Are CEOs with MBAs good for business?

 Daron Acemoglu in The FT

Every year, tens of thousands of aspiring young moguls enrol at business school for an MBA, hoping to climb the corporate hierarchy. They are following predecessors who now run many leading companies, from Alphabet, Amazon and Apple to Microsoft and Walmart. 

And the aim of faculty and administrators remains what Harvard Business School’s first dean, Edwin Gay, expressed in 1908: “To train people to make a decent profit, decently”. 

Better knowledge and training can make leaders more innovative and productive, raising the returns to all stakeholders. Better managed businesses can more effectively achieve whatever objectives they set, including helping to tackle the myriad challenges society faces. 

But has the MBA actually achieved these goals? Our recent research suggests a much less encouraging picture. Using detailed data on companies and workers from the US and Denmark, we looked at the effects when a chief executive with an MBA or undergraduate business degree takes over from one without such qualifications. 

We found no evidence that CEOs with such degrees increase sales, productivity, investment or exports relative to the levels the company achieved before. 

The biggest shift when a chief executive with a business degree takes charge is a decline in wages and the share of revenues going to labour, even in countries with different cultures. In the US, wages under business-degree holding CEOs were 6 per cent lower than they would otherwise have been after five years, and labour’s share of revenues was down five percentage points. In Denmark, the figures were respectively 3 per cent and 3 percentage points. 

We found no evidence that these were companies with declining sales and appointed leaders with business degrees to rescue them. The patterns are similar when new MBA managers are appointed following the death or retirement of a previous CEO. Nor was there any indication that by reducing wage growth, chief executives with business education were creating more retained earnings to fund investment, which is no higher in their companies. 

It may even be that, by ignoring broader stakeholders, such managers damage long-term profitability. For example, we found that higher-skilled employees were more likely to leave after the relative wage declines. 

However, shareholders gain from the appointment of a CEO with a business degree — at least in the short term. Share prices increase, and we see more share repurchases in the US and higher dividends in the US and Denmark. Business-educated managers are also paid more. 

The reason for the relative decline in workers’ wages and shareholders’ gain is clear. Companies run by CEOs without a business degree share increases in revenues or profits with their workforce — typically one-fifth of higher value-added. This ceases when a business-educated leader takes over. The wage impact is greater in concentrated industries. 

It is impossible to know for sure why business-educated leaders have these effects, but our work provides clues. One reason could be the legacy of the economist Milton Friedman’s doctrine from 1970, which stated that “the social responsibility of business is to increase its profits”. 

The idea that good managers raise profits is common in business schools and economics departments. Many courses advocate “lean corporations” or “re-engineering businesses” using digital tools to cut costs. It is possible that these ideas encourage leaders to take a tougher stance and ensure higher corporate profits are not shared with employees. 

Another factor may be that the majority of business degree students interact closely with each other and often have little contact with blue-collar and clerical workers. As CEOs, they may not see the viewpoint of the rank-and-file or consider workers as stakeholders. 

So is the current business school system broken? Not necessarily. First, only a small fraction of students become chief executives. Many work in other managerial positions, where their training may have very different implications. 

Second, the majority of the chief executives in our sample received their degree before 2000. Business schools today may have evolved, but there are not enough CEOs with more recent degrees to judge the effects. Indeed, schools do appear to have changed rapidly this century. Many now have ethics courses and prepare their students for diverse careers, including in government service and non-profit organisations. Many students learn about corporate environmental and governance responsibilities. 

Being aware of what managers with business degrees used to do is an important step in reflecting on how we can build better programmes. 

Third, and most importantly, there is nothing hard-wired about business degrees. What MBAs mean and achieve will change, often prompted by students themselves. If they demand an experience that is richer than the Friedman doctrine and that prepares them for today’s societal challenges, most schools will adapt. 

The change will have to start with what is taught in business schools, but it cannot stop there. The whole business school experience may need to be rethought, including how students socialise, form networks and gain experience. It will also have to involve a broader discussion of the social responsibilities of corporations and their business leaders.

Welcome to the era of the bossy state

The relationship between governments and businesses is always changing. After 1945, many countries sought to rebuild society using firms that were state-owned and -managed. By the 1980s, faced with sclerosis in the West, the state retreated to become an umpire overseeing the rules for private firms to compete in a global market—a lesson learned, in a fashion, by the communist bloc. Now a new and turbulent phase is under way, as citizens demand action on problems, from social justice to the climate. In response, governments are directing firms to make society safer and fairer, but without controlling their shares or their boards. Instead of being the owner or umpire, the state has become the backseat driver. This bossy business interventionism is well-intentioned. But, ultimately, it is a mistake.
 
Signs of this approach are everywhere, as our special report explains. President Joe Biden is pursuing an agenda of soft protectionism, industrial subsidies and righteous regulation, aimed at making the home of free markets safe for the middle classes. In China Xi Jinping’s “Common Prosperity” crackdown is designed to curb the excesses of its freewheeling boom, and create a business scene that is more self-sufficient, tame and obedient. The European Union is drifting away from free markets to embrace industrial policy and “strategic autonomy”. As the biggest economies pivot, so do medium-sized ones such as Britain, India and Mexico. Crucially, in most democracies, the lure of intervention is bipartisan. Few politicians fancy fighting an election on a platform of open borders and free markets.

That is because many citizens fear that markets and their umpires are not up to the job. The financial crisis and slow recovery amplified anger about inequality. Other concerns are more recent. The world’s ten biggest tech companies are over twice as big as they were five years ago and sometimes seem to behave as if they are above the law. The geopolitical backdrop is a far cry from the 1990s, when the expansion of trade and democracy promised to go hand in hand, and from the cold war when the West and the Soviet Union had few business links. Now the West and totalitarian China are rivals but economically intertwined. Gummed-up supply chains are causing inflation, reinforcing the perception that globalisation is overextended. And climate change is an ever more pressing threat.

Governments are redesigning global capitalism to deal with these fears. But few politicians or voters want to go back to full-scale nationalisation. Not even Mr Xi is keen to reconstruct an empire of iron and steel plants run by chain-smoking commissars, while Mr Biden, despite his nostalgia for the 1960s, need only walk through America’s clogged West Coast ports to recall that public ownership can be shambolic. At the same time the pandemic has seen governments experiment with new policies that were unimaginable in December 2019, from perhaps $5trn or more of handouts and guarantees for firms to indicative guidance on optimal spacing of customers in shopping aisles.

This opening of the interventionist mind is coalescing around policies that fall short of ownership. One set of measures claims to enhance security, broadly defined. The class of industries in which government direction is legitimate on security grounds has expanded beyond defence to include energy and technology. In these areas governments are acting as de facto central planners, with research and development (r&d) spending to foster indigenous innovation and subsidies to redirect capital spending. In semiconductors America has proposed a $52bn subsidy scheme, one reason why Intel’s investment is forecast to double compared with five years ago. China is seeking self-sufficiency in semiconductors and Europe in batteries.

The definition of what is seen as strategic may well expand further to include vaccines, medical ingredients and minerals, for example. In the name of security, most big countries have tightened rules that screen incoming foreign investment. America’s mesh of punitive sanctions and technology export controls encompasses thousands of foreign individuals and firms.

The other set of measures aims to enhance stakeholderism. Shareholders and consumers no longer have uncontested primacy in the hierarchy of groups that firms serve. Managers must weigh the welfare of other constituents more heavily, including staff, suppliers and even competitors. The most visible part of this is voluntary, in the form of “esg” investing codes that score firms for, say, protecting biodiversity, local people or their own workers. But these wider obligations may become harder for firms to avoid. In China Alibaba has pledged a $15bn “donation” to the Common Prosperity cause. In the West stakeholderism may be enforced through the bureaucracy. Central banks and public pension funds may shun the securities of firms judged to be anti-social. America’s antitrust agency, which once safeguarded consumers alone, is mulling other aims such as helping small firms.

The ambition to confront economic and social problems is admirable. And so far, outside China at least, bossier government has not hurt business confidence. America’s main stockmarket index is over 40% higher than it was before the pandemic, while capital spending by the world’s largest 500-odd listed firms is up by 11%. Yet, in the longer term, three dangers loom.
High stakes

The first is that the state and business, faced by conflicting aims, will fail to find the best trade-offs. A fossil-fuel firm obliged to preserve good labour relations and jobs may be reluctant to shrink, hurting the climate. An antitrust policy that helps hundreds of thousands of small suppliers will hurt tens of millions of consumers who will end up paying higher prices. Boycotting China for its human-rights abuses might deprive the West of cheap supplies of solar technologies. Businesses and regulators focused on a single sector are often ill-equipped to cope with these dilemmas, and lack the democratic legitimacy to do so.

Diminished efficiency and innovation is the second danger. Duplicating global supply chains is extraordinarily expensive: multinational firms have $41trn of cross-border investments. More pernicious in the long run is a weakening of competition. Firms that gorge on subsidies become flabby, whereas those that are protected from foreign competition are more likely to treat customers shabbily. If you want to rein in Facebook, the most credible challenger is TikTok, from China. An economy in which politicians and big business manage the flow of subsidies according to orthodox thinking is not one in which entrepreneurs flourish.

The last problem is cronyism, which ends up contaminating business and politics alike. Firms seek advantage by attempting to manipulate government: already in America the boundary is blurred, with more corporate meddling in the electoral process. Meanwhile politicians and officials end up favouring particular firms, having sunk money and their hopes into them. The urge to intervene to soften every shock is habit-forming. In the past six weeks Britain, Germany and India have spent $7bn propping up two energy firms and a telecoms operator whose problems have nothing to do with the pandemic.

This newspaper believes that the state should intervene to make markets work better, through, for example, carbon taxes to shift capital towards climate-friendly technologies; r&d to fund science that firms will not; and a benefits system that protects workers and the poor. But the new style of bossy government goes far beyond this. Its adherents hope for prosperity, fairness and security. They are more likely to end up with inefficiency, vested interests and insularity.

General Electric’s accounting tactics bared in SEC settlement

 Industrial powerhouse underlines risk of short-term, market-orientated approach to management writes Sujeet Indap in The FT 

In 2015, Larry Fink, the BlackRock founder and chief executive, released a public letter pressing fellow CEOs to eschew making business decisions based on short-term considerations. 

“It is critical, however, to understand that corporate leaders’ duty of care and loyalty is not to every investor or trader who owns their company’s shares at any moment in time but to the company and its long-term owners,” he wrote. 

One company that BlackRock was a major shareholder at the time was General Electric with a stake of nearly 6 per cent. Around then, Jeffrey Immelt, the chief executive of GE, appears to have been overseeing just the kind of instant market gratification management effort that Mr Fink was condemning. 

The industrial group “misled investors” and “violated antifraud, reporting [and] disclosure controls”, according to a recent US Securities and Exchange Commission order. In early December, GE agreed with the regulator to pay $200m to settle charges that it had misled investors about its financial condition in between 2015 and 2017.  

In statement, the company noted that no financial statements required correction and that it had neither admitted nor denied guilt as a part of the SEC settlement. 

Five years after Mr Fink’s letter, there has been a continued rise in “stakeholder capitalism” and investing for better environmental, social and corporate governance standards. But this coda to the GE saga of the 2010s is an ugly reminder of the world these new principles are attempting to replace. 

The SEC’s order alleged GE pulled forward future profits and cash flow and, separately, delayed reporting big losses in order to boost immediate results. Damningly, the SEC described how Wall Street pressure and undue attention to the company’s stock price appeared to drive the company’s actions. 

In 2015, GE announced that its once high-flying but controversial GE Capital unit would shrink by $200bn worth of assets. While highly profitable at times, the banklike entity was volatile and its heavy losses during the 2008 financial crisis had nearly sunk the entire company.  

Mr Immelt wanted to reposition GE as an industrial powerhouse with aviation, healthcare, energy and oil and gas units that were supposed to help the developing world become urbanised. In late 2015, the group would close its $15bn acquisition of France’s Alstom to boost its power plant business. 

The power division, according to the SEC, would become the home of accounting mischief. Maintenance contracts with customers that ran several years required estimates of costs and the reduction of such inputs allowed GE to boost its book profits. Separate alleged manoeuvres included selling receivables to GE Capital, allowing for commensurate gains in cash flow. 

The company had announced in 2015 that it would seek to hit $2 per share of earnings in 2018. It appears that precise and ambitious figure effectively became the central organising principle of the company. 

“GE was aware of investor and analyst concerns that its cash collections were not keeping pace with revenue and that its unbilled revenue was growing in its industrial business,” wrote the SEC. 

It said executives at GE Power and GE Power Services cited analyst reports when they discussed internally the need to show improved cash performance. In one 2016 presentation to GE senior management, the SEC said, one executive posited that GE’s stock price could reach $40 if operating cash flow performance improved. It averaged about $30 during that year.

At the same time, the pieces of GE Capital the parent company had retained would prove to be another time bomb. GE kept an interest in long-term healthcare insurance policies that had been sold decades earlier. Those policies proved to be more expensive than had been anticipated, a reality that became clear in 2015. 

In 2016, as it became evident that higher losses were going to need to be realised, one executive called the situation in the insurance business a “train wreck”. 

It seems GE only came clean with investors about its accounting practices in the power division in 2017 while also eventually taking a $22bn impairment to goodwill related to the Alstom buyout. 

And it finally took a $9.5bn charge related to insurance liabilities in 2018 and committed to plug another $15bn of capital into shoring up the GE financial services unit. 

A spokesperson for Mr Immelt said GE sought to comply with all standards for financial accounting. “To achieve this goal, it put in place strong processes with multiple checks and balances,” the spokesperson added. 

BlackRock continues to hold a stake of about 6 per cent in GE shares, which currently hover around $10. A recovery to the peak of nearly $33 seen in 2016 will undoubtedly require a very long-term orientation.

Dickens and Orwell — the choice for capitalism

When this is all over, there is likely to be a new social contract. Which way will we go?  asks JANAN GANESH in The FT

This year is the 70th anniversary of George Orwell’s death and the 150th of Charles Dickens’s. Never spellbound by either (“The man can’t write worth a damn,” said the young Martin Amis, after one page of 1984), I was inclined to sit out all the commemorative rereading. And I did. But then the crisis of the day took me back to what one man wrote about the other. 

More on that in a minute. First, you will notice the pandemic is putting large corporations through a sort of moral invigilation. Ones that rejig their factories to make hand sanitiser (LVMH) or donate their knowhow (IBM) are hailed. Ones that behave like skinflints (JD Wetherspoon, Britannia Hotels) are tarred and feathered. 

Companies have to weigh how much discretionary help to give without flunking their narrow duty to survive and profit. 

This is the stuff of Stakeholder Capitalism or Corporate Social Responsibility.The topic has been in the air all of my career. It has been given new urgency by events. It is the subject of much FT treatment. 

And Orwell, I suspect, would see through it like glass. 

In a 1940 essay (how spoilt we are for round-number anniversaries) he politely explodes the idea of Dickens as a radical, or even as a social reformer. His case is that, for Dickens, nothing is wrong with the world that cannot be fixed through individual conscience. 

If only Murdstone were kinder to David Copperfield. If only all bosses were as nice as Fezziwig. That no one should have such awesome power over others in the first place goes unsaid by Dickens, and presumably unthought. And so his worldview, says Orwell, is “almost exclusively moral”. 

Dickens wants a “change of spirit rather than a change of structure”. He has no sense that a free market is “wrong as a system”. The French Revolution could have been averted had the Second Estate just “turned over a new leaf, like Scrooge”. 

And so we have “that recurrent Dickens figure, the Good Rich Man”, whose arbitrary might is used to help out the odd grateful urchin or debtor. What we do not have is the Good Trade Unionist pushing for structural change. What we do not have is the Good Finance Minister redistributing wealth. There is something feudal about Dickens. The rich man in his castle should be nicer to the poor man at his gate, but each is in his rightful station. 

You need not share Orwell’s ascetic socialism (I write this next to a 2010 Meursault) to see his point. And to see that it applies just as much to today’s economy. 

Some companies are open to any and all options to serve the general good — except higher taxes and regulation. “I feel like I’m at a firefighters’ conference,” said the writer Rutger Bregman, at a Davos event about inequality that did not mention tax. “And no one is allowed to speak about water.” 

What Orwell would hate about Stakeholder Capitalism is not just that it might achieve patchier results than the universal state. It is not even that it accords the powerful yet more power — at times, as we are seeing, over life and death. Under-resourced governments counting on private whim for basic things: it is a spectacle that should both warm the heart and utterly chill it. 

No, what Orwell would resent, I think, is the unearned smugness. The halo of “conscience”, when more systemic answers are available via government. The halo that Dickens still wears. You can see it in the world of philanthropy summits and impact investment funds. 

The double-anniversary of England’s most famous writers since Shakespeare meant little to me until the virus broke. All of a sudden, they serve as a neat contrast of worldviews. Dickens would look at the crisis and shame the corporates who fail to tap into their inner Fezziwig. Orwell would wonder how on earth it is left to their caprice in the first place. 

The difference matters because, when all this is over, there is likely to be a new social contract. The mystery is whether it will be more Dickensian (in the best sense) or Orwellian (also in the best sense). That is, will it pressure the rich to give more to the commons or will it absolutely oblige them?

‘Quarterly capitalism’ is short-term, myopic, greedy and dysfunctional

Will Hutton in The Guardian


It has been obvious for years that British capitalism is profoundly dysfunctional. In 1970, £10 of every £100 of profit was distributed to shareholders: today, under intense pressure from short-term owners, companies pay out £70. Investment, innovation and productivity have slumped. Few new companies grow to any significant size before they are taken over.

Exports have stagnated. The current account deficit is at record proportions. The purpose of companies now is not to do great things, solve great problems or scale up great solutions –why capitalism is potentially the best economic system – it is to become payolas for their disengaged owners and pawns in the next big deal or takeover. Not only the British economy suffers – this process has become the major driver of rising inequality, low pay and insecurity in the workplace as management teams are forced to treat workers as costly commodities rather than allies in business building.
Regular readers of this column will be familiar with the refrain, and the stubborn resistance from the British mainstream. There is absolutely nothing wrong at all with the British private sector, runs the Conservative argument: to the extent the British economy does have problems they are rooted entirely in taxation, regulation, unions and government. But in a week when the Financial Times – a great British asset and embodiment of the best of our journalism – has been sold to Nikkei for no better reason than to support Pearson’s short-term share price, powerful and public criticism of the way British capitalism operates has come from an unexpected quarter.

Last year, the governor of the Bank of England, Mark Carney, called on firms to have a greater “sense of their responsibilities for the system”, in particular the social contract on which market capitalism’s long-term dynamism depends. On Friday’s Newsnight, the chief economist of the Bank of England, Andy Haldane, built on the governor’s concerns. He began with the seven-fold increase in the proportion of profit distributed to shareholders in dividends and bought-back shares over the last 45 years, which he said necessarily “leaves less for investment”. The explanation was simple: British (and indeed American) company law “puts the shareholder at front and centre. It puts the short-term interest of shareholders in a position of primacy when it comes to running the firm.” He thought company law that placed shareholders on a more equal footing with other stakeholders – workers, customers, clients – would work better. Dare I say it – stakeholder capitalism?

He damned the way the public limited company has developed. “The public limited company model has served the world well from a growth perspective. But you can always have too much of a good thing. The nature of shareholding today is fundamentally different than what it was a generation ago. The average share was held by the average shareholder, just after the war, for around six years. Today, that average share is held by the average shareholder for less than six months. Of course, many shareholders these days are holding shares for less than a second.”

In New York, at almost exactly the same time Newsnight was transmitting its interview with Andrew Haldane, Hillary Clinton was speaking from the same script, attacking what she called “quarterly capitalism”. “American business needs to break free from the tyranny of today’s earning report so they can do what they do best: innovate, invest and build tomorrow’s prosperity,” the Democratic presidential front runner declared. “It’s time to start measuring value in terms of years – or the next decade – not just next quarter.” She does not want to reinvent the public limited company, but she proposed the most far-reaching tax reforms of any Democrat presidential nominee to change the incentives for shareholders and executives alike. In American terms this is a revolution.

It is long overdue and the argument is beginning to get traction in the US. Free-market apologists insist that the more cash is handed back to shareholders, then the more they have to invest in innovation. The stock market is doing its job: promoting efficiency. The trouble is that everyone can see it’s 100% wrong. The market is hopelessly inefficient, greedy and myopic. When Larry Page and Sergey Brin floated Google, they took care to insulate the company from “quarterly capitalism”: they accorded their shares as Google’s founders 10 times the voting rights in order to protect their capacity to innovate from the stock market – what they considered Google’s real business purpose.

From robots to self-driving cars, from virtual reality glasses to investigating artificial intelligence, Google is now one of the most innovative firms on Earth. Meanwhile the typical US Plc, like its counterpart in Britain, is hunkering down, investing and innovating ever less and distributing more cash to shareholders for the reasons Haldane explains. Far from market efficiency, the whole system is undermining the legitimacy of capitalism.

But bit by bit influential voices such as Haldane’s are having the nerve to declare the Anglo-American system does not work. A rich collection of reflections and commentary edited by Diane Carney (Mark Carney’s wife) was published after London’s Inclusive Capitalism conference last month. Yet, except for former business secretary Vince Cable, no leading British politician has entered the lists. It will be intriguing how George Osborne reacts: one instinct will be to sack Carney and Haldane, as he has done Martin Wheatley, the head of the Financial Conduct Authority, for being too tough on the City. Another will be to co-opt the argument for the one nation Tory cause before the Labour party does.

He needn’t worry too much. One of the reasons that Tony Blair dropped his advocacy for stakeholder capitalism back in 1996 after the publication of The State We’re In was because too many leftwing Labour MPs took the Jeremy Corbyn line that the party’s mission was to socialise capitalism rather than reform it, while too many rightwing Labour MPs such as Peter Mandelson and Alistair Darling were terrified of upsetting business, as today, it seems, is Liz Kendall. He had zero internal political support, business was distrustful and the Tories were accusing him of returning to 1970s corporatism. Today the Bank of England and the likely next US president are supporters. Will one of the contenders for the Labour leadership have the courage to make the case? So far, they have all been mute. If Andy Haldane has done nothing else, he will have dramatised the poverty of today’s thinking about capitalism – in both main political parties.

How could Greece and Argentina – the new 'debt colonies' – be set free?

If nations were able to go bankrupt like companies it would benefit everyone, especially society's poorest

• 
• • Ha-Joon Chang
  • The Guardian, Sunday 25 November 2012 19.30 GMT

Protesters wear chains in a protest against Greece's austerity measures. The burden of debt falls mostly on the weaker members of society. Photograph: Aris Messinis/AFP/Getty Images

Colonialism is back. Well, at least according to leading politicians of the two most famous debtor nations. Commenting on the EU's inability to deliver its end of the bargain despite the savage spending cuts Greece had delivered, Alexis Tsipras, the leader of the opposition Syriza party, said last week that his country was becoming a "debt colony". A couple of days later, Hernán Lorenzino, Argentina's economy minister, used the term "judicial colonialism" to denounce the US court ruling that his country has to pay in full a group of "vulture funds" that had held out from the debt restructuring that followed the country's 2002 default.

While their language was deliberately incendiary, these two politicians were making extremely important points. Tsipras was asking why most burdens of adjustment for bad loans have to fall on the debtor country and, within them, mostly on its weaker members. And he is right. As they say, it takes two to tango, so those who condemn Greece for imprudent borrowing should also condemn the imprudent lenders that made it possible.

Lorenzino was asking how we can let one court ruling in a foreign country in favour of one small group of creditors (who bought the debt in the secondary market) derail a painfully engineered process of national recovery. The absurdity of this situation becomes clear when we recall that, partly thanks to the default and subsequent debt restructuring,Argentina, expanding at close to 7% per year, has been the fastest growing Latin American economy between 2003 and 2011.

But there is far more at stake here than the national welfares of Greece and Argentina, important though they are. The Greek debt problem has dragged down not just Greece but the whole eurozone, and with it the world economy. Had the Greek debt been quickly reduced to a manageable level through restructuring, the eurozone would be in a much better shape today. In the Argentinian case, we are risking not just an end to Argentina's recovery but a fresh round of turmoil in the global financial market because of one questionable US court ruling.

Many people argue that, regrettable as they may be, such situations are unavoidable. However, when it comes to debt problems within our borders, we actually don't let the same situation develop. All national bankruptcy laws allow companies with too big a debt problem to declare themselves bankrupt. Once bankruptcy is declared, the debtor company and its creditors are forced to work together to reorganise the company's affairs, under clear rules.

First, a standstill is imposed on debt repayments – for as long as six months in the case of the debtor-friendly American bankruptcy law. Second, subject to the majority (or in some countries a super-majority of two thirds) of them agreeing, creditors are required to accept a debt reduction programme in return for a new company management strategy. This programme could involve outright reduction (or even cancellation) of debts, lowering of interest rates, and extension of the repayment period. Third, lawsuits by individual creditors are banned until there is an agreement, so that individual creditors cannot disrupt the restructuring process. Fourth, the claims of other stakeholders on the company are also taken into account, with wages being typically given "seniority" over debts.

Unfortunately, no mechanism like this exists for countries, which is what has made sovereign debt crises so difficult to manage. Because they don't have any legal protection from creditors in times of trouble, countries typically postpone the necessary restructuring of their economies by piling on more debts in the (usually unfulfilled) hope that the situation will somehow resolve itself. This makes the debt problem bigger than necessary.

What's more, because they cannot officially go bankrupt, countries face a stark choice. Either they default and risk exclusion in the international financial market (although countries can overcome it quickly, as Russia and Malaysia did in the late 1990s) or they have to opt for a de facto default, in which they pretend that they have not defaulted by making full repayments on their existing loans with money borrowed from public bodies, like the International Monetary Fund and the EU, while trying to negotiate debt restructuring.

The problem with this solution is that, in the absence of clear rules, the debt renegotiation process becomes lengthy, and can push the economy into a downward spiral. We have seen this in many Latin American countries in the 1980s, and we are seeing it today in Greece and other eurozone periphery economies.

Meanwhile, the absence of rules equivalent to the protection of wage claims in corporate bankruptcy law means that claims by weaker stakeholders – pensions, unemployment insurance, income supports – are the first to go. This creates social unrest, which then threatens recovery by discouraging investment.

It is not because people condoned defaulting per se that they came to introduce the corporate bankruptcy law. It was because they recognised that in the long run, creditors – and the broader economy, too – are likely to benefit more from reducing the debt burdens of companies in trouble, so that they can get a fresh start, than by letting them disintegrate in a disorderly way.

It is high time that we applied the same principles to countries and introduced a sovereign bankruptcy law.

Management theory was hijacked in the 80s. We're still suffering the fallout.

Good governance went out of the window when the Chicago school's reductive view of human nature took hold

• 
• • Simon Caulkin
  • guardian.co.uk, Monday 12 November 2012 08.30 GMT

'Managers abandoned their previous policy of retaining and reinvesting profits in favour of large dividend and share buyback payouts to shareholders.' Photograph: David Karp/AP

This week the City has been congratulating itself on 20 years of UK corporate governance codes. Since the original Cadbury document in 1992, the UK has basked in its role as governance leader, with 70 other countries having followed its example and adopted similar guidelines.

There's just one problem: is it the right kind of governance? The day the FT carried the story, Incomes Data Services reported that FTSE 100 boardroom pay went up by a median 10% last year, a soaraway trend that the best code in the world has complacently overseen. Nor could it prevent the RBS meltdown, Libor or PPI mis-selling to the tune of £12bn, the biggest rip-off in financial history. It didn't stop phone-hacking or BP taking short cuts. It has sanctioned wholesale offloading of risk, whether individual (pensions, careers) or collective (global and financial warming) on to society, while rejecting any responsibility of its own except to shareholders.

So jerry-built is the corporate economy erected on the scaffolding of the City codes that it can no longer deliver even the material progress by which it justifies its privileges: even with a return to growth, living standards for lower and middle earners may be no higher in 2020 than in 2000, according to the Resolution Foundation. The truth is that UK corporate governance has neither headed off major scandal nor nurtured effective long-term management. In fact the opposite is true.

The irony is that we know what makes companies prosper in the long term. They manage themselves as whole systems, look after their people, use targets and incentives with extreme caution, keep pay differentials narrow (we really are in this together) and treat profits as the score rather than the game. And it's a given that in the long term companies can't thrive unless they have society's interests at heart along with their own.

So why do so many boards and managers, supported by politicians, systematically do the opposite – run companies as top-down dictatorships, pursue growth by merger, destroy teamwork with runaway incentives, attack employment rights and conditions, outsource customer service, treat their stakeholders as resources to be exploited, and refuse wider responsibilities to society?

The answer is that management in the 1980s was subject to an ideological hijack by Chicago economics that put at the heart of governance a reductive "economic man" view of human nature needing to be bribed or whipped to do their exclusive job of maximising shareholder returns. Embedded in the codes, these assumptions now have the status of unchallenged truths.

The consequences of the hijack have been momentous. The first was to align managers' interests not with their own organisations but with financial outsiders – shareholders. That triggered a senior management pay explosion that continues to this day. The second was that managers abandoned their previous policy of retaining and reinvesting profits in favour of large dividend and share buyback payouts to shareholders.

Ironically, the effect of this stealth revolution was to undercut the foundations of the very shareholder value under whose flag the activists had ridden into battle. Along with corporate welfare and customer service, among the functions squeezed in the shareholder bonanza was research and development. Innovation has stalled since the 1980s, prompting some economists to query whether the era of growth itself is over.

But it's not economics, it's management, stupid. Unsurprisingly, downtrodden and outsourced workers, mis-sold-to customers, exploited suppliers and underpowered innovation cancelled out any gains from ever more ingenious financial engineering – leaving shareholders less well off in the shareholder-value-era since 1980 than in previous decades. The great crash of 2008 stripped away any remaining doubt: the economic progress of the last 30 years was a mirage. As Nassim Nicholas Taleb put it in The Black Swan, the profits were illusory, "simply borrowed against destiny with some random payment time."

Over the last decades, misconceived ideologically based governance has recreated management as a new imperium in which shareholders and managers rule and the real world dances to finance's tune. A worthier anniversary to celebrate is the death seven years ago this month, on 11 November, of Peter Drucker, one of the architects of pre-code management, which he insisted was a "liberal art". Austrian by birth, Drucker was a cultured humanist one of whose distinctions was having his books burned by the Nazis. In The Practice of Management in 1954 he wrote: "Free enterprise cannot be justified as being good for business. It can be justified only as being good for society".

We need a revolution in how our companies are owned and run

The second of this series on a new capitalism calls for a culture dedicated to long-term, ethical goals

• 
• • Will Hutton
  • The Observer, Sunday 30 September 2012

Rolls Royce: almost our last remaining great industrial company. Photograph: Simon Stuart-Miller/guardian.co.uk

Twenty years ago, Britain's greatest industrial companies were ICI and GEC. A third, Rolls-Royce, secured from hostile takeover by a government golden share, had a board that was boringly committed to research and development and to investing in its business. ICI and GEC, under colossal pressure from footloose shareholders to deliver high short-term profits, tried to wheel and deal their way to success. Neither now exists. Rolls Royce, free from concerns about hourly movements in its share price, has gone on to be almost our last remaining great industrial company.

Britain, as the Kay review on the equity markets reported, has far too few Rolls-Royces. Instead the report identified a lengthening list of companies – Marks and Spencer, Royal Bank of Scotland, BP, GlaxoSmithKline, Lloyds and now BAE – which have made grave strategic errors, taken ethical short cuts or launched ill-judged takeovers, hoping to benefit their uncommitted tourist shareholders. Their competitors in other countries, with different ownership structures and incentives, have survived and prospered.

It is an unreported crisis of ownership that goes to the heart of our current ills. Over the last decade, a fifth of quoted companies have evaporated from the London Stock Exchange, the largest cull in our history. Virtually no new risk capital is sought from the stock market or being offered across the spectrum of companies. A share is now held for an average of seven months. Britain has no indigenous quoted company in the fields of car, chemical or building materials. They are all owned overseas, with design and research and development travelling abroad as well.

The stock market has descended into a casino, served by a vast industry of intermediaries – agents, trustees, investment managers, registrars and advisers of all sorts – who have grown fat from opaque fees. It has become a transmission mechanism for highly short-term expectations of profit driven into the boardroom. Directors' pay has been linked to share price performance, offering them the prospect of stunning fortunes. As a result, R&D is consistently undervalued.

British companies are now hoarding some £800bn in cash, cash they would rather use buying back their own shares than committing to investment. We have allowed a madhouse to develop. An important reason why Britain is at the bottom of the league table for investment and innovation is the way our companies are owned or, rather, notowned.

It is a crisis of commitment. Too few shareholders are committed to the companies they allegedly "own". They consider their shares either casino chips to be traded in the immediate future or as no more than a contract offering the opportunity of dividends in certain industries and countries; this requires no engagement in how those profits and dividends are generated. British law and corporate governance rules demand the narrowest interpretation of investors' and directors' duties: to maximise short-term profits while having minimal associated responsibilities.

The company is conceived as nothing more than a network of short-term contracts. Any shareholder – from a transient day trader to a long-term investor – has the same standing in law. American directors' ability to defend their company from hostile takeover or German directors having to live – horrors – with trade union representatives on their supervisory boards are seen as obstacles to enterprise that Britain must not go near. But companies and wealth generation, as Professor Colin Mayer argues in his important forthcoming book Firm Commitment, are about co-creation, sharing risk and long-term trust relationships: Britain's refusal to embrace these core truths is toxic. Companies were originally invented as legal structures to enable groups of investors to come together, committing to share risk around a shared goal and so make profit for themselves, but delivering wider economic and social benefits in the process. Incorporation was understood to be associated with obligations: a company had to declare its purpose before earning a licence to trade. There existed a mutual deal between society and company.

No game-changing improvement in British investment and innovation is possible without a return to engagement, stewardship and commitment. Limited liability should not be a charter to do what you like. It must be conditional on a core business purpose, along with the creation of trustees to guard it. Directors' obligations should be legally redefined to deliver on this purpose. What's more, every shareholder should be required to vote, with voting strength, as Mayer argues, increasing for the number of years the share is held.

To solve the problem that individual shareholders – even savings institutions – do not have sufficient muscle nor sufficient incentive to engage with managements, voting rights could be aggregated and given to new mutuals. These would support directors in delivering their corporate purpose, a proposal made by the Ownership Commission I chaired. Companies would become trust companies, with a stewardship code. The priority in takeovers would be the best future for the business, not the ambition to please the last hedge fund to take a short-term position.

Stakeholders should also have a voice in how the company is run. In Germany, a company's bankers and its employee representatives have seats on the supervisory board. Why not copy success rather than continue with our failed system? The Kay review's proposals to stop quarterly profit reporting, while a useful first step, do not address the core of the problem. The company has become a dysfunctional organisational construct that needs root-and-branch reform.

As part of the reform, Britain also needs more co-operatives, more employee-owned companies and more family-owned firms. It needs to be more attentive to which foreign companies own our assets and for what purpose. It is an ownership revolution to match the revolution in finance proposed last week. Together with an innovation revolution – see next week – the British economy could at last begin to deliver its promise.

Huaxi: The socialist village where everyone is wealthy

Imagine a place where everyone is entitled to a free home, a free car and free healthcare. Clifford Coonan travelled to Huaxi to find out the secret of its success.

Clifford Coonan

Tuesday, 17 January 2012

The sort of oxen you expect to see in Chinese villages tend to be pulling carts or tilling fields, not a beasts made of a ton of gold. This precious cow is located on the 60th floor of a 328m-tall skyscraper in Huaxi, China's richest village, and building that juts out of the eastern landscape like a giant tripod topped by a golden ball.

Huaxi is a "model socialist village", according to local officials, and was founded by local Communist Party secretary Wu Renbao in 1961. His foresight was to transform a poor farming community into a super wealthy community, built on its clever adaptations of modern agribusiness methods, then its diversification into steel mills, its logistics firms, and its textile businesses.

The commune listed on the stock exchange in 1998 and is now a major corporation in its own right. Its subsidiary companies, built into something that resembles a modern-day conglomerate, exports to more than 40 countries around the world. Huaxi is where Chinese people come to learn how to get rich. At a time when the rest of the world, and indeed much of China, is trying to absorb an economic slowdown, Huaxi is like a parallel universe.

"This cow cost 300 million yuan (£31m), but now it's worth 500 million yuan," says our guide, Tina Yao, as she steers us from floor to floor in the Zengdi Kongzhong New Village Tower, which is taller than anything in London. "Zengdi" translates as "increase the land" and the skyscraper cost three billion yuan (£310m).

Other floors have giant animals of solid silver. Fearsomely bejewelled chandeliers hang over your head in banquet halls that hold thousands of people. You approach these glittering sites walking on gold-leaf marble, passing aquariums with sharks and stingrays.

Far below, you see the villas and theluxury cars. Every villager gets a share of the corporation's profits and is entitled to a car, a house, free healthcare and free cooking oil.

The village feels a little like Dubai. It is not big on charm – the replicas of the Arc de Triomphe and the Sydney Opera House – are of questionable taste, but where it is widely different is in how well it is able to meet its people's needs. Mr Wu is keen that Huaxi should showcase China's achievements and now some two million visitors come to Huaxi every year to gaze upon its splendour.

The original founding families, who are known as "stakeholders", number around 1,600 and the average household income is around £100,000 a year, once all the bonuses, pensions and wages are factored in. White BMWs are ubiquitous and the murals, instead of depicting socialist realist muscled workers in overalls, have pictures of happy families living in wealthy villas.

This is where Huaxi stands apart from so many other villages in China. While the rest of the country suffers from a yawning wealth gap between the rich cities of the eastern seaboard and southern coasts and the rural hamlets, Huaxi took the initiative, driven by Mr Wu's pragmatism, and headed its own way. It behaved like a city, even importing migrant labour.

"We only ever wanted what was good for our people," is a dictum of Mr Wu, who is now 86 years old and retired. His son has taken over as party secretary, but the father still gives lectures on socialism every day. He avoids allying himself too closely with either capitalism or communism, though his pragmatism has strong elements of the Chinese Communist Party about it.

No one doubts the wisdom of Mr Wu, and looking at the village's wealth, why would they? He broke up the collective system of farming and encouraged people to grow their own crops.

Below the stakeholders in the hierarchy come the residents from neighbouring villages that have been absorbed into Huaxi, and then tens of thousands of migrant workers who perform most of the rest of the work.

Work and wealth are the crowning ideologies. No one takes weekend breaks, and the streets tend to be deserted of residents because they are all off working. The hard work has clearly paid off and the money raised has helped the villagers diversify into other industry.

One of those areas is tourism – wealth tourism – and some of the locals help to meet and greet the two million tourists that come every year to see the village.

A new reason to come is to see the skyscraper, which is impressive, although as there is nothing even remotely as tall in the surrounding countryside, it looks strangely incongruous.

The reason it is so tall is a useful insight into the mindset of the people here. It is, as Mr Wu said in a recent interview, because the people Huaxi can compete with anyone in the country. "Beijing's tallest building is the 328m-tall World Trade Centre. Huaxi wants to maintain the same height with the Central Committee of the Communist Party," he said.

The village's total square area is a little less than one square kilometre, and there are barrack-style dormitories, factories, and pagoda style-buildings for local residents. The skyscraper houses the Longxi International Hotel, which has 2,000 beds and will employ 3,000 people eager to learn how to become wealthy, Huaxi-style.

Intriguingly, in the central village park, there are the statutes of five of the true icons of Communism in China, some more controversial than others. The panoply includes the former mayor of Beijing, Liu Shaoqi, who was purged in the period of ideological frenzy that was the Cultural Revolution and whom many believed Mao had murdered. He has never really been rehabilitated and remains outside the pantheon of true revolutionary heroes.

But then Mr Wu himself suffered during the Cultural Revolution. He set up factories but the Red Guards paraded him in the village as a "capitalist roader" and locked him up, much in the same way as Liu Shaoqi. Like Deng Xiaoping, who also suffered during the Cultural Revolution, Mr Wu bided his time and soon was back on his capitalist track after Mao died in 1976, except that these ideas became formulated as socialism with Chinese characteristics.

All over the village are megaphones blasting out the village anthem, which tells of how communist skies shine down Huaxi, a village of everyday miracles. "I have heard about Huaxi for many years. I have wanted to see it for many years," said one octogenarian visitor from Chengzhou.

Two men, both of them employed in security and not stakeholders in the village, say they love what is going on in Huaxi, but they admit they are a bit jealous of the shareholders who get a stake in the village's profits every year.

Certainly, there is a lot of bluster in the way Huaxi markets itself. The divisions between the stakeholders and the migrants on the streets are large. But no one in China doubts its importance as a model for the success of the nation. And deny at your peril the wisdom of Mr Wu and of the wider Chinese psyche: The song from the public address system says it proud: "Socialism is best."