THE BLOG
05/30/2013 05:31 pm ET | Updated Jul 30, 2013

Capitalism and Democracy: Time to Refresh First Principles?

Getty Images

The Aspen Institute was founded in 1950 by Walter Paepcke, the CEO of the Container Corporation of America. He and other leaders of some of America's most successful companies felt that they and their peers needed to have a much better understanding of the moral underpinnings of capitalism and democracy.

The challenge then was whether American values, including those that animated the country's boardrooms, could meet the challenge of the Cold War. Farsighted business executives worried that without a thorough review of first principles, and a candid consideration of the weaknesses as well as strengths of the American business ethos, continued American progress could not be taken for granted. They embraced the most difficult questions -- such as the inherent tradeoffs between liberty and fairness, and between equity and efficiency -- and worked to recalibrate the moral compasses business leaders follow as they guide their companies -- to assure not only their commercial success but the achievement of the "good society" for all of America.

In 1998, the Aspen Institute began to take a fresh look at this question, launching our Business and Society Program. It champions the very issue that inspired Walter Paepcke: consideration of the rules and protocols that businesses follow to be successful and sustainable but that also assure the continued health of the society in which they operate -- and upon which of course, at least in the long-run, their enterprises depend.

The environment in which Paepcke and his colleagues raised these concerns 63 years ago now seems like a fantasy world. Given the pressure today on companies, especially those operating in the public markets -- punctuated by intense and near mono-dimensional pressure to meet short-term stock price expectations -- carving out the time to consider the "good society," or even the purposes of the corporation, may seem an academic luxury. But it has never been more essential.

Think about the tragedy that continues to unfold in Bangladesh. It took a human catastrophe, public outrage and media attention about grossly substandard working conditions -- clearly abysmal for years -- and finally, a threat to brand value and future profits -- for a critical mass of companies at the end of the supply chain to react and begin to collaborate on large scale change to the infrastructure. Or consider the financial crisis that sent the world economy tumbling, and continues to exact a price in millions of jobs lost, and innocent families' livelihoods and hopes shattered. Or Apple's aggressive, albeit legal, scheme for tax avoidance, remarkable only in its scale and complexity.

There is growing evidence that the model of value that has guided the American corporation over recent decades is broken, threatening not just the long-term health of those companies and the long-term interests of their shareholders, but that of global society as well. In an Aspen Institute statement issued four years ago, Warren Buffett and two dozen other business, investment, government, academic and labor leaders agreed that "a healthy society requires healthy and responsible companies that effectively pursue long-term goals... Short-termism is system-wide... It has eroded the competitiveness of our economy and our faith in our economic system to provide a foundation for a thriving society."

The concern for short-term goals is not just an American fixation. Dominic Barton, global head of McKinsey, has decried "quarterly capitalism," pursued at the expense of the five-to-seven-year time horizons required to build real value; he likens capitalism's short-term metrics to tearing up trees every three months for inspection and re-planting.

Over what time frame is it appropriate to measure shareholder value, and what is the right balance between focus on investors, versus other critical inputs to the business, like a well-trained, healthy, safe and loyal workforce? Who gets to decide what constitutes success when those that take the greatest risks -- like the employees and communities in the Bangladesh example have the least power? How have compensation models become disassociated from long-term value creation, and with outcomes yielding inequality of a dimension that would shock American corporate executives of just a generation ago? Should there be limits to the use of short-term stock metrics when they may entice the company to externalize costs to keep the stock price high? And perhaps the largest question of them all, what is the purpose of the corporation, and what should the obligations be in return for the license to operate and the extraordinary legal protections offered by limited liability?

The time has come for an honest reassessment of these and similar questions.

Consider the mantra about public corporations -- that the goal of executives should only be to maximize shareholder value. It sounds simple but it isn't. First, what does that actually mean? Does "shareholder value" mean something more than share price, and over what time-frame does the stock price matter? How does one know when it is "maximized' anyway? And doesn't the drive to push up investor returns in the short-run create a zero-sum game in which short -term gains come at the expense of customers, employees, communities -- and future shareholders?

And what about stock-based executive compensation, much ballyhooed for its ability to "align management and shareholders." Since the U.S. tax code was amended to promote this aim in 1993, studies have shown that "pay for performance" may not lead to any discernible improvement in corporate performance. Yet executive compensation sky-rocketed, growing from 140 times the average worker's pay from two years before the tax code change to 500 times average pay just eight years after.

The pernicious effects of our overly short-term and shareholder-centric model are legion. The metrics of this system encourage executives and boards to externalize costs and discount the future, regardless of the consequences to the natural environment or to society at large. Consider for example some of the criticism that Pepsi CEO Indra Nooyi has endured in her attempts to make and market healthier foods and beverages -- which is unquestionably of great public benefit, and of likely benefit to the brand as she diversifies. But our short-term share-price driven world puts the premium on market share of soda sales, ignoring the long term consequences for the business and society.

There is even the risk that our failure to develop new methods and metrics for capitalism could threaten the public's support for it -- ominous indeed as the philosophical bases for capitalism underlie many of our democratic principles and are so closely associated with our freedoms. Many developing countries are openly questioning our model, and economically successful alternatives exist, such as Chinese and other autocracies' versions of state capitalism.

Moreover, increasing numbers of Americans believe that our system simply no longer serves the needs of average people. As a Los Angeles resident put it in a letter to the New York Times, it seems that "virtually all of our economic growth of the last three decades has been swept into a very small corner." Pollsters see steadily declining trust in our business leaders -- once trusted far more than our political leaders -- but now following political leaders down to astonishingly low levels. Only 18 percent of Americans trust business leaders to tell the truth in a complex situation.

Clearly the time has come for deep and serious reflection about the contracts that exist between corporations and society. Churchill famously observed that democracy is the least worst system. The same can be said of capitalism. Americans seem broadly to agree that there are parts of our government machinery that are badly broken, and that repairs to our political system are essential. It is past time to acknowledge that the same is true of our economic system.

So just as there is a critical need for Americans to find a way to fix the mechanics of our political system, there is a need for Americans -- almost all still basically supportive of free markets and capitalism (but for how long?) -- to find ways to fix the mechanics of our economic system. Whether capitalism's engine needs just some fine-tuning or major repair is a matter of fair opinion -- but that it needs attention and debate should be clear. And The Aspen Institute, true to its defining principles, will be an important venue for that debate.