Business leaders have no natural authority

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Modern business and the people who lead it achieve authority through, and only through, their success. The legitimacy of their authority is achieved – literally – by delivering the goods.

When people tell us what to do, we tend to ask: “what gives them the right to do that?” We ask it of political, spiritual and intellectual leaders; we ask it of traffic wardens and teachers. The legitimacy of authority is a fundamental social and political issue that defines the structures of modern democracy.

Companies are among the most powerful of modern institutions and business leaders are among the most powerful people in modern society. What is the source of their legitimacy? Marx believed that the difficulty of finding good answers to these questions would destroy capitalism itself. So far, he has been wrong. But the health of capitalism nevertheless demands an answer.

When I said this at a recent conference, there was a crisp retort from a representative of the ubiquitous rightwing think-tanks. Tell people who ask these questions to mind their own business, he said. This answer is not likely to be well received outside the self-congratulatory world of rightwing think-tanks. But it is an extreme expression of a widely held view: the governance of companies is a matter of private contract. The composition of a board, the remuneration of its directors, the strategic direction of the company – all these are matters between the company and its shareholders.

In the face of well-known abuses, this doctrine is in retreat. The US Sarbanes-Oxley act prescribes in considerable detail what large companies must do. Britain’s new Operating and Financial Review requires large companies to give a public account of their current business and future plans. Yet there is equivocation in these provisions. Although they reflect concern about the broader impact of corporate activity on the public, they take the form of regulation of the relations between the business and its shareholders.

When I visit the local newsagent, it is impertinent to ask him about his corporate governance. I do not, and should not, ask him how many independent non-executive directors are on his board. If I do, he will probably suggest that I buy my Financial Times elsewhere. Conversely, if poor corporate governance means that he does not open the shop on time, I will stop patronising it. The market adequately governs our mutual relationship.

But my relationship with General Electric does not have this voluntary character. To avoid interaction with the company, I would have to decline admission to hospitals that use GE equipment; ensure that no aircraft powered by a GE engine will ever fly over my house; be confident that none of my insurance policies are underwritten by GE Insurance Solutions and that no part of my pension will be invested in GE stock or bonds. The company’s activities are so extensive that you necessarily encounter them daily, often without knowing you are doing so. GE’s business is our business even if we do not want it to be.

So we tell the Federal Aviation Administration to keep a vigilant eye on aircraft safety, employ regulators around the world to monitor the solvency of insurance companies and ask that the Securities and Exchange Commission and the Financial Accounting Standards Board review the company’s financial statements. But that is not enough. We reasonably expect that GE should care that its engines are safe, not just that they comply with FAA procedures; that if there is a problem with its medical equipment the company will try to put it right, not to cover it up; that GE financial statements are true and fair and not just compliant with accounting standards.

That is why the governance of large companies is a public as well as a private matter. When a company says: “we seek to create shareholder value”, it is proper to ask: “what gives you the right to do that?” The case for capitalism is not a moral one derived from abstract notions of freedom of contract but a pragmatic argument rooted in the success of the system in promoting efficiency and innovation. Modern business and the people who lead it achieve authority through, and only through, their success. The legitimacy of their authority is achieved – literally – by delivering the goods.

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