Upper Class Warfare
A class war is brewing in America, but it is not the kind that Marx would have predicted. Instead of the proletariat seizing the means of production from the capitalists, a class of plutocrats has seized the means of production from a class of investors. In essence, the capitalist class has cleft into two groups with wholly different class interests. As Marx did foresee, however, the underlying economic relations between the classes has ramifications for politics and for the society at large. Nowhere is this more apparent than through the support that the Republican party in general and the Bush administration in particular has given to the overclass.
By overclass, I refer to the executives and members of the board of large corporations. For the most part, they differ from the capitalists who were contemporaries of Marx, because they have served their corporations as managers hired on behalf of shareholders by boards of directors. They are not the founders of their companies. They did not risk their own capital to grow the company. Instead, they have relied on outside bondholders and shareholders to take the risks formerly taken by capitalists; they have reserved to themselves the rewards.
The recent travails of the American stock market have in their roots a growing crisis within American corporations. The investors, who nominally own their companies, have rarely seized control of what those companies do. Except for some activist pension funds, and a handful of "socially responsible" mutual funds, institutional investors rarely exercise their prerogatives as owners to force management to address issues of corporate governance or to force shareholders votes on issues. What little contact management has with actual investors is generally confined to annual meetings, held at the disconvenience of most investors.
The economics behind executive compensation now pits the executives against the shareholders at large. Executives can make, and have made, huge profits from exercising stock options that reward short-term gains in stock price of a company, not necessarily the long-term health of that company. Ironically, the idea behind stock options was to align the interests of executives with ordinary shareholders by making it easier for them to be significant shareholders. But options have only made the principal-agent problem worse. Executives who do not have sizable stakes in their companies can act indifferently to the health of the company, because the stock price does not really affect their financial situations. But executives who can become very rich through stock options no longer have the financial incentive to act like long-term shareholders. Furthermore, for every stock option that they exercise, the ownership share of all of the other owners is concomitantly reduced.
Supporters of stock options, like Senator Joe Lieberman, have proclaimed the benefits of stock options to rank and file workers. But a recent story in the New York Times pointed out that, as of two years ago, companies disproportionately rewarded their executive employees. The top 5 company executives received 75% of all stock options; the next 50 executives received another 15%. Very few employees earning less than $75,000 per year received any stock options at all. Stock options are an integral part of executive compensation at almost every large American corporation. In addition, most companies grant significant numbers of options to their boards of directors, the very group who approve the plans that grant stock options to employees and executives. These grants do more to align the interests of the executives and directors than to align anyone's interests withy the shareholders.
Three quirks of American tax law and financial rules encourage the use of stock options. First, large companies cannot deduct on their taxes any base compensation to their top executives of over $1,000,000, yet most executives demand higher annual compensation. Second, the cost of stock options are as deductible on corporate taxes as any other business expense. Third, the cost of those options does not need to be deducted from the net income that companies declare in their quarterly and annual financial reports. The last time that the Financial Accounting Standards Board (FASB) set the rules for accounting for stock options, it recommended that options be deducted from net income. It would have required this treatment, except for an intense lobbying effort from both Democrats and Republicans in Congress. The alternative treatment, the one used by almost every large American corporation, except for outliers like Boeing, relegates the cost of the options to a footnote in the financial statements.
Several senators, notably John McCain of Arizona and Carl Levin of Michigan, have tried for the past few years to force companies to use the recommended treatment, chiefly by requiring that treatment for companies to claim a tax deduction for the options. The corporate lobbying against these measures has been both intense and effective. Despite the huge executive windfalls from options at fallen companies like WorldCom and Global Crossing, the Senate turned down an opportunity to have financial statement reflect the actual cost of granting options. What is particularly galling is that reporting options as expenses should not matter. It would not affect the tax deductions that corporations receive from granting options. It would, however, move the cost of stock options out of the footnotes and into the main pages of the financial statements. Simply put, corporate executives are afraid that investors will know the truth.
Among the chief proponents in Washington for keeping the current rules on options are the accounting firms of the large corporations. A naïve observer might think that accounting firms would be indifferent to what FASB recommends for the treatment of options. But an informed observer would note that the accounting firms have an economic interest in serving the needs of corporate executives. Corporate executives know that increasing net profits is paramount to increasing stock prices, and therefore increasing the value of their stock options. Accounting firms know that finding ways to improve the bottom line makes them more valuable to their clients. At firms like Merck, where executive bonuses were tied to revenue growth, accountants find ways to increase revenues artificially. In addition, both corporations and their rich executives excellent candidates for the confidential tax shelters that firms like KPMG, Ernst and Young, and BDO Seidman offer.
The immediate loser to date in the class war has been the investor class. Throughout much of the 1980s and 1990s, investors did well even as the overclass got richer and richer, because owning stock—almost any stock—was an easy and lucrative way to make money. Although the burgeoning bulk of executive compensation was obvious, the gains to be had in the stock market kept investors happy. The last two years have changed all that. The major stock indices are now match levels from several years ago; the NASDAQ index, dominated by technology stocks, is down over 75% from its all-time high. Investors who planned to retire early now face their dreams of a carefree bourgeois retirement deferred or even dashed. Parents who counted on the stock market to fund college educations for their children now face financial hardship.
The indirect losers are the working class, what Marx called the proletariat. When companies like Enron, WorldCom, or Lucent dissolve or shrivel thanks to the accounting shenanigans of their executives, the employees who counted not on options but on paychecks are out of work. They might not be if their bosses had concentrated on growing their businesses for the long term.
For the past several decades, the Republican party has been the natural party of the investor class. It stood for relaxed rules and regulations for business of all stripes, but it also stood for law and order. The party long had a branch going back to Teddy Roosevelt that sought to constrain capitalism for the good of the capitalist system. But those days have changed. The Roosevelt wing of the party has all but shriveled, although John McCain sometimes echoes some of Roosevelt's populism.
More typical of the party has been the reaction of President Bush. In a recent speech in New York, he recounted recent corporate misdeeds, and recommended a set of mild reforms, so mild that only the executives in the audience found the speech reassuring in the least. Bush is the first American president to have an MBA degree, and he heads an administration with a slew of ties to executive suites. Not only was Bush a corporate director, but his vice president and secretary of the treasury were both CEOs of large American corporations. These men do not just represent the overclass: they are part of it.
It is far too easy for the rest of America to wallow in some schadenfreude as corporate bigwigs get their just desserts. The investor class is revolting against the overclass and the men who represent it in Washington. The wedge between the investor class and the overclass means that for the first time in decades, capitalists are not united economically. When this split last occurred, the working class mobilized and carried the day politically. In the 1930s, the massive changes to the American polity were called the New Deal. America has another chance at big changes yet again, if the working classes can seize this new opportunity.
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