The 25-year asset bubble has caused a crescendo of corporatism, as large corporations, their values swollen by asset price inflation, have sought to impose themselves on our lives. Their interaction with the left of politics has been especially poisonous, with “corporate-woke” schemes generated by top management threatening to eliminate the interests of the shareholders who are nominally their masters. Is this our future, or will we find a way to defeat it?
Adam Smith warned us about large corporations. He was strongly in favor of capitalism, but not of large monopoly companies: “Since the establishment of the East India Company, the other inhabitants of England, over and above being excluded from the trade, must have paid, in the price of the East India goods which they have consumed, not only for all the extraordinary profits which the company may have made upon those goods in consequence of their monopoly, but for all the extraordinary waste which the fraud and abuse inseparable from the management of the affairs of so great a company must necessarily have occasioned.” He could have been writing today — about Alphabet Inc. (Nasdaq:GOOG), for example.
In the nineteenth and early twentieth centuries, huge agglomerations of capital in large corporations were inevitable. The economies of scale, in both manufacturing and marketing, in mass producing automobiles and organizing a nationwide chain of dealers to sell them were so great that even the enormous “fraud and abuse” of 1950s General Motors and the United Auto Workers’ collusion was not sufficient to prevent the company being market-dominant, enormously large (576,667 employees in 1955) and extremely profitable. When “Engine Charlie” Wilson told the Senate Armed Services Committee in January 1953: “What’s good for America is good for General Motors, and vice versa” he was pretty well correct, both quantitatively and qualitatively.
Technology has moved on since Engine Charlie’s day. There are no longer such gigantic economies of scale available from mass production; computerized manufacturing enables us to produce goods in much smaller batch sizes, satisfying a broader range of consumer desires. There are no longer great economies of scale in distribution; Internet ordering and order processing enable even small manufacturers to service customers all over the world. Only in marketing are the economies of scale still vast, perhaps even larger than in Engine Charlie’s day, as the Internet allows ever louder voices to drown out small sellers and quell unpopular minority opinions, in a way that was impossible in 1953.
While the economic reasons for corporatization have diminished somewhat, financial distortions have instead contributed greatly to the economy’s corporatization. Before 1995 began the Fed’s distorted interest rate regime, medium sized companies along the lines of the German “mittelstand” could if they wished remain private. The advantage of doing so was that control was maintained in the founder and his family, allowing them to pass a thriving business on to their heirs. With the gross explosion of equity values since 1995 two major factors have prevented this natural generation of long-lasting privately held businesses.
First, the profits from “going public” at the top of a bull market are so exorbitant as to be irresistible. For the immediate company founder, the attractions of passing the business down to one’s heirs may still be sufficient to resist this temptation, but for senior management not part of the owner’s family, they certainly are not. If the owner gives out modest equity participations, the urge to convert those participations into stellar amounts of cash is irresistible. If the owner keeps control by refusing such participations, he will lose most of his senior management, since working for his company will be financially very unattractive compared with the possibilities available elsewhere.
Even more damaging to the existence of long-term private companies is the venture capital/private equity industry. Initially, this appeared to be helpful. An outside source of capital helped many dreams get off the ground, notably for example the $250,000 that Mike Markkula invested in Apple in 1977, to become one third owner of the fledgling company. However, the professionalization of venture capital, its transformation into “private equity” and the enormous sums of money poured into the sector have poisoned the U.S. economic system.
The temptation to an entrepreneur struggling with the early stages of a venture to get it capitalized with more money than it can possibly need can be irresistible. The downside is that the private equity investors who have provided him with this bonanza will want an exit. Within five years or so, he will either have to “go public” almost certainly losing control of the company he created, or acquiesce in a trade sale of his company, becoming part of a sluggish behemoth. Either way, his entrepreneurship will have been corporatized and the original spark of flair or even genius will have been lost.
The rate of U.S. new business formation had already halved from the 1970s before the Covid-19 pandemic and will have fallen further since. Instead of healthy private companies, there are innumerable private-equity-owned monsters, often unprofitable for a decade or more, which will almost all prove in the end to have sucked up far more resources than they generated.
The corporatization of the U.S. economy is becoming increasingly damaging. The Business Roundtable’s foolish call for companies to embrace the leftist “ESG” agenda and the tech giants’ increasing enthusiasm for censoring any political views to the right of Mitt Romney are not only politically damaging, giving aid and comfort to the worst elements in the U.S. political system, they are also economically disastrous. A corporate sector that throws trillions of dollars at the woke chimaera of “climate change” is a corporate sector that is not going to produce any economic advances worth having. Economic domination by the Warren Buffetts (post-1990), Tim Cooks and Jamie Dimons of this world is political as well as economic death. Any chance of getting out of the current productivity rut and returning to technological and economic advance will disappear.
We must thus devise mechanisms to reduce the corporate dominance of the U.S. economy. One such mechanism will be the restoration of positive real interest rates, whose necessity will become obvious to all once inflation takes hold over the next year or two. This will sharply reduce asset values, doubtless in a huge and painful crash. Most important, it will reduce the premium available from the award of corporate stock options; there will no longer be such a force to “go public” or accept dodgy private equity financing, thereby destroying the creativity and long-term future of the company.
Conversely, the market’s penalties for corporate failure would be more sharply imposed, thus ensuring that deviations from market principles towards “woke” management would be punished by the demise of the company. Expensive leverage reduces the ability of the company to coast along satisfying its top management’s political prejudices and achieving sub-market returns. High interest rates make good managers.
A second de-corporatizing step would be legislation that banned stock buybacks (returning the U.S. to the pre-1978 position) and imposed a severe taxation regime on corporate-awarded stock options. This would ensure that corporate management worked primarily for their salaries and any bonuses; it would reduce the manipulation of earnings and stock prices by corporate management, and it would place more control of companies back in the hands of shareholders, where it belongs. It would also enable a long-term oriented company founder to hire managers who agreed with his approach to the company’s future, by ensuring that they would be paid primarily by their success in achieving the goals he determined.
A third change would be simple: the return of a government that is committed to free-market principles and opposed to companies that waste shareholders’ money on crusades against global warming or other shareholder-hostile activities. The Biden administration’s action in attempting to invalidate drug patents for vaccines, for example will have the effect of reducing the energy with which new vaccines are created in the next pandemic. An active anti-trust division would also be helpful, preventing the growth of monopolistic behemoths such as Apple (Nasdaq:AAPL), Alphabet, Facebook (Nasdaq:FB) or Microsoft (Nasdaq:MSFT) that suppress competition and inhibit the creation of new and nimbler competitors.
We should aim at an economy in which there are no gigantic woke-governed behemoths, but many innovative medium sized public and private companies, managed with a view to innovation and their long-term future. A world of strong competition, in which capable individuals make economic decisions, will make the world better for everybody, capable or not.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)