Monday, August 31, 2020

Markets, morality, and mobsters: corporate governance requires solid morals, says Commissioner Peirce

By Joanne Cursinella, J. D.

SEC Commissioner Hester M. Peirce, in prepared remarks to the 18th Annual Corporate Governance Conference, focused on what U.S. capitalism can learn from one of the most famous Japanese capitalists of the 19th century, Shibusawa Eiichi. Much of the developed world seems to be turning against capitalism, Peirce observed, which they view as a system designed for the benefit of the few, at the expense of the many. But Shibusawa understood that capitalism—in which private individuals come together voluntarily to build profit-making enterprises—can elevate hardworking, talented people of good character; spread prosperity; and benefit society, she added Shibusawa’s role in creating the modern Japanese economy is hard to overstate, but he has much to offer our nation as well, she concluded.

Japan’s challenges. Peirce began by telling her audience a little bit about Shibusawa and the challenges Japan faced when he embarked on his career in the second half of the 19th century. When Shibusawa was born in 1840, Japan was still a feudal society. A man’s highest calling was service to the state; commerce was seen as the realm of those who sought profit without adherence to any code of honor or morality, Peirce said. The arrival of Commodore Perry off Japan’s Pacific coast in 1853 forced Japan to open its doors to the outside world for the first time in two centuries and plunged the feudal hierarchy into chaos.

During an extended trip to Europe in 1867-68 as part of an official study delegation, Shibusawa learned that much of the European powers’ strength derived from the value that they placed on commerce and the market technologies on which commerce relied, Peirce explained. Shibusawa concluded that Japan’s economic development would require a transformation of values: disdain for commerce would need to give way to a respect for commercial enterprise.

Heightened moral sensitivity. Shibusawa’s insight is one that is often overlooked, but it is important, Peirce averred. Voluntary commercial activity both requires and cultivates a heightened moral sensitivity in those who engage in commerce and according value to those who engage in this activity helps build healthy societies. Others have made the same point, Peirce pointed out, among them Deirdre McCloskey, who argued that "[t]he growth of the market promotes virtue, not vice."

By pushing us to listen and to engage with each other, commercial activity encourages all of us to be better neighbors and to treat others with civility and tolerance, Peirce pointed out.

Modern capitalism. Shibusawa played a central role in introducing to Japan the central financial technologies of modern capitalism, including the joint-stock company, double-entry accounting, and modern banking, Peirce said. As one Shibusawa biographer noted, once he concluded that the key to national prosperity was not in the state but in the people, the question was how to marshal these resources and talents to empower the people to achieve a broad-based prosperity, she added. In Shibusawa’s view, the joint-stock company was a tool uniquely suited to offer opportunity to anybody, regardless of social class, Peirce pointed out.

Shibusawa helped establish, and mentored the leaders of, dozens of national banks throughout Japan, but he had a vision for the transformative power of capitalism—and the joint-stock corporation—across the entire economy, Peirce noted. He was involved in establishing between 400 and 500 corporate entities that were part of the financial, physical, and logistical infrastructure that Japan needed to participate as an equal in the modern global economy, she added.

Integrity was the key. According to Peirce, integrity was key to the capitalist society Shibusawa championed. Profit-seeking was not a selfish pursuit. He commended hard work for the purpose of building an enterprise but recognized the danger of self-interested managers. Much of Shibusawa‘s mentorship activity appears to have been devoted to instilling in younger corporate managers the importance of looking beyond one’s own personal interests in managing a corporate enterprise, Peirce pointed out. Shibusawa spent much of his life selling capitalism to his country. He also was "tireless" in his efforts to foster better U.S.-Japan relations, she said.

Help for America. Shibusawa can help his American friends to remember why capitalism is worth keeping, Peirce said. He can remind us that the goal of a corporation is to join people together in a cooperative enterprise that draws on their capital and talent to make products and services that people want, which is the reason that a corporate enterprise generates profits. A corporation is not something that requires government direction; and such involvement will almost certainly lead to either compulsion or rent-seeking, she added. And Shibusawa can remind us that for those working in private enterprise to meet the needs of other people and doing this work well is morally exemplary; members of the private sector ought not think themselves inferior to "public servants," Peirce said. Finally, the people running the company have to remember that they work for the shareholders, not for themselves.

U.S. contrast. According to Peirce, many people from within and without corporate America are undermining the corporation rather than harnessing its power to address society’s problems. "Intricately thick regulatory barriers" to the formation and financing of companies can make it harder to start a corporation and take it public, she said. The existing exempt offering framework not only imposes burdensome compliance costs on startups, but also "ties their hands" when it comes to tapping into their networks in order to raise capital. Large, incumbent firms often use regulatory barriers to entry to their advantage. Further, the suggestion that the market is something for the powerful to carve up for their own benefit suggests a view of capitalism similar to that of Al Capone, who is alleged to have said: "Capitalists believe they can take everything at the table as belonging to them," Peirce said.

Bad habits too easily replace the qualities that make a business enterprise truly successful, she warned. The pressure to develop these habits is particularly strong in public corporations, which are under increasing regulatory and societal pressure to focus on objectives other than profit-making, she added. As a consequence, she said, companies are losing their singular focus on maximizing the value of the company. The irony of current corporate responsibility movements, which encourage corporations to do things other than focus on profit-making, is that the diverted focus will undermine corporations’ ability to improve people’s lives, Peirce pointed out. Shibusawa recognized that the ability of corporations to play a leading role in improving people’s lives depended on them being permitted to be profit-seeking entities, she added.

Moreover, the dilution of the role of shareholders in corporate governance reduces management’s accountability for their actions. Success is no longer measured solely by shareholder value, but instead is defined, at least in part, Peirce said, by the good intentions of management with respect to favored stakeholders. But by shifting their focus to stakeholders rather than investors, CEOs may be attempting to distance themselves from their fiduciary duties to shareholders, duties that are underpinned by moral principles, she warned. No such higher standard of conduct applies to the relationships between stakeholders and corporate officers and directors, so it is not surprising that those relationships are being used to justify certain business decisions, she concluded.

Regulator’s role. As a federal securities regulator, Peirce’s reach into state corporate law is, and should be, limited, she said. Relations among corporate boards of directors, managers, and shareholders are appropriately governed by state law, she added. Yet, discussions about corporate purpose and governance affect discussions about disclosure requirements for public companies. If the objective of a company is no longer to maximize value, then the company’s disclosures become as unfocused as the company’s management team. That is not a good result for investors, she concluded.