So much of how we interpret the financial crisis and subsequent reform turns on how we read the past. In the frantic search for the smoking gun of 2007 and 2008, too little attention has been paid to the now-ancient '70s, which launched both the transformation of Wall Street into its current state and saw the first real anxiety over decline in the post-World War II years. And to establish some historical context for the '70s, you're forced back to the antediluvian '30s. After all, much of the "reform" in the '70s was a reaction to steps taken to cope with an earlier economic breakdown, the Great Depression. One thing led to another, as it always does.
Two recent episodes remind us of that historical reality. We recently posted some video interviews with Wachtell Lipton's eminence grise Martin Lipton from The Deal's December Deal Economy 2011 conference at the New York Stock Exchange. Lipton briefly discussed the history of corporate governance, especially the role of Adolf Berle, the Columbia Law School professor, Rooseveltian "brains truster" and author, with Gardiner Means, of the book commonly accepted as the foundational text of corporate governance, "The Modern Corporation and Private Property." As a young lawyer, Lipton had worked with Berle. In the video, Lipton said that he has long held a stakeholder view of corporate governance, which certainly fits his long defense of managerial prerogatives. And when asked how Berle, who is often lauded as the father of shareholder democracy, would have reacted to the rise to pre-eminence of the shareholder model after the '70s, he argued that he would have been unhappy, that he favored a "balancing" of constituencies rather than the primacy of a single group, shareholders.
In another video, University of Pennsylvania Law professor and bankruptcy specialist David Skeel discussed his new book on the Dodd-Frank financial reform bill, "The New Financial Deal." Skeel argues that Dodd-Frank represented a uniform "corporatist" approach to regulation, in contrast to a Brandeisian perspective that, at least when it came to financial regulation, emerged in the '30s with both the formation of the Securities and Exchange Commission and the Glass-Steagall separation of commercial and investment banking. A corporatist approach, Skeel says, resists structural changes, like breaking up the banks, in favor of a regulatory-driven cooperative arrangement between government and industry.
In many ways, these two sets of ideas are linked by a single individual: Berle. The Columbia professor and seminal corporate law practitioner and scholar was recruited to help the Roosevelt presidential campaign in the early '30s. The "brains trust" had a strong Columbia flavor, with key members from the university like government professor Raymond Moley, economist Rexford Tugwell and Berle. All three were strong corporatists, particularly Berle, who was at the same time preparing The Modern Corporation for 1932 publication. The message of that book was that the American economy had become dominated by a relatively small number of efficient and technologically advanced corporations that had grown so large that a separation of ownership and management had occurred. That separation allowed managers to maximize their own, not shareholders', interests. But the brains trust did not reject the large corporation. Instead, its members argued that the answer to the spreading depression was not to break up large corporations, but to enhance regulation and use the power of the state to impress a "public interest" on industry and finance, a sort of collectivist response to the crisis.
In Berle, corporatist ideas had a personal, political, and intellectual context. Berle had long had acrimonious relations with Felix Frankfurter, since taking one of Frankfurter's early Harvard Law School classes. According to Jordan Schwarz's 1987 biography of Berle, Liberal: Adolf A. Berle and the Vision of an American Era, they intensely disliked each other. Frankfurter, of course, was a protégé of Louis Brandeis, the Progressive lawyer and (like Frankfurter) Supreme Court justice, and Berle, once a law school wunderkind, was famously arrogant. But there was more to it than just bad chemistry. In books like Other People's Money, Brandeis argued that corporate size was a major social problem and that large corporations should be broken up through active antitrust and the aggressive enforcement of unfair trade practices. Brandeis urged the nurturing of small business, not the favoring of the large corporation. Within the Roosevelt campaign, there were already mounting tensions between Brandeisians like Frankfurter, who was close to FDR and already placing his network of Harvard protégés in key policy positions, and the corporatists in the brains trust. Indeed, the corporatist influence peaked during the campaign and early in the administration; Berle himself wrote FDR's "New Individualism" campaign speech, a radical articulation of the corporatist position, and claimed that the idea for the bank holiday was his. He viewed the large corporation as a necessary fact of life and the Brandeisians as unrealistic (although Berle always admired Brandeis himself). But as the administration began to write reform legislation, Frankfurter's influence mounted, particularly after he recruited three former students -- James Landis, Thomas Corcoran and Benjamin Cohen -- to write the ultimately successful 1933 legislation creating the SEC.
Here's where the mystery of FDR's decision making comes into play. FDR routinely encouraged competitive proposals. But despite the fact that the administration as a whole took on an aggressively corporatist approach with legislation like the National Industrial Recovery Act, FDR chose the more Brandeisian approach, with its emphasis on enhanced transparency, for finance. Financial reform thus took on a Brandeisian cast within a broadly corporatist administration. As Skeel points out, this runs counter to Dodd-Frank financial reform, which was primarily corporatist, with a few Brandeisian proposals -- the Volcker Rule and the consumer agency -- tossed in.
How did Berle's corporatist approach sit with his reputation for advocating shareholder primacy? Well, it didn't, as laid out in all its fascinating complexity in a 2007 Journal of Corporation law paper by University of Pennsylvania law professors William Bratton and Michael Wachter. The pair examines a famous debate in governance circles between Berle and Harvard Law School's E. Merrick Dodd in 1932. Dodd argued a position (known in academia today as corporate social responsibility, or CSR) that stakeholder advocates today recognize as their own: that managers had a responsibility to balance constituencies, including workers, customers and communities. Berle, who was becoming more deeply involved in the FDR campaign and, for that reason, somewhat constrained in his reply, defended the case that the shareholder crowd today sees as its own and that he had laid out in the '20s: that managers are "trustees" for a single constituency, shareholders, and that giving managers the power to choose between interest groups provides them the latitude to seek out their own self-interest.
Bratton and Wachter demolish that simple reading. Both Berle and Dodd, they say, agreed on the basic tenets of the stakeholder model. Berle's thinking at the time, under the pressure of the deepening depression, was changing. In the boom years of the '20s, Berle had argued that managers of large corporations often conspired to disenfranchise shareholders; the remedy, the "Early Berle" argued, was increased market regulation: give greater power to shareholders. But in the face of a larger economic breakdown, the answer seemed to him not to empower shareholders but to enhance government regulation -- that is, a form of corporatism. As Berle's thinking evolved, that set of ideas never substantively changed. And so Lipton's impression was accurate: Later in life Berle, and despite his debate with Dodd, which caught him in transition, did favor a balancing of constituencies, more akin to stakeholder theory than shareholder democracy. He certainly did not identify shareholders, particularly institutional investors, which he early on identified as a powerful new force, necessarily with the public good.
In a 1968 Columbia Law Review paper on the issue of control in corporate law, three years before he died, Berle revisited the Dodd debate, which had since grown ever more mythic. It was less than a decade before a paper that many believe revived the shareholder model, Michael Jensen and William Meckling's "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure" in 1976. Berle agreed that Dodd had won the debate: "The late Professor E. Merrick Dodd of Harvard insisted, and history seems to have vindicated him, that they [large corporations] are also stewards for the employed personnel, for customers and suppliers, and indeed for that section of the community affected by their operations. Any reasonable consideration of the responsibilities resting on the management of any large corporation, especially of the two or three hundred giants, will support this view."
For anyone who thinks intellectual history lacks a sense of humor, consider Dodd's own shifting stance. According to Bratton and Wachter, Dodd retreated from the stakeholder approach once the Great Depression passed and new federal regulation emerged. "This places Dodd where Berle had placed himself in the late 1920s: looking to market regulation to solve the problem of separation of ownership and control," they write. Late Berle came over to Early Dodd as Late Dodd moved closer to Early Berle. You can almost hear them chuckling.
What does all this say to us today? First, it's a reminder not only how a few basic ideas persist over time -- corporatism and Brandeisian progressivism, stakeholder and shareholder models -- but how their articulation depends so heavily on current context. Berle and Dodd were debating not in a vacuum but in a period of extraordinary threat; the capitalist system seemed to be collapsing from its own contradictions (a Marxian-tinged belief far less common today than 1932). There are very few rights and wrongs here, or rather, very few ideas that can survive in practice over long periods of time unaltered and unmodified. Today, the doctrine of corporate governance, notably shareholder primacy, has become embodied in everything from Delaware law to SEC regulations (although Berle himself, as Bratton and Wachter point out, always favored the principle-based approach of an equity court like Delaware's Chancery Court to piles of legislatively mandated rules and regulations). Shareholder democracy appears to be "vindicated by history," just as, in 1968, stakeholder theory reigned supreme. Of course, history can be fickle. As Bratton and Wachter write, "Berle has lost the debate in history, and, at least for now, shareholder primacy has won." But they also note: "When the existing regime runs its course and a new regime dawns, as at some point it certainly will, Berle's co-operative model of corporate duties may become relevant again."
The law, regulation and modes of governance follow deeper impulses. At the core of Berle's corporatist belief was empirical fact, quantified by Means, describing the concentration and dominance of large corporations. From Berle to John Kenneth Galbraith in the '50s, the corporatist thrust was based on the belief that large corporations were the most advanced, innovative and perfect form of industrial organization; they had won the battle of natural selection; they had been vindicated by history; they possessed the techniques to retain that pre-eminence. To toss them away on some belief that small was "better" and more democratic was destructive and retrograde, particularly in a nation that Berle, who spent the war years in the State Department, long viewed as an empire. It was far better to build up the administrative state to create a working partnership between business and government. Thus the Brandeisian-corporatist split was easily characterized, then and now, as one between idealism and pragmatism. The apotheosis of corporatism came in World War II and the early Cold War years. Corporatist ideas -- reflected in everything from Daniel Bell's "The End of Ideology" (1960) to Galbraith's "The New Industrial State" (1967) -- had real bite, so much so that one might speculate that corporatism fostered a stakeholder approach. Then another dislocation -- the chronic and at the time mysterious stagflation -- stirred doubts about the eternal dominance and competitiveness of large corporations, while developments like venture capital, digital technologies and globalization furiously recast the corporate structure of the economy. Peter Drucker sensed some of these themes in "The Age of Discontinuity" as early as 1968. The stock market began to reward high-performing small companies more than corporations beset by the law of large numbers. New technologies spawned decentralizing tendencies, releasing forces of rapid change within companies saddled by what increasing was viewed as stifling bureaucracies.
Berle missed that. Never lacking confidence, Berle never lost his belief that skilled administrators could guide the corporate economy effectively. Today, that confidence has been shredded, gone with state planning and the Soviet Union, not to say the Friedmanite free-market counterinsurgency and the persistent evidence of regulatory capture; one of the New Deal apostles of regulation, Landis, wrote a report calling for regulatory reform in the first years of the Kennedy administration. The corporatist mentality no longer even has the empirical support that buttressed Berle's confidence in the power and long-term supremacy of large corporations. An IBM, a Microsoft, a Google all seem to be built on the shifting sands of rapid change; M&A can quickly reshape large swaths of the corporate sector. In a way, the Brandeisians have won, certainly in the economy at large (although the economy is continually in flux on these issues, and perfectly capable of swinging back).
And yet, there is an exception here worth pondering: finance. The forces of deregulation, technology and globalization have reshaped finance into smaller numbers of larger entities. When the crisis came, accelerating that trend, the corporatist mentality emerged, as Skeel argues, in both Dodd-Frank and the administration at large. The competitive decentralization that threatened IBM and Microsoft seem to dissipate against the thick walls of Goldman, Sachs & Co. and J.P. Morgan Chase & Co. Today, the corporatist mentality views these firms as necessary. Banks and other financial firms are seen as different, systemically dangerous, competitively important -- some of which may be true, although it spawns significant political problems. Indeed, even Berle admitted in the '30s that while corporatism might be the most pragmatic approach, the Brandeisian romance of the little guy and small business made for better politics. Obama has not reprised Roosevelt's "New Individualism" speech. And Barney Frank does not toss around phrases like corporatism, or its near-synonym, collectivism. (Bratton and Wachter at one point admit that the term "corporatist" "is not well known in the United States." One reason: its close "association" with the fascist politics of the '20s and '30s in Europe, much as collectivism is redolent of the Soviet Union. It's probably no coincidence that Skeel, who teaches with Bratton and Wachter at Penn, uses it in "The New Financial Deal." Like "bureaucracy," "corporatism" has a clearly negative edge.)
Like political theory, governance has no eternal answers. Corporations, like all organizations, may maximize their value, or crash and burn. Banks will fail, markets will slump. It may well be that the creation of dogmatic structures like the current state of shareholder democracy provides the kind of fragile rigidity that, like hubris in a bubbly market, foreshadows a shift. There are fundamental structural problems with shareholder democracy, which begin, but do not end, with the passivity of the largest shareholders, and which includes excessive compensation. Who knows where this will go? But the lesson of this historical excursion is how closely linked these two big ideas -- the relationship between the state and large corporations (and the balance of power between large and small companies) and notions of corporate governance -- are. Jensen and Meckling's 1976 paper argued persuasively that the market, embodied in shareholders, was far more effective in monitoring wayward managers than the state. Shareholder primacy was designed to replace a floundering, even failing, corporatist mentality. As long as that critique held, stakeholder theory appeared to be the buggy whip of corporate law. But as failure begins to shadow shareholder orthodoxy, the appeal of the stakeholder, or of the corporatist approach, becomes palpable. Even if few will discuss it, financial reform, as Skeel points out, has a definitely corporatist flavor. Even Jensen, long the academic godfather of shareholder primacy, wrote a paper in 2000 proposing a more balanced stakeholder approach to insure long-term value maximization. So who knows? What we can know is that wherever you go, Berle seems to have gotten there first.