This is the fourth article in a series about Post-Modern Security Analysis.

The analysis of corporate governance

The term “corporate governance” came into vogue in the 1990s and now dominates discussion of ethics and morality in investment markets.

For five essays on “corporate governance” on this site, go here.

Often, the pretense of “good corporate governance” has served to shield ethically-challenged management from critical scrutiny by ordinary investors — an exercise in hypocrisy.

However, the corporate governance movement has come up with one important concept: stakeholders. The view that a corporation has many different “stakeholders”, with different interests, is essential to Post-Modern Security Analysis.

Management still talk about “looking out for shareholder interests”, but the influence of other stakeholders can hardly be ignored, especially the stakes of various governments, labor unions, franchise owners, administrators of off-balance sheet assets, license holders, creditors, employees, trading counter-parties, out-sourced suppliers, down-stream customers, banks, and, last but not least, management itself.

The analysis of corporate governance and of the relative importance of various stakeholders should be the first step in Post Modern Security Analysis.

Determining the relative importance of various stakeholders

Investment securities are a combination of contractual agreements and legal requirements merged with expectations of customary behavior. Normal and reasonable expectations of the benefits and risks of a specific investment opportunity vary among the stakeholders in each case.

For example, fifty years ago, common stockholders expected that most profits would be distributed to them in the form of dividends and that hired management would be content to provide faithful service for a fixed salary and occasional modest bonus.

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On June 29, 2020, Pope Benedict XVI issued the encyclical “Caritas en Veritate” that dealt directly with capital market operations.

Here are some citations from this encyclical:

Besides requiring freedom, integral human development as a vocation also demands respect for its truth. The vocation to progress drives us to “do more, know more and have more in order to be more”

Profit is useful if it serves as a means towards an end that provides a sense both of how to produce it and how to make good use of it. Once profit becomes the exclusive goal, if it is produced by improper means and without the common good as its ultimate end, it risks destroying wealth and creating poverty.

The complexity and gravity of the present economic situation rightly cause us concern, but we must adopt a realistic attitude as we take up with confidence and hope the new responsibilities to which we are called by the prospect of a world in need of profound cultural renewal, a world that needs to rediscover fundamental values on which to build a better future.

Corruption and illegality are unfortunately evident in the conduct of the economic and political class in rich countries, both old and new, as well as in poor ones.

In our own day, the State finds itself having to address the limitations to its sovereignty imposed by the new context of international trade and finance, which is characterized by increasing mobility both of financial capital and means of production, material and immaterial. This new context has altered the political power of States.

Deeds without knowledge are blind, and knowledge without love is sterile.

Moreover, the human consequences of current tendencies towards a short-term economy — sometimes very short-term — need to be carefully evaluated. This requires further and deeper reflection on the meaning of the economy and its goals, as well as a profound and far-sighted revision of the current model of development, so as to correct its dysfunctions and deviations.

Then, the conviction that the economy must be autonomous, that it must be shielded from “influences” of a moral character, has led man to abuse the economic process in a thoroughly destructive way.

In fact, if the market is governed solely by the principle of the equivalence in value of exchanged goods, it cannot produce the social cohesion that it requires in order to function well. Without internal forms of solidarity and mutual trust, the market cannot completely fulfill its proper economic function. And today it is this trust which has ceased to exist, and the loss of trust is a grave loss

Economic activity cannot solve all social problems through the simple application of commercial logic. This needs to be directed towards the pursuit of the common good, for which the political community in particular must also take responsibility.

It must be remembered that the market does not exist in the pure state. It is shaped by the cultural configurations which define it and give it direction. Economy and finance, as instruments, can be used badly when those at the helm are motivated by purely selfish ends. Instruments that are good in themselves can thereby be transformed into harmful ones. But it is man’s darkened reason that produces these consequences, not the instrument per se. Therefore it is not the instrument that must be called to account, but individuals, their moral conscience and their personal and social responsibility.

Adam Smith and the Pope

Much of what the Pope has written in “Caritas en Veritate” would have the full and enthusiastic support of Adam Smith.

Smith, who considered his writings on morals and ethics as more important than “Wealth of Nations” had always insisted that capitalism and economic activity must have a moral foundation. Nor was Adam Smith opposed to the idea that the state has a role to play in economic systems nor that mankind should have a goal beyond the material wealth of individuals.

The teachings of Adam Smith and the Pope are the direct opposite of the lessons drummed into young minds by the Harvard Business School and its many clones. See: MBAs and Ethics.

The Harvard Business School vs. the Pope

It is hard not to note the connection between the philosophy of moral relativism (no right — no wrong) taught by the Harvard Business School case method and the short-term, profit-at-all-costs, ignore-ethics philosophy that contributed to the Crash of 2008 and the current recession.

The practical consequences of the doctrines taught MBAs at universities today are described in the article Jeff Skilling Tells the Truth about US Corporate Ethics.

The pseudo-science of modern economics that has supported much of investment market activity over last generation are described in the articles Fallacies of the Nobel Gods , The Non-Efficient Market, and The Common Stock Legend.

The Crash of 2008 and the Pope’s encyclical may help to bring reason back to economics. However, do not expect universities to change any time soon. As Adam Smith pointed out, universities are “a sanctuary in which exploded systems and obsolete prejudices find shelter and protection, after they have been hunted out of every other corner of the world.”

The Pope has an uphill battle fighting against the Harvard Business School, but, at least, he has a bigger megaphone than I do.