Abstract

These days, Americans seem to take their corporate governance model for granted. Shareholder interests are now all that matter. But the author traces the history of corporate governance to show that such models change over time. And they are different in other nations, such as Japan. In his view, American-style corporate governance has resulted in wage inequality and poor management. And financial reforms, despite the recent major scandals, have not gone far enough.
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Corporate Governance and Society
Sanford Jacoby
To cite this article: Sanford Jacoby (2005) Corporate Governance and Society, Challenge, 48:4,
69-87
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Corporate Governance
and Society
Sanford Jacoby
These days, Americans seem to take their corporate
governance model for granted. Shareholder interests
are now all that matter. But the author traces the
history of corporate governance to show that such
models change over time. And they are different in
other nations, such as Japan. In his view, American-
style corporate governance has resulted in wage
inequality and poor management. And financial
reforms, despite the recent major scandals, have not
gone far enough.
CORPORATE GOVERNANCE IS AN ESOTERIC TOPIC TO WHICH MOST AMERI-
CANS pay little attention, even after the business scandals of
the last few years. Yet corporate governance is of vital impor-
tance to those Americans who work for corporations, own stock in
them, or are affected by their decisions. That includes nearly every-
one, because corporate decisions influence everything from the food
you eat to the air you breathe.
So, what exactly is corporate governance? It comprises the laws
and practices by which managers are held accountable to those who
have a legitimate stake in the corporation. Defining who has a legiti-
SANFORD JACOBY is professor of management, public policy, and history at UCLA and author
of The Embedded Corporation: Corporate Governance and Employment Relations in Japan
and the United States (Princeton University Press, 2005), on which this article is based.
Jacoby
70 Challenge/July–August 2005
mate stake is less straightforward than it sounds. Shareholders are a
key constituency, and in the United States their interests are repre-
sented by the board of directors, who, in turn, supervise manage-
ment. But shareholders include speculators who flip a stock in a single
day as well as long-term investors who hold a stock for years. Do the
two groups have equal stakes in the corporation? And what about
employees? Many employees have spent both time and money in-
vesting in skills that can only be utilized at a particular company
(what economists call firm-specific human capital). Do their human-
capital investments endow employees with a legitimate stake in the
enterprise?
Nations have supplied different answers to these questions, giving
rise to diversity in corporate governance systems. In Germany, the
law insists that employees are stakeholders whose interests must be
represented on corporate boards of directors. This is called co-deter-
mination. Large Japanese corporations balance the interests of share-
holders along with those of employees, banks, and business-group
members. Employees are considered part of the corporate commu-
nity, along with shareholders, although there is no legal requirement
to do so. The United States and other common law nations assign an
exclusive role to shareholders as the only group whose interests must
be considered by boards of directors. This is the “shareholder value
model” of governance.
Shareholder-value systems are designed to produce high returns
for shareholders and the executives whose pay is linked to stock prices.
In 2000, CEOs of the largest U.S. public companies received 531 times
more compensation than their average employee. French CEOs re-
ceived 16 times more; in Japan they received 10 times more.1
Such a system of corporate governance, then, has a direct bearing
on pay inequality. A shareholder-value system also tends to ask ordi-
nary employees to bear more of the risk associated with business.
Corporations are quicker to lay workers off when there is a decline in
demand for the company’s product or service, whereas European and
Japanese companies—and also some privately owned U.S. companies—
carry more of the burden of protecting employee jobs during down-
Corporate Governance and Societ y
Challenge/July–August 2005 71
turns. Because shareholder-value companies view workers more like
commodities than assets, they have higher employee turnover, invest
less in employee training, and are less willing to make long-term fi-
nancial commitments to employees, as, for example, with retirement
benefits. In other words, developments in American society over the
past twenty-five years—greater inequality, greater insecurity at the
workplace—have been fueled, in part, by our corporate governance
system.
It’s important to understand that systems of corporate governance
are not carved in stone. They can and do change as different stake-
holder groups seek to shape the internal balance of power. In other
words, corporate governance is politically constructed and histori-
cally mutable. The current German and Japanese stakeholder systems
are actually rather recent innovations. They emerged in the immedi-
ate postwar years, when enthusiasm for democracy was high and the
status of business leaders and owners—who cooperated with wartime
governments—was low. Both Germany and Japan forged social com-
pacts that included a stakeholder role for labor in corporate gover-
nance. Today those contracts are being renegotiated, due partly to
changing domestic politics and partly to globalization, which makes
corporations more sensitive to fickle foreign investors. Yet change is
slow in Europe and Japan because stakeholders in those countries—as
well as many business executives—remain skeptical that the share-
holder-value model makes sense for them.
The U.S. corporate governance system also has gone through ma-
jor changes over the years. Prior to the 1980s, executives paid atten-
tion to shareholder interests, but they defined those interests
differently than they do today. Allocating corporate resources to re-
tained earnings (for internal expansion) and to employee pension
and health benefits was viewed as being good for shareholders in the
long term, even though it might mean that less money flowed to
shareholders in the short term. CEOs, unlike their contemporary coun-
terparts, were more likely to have come up through the ranks and
more likely to view the corporation as a community of stakeholders
than as shareholder property.
Jacoby
72 Challenge/July–August 2005
The Way It Was
Writing in the early 1930s, economists Adolf Berle and Gardiner Means
observed that large American corporations had ceased being controlled
by their owners and that control had passed into the hands of a new
class of professional managers.2 The separation of ownership and
control had taken decades to occur, as the fortunes of founding fami-
lies were split up and as new shares found their ways into the hands
of millions of individuals. Any one of these individuals did not own
enough stock to sway management decisions, nor did they own enough
to make it worth their time to try. This left executives with discretion
to do what they thought was in the corporation’s best interests.
For many large American companies in the early decades of the twen-
tieth century, a crucial problem was the “labor question”: the threat of
militant unionism and worker unrest. Employers also worried about
taxation—in particular, that the United States might follow Europe in
adopting expensive unemployment, old-age, and health insurance plans.
Gradually, employers crafted a solution. They stopped treating em-
ployees as commodities that could be hired and fired at will and began
to seek worker loyalty through a bevy of programs known collectively
as welfare capitalism. Welfare capitalism ranged from training schools
and safety programs to recreational activities and company housing.
New personnel departments took away the foreman’s power to hire
and fire and made employment more orderly and secure.
Some shareholders were leery of companies that were spending
money on workers that could instead have been paid as dividends. So
managers were at pains to point out that these expenditures more
than paid for themselves by reducing employee turnover and union
activity. As one manager said after World War I, “In dollars and cents
it pays to treat employees as they deserve.” While there was a lot of
hype attached to welfare capitalism, it did establish the principle that
corporations had an obligation to shelter employees from certain
kinds of risk—injury on the job, unemployment, illness—and that this
might require allocating resources away from shareholders in the
short term in order to secure loyalty—and profits—in the long term. A
pioneer in welfare capitalism, medical company Johnson & Johnson,
Corporate Governance and Societ y
Challenge/July–August 2005 73
formalized this principle in a credo stating that shareholders would
get a fair return only after the company had ensured outstanding
treatment of customers, employees, and the communities where it
operated. Today those principles are etched in stone at the company’s
New Jersey headquarters.
Come the 1930s, however, employers found themselves in a diffi-
cult situation. The Great Depression had forced companies to fire
millions of employees and cut back on welfare capitalist programs.
Feeling that employers could not be trusted, workers turned to unions
and to government to protect them from future catastrophes. The
ranks of organized labor swelled, while Congress enacted European-
style programs such as old-age and unemployment insurance (social
security) and minimum-wage laws. But the United States took a dif-
ferent approach than the European welfare states. The Social Secu-
rity Act provided only modest pension and unemployment benefits,
leaving the door open for employers—and some unions—to supple-
ment these benefits with spending of their own. That kind of ap-
proach was the legacy of welfare capitalism, and it became the basis
for America’s “mixed” (government- and employer-provided) ben-
efits system.
Before the New Deal, American business had no serious contender
for power and influence. Now it competed with a vigorous labor
movement and a vastly expanded federal government. During and
after World War II, business groups and corporate executives worked
hard to develop a new philosophy that would bolster their standing
in the eyes of the American people. What businessmen came up with
included rhetorical assaults on “big labor” and “big government,”
more generous spending on employee benefits, and an application of
the Johnson & Johnson credo to corporate governance.
In 1956, a group of Harvard social scientists led by Francis X. Sutton
published a classic study of postwar business ideology called The
American Business Creed.3 In it the authors observed that “corporation
managers generally claim that they have four broad responsibilities:
to consumers, to employees, to stockholders, and to the general pub-
lic . . . each group is on an equal footing; the function of management
Jacoby
74 Challenge/July–August 2005
is to secure justice for all and unconditional maxima for none. Stock-
holders have no special priority; they are entitled to a fair return on
their investment, but profits above a ‘fair’ level are an economic sin.”
This was a stakeholder philosophy of governance, in which sharehold-
ers were just one of several groups recognized by managers. It would
be viewed as heretical by today’s proponents of shareholder value.
According to the Harvard st udy, managers in the 1950s insisted on
their right to make decisions independent of shareholder pressure,
within “a sphere of unhampered discretion and authority which is
not merely derivative from the property rights of owners.” Manag-
ers also asserted their authority to plow surplus cash back into the
enterprise rather than pay it to shareholders, a practice that they
defended as “the way the American system works.” Apportioning
profits between dividends and retained earnings (and other spend-
ing purposes) was viewed as “one aspect of the general function of
balancing competing economic interests which devolve on corpo-
rate management.”
The new stakeholder philosophy had ideological purposes, but it
was more than mere words. The years from the 1950s through the
1970s were the high point of corporate social responsibilit y in the
United States, as evidenced in the fact that by the 1970s, forty-eight
states had passed laws permitting corporations to give funds to chari-
ties without specific charter provisions. Courts conceded that these
social activities might hurt shareholders in the short run. But respond-
ing to the needs of various stakeholders was, in the words of legal
scholar Margaret Blair, thought to be “good for the shareholders ‘in the
long run’ because the health and well being of the communities in
which companies operate was considered important for business.”4
Did the loose coupling of management and shareholders have con-
sequences for employees? The post war decades were far from being a
golden age of industrial democracy. But it is hardly a coincidence
that the era was one in which large corporations treated workers as
stakeholders in the enterprise—not on a par with shareholders, to be
sure, but definitely having a stat us in the corporate family. Employ-
ment was construed as a quasi-permanent relationship that endured
Corporate Governance and Societ y
Challenge/July–August 2005 75
through bad times and good. Corporations sheltered employees from
risk in a variet y of ways: through health and pension benefits, by
smoothing wages rather than raising and lowering them in response
to business fluctuations, and by avoiding layoffs during downt urns
(for white-collar employees) or rehiring them immediately after a
temporary layoff (for blue-collar workers). In the industrial sector,
collective bargaining was accepted as a legal and social responsibil-
ity, although usually with little enthusiasm. One indicator of how
these changes affected resource allocation within corporations was
the rising share of national income going to wages and salaries, which
trended upward from the end of World War II through the 1970s.
Buffering employees from risk and treating them as stakeholders
had an economic rationale. Companies were spending heavily on
corporate training, transforming employees from commodities into
investments that employers were loath to part with prematurely. Be-
cause employees paid for some of this training too (as forgone wages),
they also had become corporate investors. While the legal system did
not recognize them as such, executives informally treated employees
as stakeholders. They kept employees apprised of key developments;
in unionized companies, labor leaders occasionally participated in
key strategic decisions. As the finance scholar Gordon Donaldson says
of this era, the typical mindset of senior management was “an intro-
verted corporate view . . . focused on growth, diversification and op-
portunity for the ‘corporate family.’ . . . As career employees
themselves, it was natural for management to identify with all con-
stituents who were long-term investors in the enterprise and to view
shareholders in the same light.”5
Shareholder Value
After 1973, the U.S. economy began to grow more slowly than in the
postwar years. Part of the problem was growing competition from
the rebuilt economies of Europe and Japan. Inflation was also partly
responsible for slow growth, implicating those who had pricing power:
regulated industries (transportation and communications) and some
Jacoby
76 Challenge/July–August 2005
labor unions. Investors were unhappy with the economic situation
and the way business was responding to it. They felt that company
executives had grown too complacent and were not doing enough to
squeeze value out of corporate assets. Another investor complaint
was that companies had spent too much money acquiring companies
in unrelated industries where they had no particular competence, the
most egregious example being conglomerates like ITT and Textron,
which operated in dozens of sectors. Investors argued that cash from
mature businesses would be better spent on share repurchases or divi-
dends, since investors could earn a higher return on those funds than
the companies themselves could.
Investors became more vocal in the 1970s because the structure of
shareholding had changed since the time of Berle and Means’s study.
A growing number of shares now were concentrated in the hands of
giant institutional investors: chiefly pension funds, but also mutual
funds, trusts, and insurance companies. Whereas instit utional inves-
tors held less than 10 percent of shares in the early 1950s, by the early
1980s this proportion had risen to almost 45 percent. Institutional
investors were different from households in at least two ways. First,
they owned or managed significant chunks of a corporation, not
enough to give them outright control, although sometimes this could
be achieved through alliances with other institutional investors. Sec-
ond, because their holdings were so large, they were illiquid, mean-
ing that when institutional investors were dissatisfied with a
company’s performance, they were likely to use “voice” (pressuring
corporate executives), not just “exit” (selling their holdings).
The 1980s saw the advent of the corporate raider: individuals like T.
Boone Pickens and investment groups like KKR, which promised that
by taking a company private, they would make it more profitable
than under its incumbent management. Hostile acquisitions, rare
before the 1980s, became increasingly common, in part because in-
stitutional investors provided the margin of shares necessary to ef-
fectuate a takeover. Raiders made money by selling off parts of the
company—“stripping” a conglomerate of its assets—and also by load-
ing companies up with debt (including junk bonds), which conferred
Corporate Governance and Societ y
Challenge/July–August 2005 77
enormous tax advantages. The remaining company was left more fo-
cused, but also less stable and riskier.
Another way to produce value out in a company was to squeeze its
workforce. This became easier during the 1980s as unions lost mem-
bership and political clout. High and persistent unemployment sapped
their bargaining power and that of unorganized employees. A wave of
layoffs hit blue-collar workers in the early 1980s and then was ex-
tended to white-collar workers—including middle management—in the
early 1990s. These force reductions occurred not only at troubled
companies but also at profitable firms. The latter sought to restruc-
ture themselves so that more of their resources went to shareholders
and executives and less to ordinary employees. Some of the work
formerly done by full-time employees was taken up by cheaper part-
time workers; some of it was outsourced. “Survivor” employees car-
ried much of the remaining workload, leaving them with longer hours
and more work—and more stress—than before.
Meeting investor demand for higher returns entailed not only re-
source reallocation but also a redistribution of risk. Over the past t wenty
years, companies have shifted more of the risk burden that they had
carried during the postwar decades onto employees’ shoulders. De-
fined benefit pension plans, which assured employees of a guaranteed
benefit, are being converted to riskier defined contribution plans.
Employees have taken on more of the risks associated with health in-
surance, through higher copayments and other refinements. Wages and
employment today are more sensitive to business conditions, mean-
ing pay cuts and layoffs happen more rapidly than before. The greater
volatility of income is occurring at the same time as corporate earn-
ings are higher. In other words, risk has risen and has been shifted to
employees, yet most of them have not shared in the returns associated
with greater risk. Moreover, the impact is magnified by the fact that
public spending on health, pensions, and unemployment insurance
was relatively meager in the United States to begin with.
These changes were inconsistent with the old stakeholder-gover-
nance credo and required a new philosophy to justif y them. Enter
the shareholder-value model, promulgated by Wall Street and its al-
Jacoby
78 Challenge/July–August 2005
lied attorneys and economists. Now, what had previously been latent
and fluid in corporate law was made rigidly manifest: corporations
were the propert y of shareholders; boards and executives had the
solitary charge of maximizing share prices. To ensure that boards did
their job, it was recommended that they be small and independent of
the company’s senior management. Management’s job was to con-
centrate every day on boosting the company’s share price. But to do
this, executives needed incentives to make sure that they did the share-
holders’ bidding.
Executive compensation was completely changed, with pay now
tied to stock performance through options and similar devices. The
growth of options was phenomenal: fewer than a third of CEOs re-
ceived them in 1980, whereas twenty years later almost all CEOs had
them. Although options sometimes were paid to middle managers or
even ordinary employees, the bulk went to a firm’s top executives,
for whom they eventually dwarfed base salary. When hiring CEOs,
corporate boards increasingly rejected insiders in favor of tough out-
siders who had no sentimental loyalty to the workforce. As competi-
tion for talent heated up, executive compensation rose ever higher,
and the average tenure of corporate leaders declined (to about three
years, on average).
It may seem obvious—a tautology, really—that shareholder value is
good for shareholders, if not for employees and the environment. But
even for shareholders, problems arose in the way the shareholder-
value model incentivized executives to produce value. Executives
realized that they could get rich under the new system by pumping
up share prices. But with only three years available, they had to act
quickly. These circumstances were ripe for abuse, and in some cases
they led to the corporate scandals we associate today with Enron.
One way to get rich quick was to manipulate stock option formu-
las. Many companies did so in ways that were inimical to shareholder
interests, as when options rewarded executives for general market
movements or when they were repriced after a slide in the company’s
stock. Another approach was to pursue quick, dramatic restructurings
through acquisitions or downsizings, the kind of tactics pioneered
Corporate Governance and Societ y
Challenge/July–August 2005 79
by corporate raiders. Restructuring was accompanied by a lot of chest-
thumping about getting lean and mean, rhetoric that gave a boost to
share prices. But only now, years after it all started, are we discover-
ing that restructuring often failed to produce lasting value. Take merg-
ers and acquisitions. An analysis by Business Week showed that, while
there were some successful M&As during the period 1995–2001, the
majority resulted in a reduction in share prices several years after the
acquisition. As for downsizing, a recent Russell Sage Foundation study
finds that downsizing in the 1980s and 1990s did increase profits—
and executive pay—but that it did not boost productivity, contrary to
Wall Street’s claims that it did.6
Sometimes it takes an insider to tell the truth, a CEO who knows
other CEOs and has watched corporate America from up close. James
Goodnight, the CEO of software manufacturer SAS, is one such per-
son. SAS is a privately held company; Goodnight personally owns
about two-thirds of its stock. The company is famous for treating its
employees lavishly—it has an on-site health center and flexible work
schedules—which gives it one of the lowest employee turnover rates
in the technolog y industry. When asked why his company paid such
high benefits to its employees and refused to lay them off during
slack periods, Goodnight said, “At many companies the focus is not
on the employee or the customer but on the shareholder. The out-
look is not for long-term growth but for the next quarter. In today’s
Wall Street-driven business environments, I think it’s difficult for
many people to see how employee turnover or employee morale can
impact a company’s performance over a long period of time. . . . It all
comes back to the fact that I don’t need to justify SAS’s benefits to
thousands of shareholders.”7
Goodnight’s words echo those of the Russell Sage study: the share-
holder-value model is fundamentally about the distribution of re-
sources and risk. Its adoption is one reason that labor’s share of
national income started to plummet in the 1980s from the level where
it had stood during the preceding three decades. But not everyone
who works for a living has seen their incomes grow more slowly than
profits. Corporate executives made out fabulously in the 1990s.
Jacoby
80 Challenge/July–August 2005
While there are many theories about what has caused widening
income inequalit y in the United States, surely a contributing factor
has been changes in corporate governance that boosted incomes at
the top. Among the advanced societies, Canada, Britain, and the United
States—all countries with shareholder-value models of governance—
saw top income shares increase substantially over the past twenty-
five years, rising back up to levels not observed since the 1920s. The
rich have become very rich indeed, with the share of the top 1 per-
cent doubling in the last twenty years in the United States. On the
other hand, top income shares have barely changed since 1980 in
continental Europe and Japan, countries that continue to embrace
some form of stakeholder governance.8
Taking It on the Road
In the 1990s, U.S. investors were intoxicated by what the shareholder-
value model apparently had wrought. The U.S. economy and its stock
market were booming, while Europe and Japan languished. Investors
leapt to the conclusion that changes in corporate governance had
produced the U.S. boom. They reasoned that if European and Japa-
nese companies could be persuaded to similarly revamp their gover-
nance practices—and get lean and mean—their shareholders would
reap ample rewards. Greater corporate efficiency and a rising stock
market would bring an end to economic stagnation, as it had in the
United States. That was the message delivered to Europe and Japan in
the 1990s by a bevy of American investors, government officials,
economists, and journalists.
Unfortunately, the message was wishful thinking. The causal links
between governance, productivity, and growth are vague and un-
proven. Research by Dan Dalton and others shows that even the most
basic elements of shareholder-value governance—independent boards,
small boards of directors, use of stock options—are not statistically
associated with better corporate performance. In the wake of Enron,
this should come as little surprise. Moreover, if shareholder-value
policies produce higher profits by redistributing resources rather than
Corporate Governance and Societ y
Challenge/July–August 2005 81
raising productivity, those profits—and share prices—will not keep
growing in the future.
A great leap was involved in inferring that a nation’s growth—or
lack of it—has something to do with its dominant governance model.
Japan and the United States boomed in the 1960s without the share-
holder-value model. The evidence is lacking that corporate gover-
nance affects a nation’s growth and productivity rates.
Yet U.S. investors preached the shareholder-value gospel abroad.
Some, like the giant union pension fund CalPERS, were true believ-
ers. Others hoped that changes in governance would stimulate M&A
deals and generate juicy fees for lawyers and investment bankers.
Nowhere was the shareholder-value credo pushed more aggressively—
and met with greater skepticism—than in Japan.
Japanese corporate governance in the postwar decades was a form
of stakeholder capitalism, in which corporate boards balanced the in-
terests of employees, business-group members, banks, customers, sup-
pliers, and shareholders. At Japanese companies, according to sociologist
Ronald Dore, “nobody gives a great deal of thought to owners. Firms
are not seen as anybody’s ‘propert y.’ They are organizations—bureau-
cracies much like public bureaucracies that people join for careers, be-
come members of. They are more like communities.”9 The community
was run by its board of directors. Boards were larger than those of
U.S. and British firms, some of them having thirty to forty (or more)
members, and almost all directors were company managers who had
made a slow ascent to the top. At large companies, enterprise unions
represented all regular employees, up through the middle-manage-
ment ranks. Not infrequently, board members and even company
presidents were former union officers. Regular employees spent their
entire career with the company, with substantial training expendi-
tures and fringe benefits for both blue-collar and white-collar em-
ployees. In many respects this system was similar to large U.S.
nonunion companies of the pre-1980s era (firms like IBM, Kodak,
and Motorola), which combined welfare capitalism with a stakeholder
credo.
Although there was an active market for shares in Japan, most shares
Jacoby
82 Challenge/July–August 2005
were not traded. Instead, a system of cross-shareholding existed, in
which a company and its suppliers, banks, and customers held stock
in each other’s company. Cross-holding made it nearly impossible for
hostile acquisitions to occur. Also, it gave contracting parties a stake—
and a nose—in each other’s business. Moreover, because reciprocal shares
were rarely traded, their owners looked at long-term rather than short-
term performance. So-called patient capital permitted companies to
pursue projects with long payouts, such as building market share and
operating a career employment system. This is not to say that Japanese
companies were indifferent to shareholders. When a company did
poorly—with sagging stock and reduced cash flows—its main bank might
initiate a financial workout. Company presidents would be sacked.
After white-hot growth in the 1980s, Japan’s economy plunged into
prolonged stagnation. By the late 1990s, even defenders of the Japanese
system had begun to waver. After all, the facts advanced by advocates
of the shareholder-value model seemed convincing, even if no one
could actually prove that U.S. growth and Japanese stagnation had any-
thing to do with corporate governance. Foreign investors—especially
from the United States—lost nary a chance to criticize Japanese gover-
nance. These investors saw opportunities to make a killing in Japan if
only its companies would reallocate internal resources to favor share-
holders and shed their inhibitions about hostile acquisitions.
At the behest of American investors, the U.S. government began
to pressure the Japanese to change their governance practices. The
latest initiative is the U.S.-Japan Economic Partnership for Growth,
launched in 2001. It seeks to facilitate U.S. investment in Japan by
having the Japanese adopt the shareholder-value model and U.S. ac-
counting standards.
The Japanese took the message to heart, despite the hubris of the
messengers. Various Liberal Democratic Party governments in the
1990s opened Japan’s markets and promoted sectoral and financial
deregulation. They changed commercial law to encourage—but not
require—American-style corporate governance: corporate boards com-
posed of outsiders, stock options for executives, stock repurchases to
boost share prices, and the like. The intent was to elevate “share-
Corporate Governance and Societ y
Challenge/July–August 2005 83
holder value” above other criteria for strategic decisions. Gradually
change began to occur at the corporate level, especially in companies
that had substantial foreign ownership, like Sony. In the late 1990s,
Sony adopted a U.S.-style board with outsiders, shrank employment
at its domestic factories, and beefed up its investor relations efforts.
Japanese corporations conceded that giving more importance to
shareholders was necessary, especially since many if not most of
Japan’s actively traded shares were now held by foreigners, particu-
larly Americans. (Troubled banks have been unwinding their cross-
holdings, making more shares available for foreign purchase.) Large
companies put an outsider or two on their boards and beefed up
their investor relations departments. They also adopted more trans-
parent accounting procedures. But in my interviews with senior ex-
ecutives in Japan, I found them doubtful that stakeholder governance
was responsible for Japan’s problems or that a shift to American prac-
tices would cure what ailed the Japanese economy. Instead executives
placed the blame on other—more “macro”—factors such as botched
fiscal policies, the Bank of Japan’s monetary stringency, and a tor-
toise-like resolution of Japan’s banking mess.
Until recently, these doubts were expressed quietly. But dissenting
voices have grown louder since 2001 as the U.S. economy has been hit
by corporate scandals and the collapse of its own financial bubble.
Business leaders like Fujio Mitarai of Canon and Hiroshi Okuda of
Toyota are two leading Japanese executives who refuse to accept the
idea that there is one best way—the American way—of organizing a busi-
ness corporation. Instead, companies like Canon and Toyota continue
to staff corporate boards largely with insiders, to pay executives mod-
estly, to consult enterprise unions, and to avoid layoffs of “lifetime”
employees. Adjustments occur instead through early retirement or re-
duced wage growth and hiring (except of part-timers). Large corpora-
tions continue to shoulder more risk for employees and share resources
more equitably with them than American companies do.
The other recent development has been the recovery of the Japa-
nese economy over the past two years. Since the beginning of 2002,
Japan’s gross domestic product (GDP) has grown more rapidly than
Jacoby
84 Challenge/July–August 2005
America’s GDP for six of the eleven quarters covered. Although growth
has been slower this year than last, a key sign of health is the recent
Bank of Japan prediction that Japan will experience modest inflation
in 2005, after years of falling prices. If the recovery continues, as is
expected, it will make Japanese companies more assertive in their
rejection of the shareholder-value model. It’s not that Japanese ex-
ecutives are altruistic social democrats. Rather, their views are much
like Jim Goodnight’s: that treating employees well pays off in the
long term with better products, better customer service, and harder-
working employees. Adopting the shareholder-value model runs the
risk of undercutting Japan’s comparative advantage in global compe-
tition, which is based, in part, on its high levels of employee train-
ing, skill, and effort.
The Japanese also don’t want the levels of inequality that have sur-
faced in the United States in the last t wenty years. Japan remains an
almost homogeneous society, where the upper-middle class and the
working class still live and commute in relatively close proximity.
True, there has been some growth of income inequality since the
1980s, and with it phenomena like middle-class flight to private
schools. But Japan remains egalitarian as compared to the United
States. Ranked by income inequality, its standing has changed little
among the Organization for Economic Cooperation and Development
countries since the 1980s, putting it between the welfare states of
Northern Europe and the Anglo-Saxon nations, such as the United
States, the United Kingdom, and Canada.
Back at the Ranch
America’s corporate scandals—and recent academic research—have
revealed various defects in the shareholder-value model. True believ-
ers claim that the defects stem from just a few bad corporate apples,
yet the truth is that the barrel contains a great deal of rot. Enron is
now four years behind us, yet Eliot Spitzer’s investigations show no
signs of slowing down. The reforms adopted in the wake of Enron
have been extensive—-the Sarbanes-Oxley law, new rules at the major
Corporate Governance and Societ y
Challenge/July–August 2005 85
stock exchanges, and additional requirements from the SEC. There
has also been voluntary reform by corporations, especially on stock
options, which are now less likely to be offered and, if they are, more
likely to be expensed for tax purposes.
Yet despite all this, many of the assumptions behind the share-
holder-value model remain in place: that outsiders are better than
insiders as CEOs and board members; that executives need substan-
tial compensation to motivate them; and that shareholders are the
only group whose interests executives should serve. Hence for most
employees, it remains a mean season. Risk continues to be shifted to
the workforce or, as in the case of pension plan terminations, to the
U.S. taxpayer. Downsizing and outsourcing continue, causing re-
sources to be reallocated from labor to capital. On the other hand,
executive compensation remains at stratospheric levels.
Part of the problem has to do with boards of directors. Even when
directors are nominally independent (as most in the United States
are), they are unwilling to question the need for huge salaries and
options grants. These directors are themselves current or former
business executives. They conform to and reinforce each other’s
ideas about corporate governance, a phenomenon that psycholo-
gists label “groupthink.” They also are themselves beneficiaries of
the executive compensation approach that emerged in the 1980s.
Another part of the problem is institutional investors, who tend to
be equally rigid in their thinking about corporate governance. Many
were passionate advocates of the shareholder-value model in the
1980s and 1990s. Those major investors find it difficult now to ad-
mit that the model’s virtues were oversold and caused problems for
shareholders as well as other stakeholders. However, many of them—
including CalPERS—are in favor of a recent proposal from the Securi-
ties and Exchange Commission that might revolutionize U.S. corporate
governance.
Last year, the SEC proposed a rule permitting long-term sharehold-
ers to nominate candidates for a company’s board of directors. So-
called proxy access is opposed by much of the business community,
yet supported by several large pension and mutual funds. These funds
Jacoby
86 Challenge/July–August 2005
hold their shares for long periods and therefore would meet the
participation thresholds in the SEC proposal. (The proposal says
that only shareholders holding 5 percent of shares for at least two
years may nominate directors, and only if there is evidence of oppo-
sition to nominees proposed by management.) If adopted, the rule
would be a major change from the present situation, in which
boards are not obligated to act on shareholder resolutions and
shareholders have no right to nominate board candidates. The pres-
ence of shareholder-nominated directors would promote greater
independence and accountability in the boardrooms of poorly gov-
erned companies.
With President Bush in his second term, the SEC is under intense
pressure from business to shelve the proposal. (In fact, CalPERS’s
support for the proposal has incensed the business community and
is one reason that California Governor Arnold Schwarzenegger has
proposed terminating CalPERS in favor of a defined-contribution
pension plan for state workers.) Yet the SEC proposal is a modest
step in the right direction, one that would help to counteract con-
formity and cronyism on corporate boards. By giving shareholders
a real opportunity to be represented on boards, it would repair de-
fects in the crude shareholder-value model. Combined with other
recent changes—the de-emphasis of stock options and quarterly re-
sults, the explosive growth of socially responsible investing—it would
push U.S. corporate governance toward a more balanced approach,
one that recognizes that shareholders are not the only group with a
financial stake in corporate decisions. Ironically, this change would
come at the same time as Japanese corporations are being pressured
to move in the opposite direction.
We are only just now beginning to appreciate the myriad links
between decisions made in the rarified atmosphere of corporate head-
quarters and major social outcomes such as equality, risk bearing,
and environmental quality. Japan right now is engaged in a debate
over the corporation’s societal role and responsibilities. The United
States is ripe for a similar, wide-ranging debate; if not now, then surely
in 2008.
Corporate Governance and Societ y
Challenge/July–August 2005 87
Notes
1. Louis Lavelle, “Executive Pay,” Business Week Online, April 16, 2001.
2. Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private
Property (New York: Commerce Clearing House, 1932).
3. Francis X. Sutton, Seymour E. Harris, Carl Kaysen, and James Tobin, The Ameri-
can Business Creed (Cambridge: Harvard University Press, 1956).
4. Margaret M. Blair, Ownership and Control: Rethinking Corporate Governance for
the Twenty-First Centur y (Washington, DC: Brookings Institution, 1995).
5. Gordon Donaldson, Corporate Restructuring: Managing the Change Process from
Within (Boston: Harvard Business School Press, 1994).
6. David Henry and Frederick F. Jespersen, “Mergers: Why Most Big Deals Don’t
Pay Off,” Business Week (October 14, 2002); William J. Baumol, Alan S. Blinder, and
Edward N. Wolff, Downsizing in America: Reality, Causes, and Consequences (New
York: Russell Sage Foundation, 2003).
7. Tricia Bisoux, “Corporate Counter Cult ure,” BizEd (November–December
2004): 16–21.
8. Emmanuel Saez, “Income and Wealth Concentration in a Historical and In-
ternational Perspective,” working paper, University of California–Berkeley Depart-
ment of Economics, 2004.
9. Ronald Dore, Stock Market Capitalism: Welfare Capitalism; Japan and Germany
Versus the Anglo-Saxons (Oxford: Oxford University Press, 2000).
To order reprints, call 1-800-352-2210; outside the United States, call 717-632-3535.
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Mergers: Why Most Big Deals Don't Pay Off
  • David Henry
  • Frederick F Jespersen
David Henry and Frederick F. Jespersen, "Mergers: Why Most Big Deals Don't Pay Off," Business Week (October 14, 2002);
Corporate Counter Culture
  • Tricia Bisoux
Tricia Bisoux, "Corporate Counter Culture," BizEd (November-December 2004): 16-21.