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MANAGEMENT FROM HELL How Financial Investor Logic Hijacked Firm Governance

Robert R. Locke

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MANAGEMENT FROM HELL Table

! The Author

! Dedication

! Prologue: Accountants Came To Power

! Chapter 1: The Rise Of Investor Capitalism

! Chapter 2: Ways To Measure Success

! Chapter 3: The Social Cost Of Director Primacy Governance

! Chapter 4: US Income Redistribution Under Investor Capitalism

! Chapter 5: Investor Capitalism And Enterprise Efficiency

! Chapter 6: Learning In The Japanese Classroom

! Chapter 7: The Start-Up Habitat

! Chapter 8: The Quest For 2.0 Network-Centric-Management

! References

! About Us

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THE AUTHOR After an academic career in management history at the University of Hawaii (Manoa), with (among others) prolonged guest professorships at the Max-Planck Institute for History in Göttingen (Germany), the European Institute for Advanced Studies in Management/EIASM in Brussels (Belgium), the London School of Economics (UK) and Meiji University in Japan, Robert R. Locke lives since 2004 in Görlitz (Germany), from where he especially observes and comments about the European management and management education scene.

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PROLOGUE: ACCOUNTANTS CAME TO POWER When Managerialism Appears

In this book the « good » of management is considered with regard to various forms it has assumed since World War 2. Historically, owners managed family businesses and still do. But at the beginning of the 20th century huge firms arose, with dispersed ownership; lodged in a multitude of shareholders. And firms came to be run by a professional management caste. TThe resultant Managerialism is defined as follows:

« What occurs when a special group, called management, ensconces itself systemically in an organization and deprives owners and employees of their decision-making power (including the distribution of emoluments) – and justifies that takeover on the grounds of the managing group’s education and exclusive possession of the codified bodies of knowledge and know-how necessary to the efficient running of the organization. » (Locke, 2009, 28)

With thousands of administrators and tens of thousands of employees, these giant firms threatened to become ungovernable as top managers became more and more distanced from workers and managers in everyday operations. To cope, corporate leaders separated managers involved in strategic decision-making from managers preoccupied with daily operations. Alfred D. Chandler, Jr. and Fritz Redlich wrote about the new management hierarchies in a seminal article published in 1961:

« The centralized coordination, evaluation, and planning for the diverse activities of a large number of sub-units which often carried out several different functions of production, distribution, and transportation within a single, purely private enterprise, were

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something new in economic history. Such needs brought the managerial enterprise into being. The new enterprise could not run efficiently without formal internal organizations. They required the generation of internal operating, financial and cost data. Only through a flow of internal impersonal statistics could control of these large enterprises be maintained. »

In the giant multidivisional (or M Form) corporations the higher and lower-level staffs, organized on functional bases, utilized standard cost and budgetary methods to run increasingly complicated enterprises. The managerial revolution originating in America created the organization structure of the postwar global corporation and the managerial instruments the organization used.

The resultant division of labor between top corporate management and sub-units also changed management goals. Engineers on the shop floors and in the manufacturing divisions of M-form corporations made artifacts. TTop management, in which controllers trained in accounting increasingly replaced the engineers, thought about money, i.e., constantly improving ROI. Money is particularly susceptible to management thinking based on general principles. As John Quiggin defined it:

« The belief [is] that organizations have more similarities than differences, and thus the performance of all organizations can be optimized by the application of generic management skills and theory. To a practitioner of managerialism, there is little difference in the skills required to run a college, an advertising agency or an oil rig. » (Quiggin, 2003, 1)

The controller (today the Chief Financial Officer) became the board of director’s indispensable man. He was generally a vice president in the company, with direct access to the chief executive. His function made him a fount of information for policy decisions of a financial, technical, and/or commercial nature. He also had an instrumental role in policy implementation once decisions were taken.

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Emergence Of The Management Caste

American corporations began to create controllers in large numbers in the 1920s. The position became significant enough by 1929 for controllers to organize their own professional institute. These developments and their consequences soon drew public attention. In 1932, Adolf Berle and Gardiner Means, in The Modern Corporation and Private Property, described management as a functional caste; on the left Simone Weil about the same time (1933) recognized that the separation of ownership from control had created a new « oppressive » class, as opposed to the older idea from Marx of the bourgeoisie as an « exploitive » class; (Grey, 1996, 597) James Burnham’s The Managerial Revolution appeared in 1937. By World War II the management caste had come to constitute, in Heinz Hartmann’s words, « a fourth production factor … a strategic variable for the development of the firm. » (Hartmann, 1963, 113)

Hartmann’s point is significant because the chief executive officer (CEO, PDG), at the top of corporate governance structures employs the factors of production, including the « fourth production factor »– management itself – that the firm exploits. This means in a director primacy model that power and the right to exercise decision making (who decides and whose interests prevail) resides in the CEO and the board of directors.

The issue, then, became who selects and controls the CEO and the board? And the answer that emerged in large US and international corporations was: the CEO himself.Through control of the proxy process, incumbent CEOs nominated their own candidates for board memberships, thereby turning the boards into management-selected, instead of shareholder-selected entities. Shareholders ceased to exercise control over day-to-day operations or over long-term policy. The director primacy model signified that CEO dominated directors were not agents of the shareholders but sui generis – « platonic guardians » of corporate interests.

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According to Bainbridge « director primacy » placed « power and the right to exercise decision making neither in shareholders nor the managers, but in the Board of Directors who asserts therewith the right to assure the efficient maximization of shareholders’ residual claims » but without the shareholders in effect being able to control the board (Bainbridge, 2006).

Director primacy triumphed in the US, the UK, and through the postwar expansion of primarily US multi-national firms, set the international governance standard elsewhere. Its triumph was fostered by extra-firm agencies including the elite business schools that spread the ideology of director primacy corporate governance in their domestic research and teaching programs that were then internationalized during the expansion of US-style business schools education beginning in the 1960s.

A Viable Governance Alternative

However, a counterbalance to director primacy firm governance also developed in the immediate postwar period. In Europe it assumed its most complete form in the system of co-determination adopted in the 1950s and 1970s in Germany. Michel Albert drew attention to this Rhineland model in Capitalisme contre capitalisme (1991). Although it emerged after the war, the German system, rooted in German ideas about community (Gemeinschaft) and an entity conception of the firm, looks at the enterprise as a body of often-conflicting interest groups (employees, stockholder, customers, and community) but one bound together by a common interest, the sustainability of the firm-entity.

The idea of worker participation in Germany originated in the 1830s when profit-sharing schemes necessitated workers’ access to management information. « Professor socialists » in the Verein für Sozialpolitik embraced participation, which gained more respectability when Emperor Wilhelm II, spurred by enlightened bureaucrats, incorporated the concept into a speech in 1890, asking for the creation of worker-representative bodies within

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factories that could defend employee interests in negotiations with employers.

The resultant law for the protection of labor, granted workers joint consultation rights (Mitberatungsrecht) on social matters, which was not co-determination (Mitbestimmung), but a step in that direction, since the law authorized the organization of plant committees in all factories covered by the Industrial Code of 1869 (i.e. factories with at least 20 employees), requiring employers to issue and abide by shop regulations that spelled out relations with workers.

Powerful labor unions and the Social Democratic Party backed co-determination thereafter, with various degrees of success, depending on the regime, until the sorrow of Germany’s defeat in 1945 gathered enough political and social will behind it to achieve a qualified success. Social Democrats and trade unions were joined by conservatives under Konrad Adenauer (the German Christian Democrats and the German Christian Social Union) and by Catholic and Protestant church leaders all over the country, in a successful campaign to enact the laws that created the legal basis for co-determination in German firm governance.

In 2005, Chancellor Angela Merkel acknowledged this historical process. Addressing her Christian Democratic Party faithful, she said that the German « social market economy, in which co-determination is embedded, concretized the Christian view of man. It is a social and economic order created by Adenauer and Erhard. It arose from the Catholic social teaching and the Protestant ethic that was then brought into reality as a practical model » (Merkel, 2005).

In the co-determination laws German religious conservatives sought moral redemption right after the war, to « punish » corporate managerial elite that had seriously compromised themselves through collaboration with the Nazi dictatorship in its crimes against humanity, and to render justice to workers and their unions who had often been the Nazis’ victims. From this

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immediate historical context, a socially responsible corporate governance system emerged.

Two Boards For Check And Balance

There are two elements to the German system of co-determination: one at the board level, the other within the firm. At the top, large German firms have two boards: one, a supervisory board (Aufsichtsrat), is charged with selecting the second board, the managing board (Vorstand) that actually runs the firm. The supervisory board, on which the director of the managing board cannot sit, not only selects the managing board but sets its members’ emoluments; it also has jurisdiction over long-term strategic decision-making (amalgamations, joint-ventures, partnerships, etc.).

Since shareholders and employees elect supervisory board members, their number includes people from trade unions as well as other firm-external people, with whom the firm often does business, such as representatives from a firm’s Hausbank, or people from client firms. Consequently, unlike director primacy, in which the CEO dominates through CEO-controlled appointments to the board of directors, German managing directors are subject to surveillance from a board that includes a broad section of interests from inside and outside the firm.

German law also set up works councils (Betriebsräte) inside firms, which are employee-elected. The works councils protect employee interests in intra-firm interaction with management in day-to-day operations. Managers cannot easily lay-off workers and have to concede rationalization protection measures to the works councils that are unparalleled in US corporations. German managers have to give full information in advance about technological and organizational changes that affect personnel.

They must outsource suppliers only after allowing works councils to study proposals and suggest alternatives. They must negotiate terms of change within the firm, including no layoffs and full pay

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protection. The managing boards have no formal or practical authority to impose terms on a reluctant work force without extensive negotiations and substantive agreement with the works councils.

Works councils are provided with full information, and are drawn into shop-floor production discussions concerning the introduction of new technology, work organization, and the training of the work force. And they do so not as suppliants, but as partners, if perhaps unequal partners, in the plants. In short, works councils are deeply involved in the management of work processes in firms.

Other examples of capitalist governance that differ from director primacy could easily be added to the German one, especially Japan, but there is no need to belabor the point, which is that alternatives to director-primacy capitalism developed and thrived in advanced industrial nations in the late 20th century.

Because of the strong competition with director-run firms, Americans and Europeans could not ignore the presence of these alternatives. A considerable effort went into analyzing the source of German and especially Japanese competitive success in the 1980s, but people in control of the director primacy model, if willing to acknowledge the efficacy of German and Japanese organization of the work process, never really criticized their own system as a source of injustice and inefficiency.

American corporate executives, in fact, specifically opposed the adoption of co-determination in Germany and fought tenaciously to hinder its spread into US firm governance. Henry Ford II, while visiting Ford’s German plant in 1975, pointedly rejected the new bill before the Bundestag that extended co-determination governance, as an infringement on management’s right to manage in the interests of stockholders (New York Times, 17.08.1975).