Felix Salmon

How Justin Fox almost saved American democracy

By Felix Salmon
January 24, 2010

It’s auf Wiedersehen but not goodbye to Justin Fox, as he leaves his perch at Time to blog anew at HBR come Monday. His value to the blogosphere was clear from his very first post, a thousand-word disquisition on how boards of directors are a bit like an tonsils: “a largely useless, if mostly harmless, institution”. It included this passage:

As recently as the early 1900s, the board had a pretty clear function. It was the perch from which big shareholders and creditors watched carefully over the men they had hired to manage their companies (as is true today at companies controlled by private equity firms). But the very success of some of these pioneers of industrial capitalism led to the undoing of this model. Corporations outlived their founding shareholders, outgrew the need to borrow money, and, as the stock market captured the public imagination in the 1920s, found their shares in the hands of thousands of small investors in no position to watch carefully over anything. Managers naturally took charge, and boards became appendages entirely beholden to them.

If only the Chief Justice of the United States spent more time reading blogs! James Fallows finds this passage from oral arguments in the case in which John Roberts helped overturn over a century of jurisprudence to allow corporations to spend unlimited amounts of money in political campaigns:

” ‘When corporations use other people’s money to electioneer,’ as Kagan explained, ‘that is a harm not just to the shareholders themselves but a sort of a broader harm to the public,’ because it distorts the political process to inject large sums of individuals’ money in support of candidates whom they may well oppose.

“Roberts sharply challenged this line of argument. ‘Isn’t it extraordinarily paternalistic,’ he asked, ‘for the government to take the position that shareholders are too stupid to keep track of what their corporations are doing and can’t sell their shares or object in the corporate context if they don’t like it? … ‘ “We the government have to protect you naive shareholders.” ‘

Of course, as both Fox and Fallows could have explained to Roberts, that isn’t how it works at all. Here’s Fallows, making mincemeat of Roberts’s argument:

Virtually all such “wealth” as my wife and I hold, apart from our house, is in low-cost indexed mutual retirement funds. I literally have no idea which specific companies I might have bigger or smaller positions in. By the prevailing wisdom of the day, I’m behaving rationally for a non-expert prudent investor. By Roberts’ standard, I am “too stupid to keep track” of what every one of these companies is doing and shifting my positions day by day in response. Or maybe just too lazy.

As long ago as 2003, Roberts owned no fewer than 46 different common stocks, on top of 31 different mutual funds, one ETF, and a REIT. I very much doubt that he was keeping track of what all of the corporations he owned were doing, and selling his shares or objecting in the corporate context if he didn’t like it. And I don’t think that he believed that his mutual-fund managers were doing that either. Maybe he assumed that the magical qualities of the efficient market hypothesis meant that he didn’t need to do that, and that some other group of shareholders would do it for him. Although it’s hard to understand why someone who believed so strongly in the EMH would own 46 individual common stocks.

In any case, a perusal of Justin’s book would surely have disabused Roberts of his faith in the EMH. But clearly, Roberts has read Fox in neither blog nor book form, and as a result we are now left with a devastating piece of jurisprudence which threatens to fundamentally alter US democracy for decades to come. Of course, it’s not Justin’s fault that Roberts didn’t read him. But it does go to show just how powerful a single blog entry can, theoretically, be.

3 comments so far | RSS Comments RSS

Felix, you have made the right criticism.

If a corporation is just a grouping of people, it is hard to argue that they can do whatever they want in the political arena.

Yet in reality, large corporations almost without exception are many layers detached from those who own them. Any given company in the S&P 500 for instance is co-owned indirectly by tens of millions, usually through funds and retirement accounts. The chance that these tens of millions have influence over the political donations of those companies is roughly nil.

It seems clear that large organizations (and that does not just include corporations) should be required to do proxies every time they want to make major political donations above some level. How embarrassing that would be! The most egregious lobbying would quickly shrivel down to size in the bright light of openness.

Posted by DanHess | Report as abusive

Is “laziness” really an adequate defense here? Is it really “laziness” that makes “mincemeat” of Robert’s argument? Doubtless is there a problem of “time” when it comes to diligence: nobody can stay on top of everything that happens within a corporation. Yet, to ignore the possible free-market solutions to the “diligence-time” problem seems awfully arrogant to me. A defense of “laziness” is a slippery road… I mean we should definitely ban CDOs because of their over-complexity, so why not also the automobile? Clearly, the lazy laymen can’t understand these either. How can one possibly evaluate risk in such a world?

Posted by Caol | Report as abusive

threatens to fundamentally alter US democracy for decades to come
Actually, many states already had no restrictions on funding of state-level campaigns. Australia has hardly any either. But doubtlessly you never actually examined the effects of such different policy regimes before opining on what the effects of the recent decision will be.

In any case, a perusal of Justin’s book would surely have disabused Roberts of his faith in the EMH
Expositors of the EMH have read Fox’ book and not changed their minds. Perhaps you exaggerate how influential it is or how openminded most people are.

There is nothing at all incoherent in Roberts declining to engage in shareholder activism and objecting to the government doing so on his behalf. See Demsetz and the “Nirvana fallacy”.

Posted by TGGP | Report as abusive

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