Why and how to democratise capitalism using stakeholder networks

Contemporary capitalism is forcing the degradation of democracy by strengthening plutocracy and autocracy. Plutocracy is government by the wealthy. Corporate directors are not elected on the democratic basis of one vote per member of the company but by one vote per share. This means that the wealthy get the most votes to govern corporations.

However, when shareholders neglect to vote or provide directors with their votes by proxy, plutocracy is replaced with autocracy. Autocracy is when the power to govern is self-sustaining. Autocratic capitalism is most prevalent in the US and the UK where institutional investors may collectively hold the majority of shares in many large corporations. This introduces autocracy as institutions typically are not active owners and often provide their proxy vote to corporations. The ironic result is that capitalism is undermining democracy in those countries that provide a role model and where democracy appears to be most well established and robust.

Many of the largest corporations control economic activity greater than that of most democratically elected governments around the world. Such corporations possess the resources to subvert democracy at local, state and national elections. The degradation of democracy by this means is not unknown in even the most powerful and nominally democratic nations of the world.

US politicians are reliant on corporate largesse to fund their election at local, state and national levels. In addition, corporations have more extensive and powerful resources than citizens do to lobby government for favoured treatment. In this way, democracy is degraded, as it becomes a tool of corporate plutocrats and autocrats.

Control of large enterprises on a plutocratic or autocratic basis is not required for organisations to operate successfully, as illustrated by mutual associations, cooperatives, town councils, community-controlled health and education institutions, and so on.

The introduction of plutocratic voting for corporations was initially considered to be a “dangerous innovation” in the US and ruled to be illegal, according economic historian Professor Coleen Dunlavy. Dunlavy reports that in 1834 the New Jersey Supreme Court disallowed "one share one vote" as specified in corporate by-laws as being inconsistent with common law.

One judge stated that the by-laws acted “to lessen the rights of the smaller stockholders, depreciate the value of their shares, and throw the whole property and government of the company into the hands of a few capitalists, and it may be to the utter neglect or disregard of the public convenience and interest.”

Dunlavy describes how in many other jurisdictions around the world various forms of sliding-scale voting were used in the 20th century to provide a balance between plutocracy and democracy. When I began my career as an corporate raider in the late 1960s, plutocratic voting with one vote per share was very much the exception. The general rule in Australian was sliding-scale voting that prevented any shareholder obtaining more than 20 or 25 per cent of all votes cast. This provided a compromise between plutocracy and democracy. Sliding-scale voting protects minority investors when there is dominant shareholder as is still the case in the majority of Australian listed companies and in most other countries around the world except in the UK and the USA.

The problem today is that corporate “disregard of the public convenience and interest” can become excessive. Corporations have become very much more powerful with the ability to buy favours from government to further entrench their power and influence to challenge the integrity of democratic processes. However, at the same time their excessive power has resulted in excessive laws and regulation that control many of the details of their behaviour and operations. This degrades the efficiency of both corporations and the economy with the dead weight of regulation.

Corporations also aggravate the degradation and diminishing of democracy by encouraging and participating in privatisation. Public-sector enterprises are accountable to governments elected on a contested democratic basis of one vote per citizen. Privatisation replaces democratic control with plutocratic control and/or autocracy. De-mutualisation also diminishes democracy for the same reason.

The eroding of democracy through privatisation and de-mutualisation is justified on the basis that private ownership is a more compelling driver for efficiency. But if this argument is to be accepted, the efficiency gains must be at least sufficient to offset the cost of generating sufficient profit to provide the incentive to attract investors without increasing prices.

Some might argue that inefficient operations with responsive democratic control are preferable to efficient but less responsive private control by plutocrats. However, both efficiency and democracy can be achieved together with stakeholder governance discussed later.

Unless stakeholder governance is introduced, the truncation of democracy will continue, with civil governance subordinated to the interests of corporations and individual capitalists. The policies of major political parties have already become truncated and subordinated so that there is little difference in their policies. The spread of plutocracy and autocracy has become a self-reinforcing process. It is little wonder that citizens feel alienated and disinterested in democratic processes.

Corporate leaders and capitalists argue that capitalism would become degraded if directors were elected on a democratic basis of one vote per shareholder. However, this raises the question of whether degrading democracy is more important than degrading capitalism. Answering this question requires comparing many subjective political issues with economic concerns.

The question is also dependent upon what type of capitalism is under discussion. There exists the possibility of re-designing the architecture of capitalism. There are two approaches to consider for reforming capitalism to improve democracy: (i) Reducing inequity in asset ownership to make capitalism intrinsically more democratic and (ii) Sharing corporate power on a democratic as well as a plutocratic basis.

The first approach can be introduced with tax incentives to provide owners with higher, quicker and less uncertain profits when they agree to introduce dynamic-ownership rules that continually democratise ownership. The dynamics of the new ownership rules and tax incentives would increase the incentive to invest but at the same time reduce the overpayment of investors with surplus profits. Surplus profits can become very substantial. With many long-life productive investments they can become many times larger than the value of the original investment.

Surplus profits continuously and insidiously concentrate wealth even with progressive taxation. They are insidious because economic textbooks only recognise “excessive” profit but not surplus profits that are quite a different concept. Excessive profit or rents recognised by economists can occur at any time. Surplus profits can only arise after the time required by the investor to obtain sufficient returns to obtain the incentive to invest. An investor might well obtain what an economist might consider to be an excessive profit but not receive a surplus profit. On the other hand, investors can receive a surplus profit without obtaining what an economist may consider to be an “excessive” profit!

Surplus profits are not reported by accountants because accounting standards are only concerned with accounting periods, not investment time horizons. So an influential process of wealth concentration is not observed, measured or reported. However, the need to observe or measure surplus profits is not required to distribute them through introducing dynamic property rights to create “Ownership Transfer Corporations” (OTCs).

The tax incentives to introduce OTCs and the nature of dynamic ownership in regards to realty are described in my first book, written in 1975, Democratising the Wealth of Nations. My 2002 pocket book, A New Way to Govern: Organisations and society after Enron, describes the second approach to change the architecture of capitalism to enrich democracy.

Democratising the control of corporations can be achieved in two complementary ways. One approach is to use OTCs to localise the ownership of corporations to make them accountable to their employees, customers and suppliers in their host communities. This creates a “Third Way” to work or welfare to distributing the wealth of nations. A complementary way to democratise control is to introduce “A New Way to Govern” through establishing stakeholder networks. This creates a “Third Way” to markets and hierarchies for governing society.

Stakeholder networks and governance can be introduced to the public sector, as it is not dependent upon stakeholder ownership. A basic requirement for introducing stakeholder governance is the introduction of a division of powers. This provides checks and balances and so a rational basis for developing trust and efficient operations. It also introduces sufficient variety of communication and control channels to reliably identify and control such variables that are required to sustain the organisation.

A division of powers also provides a basis to reduce and/or manages conflicts of interests while introducing competition for control within the organisation to replace the need to seek efficiency through competition for control through the stock market. This provides a counter to the efficiency argument for privatisation to justify the degradation of democracy. Distributed intelligence introduced by a separation of powers reduces information overload and bounded rationality to maximises participation in decision making and so enrich democracy.

Democracy is also enriched by stakeholder advisory councils being elected on the basis of one vote per person and having a watchdog board elected on the same basis to protect minority interests when investors are involved. So while plutocratic voting may still be used to protect the property rights of investors, minority investors are protected from exploitation by dominant investors and/or management.

What is currently described as “good corporate governance” is based on plutocratic control through a unitary board. This has two fundamental flaws: (i) directors obtain absolute power to manage their own conflicts of interest to allow absolute corruption and (ii) there is no process for either directors and/or shareholders to determine when their trust in management might be misplaced. Rather than being “Good corporate governance” is in fact irresponsible governance! Institutional investors like pension and mutual funds as fiduciary agents should not be investing in corporations subject to these two flaws that are found in most publicly traded corporations.

The solution to these problems is to introduce a division of corporate power into two or more boards described as a compound board that involves the participation of stakeholders. Compound boards provide a way to integrate civil governance with corporate governance to strengthen both capitalism and democracy. The property rights of the wealthy can still be protected by one vote per share to appoint directors.

Transferring to the private sector some of the roles of civil governance also strengthens the free enterprise system as well as strengthening democracy. Democracy is also strengthened by this approach being used to reduce the size, cost and complexity of government and regulation.

On the other hand the need to increase efficiency of essential government services by capitalising them in the private sector or contracting out their services can be avoided through stakeholder mutualisation. The introduction of stakeholder network governance enriches democracy at the coalface of organisations. This provides a basis to improve efficiency, economy, effectiveness, inclusiveness, responsiveness, transparency and accountability of organisations whether they are in the public or private sector. Network governance introduces competition for corporate control within organisations to provide them sustainable competitive advantages without the need for them to become either publicly traded or privately owned.

Stakeholder governance politically legitimates capitalism by enriching participation. It allows democracy and capitalism to become mutually reinforcing instead of one gaining at the expense of the other as they do now.