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To put someone in from the outside, I think you run the risk of really having an individual that is not a person who works who can work well with the rest.

You see, for instance, I am in some sense a kind of risky member from this standpoint. I come in with no need, no obligations.

I am not obligated in any way to the management. I am, and consider myself, an outside director representing the public, but I also am able, because of my background, to know something about the way the firm operates.

I push for improvements in the management; for example, in the way certain decisions are made.

I think that kind of process, more firms are looking for directors of that kind, is the way that we want to go. After 2 or 3 years, if one still sees that these kinds of developments have not really increased, then maybe one has to take another hard look at the whole situation.

I do believe there are trends now that are self-correcting.

Senator HARTKE. Do you see any situations in which that part of society which is affected as a result of corporate action should have a director, such as labor!

Mr. CYERT. Well, this is an item that I know has received a lot of discussion and, as you pointed out, in Germany in particular, they have this.

The Yugoslavs have had something like this for a long time.

I would say, again, I don't think that that should be forced on a corporation. I think there will be some corporations that are going to move in this direction on their own.

I think the danger of having particular directors of that kind is that sometimes long-run interests, which are crucial for the corporation, are sacrificed for short-term interests.

For example, in Yugoslavia, where this is done, there is a great problem in terms of getting enough investment in the corporations.

They really do have corporations in Yugoslavia. The danger is that the labor members want everything paid out, and little invested, because that is to their own self-interests.

These are dangers.

Senator IIARTKE. Let me ask you: In other words, what you are saying is that you can rely upon what you call self-discipline; is that right! Mr. (YERT. Among Senator HARTKE. On the board of directors? Mr. CYERT. I think there is a great deal of that, yes.

Mr. HARTKE. Can we rely upon that to create this statesmen like attitude that you are talking about?

Mr. CYERT. Let me say this: In terms of the boards that I am on, I would say unequivocally yes.

I don't know, obviously, all the other boards in that much detail. It is my strong feeling that the environment in which we are operating now is reinforcing that attitude, and that there is increasingly on boards a strong element of this kind of self-discipline.

We mentioned the Gulf thing. I would go back to that. The notion that it was the Mellon family that somehow threw out the management is an incorrect point.

I know that the Wall Street Journal had such a story. I happen to know the members of that board well. I happen to know the whole situation.

It was really two outside directors, both from academic life, who were the crucial people.

Senator HARTKE. All right. Thank you, sir. I appreciate your coming.

[The statement follows:]

STATEMENT OF RICHARD M. CYERT

SOCIAL AND ECONOMIC RIGHTS AND DUTIES OF CORPORATIONS A number of interesting questions about corporations are being raised by this committee and several other groups in the society. Generally, the questioning of the structure of our economy and the organizational form of our basic business unit, the corporation, have been stimulated by books. These books have been written by lawyers, economists, professors of business administration and concerned citizens. The books have been stimulated by the recession, by environmental prob. lems, and by disclosures on illegal payments. Historically, criticisms arise during periods of economic transition, more generally when the economy is in recession, and the tendency is generally to recommend radical reform. Frequently, the reforms suggested have no relationship to the problem. It is like recommending open heart surgery for the cure of the common cold. Nevertheless, it is only through criticism that any system is stimulated to improve even though the critics may be ignorant of the real problems and speak in the form of falsehoods and half-truths. I am reminded of the student demonstrations of the sixties. The demonstrations were almost always based on symptoms rather than basic ills and never proposed fundamental solutions of importance. Today, however, uni. versities and students are probably better off, in part at least, because of the almost random disruptions of the last decade. I have every confidence that the same situation will prevail in the case of our economic system and the corporation. Nature of the Economic System

One of the critical characteristics of our economic system and our society is its decentralized nature. The question of centralization and decentralization of decision-making power is a question of perpetual concern to organization theorists who tend to concentrate their analysis on the individual organization. But the same issues that are relevant for individual organizations are relevant for a whole system, such as our economy. There are some technical questions that affect the degree of centralization or decentralization such as the source of information for decision making and the size and cost of indivisible resources, but for the most part the most important questions revolve around incentives. Every organization must be concerned with developing a structure that will stimulate the members of the organization to exert their maximum effort and to become committed to the organization so that each of them behaves as through the business was owned by him or her. The more decentralized the unit, no matter how large the total organization, the greater the tendency for such behavior. The difference between the operations of the Post Office and General Motors, can, in my view, be traced to this point. I would point to the same basic point to explain the contrast between the undeniably magnificent performance of the American economy over the years and the Russian system.

One reason we have been able to maintain a decentralized system is that we have organized our economic activity so that the decisions on the use of our resources is governed by the people of the country through dollar votes in the market, with the exception of those resources taken by the government through the tax system. Those who may complain that the market system does not work well because of some characteristic of the income distribution can work to change that distribution (which can be done easily through the negative income tax) but should not condemn the system. Similarly, those who excoriate the corporation for not taking the cost of some form of polluting into account should be after Congress or their state legislatures to modify the tax system appropriately. Taxes negative and positive rather than regulation is the way to modify the system when there is agreement on the form of the modification. Regulation and government ownership are to be avoided like the plague if one thinks, as I do, that incentives are crucial.

We have been able to avoid the extensive kind of governmental interference that has occurred in the United Kingdom because we have been able to main. tain a competitive system in the economy. The data collected on concentration show that there has been no tendency in the economy toward increased concentration. The economy does not conform in all markets to the precise detinition of perfect competition but it is clear, as we will show later, that markets with only a few markets (oligopolies in economic terminology) are far more competitive than the casual, non-technical observers would believe. We have a competitive economic system that enables governmental interference to be minimized and the system to be decentralized so that it is sensitive to the market. The basic business unit is the corporation and it is important to examine the method of governance since that question is of importance to this committee. Corporate Governance

The ultimate authority in the corporation is the board of directors. Boards vary in size but there are few smaller than ten and few larger than fifteen when the corporation is of any significant size (sales over $100 million). Boards are the final authority in selecting the chief executive officer (CEO) and on the investment of resources of a particular amount. The amount will vary from corporation to corporation. The board is responsible for executive compensation and generally must approve salaries over a given amount. In general the board is responsible for the overall strategy of the firm and, in the final analysis, for the performance of the organization.

Boards are generally composed of inside and outside board members. The inside members are there because they are crucial to the firm's operations and appointment to the board is a recognition of this fact. As long as there are an adequate number of outside board members, perhaps one-half to three-fourths of the directors, the inside members can play an important role. They can be effective in educating the outside members and they can bring a degree of realism to decisions that may occasionally be missing in a strictly outside board. By the time they are appointed they have independence from the CEO so that there is no problem, generally, in their speaking their mind.

Outside directors are, of course, elected by the stockholders, voting on the basis of share ownership. The president, with the help of the board, is responsible for recruiting new members. The process of recruitment is taken seriously. Generally, discussions on the desired qualities of the new member are held by groups of board members as well as the president and board members. Recruitment is not a question of the president getting his friends on the board. Every president worthy of his job recognizes the difficulty and the enormity of his responsibilities. He wants the best talent available and searches accordingly. The best people are generally already busy and the job must be important or they will not take it. Thus, there are few rubber stamp boards. The persons recruited are generally independent thinkers who have ideas about management and are prepared to argue their positions with the CEO and the rest of the board.

At the same time it should be understood that the board has to be part of the overall management team. The board cannot be in an adversary relationship with the CEO. If the majority of the board is in that frame of mind, they must fire the CEO. The reason is that crucial decisions must be made and the management must make recommendations. If the board has no confidence in the management then recommendations will be rejected. But the board cannot by itself handle the day-to-day running of the firm. With an adversary relationship the decision making of the firm would come to a standstill. The relationship between the board and the CEO should be one in which there can be a free, give-and-take of ideas. A major contribution of a board is the fresh, outside ideas flowing into the company.

There are undoubtedly ways in which boards can function more effectively, just as it is true of any organization. I would like to see more directors get more deeply involved in the details of the firm. The line between policy formation and the everyday management of the organization is more blurred, in my view, than in that of many other directors. I think directors should “meddle" more in the operations of the company, without interfering with the management. I have been doing some of this activity in the area of decision making on the allocation of capital. A paper summarizing the findings has been written with two of my colleagues and is attached. It is useful for this committee because it demonstrates the way in which the board interacts with management on important decisions. Antitrust Policy

Some European observers have called antitrust an American religion. If so, it is a religion based on the concept that a free enterprise, laissez-faire system must rely upon competition to protect the consumer from the businessman. All antitrust legislation is at bottom an attempt to force more competition in the economy. The various laws among other things rule out rivals colluding to set prices, nullify mergers that reduce the number of competitors, and provide for the breaking up of firms into a set of smaller, but larger in number, firms. The assumption is always that competition is increased when there are more firms operating in a market.

Those economists who are the intellectual descendents of Adam Smith have refined the theory of competition into an intellectually and esthetically pleasing model of an economic system. In particular their work has developed the assumptions, in non-quantitative terms, that are necessary if competition is to prevail. Thus an important assumption is that there must be a large number of firms, so large no single firm or group of firms can affect the price. Obviously, it is difficult to know whether five, ten, fifteen, or twenty firms is enough to insure the necessary condition. In fact, it is this ambiguity that has to some extent been responsible for economists and lawyers making a living from antitrust legislation. One of the few attempts to be quantitative in this area was made by Henry Simons, one of the intellectual godfathers of the Chicago School. Simons wrote a brilliant public policy document called, A Positive Program for "Laissez-Faire." In it he suggests limiting a firm to 20 percent of the market. Thus, he is implicitly arguing that five firms are enough to produce the results of competition.

The practical implication of all markets being competitive in the economist's sense is that the role of government, to say nothing of the Ralph Naders of the world, is minimized. Competition will drive price to the lowest level compatible with the viability of the firms and the firms will be driven to operate with the greatest efficiency possible. If the product produced by one firm or a group of firms is poor enough to affect the demand, another firm will capture the business by improving the quality. So the consumer is able to live happily ever after with low prices, high efficiency in the use of resources, superb product quality, and little governmental interference.

Unfortunately, the theory as stated does not describe the world. Two developments in particular have rendered the system inoperable. The first relates to the businessman's desire to reduce the amount of uncertainty faced in the kind of competitive model the economist assumes and antitrust legislation attempts to produce. A former colleague and I wrote in a book we published in 1963, “We have argued that the business firm will attempt to avoid uncertainty in its environment by developing information systems that permit the exchange of information on prices, product changes, and so forth. Current concepts of antitrust policy, on the other hand, are directed toward enforcing competition by enforcing uncertainty, by restricting the exchange of information."

The effects of such a policy are well described by a former lawyer and businessman, “To those who labor in the system, a philosophy which makes the good society depend upon blind competition carried on in ignorance of market facts and in disregard of the profit which, and which alone, can give the business institution permanence--such a philosophy seems irresponsible. Such men find themselves pressed on the one hand by the dogma : Compete yourself out of profits. On the other hand, they are pressed to conserve the business, to make it grow, from peace to war, from old styles to new styles, from obsolete technology to advanced technology. The businessman does not understand why his quest for certainty is wrong, why the dogma of competition should be pressed so far as to make a guessing game of the system.”

The second event that upsets the idyllic system of perfect competition is the existence of economies of scale. For some time economists tried to deny the existence of such economies. In the thirties the TNEC produced its famous monograph 13 which alleged that medium size firms rather than large firms had the lowest costs. It was soon recognized that the methodology used was so full of holes that the results were worthless. The next step was to argue that economies of scale were confined to single plants. But it was argued that “It is rare to find vast economies with respect to plant size compared with the size of the market.” Exceptions were soon found to this proposition. As the same writer says, "Recall that Alcoa operated only a single aluminum plant in East St. Louis up to World War II, despite multiple sources of the bauxite input and multiple reduction facilities for the aluminum output. Could this have been due to scale economics of plant relative to market size ?"

76–083—76—--10

More recent work stemming from research by myself and other colleagues at Carnegie has developed in much detail the potential economies from vertical integration. In addition this work has vindicated, to a great extent, oligopolistic markets. Oliver Williamson, a former student of mine and now a professor of economics at the University of Pennsylvania writes, “Absent collusion, the presumption that vertical integration is innocent or beneficial is generally appropriate. Vertical merger guidelines which currently advise that acquisition will be challenged where a ten percent firm at one stage of an industry acquires a six percent firm at another stage, are plainly overrestrictive." Again, "The principal implication of the argument with respect to oligopolistic industries is that oligopoly ought not be equated with a dominant firm condition. It is much more difficult to negotiate a comprehensive collusive agreement, and there are many more problems of effecting a joint-profit maximizing outcome, than are commonly suggested. Theories of 'shared monopoly' ought accordingly to be regarded with skepticism."

Where does this type of analysis leave us ? Specifically the analysis highlights a major conflict between antitrust legislation and efficiency, particularly when transactional economies are taken into account, as they should be. The indict. ment of antitrust policies in relation to efficiency can be made as follows:

(1) The horizontal, multiplant economies tend to be ignored in Section 7 of the Clayton Act cases. If a merger can lead with some probability, to a reduction in competition, it is unlikely that the economies resulting from the merger, even though certain, will be allowed as an argument to allow the merger.

(2) Vertical, multiplant economies whether in Section 7 or Sherman Act cases are not allowed as an argument or more specifically carry little weight. The basic argument of the government is that the market mechanism and shortterm contracts are the way to go. This position is maintained in the face of evidence that vertical integration, joint ventures, or long-term contracts produce greater efficiency.

(3) Multiproduct expansions, Clorox being an example, are disallowed even in the face of evidence of distributional or supply economies.

(4) The problem of developing joint ventures for situations of high risk are not taken into account in antitrust policies.

These examples illustrate some of the aspects of the problem. The society is faced with a confrontation between a reduction in competition and a reduction in the resources expended and is ruling against changes in structure that would allow the economies without making any kind of cost-benefit analysis. Why is the government taking this kind of position? The position of the government and of most economists is given in the following quote from Al Philips, Dean of the School of Public and Urban Policy at the University of Pennsylvania, “Overall, my own assessment is that there are net social benefits from competitive policies. Costs may be apparent to those who see and bear directly some of the disadvantages of these policies. But there is a sense to competitive policy in the dynamic of social history, even if some ostensibly strange results emerge in particular cases. That some kinds of large-scale investments may be discouraged is undeniable. That the resulting social costs exceed the social benefits is an argument less easy to support. Who can point to an antitrust decision or to an unambiguous antitrust doctrine that has produced more evil than good? That is the fundamental question."

This approach is less than satisfying as a justification for the policy, par. ticularly when one looks at the gap between the principle and the practice in particular cases. The difficulty of making a sophisticated economic argument, indeed any economic argument at all before a jury, is tremendous. We are essentially left with a position in which competition as measured by numbers of firms is supported at any cost, that is, the foregone economies of scale.

I am particularly concerned about the role of antitrust legislation and have chosen this topic, because we are at a turning point in our society. It could be argued that during the 85 years of the Sherman Act we have been essentially inward looking. As a result, the pursuance of competitive policies in the internal economy has probably been advantageous. With the advent of OPEC we have been forced to realize our dependence on the rest of the world, for energy and other products. In addition, we have seen in the recent past that those countries in which business and government have a closer relation than in this country have been able to do well in international trade. In other words, I see the U.S. entering an era in which we have to have organizational forms that may be more flexible than we have allowed in the past. In particular, we will probably need more joint actions in which competitors cooperate whether for negoti.

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