Subject: Re: Inclusive Capitalism: The Role of Corporations
From: "Altman, Roger" <[email-masked]>
To: Jake Sullivan <[email-masked]>, Mike Schmidt <[email-masked]>
Cc: "Michael Pyle ([email-masked])" <[email-masked]>, "[email-masked]" <[email-masked]>
Date: Fri, 19 Jun 2015 22:23:26 +0000

Thanks, Jake
 I look forward to that
   Roger

From: Jake Sullivan
Sent: Friday, June 19, 2015 5:34 PM
To: Altman, Roger; Mike Schmidt
Cc: Michael Pyle ([email-masked]); [email-masked]
Subject: Re: Inclusive Capitalism: The Role of Corporations

Roger -- this is terrific.  Thank you for this.  I'm copying Mike Schmidt, who is working closely with Pyle and myself on this agenda.  We will be in touch next week to talk through more of the details.

On Fri, Jun 19, 2015 at 5:15 PM, Altman, Roger <[email-masked]<mailto:[email-masked]>> wrote:
I understand that HRC will soon address this subject.

Inclusive capitalism is, I think, best defined as a system generating steady growth which benefits all Americans.  Today, we have too little growth and none of the sharing.  Changing this requires adjustments both in public policy and private sector behavior.  And in both the financial sector and the industrial one.  This note concentrates on the latter and, in particular, larger corporations.

Relatively speaking, this is a good time to propose changes in corporate behavior.  Because, the combination of:  (1) shareholder pressures over performance;  (2) public pressure around income inequality;  and  (3) the possibility of an eventual labor shortage are unsettling to many corporations.

Generically, there are two categories of change – legislative and voluntary.  HRC can introduce the first and use the bully pulpit for the second.  Both are relevant because certain changes can’t be legislated.

Facts

The macro facts are well known.  A few of them are:

-          real GDP growth has averaged 2% annually over the past 6 years

-          weekly real earnings per capita have risen only 5% in 35 years

-          median real household income is $52,000, down from $58,000 at its 2006 peak

-          the labor share of total income has fallen from 69% to 60% over the past decade. Income from capital  has made up the difference

-          the top 1% of earners has captured 95% of income gains since 2008

-          total after-tax corporate profits have quadrupled since 2000

-          the Dow Jones Industrial Average has tripled since its post-crisis low point in mid-2009
Table 1: Real Median Weekly Earnings

Source: U.S. Bureau of Labor Statistics

Table 2: Corporate Profits After Tax

Source: U.S. Bureau of Economic Analysis

Adjustments in Our Shareholder Model of Governance

The U.S. system of governance for public corporations has changed considerably over the past 25 years.  And, arguably, not for the better.  In particular, institutional and activist shareholders have become much more interventionist.  Pressuring Boards of Directors and managements for short term results at the expense, to some degree, of investment, R&D and human capital.  Many corporations have imperfect motivations of their own, but this power shift to shareholders is important.  It is creating a damaging “financialization” of American corporations.

This has happened because the number of investment firms has soared.  And, they compete fiercely with each other to attract assets for management.  In effect, who has the best investment track record?  Then, compensation for the individuals who manage portfolios depends on the results they achieve.  In effect, how do I get paid this year?

It is the “active” managers who have become interventionist.  Those whose mission is to outperform the market. In contrast, the “passive” managers (index funds like the Vanguard 500), who aim to precisely match the market, are long term holders.  Increasingly, these two groups think differently, especially Mike’s firm, Blackrock.

But, interventionism is soaring and corporations and their CEO’s are under relentless pressure.  This manifests itself in growing volumes of share buybacks, cost and personnel reduction programs, split-ups, proxy fights and the ever shortening tenure of CEO’s.  None of these were active trends a generation ago.  And, each is about boosting the share price to appease institutional shareholders.  The problem is that these actions are inherently inconsistent with long term behavior.  Privately, many companies are unhappy over these shareholder pressures.  Witness the passionate essay by Paul Polman, CEO of Unilever.

One prime example is corporate inversions, i.e., transactions which redomicile a U.S. acquirer for tax purposes.  Despite the tightened Treasury regulations of a year ago, inversions have continued and more are in the pipeline.  Some of the impetus for these comes from interventionist shareholders, who pressure corporations for lower tax rates and higher valuations.  Although, some managements and boards don’t need any pushing.

A second is shareholder activism.  Huge sums have poured into the so-called activist funds, which threaten companies with proxy fights if managements and Boards don’t adopt their short term agenda.  Unfortunately, this is a real threat, as many institutional shareholders will support activists in an actual vote.  Companies from Apple to Microsoft and DuPont have been attacked this way, and the process has gone too far.  It is difficult for companies to concentrate on the long term when their leadership may be thrown out.

What’s needed is a rebalancing of the shareholder/corporate/employee relationship.  This will be hard to do because it requires the cooperation of all sides, but especially the institutional shareholders.  There are several legislative approaches which would help achieve a reset, e.g., tax reform.  But, many of the required actions are voluntary.  Nevertheless, none of the major advanced nations have financialized corporate sectors like ours.

This is why Blackrock, the world’s largest passive manager, has launched a recent campaign for “long termism.”  Its CEO, Larry Fink, sent a high profile letter to CEO’s and institutional investors calling for a renewed focus on investment, research and longer term strategies.  Blackrock also hosted a large conference on this topic and, given Blackrock’s clout, as the biggest investor, this campaign is having some positive effect.

I would urge HRC to advocate such a rebalancing.  The country needs it.  Workers need it.  Many corporations and shareholders will be receptive, if it is done correctly.  And, it is timely.

This isn’t the place for talking points.  But, the essential message is that America needs to increase both public investment (infrastructure and research) and private investment.  In order to get productivity growth and standards of living moving up again.   To do this, we need a new bargain between corporations, their employees and their shareholders.  As President, she will be committed to implementing the public policy side of this equation.  And she is calling on corporations and institutional shareholders to do their part by adopting a longer term, more worker-centric focus.

Table 3: Shares of gross domestic product: Gross private domestic investment

Source: U.S. Bureau of Economic Analysis

Table 4: S&P 500 Buybacks: ($ billions, quarterly)
Source: Standard & Poor’s

Elements of a Rebalancing

Here are just a few possible initiatives which might form the core of this rebalancing.  Each would need a thorough vetting, well beyond this note.

-          Restructured capital gains taxes:  A longer holding period, e.g., 3 years, and then a declining rate over, say, 3 more years, would likely extend shareholder horizons and thus boost investment and R&D.  It’s true that many investors, e.g., pension funds, don’t pay taxes.  But, enough do to make a longer holding period meaningful.  Further, we all know that the carried interest loophole is indefensible.  But, even if fund managers were just subject to a similar, longer capital gains period, it could take some pressure off.  Then, to offset lost revenue, such changes might be coupled with returning the tax rate on dividends to the ordinary income rate

-          Executive compensation:  Compensation above $1 million per year is not deductible for business tax purposes.  But, excluding performance based compensation from this limit has not truly worked.  Too many companies have converted to stock based compensation systems which aren’t truly performance based but which qualify as deductible.  Moreover, many companies use questionable metrics for determining performance, e.g., earnings before such stock based compensation.

Requiring executives to hold any shares received (including upon exercise of options) for a long term period, say, five years, to qualify it as deductible at the time of issuance would also promote a longer term mentality

-          Living Wages, Paid Child Care and Paid Leave:  It is possible that the U.S. will see a medium term shortage of skilled and semi-skilled workers, as demand for labor tightens and the labor participation rate remains low.  Alan Krueger, among others, is forecasting this.  In such a labor market, the importance of recruiting and retention will intensify as will the competitiveness of compensation and benefits.
            In this context, better wages and benefits will not only be justified for reasons of fairness, but also for competitive reasons.  And they can be advocated now in this dual sense.  And, the idea that no long term worker should live in or near poverty will be both morally right and one which many companies can support.
            Furthermore, several states and cities, of course, have recently passed $12-15 per hour minimum wage legislation.  Walmart and McDonald’s have responded to this movement by adjusting their wages, albeit modestly.  Which signifies that the dynamic on living wages is shifting some.  An expansion of the EITC would fit particularly well into this context.
            As do more progressive approaches to paid child care and paid leave, as HRC has already signaled.

-          Unionization, Profit Sharing and ESOP’s:  There is little doubt that the decline of unionization has contributed to wage stagnation, and job reductions and, therefore, to widening income inequality.  Indeed, the impact on employees of buybacks, split-ups and the like is hardly even discussed today by the shareholders and corporate boards who make these decisions.  Approaches to rebalancing this side of American capitalism are sorely needed.
            I cannot improve on the recommendation in the CAP Inclusive Capitalism Report on wage councils, union formation, profit sharing and ESOP’s.  I would only observe that expanded profit sharing often makes for a more productive business.

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