate reporting on the long term. To this end, these scholars recommend the following policy steps:

  • Repeal SEC Rule 10-B-18 and the 25% exemption
  • Improve corporate disclosure practices
  • Strengthen sustainability standards in 10-K reporting
  • Toughen executive compensation rules
  • Reform the taxation of executive compensation

Galston and Kamarck state that the American economy would work better if public corporations behaved more like private and family-held firms—if they made long-term investments, retained and trained their workers, grew organically, and offered reasonable but not excessive compensation to their top managers, based on long-term performance rather than quarterly earnings. To make these significant changes happen, the incentives that shape the decisions of CEOs and board of directors must be restructured. Reining in stock buybacks, reducing short-term equity gains from compensation packages, and shifting managers’ focus toward long-term objectives, Galston and Kamarck argue, will help address the most significant challenges facing America’s workers and corporations.


  • Download the paper


  • William A. Galston
  • Elaine Kamarck


Proximity to the flagpole: Effective leadership in geographically dispersed organizations

Temasys Communications' Chief Technology Officer Alexandre Gouaillard runs a demonstration of WebRTC

The workplace is changing rapidly, and more and more leaders in government and private industry are required to lead those who are geographically separated. Globalization, economic shifts from manufacturing to information, the need to be closer to customers, and improved technological capabilities have increased the geographic dispersion of many organizations. While these organizations offer many exciting opportunities, they also bring new leadership challenges that are amplified because of the separation between leaders and followers. Although much has been researched and written on leadership in general, relatively little has been focused on the unique leadership challenges and opportunities presented in geographically separated environments. Furthermore, most leaders are not given the right tools and training to overcome the challenges or take advantage of the opportunities when leading in these unique settings.

A survey of leaders within a geographically dispersed military organization confirmed there are distinct differences in how remote and local leaders operate, and most leadership tasks related to leading those who are remote are more difficult than with those who are co-located. The tasks most difficult for remote leaders are related to communicating, mentoring and building personal relationships, fostering teamwork and group identity, and measuring performance. To be effective, leaders must be aware of the challenges they face when leading from afar and be deliberate in their engagement.

Although there are unique leadership challenges in geographically dispersed environments, most current leadership literature and training is developed on work in face-to-face settings. Leading geographically dispersed organizations is not a new concept, but technological advances over the last decade have provided leaders with greater ability to be more influential and involved with distant teams than ever before. This advancement has given leaders not only the opportunity to be successful in a moment of time but ensures continued success by enhancing the way they build dispersed organizations and grow future leaders from afar.


  • Proximity to the flagpole: Effective Leadership in geographically dispersed organizations


  • Scott M. Kieffer

Image Source: © Edgar Su / Reuters […]

What must corporate directors do? Maximizing shareholder value versus creating value through team production

The outside of the New York Stock Exchange is seen in New York May 13, 2011. NYSE shareholders are scheduled to vote on the Deutsche Boerse deal on July 7 under a timeline that NYSE says is designed to comply with German law on mergers and acquisitions. REUTERS/Shannon Stapleton

In our latest 21st Century Capitalism initiative paper, “What must corporate directors do? Maximizing shareholder value versus creating value through team production,” author Margaret M. Blair explores how the share value maximization norm (or the “short-termism” malady) came to dominate, why it is wrong, and why the “team production” approach provides a better basis for governing corporations over the long term.

Blair reviews the legal and economic theories behind the share-value maximization norm, and then lays out a theory of corporate law building on the economics of team production. Blair demonstrates how the team production theory recognizes that creating wealth for society as a whole requires recognizing the importance of all of the participants in a corporate enterprise, and making sure that all share in the expanding pie so that they continue to collaborate to create wealth.

Arguing that the corporate form itself helps solve the team production problem, Blair details five features which distinguish corporations from other organizational forms:

  • Legal personality
  • Limited liability
  • Transferable shares
  • Management under a Board of Directors
  • Indefinite existence
  • Blair concludes that these five characteristics are all problematic from a principal-agent point of view where shareholders are principals. However, the team production theory makes sense out of these arrangements. This theory provides a rationale for the role of corporate directors consistent with the role that boards of directors historically understood themselves to play: balancing competing interests so the whole organization stays productive.


    • Download the paper


    • Margaret M. Blair


    JPMorgan executive pay wins slim support from shareholders

    Shareholders of JPMorgan Chase & Co narrowly approved on Tuesday the 2014 compensation packages for CEO Jamie Dimon and other top executives in a rebuke from investors over the bank’s pay practices.

    Only 61 percent of votes cast at a shareholders meeting were in favour of the compensation, which came under criticism by influential proxy […]

    Is Business Experience Enough to Be President?

    The White House is pictured in Washington D.C.(REUTERS/John Pryke).

    How to react to presidential candidates who are running, in part or wholly, on their experience in private business?

    It’s impossible for anyone to come into the White House with all the skills required to be a good president. We can know that key traits include intelligence, both cognitive and emotional; self-confidence; and decisiveness. Also needed are the ability to communicate; to listen and learn; to delegate; to recognize problems–and a sense of humor and humility.

    Candidates’ stands on the issues are critical in primaries and in the general election, but I suspect that the views of many independent voters–whose ranks are growing–may not be as intensely held as those of partisan voters.

    Given Americans’ widespread frustration with traditional politicians, it is understandable why a few candidates with at least some business experience have entered the fray. Having run a business exposes one to how government affects the private sector, which is the engine of economic growth and drives improvements in living standards.

    But running a private-sector business is very different from heading a federal government that employs millions, and that takes in and spends trillions, while also dealing with a wide range of domestic and foreign policy issues, many of which demand immediate attention. These things require dexterity–and the combined challenges are ones that no business ever comes close to dealing with. (Probably the closest experience to the presidency is running a large state. But even then, no governor has had to confront the range of foreign policy challenges facing the president.)

    A critical difference between running a business and government is that CEOs can usually make sure that their orders are carried out; and if they’re not, those who didn’t do their jobs can be fired. Imagine a president tried working with Congress that way. “My way or the highway” won’t cut it.

    One might think that military leaders would face the same problem, but successful generals, especially in recent times, have had to develop and hone political skills as well as knowing how to fight. Gen. Dwight Eisenhower is now regarded as a good president not only because of his military experience but because he also was a politician-administrator while commanding allied forces during World War II. George Washington had both a military and business background, but he was a politician too–and the government he oversaw wasn’t much larger than his (substantial) private business.

    Some 2016 voters will cast ballots based on particular issues. But for others, particularly those who believe this country is on the wrong track, a candidate running on his or her business background in an effort to stand out from the pack is not likely to have the qualifications most important to being a successful president.


    • Robert E. Litan

    Publication: The Wall Street Journal Image Source: © Reuters Photographer / Reuters […]

    The Children’s Place Sends Letter to Shareholders

    The Children’s Place, Inc. (Nasdaq:PLCE), the largest pure-play children’s specialty apparel retailer in North America, today announced that it has sent a letter to shareholders of The Children’s Place in connection with the Company’s Annual Meeting on May 22, 2015. The letter highlights the false and inaccurate claims and disruptive campaign waged against the Company […]

    Bank of America directors lose support from shareholders

    NEW YORK (Reuters) – Four Bank of America Corp (BAC.N) directors on the board’s governance committee received unusually small majorities of votes for re-election at this week’s annual meeting, according to tallies the company released on Thursday.

    None received more than 71.9 percent of the votes cast, compared with each last year receiving at […]

    Overcoming corporate short-termism: Blackrock’s chairman weighs in

    BlackRock Chairman and CEO Laurence Fink speaks at the Council on Foreign Relations in New York, February 29, 2012. Fink, who heads the $3.51 trillion asset management firm BlackRock, was speaking at the Council on Foreign Relations and discussing a series of objectives with chief executive officers.

    When the head of the world’s largest investment fund raises fundamental questions about U.S. corporations, we should all pay attention.

    In a letter earlier this week to the Fortune 500 CEOs, BlackRock Chairman Larry Fink criticized the short-term orientation that he believes shapes too much of today’s corporate behavior. “It concerns us,” he declared, that “in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies. Too many have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.” And he concluded, “When done for the wrong reasons and at the expense of capital investment, [returning cash to shareholders] can jeopardize a company’s ability to generate sustainable long-term returns.”

    Fink is correct on all counts. In a new Brookings paper out today, University of Massachusetts economist William Lazonick states that the 454 companies listed continuously in the S&P 500 index between 2004 and 2013 used 51 percent of their earnings to buy back their own stock, almost all through purchases on the open market. An additional 35 percent went to dividends. “Buybacks represent a withdrawal of internally controlled finance that could be used to support investment in the company’s productive capabilities,” he said.

    This is bad for the economy in two ways. As the growth of the U.S. workforce slows dramatically, economic growth will depend increasingly on improved productivity, must of which comes from raising capital investment per worker. Failing to make productivity-enhancing capital investments will doom our economy to a new normal of slow growth.

    Many business leaders say that they are reluctant to make long-term investments without reasonable expectations of growing demand for their products. That brings us to the second way in which corporate short-termism is bad for the economy. Most consumer demand comes from wages. If employers refuse to share gains with their employees, growth in demand is bound to be anemic.

    Although he clearly cares about his country, Fink is also acting as the steward of $4.8 trillion in investments. In an article published by McKinzie earlier this month, he warns that although the return of cash to shareholders is juicing equity markets right now, investors “will pay for it later when the ability to generate revenue in the long term dries up because of the lack of investment in the future.”

    Unlike most other corporate leaders who express concerns about these developments, Fink is unwilling to rely on moral suasion alone. Because current incentives are so perverse, he argued, “It is hard for even the most dedicated CEO to buck this trend.” The constant pressure to produce quarterly results forces executives to go along—or risk losing their jobs. That pressure comes from investors who are, in Fink’s words, “renters, not owners, who are going to trade your stock as soon as they can pocket a quick gain.”

    This logic leads BlackRock’s chairman to propose changing the tax code by lengthening to three years the the period needed to qualify for capital gains treatment while taxing trading gains at an even higher rate than ordinary income for investment held less than six months. To encourage truly patient capital, the capital gains rate would be stepped down to zero over a period of ten years.

    We can argue the merits of this idea, and we should. But the main point should be beyond argument. We need more builders and fewer traders, more Warren Buffetts and fewer Carl Icahns. And to get them, we’re going to have to change the laws governing corporate and investor behavior. Fink has opened up a crucial debate, and it’s time for Congress and presidential aspirants to join it.


    • William A. Galston
    • Elaine Kamarck

    Image Source: © Brendan McDermid / Reuters […]

    Stock buybacks: From retain-and reinvest to downsize-and-distribute

    A man looks at a board showing graphs of Japan's stock price indexes outside a brokerage in Tokyo June 5, 2012. (Reuters/Toru Hanai)

    Stock buybacks are an important explanation for both the concentration of income among the richest households and the disappearance of middle-class employment opportunities in the United States over the past three decades. Over this period, corporate resource-allocation at many, if not most, major U.S. business corporations has transitioned from “retain-and-reinvest” to “downsize-and-distribute,” says William Lazonick in a new paper.

    Under retain-and-reinvest, the corporation retains earnings and reinvests them in the productive capabilities embodied in its labor force. Under downsize-and-distribute, the corporation lays off experienced, and often more expensive, workers, and distributes corporate cash to shareholders. Lazonick’s research suggests that, with its downsize-and-distribute resource-allocation regime, the “buyback corporation” is in large part responsible for a national economy characterized by income inequity, employment instability, and diminished innovative capability.

    Lazonick also challenges many of the notions associated with maximizing shareholder value, an ideology that has come to dominate corporate America. Lazonick calls for a decrease, or even a ban, in stock buybacks so companies will be able to use these funds to finance capital expenditures but more importantly to attract, train, retain, and motivate its career employees. And some of the funds made available by a buyback ban can even flow to the government, he argues, as tax revenues for investments in infrastructure and human knowledge that can underpin the next generation of innovation.


    • Download the paper


    • William Lazonick

    Image Source: Toru Hanai / Reuters […]

    Shareholders get a louder voice

    Publicly traded companies in the U.S. provide their shareholders with a voice on who runs the company. But corporate governance is not like a political democracy where voters usually choose between two candidates. The company’s slate of directors is typically the only one presented to its shareholders who have a limited choice – vote for the company’s slate or withhold their votes.

    Recently, however, the director election process has begun to become more democratic. This is happening gradually on an individual company basis under Delaware law, and not by a federal rule applicable to all publicly traded companies.

    In the United States, the traditional rule is that a company’s current board nominates its slate of directors for the next annual election. Then the company foots the bill to prepare and solicit proxies for this slate from all the company’s shareholders, typically mailing them ballots.

    Although shareholders may nominate their own candidate to be a director, they must bear the entire expense of preparing and distributing proxy materials to all the company’s shareholders. For large publicly traded companies, this expense is so high that it effectively prevents most shareholders from making director nominations (unless someone is waging a proxy fight for control).

    In an effort to help even the playing field, the Securities and Exchange Commission (SEC) in 2010 adopted the “proxy access” rule, which would have allowed certain shareholders to nominate less than a majority of a company’s directors. Then these shareholder nominees would have to be included in the company’s proxy materials along with its slate of proposed directors. However, the SEC rule was struck down by the DC Court of Appeals on procedural grounds.

    While the SEC has not proposed a revised proxy access rule, Delaware law now permits companies chartered in that state to adopt a bylaw authorizing shareholder nominations (the charters of most large American companies are registered in Delaware because of its favorable corporate laws). Thus, Delaware law now provides a mechanism for a large company to allow proxy access under conditions acceptable to that company and its shareholders.

    On February 6 of this year, General Electric led the way by adopting a bylaw allowing shareholders to nominate a few directors if these shareholders held at least 3 percent of the company’s voting shares for at least three years. Given the size and prominence of General Electric, it is a signal event – many companies should follow suit.

    More broadly, this 3+3 approach of General Electric is being advocated by officials at New York City’s

    pension plan (NYCers), which holds over $160 billion in assets. NYCers has submitted “advisory” shareholder resolutions to 75 public companies in which it holds shares. While these resolutions are not binding on the company, they carry significant weight if approved by a substantial majority of voting shareholders.

    In response, Whole Foods has proposed to allow director nominations by shareholders owning at least 9 percent of their shares for at least 5 years. After a series of complex legal moves, the SEC has declined to permit Whole Foods to exclude the 3+3 proposal because the company is making a different proposal on the same subject.

    The SEC’s non-decision, together with General Electric’s dramatic move, reopens the debate on the pros and cons of proxy access. Here are some of the key arguments and counterarguments.

    Company officials worry that proxy access will lead to special interest groups hijacking boards for their own purposes. But shareholder advocates say that the hijacking scenario is unlikely because of the 3 percent ownership threshold and the need to garner over 50 percent of shareholder votes for their nominees. Company officials believe that shareholders would be confused if there were more than one set of directors nominated in the same proxy materials. But shareholder advocates can show how proxy materials can be easily understood by clearly separating company and shareholder nominees. Shareholder advocates believe that proxy access is likely to increase constructive engagement between company directors and their large institutional shareholders. But company officials are concerned that proxy access will disrupt the election process and lead to dissension among directors. Shareholder advocates point out that in countries like Australia and United Kingdom that do have proxy access, it is used sparingly by large shareholders. But company officials emphasize that the U.S. is a much more adversarial society, with more aggressive tactics by activist hedge funds and others.

    We cannot resolve these arguments and counterarguments on proxy access in the abstract.

    Instead, though actions of companies like General Electric and shareholders like the New York City pension plan, we will be able to examine the actual effects of various methods and conditions for shareholders to nominate directors. Let’s see what happens on the ground.

    Authors Robert C. Pozen […]