Profits, and Paychecks: Corporate Citizenship in an Era of Smaller Government
George Washington University School of Business and Public Management
February 6, 1996
If the government is to do less, then the private sector will have to do more. But the stunning announcement on the first business day of l996 that one of the nation's largest and most profitable companies will permanently lay off tens of thousands of employees raises profound questions about the private sector's ability to take on more responsibility for Americans' economic well-being. What may feel like a nightmare for the affected workers is, in fact, hailed as a dream-come-true on Wall Street -- suggesting that the company may have done exactly the right thing by its shareholders. But that is precisely the issue.
Do companies have obligations beyond the bottom line? Do they owe anything to their workers, their workers' families and their communities?
Even some of the most orthodox defenders of the free market have said that movie studios, record companies and television networks should forswear lewdness or violence, although pandering to audiences' baser appetites would yield rich profits. The profit principle, it seems, is something short of absolute. What, then, about a corporation's duty to its employees, their families and the communities in which they live? Might not the sudden loss of a paycheck be at least as damaging to family values as a titillating screen performance?
In fact, family values are intricately intertwined with what might be called home economics. The necessity to work longer hours in order to make ends meet may mean that a parent isn't home when a child is in most need of parenting. The urgency of finding a new job may mean that one spouse must move to another city, or must commute long distances, leaving family behind. Or it may require that an entire family uproot itself from friends and relatives. The financial pressures resulting from a declining paycheck or the loss of a job can disrupt and sometimes destroy families. Whether we like it or not -- whether we recognize it or not -- corporate decision-makers have significant influence over the future strength of America's families and communities.
Yet corporate executives protest, with some justification, that they have no choice. They argue that they must do what is in the interest of shareholders even at the expense of employees and the communities in which they live. If wages and benefits can be cut without imperiling production, they must be cut. If employees' efforts do not generate a sufficient return, the jobs have to go. And if an entire community loses its economic base because the company can do its work more efficiently elsewhere, then so be it. Managers who balk at executing the judgments of the market fear, with reason, that they will quickly face their own day of reckoning.
Yet this restricted vision of stewardship is ultimately disastrous for America -- including American business. Corporate leaders must reconsider.
This era of government downsizing is also a time for corporations to size up their responsibilities to America. As the President noted in his State of the Union address, employers must do their part along with employees -- sharing with workers the benefits of the good years, not just the burdens of the bad. It is a time for companies to focus beyond the bottom line. It is a time for a new corporate citizenship.
I would like to speak of what such a reconsideration might entail. But first, a little perspective on how we reached this point.
1. The End of the Social Compact
Chief executives once sang a different tune. In a l951 address that was typical of the era, Frank Abrams, chairman of Standard Oil of New Jersey, proclaimed, "The job of management is to maintain an equitable and working balance among the claims of the various directly interested groups ... stockholders, employees, customers and the public at large." That same year, Fortune magazine lectured executives on their duty to be "industrial statesmen" who worked for the good of their employees and communities as well as shareholders.
This implicit social compact between corporations, their employees and communities with which they dealt survived into the l960's and l970's. So long as the company earned healthy profits, employees could be assured of secure jobs with rising wages and benefits, and their communities could count on a steady tax base. When the economy turned sour, employees might be laid off for a time. But when the economy revived, the work would return. The very term "layoff" suggested a temporary separation.
The compact was enforced in several ways. Unions obviously played an important role. There was also a public expectation that when a company did well, its employees and community would also do well. It would be unseemly -- "un-American", if you will -- for a business not to share the benefits of its success.
What has changed? For one thing, competition. American businesses have been transformed from comfortable and stable rivals into bloodletting gladiators. Information technologies have radically reduced the transaction time between suppliers, wholesalers, retailers and customers. Airlines, telephone companies, utilities, common carriers -- and Wall Street itself -- have been deregulated. Global competitors threaten the very survival of American manufacturers. Entry barriers such as preferential access to capital markets have dropped, allowing small companies to grab market share from big ones.
Today, vast amounts of capital can be moved from place to place at the push of a key on a personal computer. Investors face an ever-wider array of choices of where to put their money.
This "electronic capitalism" has replaced the gentlemanly investment system that had given "industrial statesmen" the discretion to balance the interests of shareholders against those of employees and communities. Now, any chief executive who hesitates to subordinate all else to maximize shareholder returns risks trouble. By the same token, a chief executive who ruthlessly subordinates all else can reap handsome rewards. We are faced with the spectacle of CEO's pocketing multi-million dollar bonuses and stock options after abandoning their employees and communities -- indeed, precisely because they have abandoned their employees and communities.
The social compact has come undone. Unions are less able to enforce it. Public norms and expectations cannot sustain it. Profitable companies are shedding workers and they are leaving town. Even the term "layoff" no longer means what it used to. Most layoffs are now permanent. We need a new word to describe what the phenomenon. Perhaps we should call them not "layoffs" but "cast-offs."
2. The Trap of the Old Economy
This transformation of the corporation into the agent of the shareholder alone, and the consequent stranding of so many working people and their communities, is occurring at a particularly unfortunate time. Much of the American workforce is facing a stark challenge of adapting to new economic realities, just as sources of support in meeting that challenge are quickly eroding.
The same explosion of technological change and global integration that has intensified competition among companies and expanded investors' options is also changing the nature of work. The mass-production jobs which were once the gateways to the middle class are being replaced by jobs requiring technical or problem-solving skills and the capacity to continuously acquire new skills. The earnings of people who are poorly educated to begin with, or who have outmoded skills, are declining. The earnings of those with good educations and the right skills are rising. The gap is widening rapidly.
Tens of millions of Americans remain trapped in the old economy. I have seen them and talked with them across the nation. They are laid-off
-- cast-off -- and jobless, or in new jobs with worse wages and benefits. In fact, most people who have lost their jobs in recent years and found new ones never catch up with the earnings and benefits they once had.1 Or they have started out in a low-wage job and cannot seem to get ahead no matter how hard they work. They cannot easily acquire on their own the education and training needed to succeed in the new economy.
This is a problem for all of us, not just the bottom half of the workforce. Almost three quarters of our national output comes from people; only one quarter from machinery. The quality of our labor force is the engine of economic growth; physical capital is the caboose. If a significant portion of the American workforce lacks the skills to succeed in the new economy, the standard of living of all Americans is imperiled.
3. The Consequence
The corporation's relentless focus on one goal -- the exclusive goal of maximizing shareholder returns -- makes it less willing or able to ease the transition of the American workforce to the new economy. Were the old social compact still in effect, companies would bring their workers along, and pay the extra freight. With the compact voided, even highly-profitable companies now leave their workers behind.
The narrow economic calculus discourages such investments: The nation as a whole may be better off when employers provide adequate pensions and decent health coverage and when they teach their workers basic or industry-wide skills beyond what is required to function effectively in their current job. The economy as a whole may be more productive and flexible when employers see to it that workers who are no longer needed get trained for and placed in new jobs. Yet because the company's shareholders do not reap the full benefits of these sorts of investments, even the most enlightened Chief Executive Officer will be loathe to make them to the extent that society needs.
To be sure, some companies do take the "high road" to higher profits -- bringing employees along while improving and enlarging their businesses and thus expanding their payrolls -- rather than the low road of suppressing wages and paring payrolls. And the shareholders of these companies do perfectly well. In fact, the long-term payoff from boosting worker loyalty and security and from retaining experienced workers can exceed the more immediate financial benefits of taking the "low road".
Let me give you several examples of high-road companies. Just before last Christmas, a tragic fire destroyed the factory of Malden Mills in Methuen, Massachusetts, and with it the security and the hopes of the 2,400 people who work there. Three days later, the owner of the firm,
Mr. Aaron Feuerstein, appeared before his employees and told them that he would not only rebuild and rehire every one of them, but he would also continue paying them their salaries and their benefits during the shutdown. Today, Malden Mills is well on its way back to full operation.
Or consider another company -- this one publicly-held. Corning, Incorporated, is ensuring its worldwide leadership in its diverse product line -- from housewares to telecommunications -- through a commitment to employee participation and training. The company has won the Malcolm Baldrige National Quality Award and has been recognized by Working Mother magazine for providing a family-friendly work environment.
There are many other examples of high-road companies -- Xerox, Chrysler, Republic Engineered Steels -- to name only a few. But I wish there were more. Unfortunately, the high road is the exception rather than the rule. In too many instances, top executives are not creating value; they are merely redistributing income from employees and their communities to shareholders.
As corporations have focused more and more exclusively on increasing shareholders' returns, the consequences have become obvious. The stock market has soared while pink slips have proliferated, health care and pensions have been cut, and the paychecks of most employees have gone nowhere. Top executives, talented entrepreneurs, and Wall Street intermediaries have never done as well. Workers without adequate education and skills, or with outmoded skills, are in free fall. This situation is not sustainable. But what can be done about it?
4. The Limits on the Public Sector
Historians looking back on this era will record the double irony. As noted, the transformation of the corporation into the agent of the shareholder alone is occurring at a time just when the American workforce is in most need of help adapting to a new economic system. But it is also occurring just when the public sector is particularly constrained from filling the void. This administration came to office hobbled by more than a decade of exploding public indebtedness. We had no choice but to make deficit-reduction a first priority. Moreover, the public is increasingly skeptical of the federal government's capacity to run large programs. As the President noted in the State of the Union Address, "the era of big government is over."
Regardless of how the current budget negotiations are settled, in the future the federal government will have a more modest role in safeguarding the economic security of Americans. States and localities may have more leeway, in principle, but far fewer resources. And because they will compete with other states and locales to attract companies, they will be reluctant to impose higher taxes or any other extra burdens.
To be sure, government can make more effective use of the resources it does have. We have already taken steps to change the unemployment insurance system -- designed to provide income support during temporary layoffs -- into a genuine re- employment system designed to move people rapidly into new jobs and get them the training they need. Hopefully, Congress will heed the President's call to consolidate federal job-training programs into vouchers which unemployed or low-wage workers can use at community colleges or technical schools to get the skills they need. And we want to make pensions and health insurance more portable, so that they will move with people from job to job, and be available between jobs. The Administration strongly supports legislation now pending before Congress which would bar health insurers from cancelling policies when a job is lost.
The President remains committed to education and job training. But even if we succeed in maintaining current levels of funding in the face of severe budget constraints, it will not be nearly enough. State and local governments across America are paring back. Classrooms in too many of our cities remain overcrowded. Tuition at too many state universities and community colleges is rising faster than inflation. Vocational and technical education is too often obsolete or woefully inadequate to what the times demand. By one estimate, merely to return to the level of inequality at the end of the 1970s would require an additional yearly public investment in the skills of the bottom half of our workforce of approximately $60 billion.2 It is a safe bet that funding of that magnitude will not be forthcoming any time soon.
5. Corporate Responsibility Revisited
One ostensible purpose of eliminating the federal budget deficit is to give the private sector more capital to invest, thus widening opportunities and raising earnings for all Americans. Balancing the federal budget is not a goal in itself, but is a means to higher living standards for all.
Yet as we all see, there is no guarantee that corporations will use the extra resources in this way. Maximizing shareholders' returns may require investing the extra dollars in production abroad, or in labor-saving equipment intended to reduce wages and cut jobs, or in mergers, acquisitions and divestitures that result in mass layoffs.
How, then, to get the private sector to take more responsibility for their employees and the communities in which they live, as the federal government retreats?
I do not advocate a return to the era of industrial statesmanship. That era, too, is over. Even if we could turn the clock backward and enlarge upon the C.E.O.'s former discretion in balancing the interests of shareholders against those of employees and communities, it is far from clear that society should vest such power in private citizens.
Exhortation can have some effect. After all, most companies are understandably concerned about their public image. Good corporate citizenship is often a wise business strategy. One recent example involves the growing problem of sweatshops in the garment industry. As anyone who has had anything to do with this industry knows, the big retailers call the shots. They have the buying power to determine how the industry runs. After slave-labor conditions were discovered in California sweatshops last summer, we published the names of several of the nation's largest retailers to which the garments in question had been shipped. Subsequently, during the Christmas gift-buying season, we published the names of big retailers that had pledged to regularly inspect their contractors or to require that the manufacturers with whom they deal do so. These measures have begun to work. More than a dozen of the nation's top retailers have joined us in our campaign against sweatshops. I hope and expect that others will do so as well.
Earlier I listed several companies that have distinguished themselves as fine employers. Many companies are also taking an active role in improving their communities -- actively participating in local training programs and contributing to the public schools. They too deserve commendation. Unfortunately, these efforts are too often cancelled out by companies that conduct bidding wars among states or localities, threatening to leave one place or offering to go to another depending on how much their taxes are cut or how much of a cash subsidy they can elicit from the public sector. Such tactics result in a giant zero-sum game which fails to create a single new job but merely moves the old ones from place to place, leaving a trail of pink slips and abandoned communities. It also puts companies that don't play the game and don't get the tax breaks or subsidies at a competitive disadvantage. Worse yet, such bidding wars drain state and local governments of scarce resources that could otherwise be invested in schools, technical training, and physical infrastructure. Starting bidding wars for tax breaks or subsidies is the opposite of good corporate citizenship, and it deserves condemnation.
Assume that we have gone as far as possible in exhorting companies to be more responsible and in quelling their appetite for political favor. We have gained some ground, but most working people are still insecure and the income gap continues to widen. What else can be done?
6. A Modest Proposal
Let's look at the basics. The corporation is, remember, a creation of law; it does not exist in nature. The corporate form of business carries special advantages: Investors are not personally liable for damages or debts. A corporation has the same rights of free speech and legal action that an individual has -- but can live forever. There are disadvantages as well: Corporations must pay taxes on their incomes, as do the investors who receive dividends, resulting in double taxation.
If we want business to take more responsibility for the American workforce and its transformation to the new global economy, we will have to alter this mix of advantages and disadvantages to provide the proper incentives. If we want companies to do things which do not necessarily improve the returns to shareholders but which are beneficial for the economy and society as a whole -- actions such as upgrading the general skills of employees, providing them with decent pension and health care protections, sharing more of the profits with them, and, when laying them off, retraining them and placing them in new jobs -- we have to give business an economic reason to do so. One possibility would be to reduce or eliminate corporate income taxes only for companies that achieve certain minimum requirements along these dimensions.
This is, admittedly, a modest proposal. The tax code already treats different types of organization differently. Charitable organizations, meeting certain minimal requirements of structure and behavior, are treated quite differently from the standard corporation, as are partnerships and proprietorships. These differences reflect judgments about the societal benefits and responsibilities stemming from these various forms of organization. Similarly, there are societal advantages in improving the quality and flexibility of the workforce, and societal costs in failing to do so. Certain enterprises may be well-positioned to maximize these advantages and minimize these costs. Let us, as a society, encourage them do so, and reward them accordingly.
Those who worship at the altar of the free market need not fear blasphemy. I am not suggesting that corporations be required (or induced) to keep on their payroll workers who don't contribute to the bottom line. I am not asking that they remain in communities when there are more efficient places to produce their wares, or to take any other action which may reduce returns to shareholders. I am suggesting, however, a means of making corporations more accountable for the social costs and benefits of economic change.
7. A National Discussion
Others will have different ideas for how corporations can best respond to the growing inequalities and insecurities in our workforce. Let us have a national discussion about this -- about the role of the corporation at this unique moment in history. Surely this discussion is no less important than the one we are having about the role of government. Chief executives should contribute to this discussion -- not in order to defend the status quo but in recognition that the trends we are observing cannot be allowed to continue. In this era of smaller government, at a time when so many Americans are foundering in the face of record profits and a soaring stock market, the failure of the private sector to respond imperils this nation's continued prosperity and stability.
Will the end of the era of big government witness a new era of corporate responsibility? Nobody can yet say for sure. But I am certain that, unless checked, the resentment of stranded workers will eventually undermine the political preconditions for continued business prosperity. If too many of our people feel excluded from the upside gains of a growing economy and disproportionately burdened by its downside risks and costs, they will support policies that sacrifice growth in favor of economic security -- policies like trade protection, capital controls, and inflexible rules of employment.
I sincerely hope we do not ever get to that point. You in this room have an enormous interest in sustaining the culture of openness and economic dynamism that has served business so well. Fortunately, as you move on to positions of corporate leadership, you will also be able to exercise your influence in ways that make such an outcome more likely. I urge you, for the sake of our country, to help create and sustain a new era of corporate citizenship.
1 Stevens, Ann Huff, "Long-term Effects of Job Displacement: Evidence from the Panel Study of Income Dynamics", NBER Working Paper #5343, November 1995.
2 James J. Heckman, Rebecca Roselius, and Jeffrey Smith, "U.S. Education and Training Policy: A Re-evaluation of the Underlying Assumptions Behind the 'New Consensus,'" in Labor Markets, Employment Policy, and Job Creation, edited by Lewis Solmon and Alec Levenson, Westview Press, 1994. Heckman's estimate works out to $170 billion per year for 10 years, but that sum includes the cost to individuals of foregoing income during the course of job training. Therefore, cost to the government is probably closer to $60 billion per year.