The Divine Right of Capital: Chapter 8

Chapter 8: Emerging Property Rights

The Principle of Equality:
Under market principles, wealth does not legitimately belong only to stockholders. Corporate wealth belongs to those who create it, and community wealth belongs to all.

Thomas Paine’s Common Sense is widely credited with building public resolve for America’s independence from England. Pain started that famous document by noting that “a long habit of not thinking of a thing wrong, gives it a superficial appearance of being right, and raises at first a formidable outrcry in defence of custom. But the tumult soon subsides. Time makes more converts than reason.”

These words apply equally to our current assumptions about shareholder primacy and the idea that corporate profits should accrue exclusively to shareholders. In the knowledge era, much of the value created by the firm comes from the minds of employees. As the foundation of wealth has changed, so too should its allocation. It’s a simple principle that efficiency is best served when gains go to those who create the wealth. Rewards should be tied to contributions. Since shareholder contributions have declined over the years, so too should their compensation. Instead of allocating wealth only to wealth, it is better allocated to merit.

American courts early on established the idea that the value of property improvements accrue to their developer – that wealth belongs to its creator. Corporate law today does not comport to these principles. Instead, it maintains that stockholders own all the firm’s assets – and everything created on top of those assets. It is time to divest ourselves of these assumptions. Employees have a right to much of the value they help create. Stockholders should abide by the free market and be willing to set aside protectionist legal barriers guaranteeing them special rights to the firm’s profits. If their value-add warrants it, they will naturally be compensated.

In our best political and economic traditions, it is labor that creates the right to property in the first place. John Locke wrote that “justice gives every Man a Title to the product of his honest Industry.” Adam Smith later echoed these sentiments by writing “The property which every man has in his own labour…is the original foundation of all other property.” Similar ideas can be found in Thomas Paine’s writings, as well as those of Thomas Jefferson and Abraham Lincoln, who once noted: “Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.”

Thomas Paine, in his Rights of Man, notes that the citizen deposits his rights and capabilities “in the common stock of society, and takes the arm of society, of which is a part.” “Society grants him nothing. Every man is a proprietor in society, and draws on the capital as a matter of right.” Similarly, every employee is the natural owner of the corporation, by way of his or her contributions to the wealth they create through the firm. This is not something the firm can grant the employee – it is a matter of right based on the merit of contribution.

Founders are like the original warrior kings who conquered their territory, but when those rights are passed on to descendants or speculators, the merit of contribution is not earned.

John Locke is often ascribed as the champion of property rights, but actually he voiced strong contempt for “the idle, unproductive, and Court-dominated property owners,” who lived off their property but no longer worked it. Property rights advocates often cite Locke’s line that government “has no other end but the preservation of Property.” But Locke did not exalt property in general; he favored only those rights stemming from honest industry. Locke’s core message was that productive members of society ought to unite against “an idle and wasteful land-owning aristocracy.”

Locke was a founding theorist of democracy, and we can no longer afford to allow him to be used by wealth-rights absolutists. The same is true for Adam Smith, who believed that profits should naturally be low and that profits are “always highest in the countries which are going fastest to ruin.” He also noted that “by raising their profits above what they naturally would be” wealth holders in effect “levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens.”

Economists often dismissively refer to the notions of increased sharing of wealth with employees as the “labor theory of value” and like to say it has been discredited by lumping it in with Marx who claimed that labor was the only source of economic value. This is clearly not the case; human capital is greatly enhanced by financial capital. Today we embrace a “financial theory of value” which assigns money as the true source of all value. The reality is that corporate wealth is a joint creation of both capital and labor.

American economist John Bates Clark makes the claim that the distribution of income in society is controlled by a natural law, which in a world without friction, would naturally allocate wealth based on merit. The problem is that friction does exist, in the form of laws based on feudal traditions of privilege which assign primacy to stockholder claims to corporate profits. Kelly gives an interesting counter example from Brazil, where the publication La Prensa compensates its stockholders based on a wage or salary for providing capital. Employees are similarly compensated. Any remaining profits are then split 50-50 between shareholders and employees.

Employee ownership is a good solution to the above issues. One example is San Diego-based, Science Applications International Corp. (SAIC), which is 90% employee-owned. Employee ownership is not without its flaws, which include: 1) that it retains the notion that economic sovereignty is still tied to ownership; and 2) that it still ignores the economic rights of the community. That said, employee ownership is good in general because it taps the right incentives in helping people to work more efficiently. It is most effective when coupled with management techniques aimed at distributing decision making in the firm. Employee ownership can also defer or eliminate taxes for founders who sell to employees, thus passing on the firm to its rightful heirs – those who continue in its value-creation processes.

The time may now be right for policies aimed at increasing employee ownership through removing tax barriers and removing current regulations that require firms to buy back employee shares when employees leave the firm. Some firms like SAIC get around this problem through an internal market that allows employees and retirees to trade amongst themselves, but there may be policies for opening this up to others in ways that might also increase liquidity and help employees diversify their holdings.

Stock options are another route to employee ownership, but there are a few problems here. First, employees generally have no voting rights with stock options. Second, options tend to be given to only a few employees and in cases where it is given more broadly, it is typically only a small number of shares, which offers little in the way of real financial growth. Employees also need to buy some portion of the shares when they exercise options, which leads to 9-out-of-10 employees simply selling the options as soon as they are exercised. There are tax incentives and other policies which could be adopted to counter some of these problems, however. Existing shareholders are likely to be upset over dilution of their stake in the company, but it is a time-honored principle of capitalism that new capital dilutes old capital.

Ownership transfer is another route to employee ownership. Laws requiring indigenous ownership of foreign-owned firms provides similar incentives on a macro level. A more radical approach is simply limiting the amount of time that equity investments are allowed to create returns for investors – much like the expiration of a patent term.

When employees simply walk out and refuse to work for the firm any more, as was the case with London-based St. Luke’s advertising, it provides a rare opportunity for valuation specialists to develop a true assessment of the firm without its employees – and by contrast, the value of the employees to the firm. This valuation could form the new basis for their fair stake in the firm. Takeovers and corporate mergers are particularly ripe moments for this. If it just happened in one highly visible firm, it could start a wave of similar shifts across the corporate landscape.

Kelly closes the chapter with a look at community property rights through examples like Alaska’s Permanent Fund, compensation from a tanker company to California residents for soiling their beaches, and giving citizens a stake in things like the airwave frequency spectrum and other natural resources, though she notes the risks here in the temptation that such financial compensation might bring by encouraging citizens to allow these natural resources to be depleted.