Jack Welch and the End of Stakeholder Capitalism

Chapter 5 of The Common Good

Friends,

Between 1981, when Jack Welch took the helm at GE, and 2001, when he retired, GE’s stock value soared from $14 billion to $400 billion. Welch accomplished this largely by slashing American jobs.

I want to focus on Jack Welch today because Welch represents a stunning change that occurred in American capitalism in the 1980s, whose repercussions lead all the way to Donald Trump. If we really want to understand the decline of the common good over the last four or five decades, we need to understand this change — and no one better illustrates it than Welch.

Before Welch became CEO of GE, most GE employees had spent their entire careers with the company, typically at one of its facilities in upstate New York. But between 1981 and 1985, a quarter of these GE workers — 100,000 in all — lost their jobs, earning Welch the moniker “Neutron Jack,” along with the glowing admiration of the business community.

Welch encouraged his senior managers to replace 10 percent of their subordinates every year in order to keep GE competitive. As GE opened facilities abroad, staffed by foreign workers costing a small fraction of what GE had paid its American employees, the corporation all but abandoned upstate New York.

Between the mid-1980s and the late 1990s, GE slashed its American workforce by half (to about 160,000) while nearly doubling its foreign workforce (to 130,000).

JACK WELSH became the most admired CEO in America — at least in the business press, on Wall Street, and within rarified precincts like Harvard Business School.

His reign epitomized a chain reaction that started in the 1980s, when “corporate raiders” mounted hostile takeovers of corporations, financed by risky bonds. The raiders made fortunes, Wall Street became the most powerful force in the economy, and CEOs began to devote themselves entirely and obsessively to maximizing the short-term value of shares of stock — whatever it took.

Before then, it was assumed that large corporations had responsibilities to all their “stakeholders”— not just their shareholders, but also their employees, the communities where their operations were located, their customers, and the public at large.

In the 1940s and 1950s, CEOs of major corporations like GE, General Motors, Coca-Cola, and Eastman Kodak joined together in the Committee for Economic Development, to lobby for measures to expand jobs. They even argued that unions “serve the common good.” In the 1960s, many of these CEOs lobbied for stronger environmental protections and for passage of the Environmental Protection Act.

Starting in the 1980s, though, as a result of the corporate takeovers mounted by raiders such as Michael Milken, Ivan Boesky, and Carl Icahn, a wholly different understanding of the corporation emerged.

The raiders targeted companies that could deliver higher returns to their shareholders if they abandoned their other stakeholders — by fighting unions, cutting workers’ pay or firing them, automating as many jobs as possible, outsourcing other jobs, and abandoning their original communities by shuttering factories and moving jobs to states with lower labor costs or abroad.

The raiders pushed shareholders to vote out directors who wouldn’t make these sorts of changes and vote in directors who would (or else sell their shares to the raiders, who’d do the dirty work).

During the whole of the 1970s, there were only 13 hostile takeovers of big companies valued at $1 billion or more. During the 1980s, there were 150. Between 1979 and 1989, financial entrepreneurs mounted more than 2,000 leveraged buyouts, in which they bought out shareholders with borrowed money, each buyout exceeding $250 million.

As a result, CEOs across America, facing the possibility of being replaced by a CEO who would maximize shareholder value, began to view their responsibilities differently. Few events change minds more profoundly than the imminent possibility of being sacked.

The corporate statesmen of previous decades, who prided themselves on representing all their stakeholders, were supplanted by the corporate butchers of the 1980s, 1990s, and 2000s, whose nearly exclusive focus was — in the meat-ax parlance that suddenly became fashionable — to “cut out the fat,” “cut to the bone,” and make their companies “lean and mean.”

SINCE THEN, corporate raiders have morphed into more respectable “private equity managers” and “activist investors.” Hostile takeovers have become rare because corporate norms have changed: It’s now assumed that corporations exist only to maximize shareholder returns.

Corporations have used their profits to give shareholders dividends and to buy back their shares of stock — thereby reducing the number of shares outstanding and giving stock prices short-term boosts. All of this has meant more money for the top executives of big companies, whose pay started to be linked to share prices in the early 1990s. CEO pay soared from an average of 20 times that of the typical worker in the 1960s to almost 380 times by 2023.

Are we better off now? Some say shareholder capitalism has proven to be more “efficient” than stakeholder capitalism. It has moved economic resources to where they’re most productive, enabling the economy to grow faster. Stakeholder capitalism locked up resources in unproductive ways, CEOs were too complacent, corporations employed workers they didn’t need and paid them too much and were too tied to their communities.

But shareholders are not the only ones who invest in corporations and bear some of the risk that the value of their investments might drop. Workers who have been with a company for years often develop skills and knowledge unique to it. Others may have moved their families to take a job with the company, buying homes in the community. The community itself may have invested in roads and other infrastructure to accommodate the corporation.

When a firm abandons those workers and those communities, these stakeholders lose the value of their investments. Why should no account be taken of their stakes?

In standard microeconomics, the costs to workers and communities abandoned by profit-maximizing corporations are termed “externalities” — social costs lying outside the deals struck between corporate managers and investors. But why should these costs not be included in assessing whether the deals are good?

Over the last four decades, these “externalities” have grown so large as to swamp internal efficiencies. Entire regions of the country have been denuded of good jobs. Legions of (mostly) men without college degrees have become stranded. The bottom half of the American workforce has been left with stagnant pay and decreasing job security.

The results: rising rates of drug addiction, family violence, child abuse, deaths of despair, and an increasingly angry working class susceptible to demagogues like Trump.

EXECUTIVES CLAIM THEY HAVE NO CHOICE. They have a “fiduciary obligation” to maximize investors’ returns.

Rubbish. The argument is tautological. It assumes that investors are the only people worthy of consideration. What about the common good?

After Jared Kushner’s real estate company sued one of its tenants for moving out of her apartment without giving the company two months’ notice (she claimed she had done so), the company won an almost $5,000 judgment against her and then garnished her wages as a home health worker and her bank account. When asked to justify such Mr. Potter-like tactics, the Kushner Companies’ chief financial officer told The New York Times that the company had a “fiduciary obligation” to its shareholders to collect as much revenue as possible (the firm’s major shareholders were Jared Kushner and his family).

Maximizing profits and investor returns, whatever it takes, has leached into sectors of the economy that had once been based on the common good, such as health care. A century ago, hospitals and health insurers had public responsibilities.

The original purpose of health insurance plans, devised in the 1920s at the Baylor University Medical Center in Dallas, was not to generate profits. It was to cover as many people as possible. The nonprofits Blue Cross and Blue Shield accepted everyone who wanted to become members, and all members paid the same rate regardless of age or health. By the 1960s, Blue Cross provided hospital coverage to more than 50 million Americans.

In the 1970s and 1980s, though, entrepreneurs saw ways to make big money by exploiting this common good. They founded for-profit insurance companies like Aetna and Cigna that, unhampered by the Blues’ charitable mission, accepted only younger and healthier patients. This reduced their costs, enabling them to charge lower premiums than the Blues while still pocketing big profits.

The Blues couldn’t possibly compete. So in 1994, Blue Cross and Blue Shield succumbed and became for-profits — marking the end of nonprofit health insurance — turning the American health care system into one that eagerly insured healthy people while trying to avoid sick people, or charging people with chronic health problems a fortune for coverage.

Big financial houses, meanwhile, went from small privately held investment banks to giant corporations whose shares were traded on stock exchanges. This has also had unfortunate consequences. When investment bankers made all the profits and also suffered all the losses from their bets, they tended to be cautious. In order to understand the risks they were taking on, partners kept their banks small and their transactions relatively simple.

By 2000, because Washington deregulated Wall Street (at the behest of financiers who saw they could make vast fortunes from making risky bets with other people’s money), Wall Street morphed into megabanks with hundreds of thousands of employees, spanning the globe. There were no longer any constraints on risky trades. Shareholders bore the costs, while those who made the bets got the upside gains in the form of giant bonuses. Bankers had every incentive to grab the cheapest funding to make the riskiest bets with the highest payoffs.

This led to the crash of 2008.

When they’re not claiming a “fiduciary obligation” to maximize investor returns, CEOs argue that capital markets force their hand. To raise money for their businesses, they must attend solely to the interests of investors, or else competitive forces will wipe them out.

More rubbish. As I’ve emphasized, markets are human creations. How they’re organized depends on political decisions. Big corporations and the CEOs who head them have outsized political influence. They have enough power to change the rules.

CEOs could use their political clout to push for laws that resurrect stakeholder capitalism: making it harder for private equity and other activist investors to take over a company, for example. Giving workers greater voice in management decisions, as in Germany. Requiring companies to make “severance payments” to communities they abandon, to compensate for the disruption. Prohibiting mandatory arbitration in contracts with customers and employees. Limiting the tax deductibility of CEO pay.

Rather than reflexively seek tax cuts, CEOs could push to raise taxes on corporations and on wealthy Americans like themselves — and dedicate the funds to, say, better schools for all American kids. They could seek a higher minimum wage, bigger wage subsidies (in the form of the Earned Income Tax Credit), more portable pensions, universal health care, and other measures that would raise pay and make American workers more economically secure.

Rather than fight for laws that make it harder for workers to unionize, they could fight for laws that made it easier.

They could reduce the needs of candidates to raise vast sums of campaign money by supporting public financing of campaigns. They could back stricter limits on the “revolving door” between industry and government personnel and laws requiring full disclosure of the sources of all campaign funding.

If all this sounds far-fetched, that’s only because of how far we’ve come from the era when the heads of American business viewed themselves as “corporate statesmen” with responsibilities for the common good.

Most Americans now believe the system is rigged in favor of big corporations and Wall Street, and in many respects, it is. But nothing is stopping CEOs and top executives on Wall Street from putting an end to the rigging — except their own self-serving notion of Jack Welch-style corporate leadership as maximizing profits and shareholder value, whatever it takes.

This is not a matter of “corporate ethics.” As now routinely taught in graduate schools of business and as required for obtaining many professional licenses, corporate ethics involves fulfilling legal responsibilities, avoiding obvious conflicts of interest, and behaving in a transparent manner. It’s about avoiding legal troubles and public relations disasters. Corporate ethics is about how to be more like Jack Welch.

This is a matter of the common good.

THE SUCCESS OF THE MODERN CEO should not be measured solely by how much money they or their corporations make, how much power they accumulate, or how much influence they wield. They must be judged by the well-being they confer on everyone affected by the corporation, and by the legacy of trust (or distrust) they pass onward.

By this measure, Jack Welch has left America worse than it was before.

Next week, I’ll summarize where we’ve come so far in understanding what happened to the common good by examining why so many Americans have succumbed to Trumpism. Then, in the last three weeks of these essays, I’ll suggest what we can do to resurrect the common good.

Thanks again for joining me on this journey.

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These weekly essays are based on chapters from my book THE COMMON GOOD, in which I apply the framework of the book to recent events and to the upcoming election. (Should you wish to read the book, here’s a link).

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