Seven Ways To Fix Capitalism
Like Any Other Powerful Tool That Is Misused, Uncontrolled Capitalism Will Cause Its Own Demise
By David Grace (www.DavidGraceAuthor.com)
In my previous column, Why Many Capitalists Believe That We Need To Fix Capitalism, I argued that:
- The idea that every year management has a duty to increase unlimited profits
- A code of conduct that management has a moral duty to do anything not clearly illegal to increase the stock price
- Massive management compensation tied to short-term increases in the stock price
- Concentrating the control of most of American corporations in a small, inbred group of people without skin in the game
were fueling runaway, toxic capitalism and a new enthusiasm for failed socialist policies.
If You Don’t Like Something, Take Away The Incentive For It
You can’t efficiently eliminate bad behavior with laws, rules, regulations and litigation. If the potential reward is high enough and the risk of being punished is low enough, people will repeatedly do things we don’t want them to do.
As I said in one of my columns:
The Best Way To Stop Bad Conduct Is To Take Away The Rewards For It
1. Taking Away The Incentive To Pursue Unlimited, Perpetual Increases In Profits At Any Cost
Why is capitalism such a great tool? Because it uses the profit motive to create a supply of new and improved products while at the same time using market competition to limit the prices charged for those products.
Together, the lure of profits and the possibility of great wealth is the engine that drives investment and innovation, but the level of profit needed to encourage investment and innovation eventually reaches the point of diminishing returns.
Beyond that point of diminishing returns, higher profits are not needed to motivate the conduct we want — innovation and investment — and beyond that point higher profits become the incentive for conduct we don’t want — lower quality, lower wages and higher prices.
We want the lure of potential profits to be strong enough to spur investment and innovation but not so strong that it incentivizes shoddy products, high prices, low wages and poor service.
The damage done by the pharmaceutical industry’s pursuit of unlimited profits is a prime example.
What’s the maximum level of profits needed to strongly spur investment and innovation? Where is that point of diminishing returns?
In their best years Google, Apple and Microsoft earned a ratio of profits to costs of about 25%, so we know that a ratio of taxable profits to deductible costs of 25% is absolutely high enough to energetically drive strong investment and innovation.
At maximum, a ratio of profits to costs of 25% is our point of diminishing returns.
Limiting Profits To A Maximum Percentage Of Costs Prevents Companies From Trying To Increase Profits By Lowering Quality & Raising Prices
We want corporations to be encouraged to increase profits by selling more, higher-quality units at a lower price (good for the rest of us) and discouraged from increasing profits by selling fewer, lower-quality units at a higher price (bad for the rest of us).
We do that by tying taxes on profits to the company’s costs, namely, by collecting a 99% excess-profits tax on profits in excess of 25% of costs.
For example, Costs = $800 million X 25% = $200 million. Profits in excess of $200 million would be taxed at the rate of 99%.
Why? Because by taxing profits in excess of a set percentage of costs we deter corporations from seeking to increase profits by lowering quality and wages (bad for consumers and employees) or by seeking to increase profits by raising prices (also bad for consumers).
If we look at Mylan, famous for its EpiPen monopoly-price increases of approximately 600% over a ten year period, we find that its recent profit-to-cost ratio was $450M/$550M or about 82%! This never would have happened had an excess-profits tax been in place.
A tax capping profits based on costs leaves companies only one route to earn more money — by selling more units.
If you’re selling a million widgets at a total burden cost of $4/unit and a price of $5/unit your profit/cost ratio is $1/$4 or 25%.
If a corporation tries to increase its profits by lowering wages, cheapening materials, reducing warranties, skimping on safety, or increasing prices, any additional profit it may make will be taken away by the excess profits tax, so it won’t do that.
The tax automatically prevents the conduct we don’t want without the necessity for laws, rules, regulations, or litigation.
Instead, with the tax in place, the only way a corporation will be able to make higher profits will be for it to sell more units. If it wants to double its profits, it’s only option will be to double the number of units it sells.
The corporation can sell more units either by lowering the price or increasing the quality, which is exactly what the rest of us want it to do.
For a detailed discussion of why and how this works, see my column: We Can Have Better Products At Lower Prices Without More Gov’t Regulation.
2. Eliminating Management’s Incentive To Do Anything To Increase The Stock Price
If executives in publicly-held corporations were not compensated with stock options, the incentive to jack up the short-term stock price would largely disappear.
Publicly-traded corporations could be barred from granting any stock options to executives. Or, at the very least, all executive compensation, including stock options, with a total value in excess of the lesser of
- (1) $5 million/year, or
- (2) one-quarter of one percent (.25%) of the company’s annual gross sales
could be required to be approved in advance by at least 51% of all outstanding shares, not just 51% of the shares voting.
Additionally, public corporations could be forbidden from paying bonuses in excess of 10% of the executive’s base annual salary.
At the very least, executive compensation should be at the discretion of the shareholders. After all, it’s their money.
3. Eliminate Memberships On Multiple Boards & Require Directors To Have Skin In The Game
To ameliorate at least a little of the inbred nature of the boards of directors of America’s corporations, we could prohibit a director of a publicly-held corporation from serving on more than one board.
While we’re at it, what if the bylaws provided that no one could be a director unless he/she owned voting stock equal to the lesser of
- (a) $1M dollars, or
- (b) 1% of the company’s outstanding voting shares?
Of course, directors could always meet with outside consultants or advisers to help them understand complex issues, but the actual director’s vote would be in the hands of someone, who had skin in the game.
4. Give Voting Rights Only To Investors Who Purchased Their Shares From The Corporation Or Hold Them For A Vesting Period
What if everyone who bought their shares directly from the company, either as
- founder’s stock,
- pre-IPO purchases,
- via employee stock-option exercises or
- IPO purchases
had voting rights in those shares, and everyone who purchased shares on an exchange from a seller other than the issuer received shares without voting rights until the shares were held for at least five years? In other words, shares would need to be held for a vesting period before voting rights would accrue.
Shouldn’t the people who control a corporation be the ones who actually put money into the company or who have demonstrated a long-term commitment to it?
Why should gamblers who never contributed a dime to the company be given the power to direct its conduct?
The people who can be counted on to really care about the company are the ones who actually invested in it, not those who merely use its stock as a short-term gambling mechanism. What do gamblers care about the corporation’s long-term success?
Such a rule would weaken the implied equivalence of the terms “shareholder value” and “today’s trading price” so that when a CEO talked about increasing shareholder value we would know that he was not necessarily talking about simply increasing this year’s bottom line in order to benefit the gamblers in the Wall Street Casino who had never directly paid a single penny into the company’s coffers.
What kind of company would Hewlett Packard be today if those shareholder-voting rules and board of directors membership rules had been in place for HP for the last fifteen years?
5. Empower Shareholders To Nominate & Remove Directors
The technical framework already exists for the execution of binding legal documents via the Internet. Fingerprint verification is standard in all new phones.
Public corporations could be required to establish web pages where shareholders would be able to register votes to remove a director.
If within a fifteen day period 5% of the outstanding shares voted to remove a director then the corporation would be required to send an email to all shareholders stating that the director’s continued membership on the board was being questioned and notifying them of the issues and the voting period.
If sufficient removal votes under the company’s bylaws were cast, the director would be removed.
Similarly, 5% of the outstanding shares could nominate directors to either fill a vacancy or be elected to the board at the next shareholders’ meeting.
Voting would be as provided in the bylaws, but conducted during a fifteen-day period via written ballots or over the Internet.
6. Enact Tax Incentives That Encourage Higher Pay To Workers & Lower Pay To Executives
Half the households in the country have an income less than the median amount and half the households have an income that is more than the median amount. For 2016, the median household income was approximately $59,000.
What if executive compensation in excess of 100 times the Median Household Income was not tax deductible?
Right now that would mean that executive compensation in excess of about $5,900,000/year would be nondeductible to the corporation.
On the other end of the scale, we could allow corporations to deduct 150% of the wages paid to workers whose annual compensation was less than twice the median income.
So, if BigCorp paid $100 million in wages to workers whose annual compensation was less than $118,000, BigCorp could deduct $150 million on its income taxes, but that extra deduction would not apply to the calculation of excess profits taxes.
7. Enact Legislation Declaring That Management Has No Duty To Increase The Share Price
We could eliminate the “I have a fiduciary duty to increase shareholder equity” mantra by legislatively declaring that management does not have a fiduciary obligation to take or refrain from taking any action primarily designed to increase the company’s profits or the price of its shares when that action would materially hurt the company’s employees, customers or members of the public.
Like Any Other Powerful Tool That Is Misused, Uncontrolled Capitalism Will Cause Its Own Demise
We can have capitalism that works, that provides great goods and services, that gives investors, inventors, innovators and entrepreneurs the opportunity to get rich in an environment of limited regulations, if we take away the incentive for management to pursue profits via low quality, low wages, and high prices.
If we cling to the system of uncontrolled capitalism that is free to pursue perpetual increases in unlimited profits, we will eventually have a toxic society or a semi-socialist one, or both.
— David Grace (www.DavidGraceAuthor.com)
