Senator Elizabeth Warren’s proposal to remake American capitalism is flawed at its core

  • Senator Elizabeth Warren on Wednesday proposed The Accountable Capitalism Act – new federal legislation requiring corporations to consider the interests of employees and other stakeholders as well as shareholders.
  • Warren's legislation is based on the belief that CEOs have abandoned all stakeholders other than shareholders.
  • In principle, Warren's ideas sound good, but they are based on a flawed premise.
Sen. Elizabeth Warren (D-MA)
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Sen. Elizabeth Warren (D-MA)

In her Op-Ed in this Wednesday's Wall Street Journal, Senator Elizabeth Warren proposed The Accountable Capitalism Act – new federal legislation requiring corporations to consider the interests of employees and other stakeholders as well as shareholders.

In principle, Warren's ideas sound good, but they are based on a flawed premise. She contends that CEOs and boards are following Nobel-Prize winning economist Milton Friedman's philosophy of maximizing shareholder value.

Warren's proposed legislation would require corporations to be federally chartered and consider the interests of all major stakeholders.

Furthermore, employees would elect at least 40 percent of directors, companies would limit political expenditures, and officers and directors would face a requirement to hold stock for a minimum of five years. She amplified her arguments on CNBC's "Mad Money" with Jim Cramer this week.

Her arguments are filled with so many flaws that it is hard to know where to start. Listening to her, I could not help but wonder how many CEOs she spoke to before launching her bill, or whether she has ever been in a corporate board meeting?

"Equity-based compensation is a good thing because it aligns their interests with their shareholders. I would like to see stock-based compensation spread more broadly throughout the workforce."

Warren's Op-Ed piece and her legislation are based on the belief that CEOs have abandoned all stakeholders other than shareholders. As a Harvard Business School professor, former CEO of Medtronic, and having served on nine public company boards, I can attest to the fact that every CEO I know recognizes the importance of multiple stakeholders in business.

To flourish in the long-term, any successful company must serve the interests of all its stakeholders – customers, employees, shareholders and its communities. Sustainable shareholder value can only be created by focusing on customer needs with superior products and services. That is what motivates employees, and ultimately, this is how sustainable shareholder value is created.

The CEOs I know believe there is no conflict between serving shareholders and stakeholders. In fact, Delaware law – which is the predominant corporate standard – requires that boards of directors take into account the interests of the company and its shareholders in making decisions.

Under the "business judgment" rule, they are given wide latitude to make tradeoffs between competing stakeholders interests as long as they are acting in the best interests of the company. Just to confirm the point, 19 other states have laws explicating enabling boards to consider the interests of customers, employees and communities in addition to shareholders.

This past January Larry Fink, CEO of Blackrock, the world's largest fund manager, wrote to the top 500 CEOs encouraging them to have a mission that ultimately serves society.

Two-tier boards

Senator Warren's specific ideas for changing America's system of capitalism are even more off base. A law requiring employees to elect 40 percent of directors would create two-tier boards, similar to what currently exists in Germany, wherein the regular directors meet separately to make key decisions, and then bring them to the full board for ratification.

Years ago, I served on such a board in France, and saw just how dysfunctional and non-productive it was. Why would we fill boards of directors with front-line employees with limited experience in corporate governance?

Most public company board members are former CEOs or executives who have run major companies with thousands of employees who recognize the importance of a healthy culture and committed employees that are treated fairly. Annual employee surveys give them data to assess the health of the culture. They are accustomed to making complex decisions involving tradeoffs, especially when a crisis arises.

Warren's article is filled with erroneous claims, charging that "since 1985 (corporations) have extracted almost $7 trillion" in profits, instead of investing in workers. In fact, corporate investment levels are at an historic high in 2018, which is spurring the growth of the U.S. economy.

Her assertion that "between 2007 and 2016, large American companies dedicated 93 percent f their earnings to shareholders" is also incorrect. A McKinsey study indicates that "on average, US companies have returned about 60 percent of their net income to shareholders" through dividends and stock buybacks.

Credible jobs

Warren makes a valid point about CEO compensation being too high. However, even here she misdiagnoses the problem as CEOs receiving 62 percent of their compensation in equity. Equity-based compensation is a good thing because it aligns their interests with their shareholders.

I would like to see stock-based compensation spread more broadly throughout the workforce, as we did at Medtronic and as Starbucks does. Nearly all stock grants already have 3-5 year vesting periods, something I have long advocated, with some companies like Exxon requiring executives to hold their stock until retirement.

For the most part, today's CEOs and boards are doing a credible job of serving all their stakeholders. They are making thoughtful tradeoffs between long-term investment and near-term profit and cash generation in order to ensure the company's sustainable success.

Sometimes boards misstep, as has been the case with GE and Wells Fargo, but most boards and their directors take their responsibilities very seriously and are committed to serving the needs of all stakeholders.

Our system of capitalism is functioning well as evidenced by the plethora of U.S.-based companies that are dominating world markets and whose stocks are at all-time highs. This is not the time to throw out our well-functioning system of capitalism and replace it with a new bureaucracy that centralizes power at the federal level.

Commentary by Bill George, a senior fellow at Harvard Business School, former Chairman & CEO of Medtronic, and the author of "Discover Your True North." Follow him on Twitter @Bill_George .