Executive Times






2006 Book Reviews


The Battle for the Soul of Capitalism by John C. Bogle




(Highly Recommended)




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Former Vanguard CEO John C. Bogle presents a realistic summary of what has gone wrong in recent years in corporate America, followed by a forceful and optimistic recipe for how to fix it, in his new book The Battle for the Soul of Capitalism.  Few targets are overlooked for criticism, and the solutions proposed are all achievable. Here’s an excerpt, from the beginning of Chapter 2, “Why Did Corporate America Go Wrong?: ‘Somebody’s Gotta Keep an Eye on These Geniuses,’” pp. 29-34:


The failure of corporate governance lies at the heart of why corporate America went astray. As James Madison wrote in The Federalist Papers in 1788, “If men were angels, no government would be necessary.” Similarly, in describing capitalism today, we could aptly say, “If business executives were angels, no corporate governance would be necessary.”

The analogy between national and corporate governance is fitting. Just as the United States is not a pure democracy, controlled directly by its citizens, neither is the American corporation. (Even approvals of corporate resolutions by shareholders are often nonbinding.) Rather, like our nation, the corporation is a republic, with supreme power vested in its shareholders, who exercise their power through the directors they elect, who are charged With representing their ownership interests. In the search for productivity and efficiency the shareholders, perhaps because of their knowledge of their own limitations, cede control to those who will act in their behalf. Indeed, in both our national and our corporate republics, sometimes the trust of the constituency is honored, sometimes betrayed. But while our republican federal government operates under a system of checks and balances, Similar limits rarely prevail among our republican corporations.

Indeed, we have come perilously close to accepting a system of dictatorship in corporate America, a system in which the power of the CEO seems virtually unfettered. My peer business leaders of course don’t look at their jobs in those terms. When I raised this topic in a speech to the Business Council in 2003, the assembled group of CEOs was not particularly smitten by the analogy. But it holds more than a grain of truth.

The republican system of corporate governance has broken down. Too many hoards have failed to adequately exercise their responsibilities of managerial oversight. Worse, it was only the rare institutional investor that exercised its responsibilities of corporate citizenship and demanded such oversight, insisting that managers operate not in their own interest, but in the interest of the owners. In short, the owners didn’t seem to care. When the owners of corporate America don’t care about governance, who on earth should care?

Writing in The New Yorker a few years ago, business columnist James Surowiecki gave us an amusing but perceptive answer. He used the example of the 1956 comedy The Solid Gold Cadillac, in which Judy Holliday played Laura Partridge, a small investor. Her continual harassment of the board of directors finally forces the company to put her on the payroll as its first director of investor relations. She quickly uses the position to organize a shareholder revolt that topples the corrupt CEO. As Surowiecki concludes: “American companies are the most productive and inventive in the world, but a little adult supervision [by the owners] wouldn’t hurt. Laura Partridge had it right a half a century ago: ‘Somebody’s gotta keep an eye on these geniuses.”

Under our governance system, the board of directors is the first “somebody.” It is the board that is charged with holding management responsible to represent the interests of shareholders. And when the directors don’t fulfill that responsibility, the second “somebody” must hold the board accountable: the shareholders themselves. If the directors do not provide the necessary “adult supervision” required to move us away from the existing system of managers’ capitalism that we never should have allowed to come into existence in the first place, then it is up to the shareholders to do so. As owners, they have the right to vigorously demand a return to the system that began all those years ago, a system in which trusting and being trusted created a virtuous circle of progress. Only the owners can return us to owners’ capitalism.

This is not to say that the long history of capitalism has been bereft of aberrations. The Robber Barons of the late nineteenth century, the competition-stifling business trusts of the early twentieth century, the utility-holding companies of the 1920s, all were betrayals of trust. But the ugly deviations from fair play in the recent era represent a new breed of corruption. It required only two ingredients:


1.     The diffusion of corporate ownership among a large number of investors, none holding a controlling share of the voting power.

2.     The unwillingness of the agents of the owners—the boards of directors—to honor their responsibility to serve, above all else, the interests of their principals—the shareowners themselves.


The Modern Corporation and Private Property

The issue of widely diffused corporate ownership was first examined systematically in 1932, as the stock market was tumbling to its nadir in the Great Crash of 1929—33. During this period, an astonishing 90 percent of the market value of U.S. equities was erased. The examiners were Adolph A. Berle and Gardiner C. Means, professors at Columbia University whose seminal work on this topic, The Modern Corporation and Private Property, has become enshrined as an enduring business classic. They were concerned about the separation of the ownership from the control of publicly held corporations. With corporate ownership becoming more widely diffused among legions of individual investors, none of whom, in most cases, held anything resembling a controlling interest (there was then virtually no institutional ownership of stocks), they posited that the door was wide open for senior managers to operate companies in their own self-interest

Their principal conclusions:


     Most fundamental of all, the position of ownership has changed from that of an active to that of a passive agent. The owner now holds a piece of paper representing a set of rights and expectations with respect to an enterprise, but [he] has little control. The owner is practically powerless to affect the underlying property through his own efforts.

     The spiritual values that formerly went with ownership have been separated from it. Physical property capable of being shaped by its Owner could bring to him direct satisfaction apart from the income it yielded in more concrete form.

     The value of an individual’s wealth is determined on the one hand by the actions of the individuals in command of the enterprise— individuals over whom the typical owner has no control—and on the other hand, by the actions of others in a sensitive and often capricious market. The value is thus subject to the vagaries and manipulations characteristic of the marketplace.

     The value of the individual’s wealth not only fluctuates constantly, but is subject to a constant appraisal. The individual can see the change in the appraised value of his estate from moment to moment, a fact which may markedly affect both the expenditure of his income and his enjoyment of that income.

     Individual wealth has become extremely liquid through the organized markets, convertible into other forms of wealth at a moment’s notice.

     Finally, in the corporate system, the “owner” of industrial wealth is left with a mere symbol of ownership while the power, the responsibility, and the substance which have been an integral part of ownership in the past are being transferred to a separate group in whose hands lies control.2


Berle and Means, insightful prophets of how corporate control would evolve, had identified a problem that would plague modern capitalism, a problem that has yet to be resolved. But in that era of deeply depressed stock prices, with corporations struggling to achieve profitability, perhaps even an era in which standards of business conduct were higher (albeit not without some notorious abusers), their warnings gained little public notice. Only decades later, in a booming stock market environment that was aided and abetted by the happy conspiracy among virtually all market participants, did we realize the residual effects that arose from passive ownership by shareholders, including excessive management compensation, managed earnings, and merger mania. The worst potential abuses of managers’ capitalism became stark realities.

When most owners either don’t or won’t or can’t stand up for their rights, when directors lose sight of whom they represent, and when financial manipulation is unchecked by the system’s gatekeepers, corporate managers quickly step in to fill the void, confirming Spinoza’s claim that “nature abhors a vacuum.” Little good is likely to result when the CEO becomes not only boss of the business but boss of the board, erasing the bright line that common sense tells us ought to exist between management and governance. Put more harshly, in an unattributed quote that I came across a few years ago, “when we have strong managers, weak directors, and passive owners, don’t be surprised when the looting begins.”

Adam Smith, that patron saint of capitalism, would not have been surprised by this outcome. More than two centuries ago, he wrote: “It cannot be well expected that the directors of companies, being the managers rather of other people’s money than of their own, should watch over it with the same anxious vigilance with which partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they. . .very easily give themselves a dispensation. Negligence and profusion must always prevail.”3

Adam Smith’s words presciently describe corporate America in the recent era. While the actual looting we know about has been limited, negligence and profusion have been rife, and managers have given themselves, using Smith’s word, “dispensations” that would have appalled the thrifty Scot. But the malfeasance in our capitalistic system has spread far beyond executive compensation to the very financial integrity of our corporations. The contradictions of managers’ capitalism lie behind the failures of the system that we’ve witnessed.


The Failure of the Gatekeepers: Directors

Stock owners have traditionally relied on a whole bevy of gatekeepers to ensure that corporations would be operated with honesty and integrity, and in their interests. During the Great Bull Market of 199 7— 2.000, however, we witnessed a fatal breakdown among all of these gatekeepers. Independent auditors became business partners of management. The investment community put aside its professionalism, its traditional skepticism, and even its independence. Government regulations were relaxed. Our elected public officials not only didn’t care but actually stood by, aiding and abetting the malfeasance Worst of all, corporate directors, who should have constituted the front line of defense against management overreaching failed to fulfill their responsibilities.

Directors are the most important of the gatekeepers that society relies on to keep corporations functioning productively, efficiently, and honestly. Given the business saavy of board members, their joint perspective, and their intimacy with the particular organization they serve, they are well placed to intervene when necessary, on behalf of shareholders. But corporate boards often seemed reluctant, unwilling, and perhaps even unable to govern with a firm hand. As a result, our directors must assume a major portion of the responsibility for the problems that developed in corporate America.

Despite being the elected representatives of the owners, boards of directors looked on the proceedings with benign neglect, apparently unmindful of the impending storm. Lightning first struck Enron. When the firm collapsed in November 2.001, the New York Times described it as a “catastrophic corporate implosion . . . that encompassed the company’s auditors, lawyers, and directors . . . regulators, financial analysts, credit rating agencies, the media, and Congress . . . a massive failure in the governance system.”4 Other dominoes soon fell, including WorldCom, Adelphia, Global Crossing, and Tyco. In the years that followed, still more disreputable companies were to surface.


The straight forward language Bogle uses in The Battle for the Soul of Capitalism, leaves readers with a choice on every page: agree or disagree. Present an alternative, or accept the premise. Some readers will take offense at some of Bogle’s shots. Many will find his perspective refreshing, his ideas beneficial, and his solutions achievable.


Steve Hopkins, January 25, 2006



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The recommendation rating for this book appeared

 in the February 2006 issue of Executive Times


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