Problems in Comparing Political and Corporate Democracy

Why did shareholders come to vote for board members (representative democracy once removed), rather than for managers (pure representative democracy)? The answer to this question is not clear, but before going farther down this path of conjecture, it may be helpful to examine Dunlavy’s assumption that useful comparisons can be drawn at all between the corporate and the civic polity. Corporations and political states are marked by differences so fundamental that it is dangerous to extrapolate lessons from one realm to the other. Four key contrasts between corporation and state demonstrate are: (1) investing in a corporation is a completely voluntary endeavor; (2) representative democracy plays only a limited role in a corporation; (3) the shareholder vote, with the important exception of takeovers, is generally an empty exercise; and (4) shareholders have an important power that political voters lack: the power of easy exit through the sale of their shares—that is, the power to leave their polity.

First, investors choose to invest in the corporate form. They can also invest in partnerships, limited liability companies, or sole proprietorships—or not invest at all. Even more importantly, each of these alternative business forms gives the investor the potential for a much greater voice in the management of the business.

There is a second basic difference between corporate and political self-governance: the shareholder does not vote "to make value choices, to reaffirm common membership in a joint enterprise, or to give meaning to collective commitments," as voters do in the political realm. Instead, one votes "to keep directors within their role requirements, [and] to ensure that they are not stealing from the corporation or distorting it to some other purpose." In short, shareholder "democracy" exists only to "police the professionals." It makes little sense to say that the political model for voting should carry over to the corporate context when the reasons for voting in each of the two settings are entirely different.

There is a third way in which corporate and civic democracy differ. Shareholder democracy is extremely undemocratic in actual practice because, unlike political democracy, it offers voters no real choice at all. Because of corporate election structure; shareholders have no choice between nominees. The incumbent board puts forward a slate of candidates. There is almost always only one candidate for each vacant director seat. Shareholders do have the power to withhold votes, and have occasionally exercised it by opposing nominees for directorships in recent years. But the protest via non-voting had no legal significance, because the default rule in most states gives the board seat to the winner of the highest number of votes, even if this is only a small plurality. Even if a board candidate receives less than a majority of votes cast—or, indeed, even if the candidate receives just one vote and no competing ballots are cast—the candidate is still elected. The typical election is uncontested; thus, shareholders have no real choice. Each vacancy has but one nominee, and shareholders’ failure to vote for that nominee has no binding legal power on either the corporation or the board of directors. Margaret Blair and Lynn Stout justifiably have concluded that "shareholders in public corporations do not in any realistic sense elect boards. Rather, boards elect themselves."

The fourth and final disconnect between voting in the corporate context and in the political sphere: shareholders, unlike the political electorate, can exit cheaply. Shareholders can "vote with their wallets" and exit from a corporation when they disagree with management’s decisions. This is known as the "Wall Street Rule": shareholders dissatisfied with management will not attempt to make changes, but instead will sell their shares. The shareholders’ power to sell contrasts sharply with the high cost of exit for the voter in the civic polity. There is no easy exit from citizenship. Discontented members of a particular state may choose to leave it, but the costs of uprooting a household generally far exceed those of selling shares in a corporation.

Dunlavy tempts us with the political analogy, challenging us to find points of connection and disjuncture between corporate and civic polities. These comparisons are illuminating, but the analogy is by no means perfect. Given shareholders’ right of exit and the lack of shareholder interest in democratic representation in any ordinary sense, shareholder voting rights are really not that much like political voting rights. Shareholders are different from citizens; the purpose of their voting power is distinctive and limited, and their elections function very differently from those of the civic polity. Similarly, the board of directors, although sharing the characteristic of a representative democracy once removed, differs fundamentally from the Electoral College. The board provides independent directors to address areas of management conflict, while the Electoral College serves no such additional function. Comparison of political voting to corporate voting provides a useful vehicle for understanding the characteristics of each more fully. The danger lies in taking principles from the civic polity and applying them to the corporate polity without considering the different context of each.

Corporate Democracy Vs Civic Democracy

Corporate democracy though deals with all the members of the corporation starting from shareholders to all its stakeholders[employees, customers, other stakeholders and also society at large]but in the current study the focus is only on the shareholders. Since the shareholders are the one who vote, the comparison will be rather between shareholder democracy and civic democracy. Colleen Dunlavy makes such comparisons in Social Conceptions of the Corporation: Insights from the History of Shareholder Voting Rights, shedding light on what a corporation’s being more or less "democratic" might mean. She uses history to point out that it is not natural or obvious that votes should be allocated on the basis of share ownership. Indeed, in early corporate America, each shareholder (rather than each share) received a vote. This allocation, she implies, is more truly democratic than allocating one vote per share.

This Comment briefly describes Dunlavy’s treatment of democracy in the political and corporate world, and goes on to discuss how similar kinds of democracies exist in both spheres. It then focuses on one little-explored element of the political-world/corporate-world comparison by developing the striking parallel between the operations of the Electoral College in the national political setting and of boards of directors in the corporate world. The Comment then steps back from this subject and argue that comparisons between the corporate and civic polities, while intellectually tempting, ultimately falter because participation in a corporation fundamentally differs from participation in a nation. Shareholders are not citizens; their investments are voluntary and relatively liquid, and their proxy ballots lack the meaning and power of citizens’ votes. Its exploration of the Electoral College/board of directors’ analogy ultimately dead-ends because the board of directors, unlike the modern Electoral College, plays a real and useful role in governance. All of this confirms that Dunlavy’s reflections are helpful and provocative. Their primary value, however, lies more in illuminating the role of the shareholder within the corporation than in raising a sustainable critique of corporate law’s failure to protect "shareholder democracy" itself.

Shareholder democracy has many advocates today; most of who take for granted the idea that this form of "democracy" means that each share of stock equals one vote. Dunlavy characterizes the current one-share-one-vote model of shareholder democracy as "plutocratic" because it allows the wealthier (or, at least, larger) shareholders to have more of a voice in governing the corporation. She contrasts this approach with the older, more truly "democratic" version of shareholder democracy, under which each shareholder was given equal voting power regardless of his or her level of share ownership—or at least there was a cap on the voting power that came with the ownership of large numbers of shares. In examining the meaning of "democracy," Dunlavy draws a parallel between civic and corporate polities. Each involves a "body politic" (nation or corporation), and each must distribute power among its constituents. She is interested not in the vertical relationships so familiar to corporate law scholars—those between manager and employee, or manager and shareholder. Instead, she urges us to consider the horizontal by virtue of the one-vote-per-share principle, larger shareholders inevitably have a greater say in corporate governance than do smaller shareholders. One might say that although all shareholders are theoretically equal, some are more equal than others—in striking contrast to the operation of our modern political system, which is built on the principle of "one person, one vote.”

By comparing civic and corporate democracy, Dunlavy provides an intriguing method by which to analyze and ultimately critique current corporate voting structures. Fundamentally, Dunlavy asks, if we are to have corporate democracy, why settle for anything less than the full democracy that we enjoy in the political sphere? Indeed, with this question in mind, it becomes tempting to identify and critique other "undemocratic” features of the corporation. Both corporate and political democracies employ two different democratic mechanisms: direct democracy and representative democracy. Direct democracy means letting voters decide issues directly. State elections often present "directly democratic" referenda on issues ranging from bond issuances to measures to cut social services to illegal immigrants. Similarly, in the corporate world there are instances of "direct democracy," when the shareholders vote directly on a particular issue. The most notable example involves corporate mergers. Direct democracy, however, is the exception rather than the rule in both the corporate and political worlds. The main work of the shareholder is to select corporate directors in regularly held elections. Likewise, in the political arena voters’ select key representatives. The election of representatives involves indirect or representative democracy because elected officials—and not the voters themselves—make the critical day-to-day decisions for the polity. Beyond direct and representative democracy, political elections—specifically presidential elections—and corporate elections share a third style of self-governance. In order to select the President Citizens vote for electors who make up the Electoral College. These electors in turn vote for the President and Vice-President. Similarly, within the corporate world, shareholders vote for directors. These directors then choose managers—the chief executive officer, the chief financial officer, and other officers who actually manage the corporation. In both cases, it is the elected individuals who select the ultimate manager.

Corporate Business, Society and Bureaucracy: Why do we need Corporate Democracy

Companies today are in the forefront of creating social wealth. Unlike the classical model of capitalism today’s capitalism can be considered to be a social capital which has popular participation cutting across class, gender, caste etc. In the advanced societies particularly, capitalism has a mass base. Not just a class base. Any good corporation of note has thousands of shareholders: a complex governing machinery and process. As a result companies themselves have become big bureaucracy today.

Bureaucracy is a normative model of organization which emphasizes the structure of an organization. Many of its concepts have been used for several years, but the first systematic development of the theory was contributed by Max Weber around 1900. Bureaucracy shares a number of concepts such as order and rationality with administrative theory and scientific management. These three approaches together make up classical management thought.

Elements of bureaucracy are found almost universally in modern organizations if they are complex than simple face-to-face relationships. Business organizations largely are based on bureaucratic concepts. Although the demise of bureaucracy has been predicted, no alternative has been developed that can so well bring the necessary order to a complex organization.

Bureaucracy provides ordered hierarchies that can take advantage of specialization. Office holders [other than chief executive] are selected by objective qualifications rather than nepotism, patronage, or other personal whims of managers. Employees usually have a career emphasis and employment security is emphasized .Decisions are made by a consistent system of abstract rules, regulations and procedures. Authority rests with an office, not in the person of an individual holding the office.

Authority, responsibilities, activities, communication, power, and other features of the organization are structured by the bureaucracy. Bureaucracy manages complexity: it produces rationality, stability and predictability. In some ways it makes an organization more democratic by reducing patronage and other privileged treatment.

Bureaucracies are the means by which people are employed to carry out work for an association. One of the difficulties of course, is that the term bureaucracy has collected to itself an even wider range of different meanings. As Mouzelis [1992] have pointed out, there is a serious state of confusion and ambiguity about its use in modern social theory. The definition that can be used in this particular context is a more limited one than the concept as originally propounded by Weber [1948]. This definition is used as it is more apt with today’s industrial world. Bureaucracy here is defined as a hierarchically stratified managerial employment system in which people are employed to work for a wage or salary; that is to say, a stratified employment hierarchy with at least one manager who in turn has a staff of employed subordinates.

The major characteristics of bureaucracy which are applicable to any modern corporate structure are:

Employment Relationship
The office is a vocation and a full time undertaking. Officials are selected on a basis of technical qualification, education and expertise. There is a separation of office and office-holder. It is not his or her property and the employee does not possess the means of administration. Thorough and expert training is part of the conditions of employment.

A career structure is provided based on the organizational hierarchy. Tenure is for life, with fixed salary, pension rights and appropriate social status. Officials are appointed by higher authority, not and promotions are similarly regulated, for example through seniority.

Work Structures and Relations
There is a hierarchy of offices, with continuous and regulated activity within a fully ordered system of super and subordination. Within the chain of command, there is a division of labor based on defined responsibilities, rights and duties. Calculable rules and regulations, impersonal modes of conduct and a common control system govern the conduct of work. Written documentation is the basis of management of the office.

Rationalization is held to be the key modernizing characteristic for the development of industrial societies. Authority in industrial societies is rational because it is formal and based on precise and predictable rules, calculation and accounting. For these reasons the bureaucratic organization and administration best permitted the development of appropriate attitudes, structures and practices in public and private sectors. In this context bureaucracies are a specific type of rational-legal authority: officials work within a framework in which command and task are based on authority derived from impersonal rules. Weber made it clear that they referred to bureaucracy management as well as administration. The Weberian ’causal chain’ links the concept of rationality explicitly to the emergence of capitalistic enterprise and markets. These were held to be rational because of their capacity for calculability, predictability and routinisation-through production, distribution, accounting and market pricing mechanisms. Precondition for the rationalized capitalism started from the complete private appropriation of the means of production, which Weber said must be unhampered by ‘irrational obstacles’ such as workers’ right to participate in the management. In addition, there was the need for common management, free labor under the compulsion of the ‘whip of hunger’, mass markets, minimal trade restrictions and institutional, legal support from the bureaucratic state.

Weber also argued that large capitalist enterprises were becoming ‘unequaled modes of strict organization’ [Weber, 1984:32].he was aware and approving of the role played by scientific management in this process. It was completely the ideal vehicle for the necessary imposition of military discipline in the factory, given its capacity for dehumanization and conditioning of work performance.

Bureaucracy has many unintended consequences, or dysfunctions. It tends to be non adaptive and impersonal. Some critics claim bureaucracy as a rigid ‘machine model’ that fails to account adequately for many human characteristic. It offers numerous opportunities for members to displace objectives and to work for personal goals that may not adequately contribute to the overall objectives of the organization. Bureaucracies may tend to grow and perpetuate themselves beyond their useful lives. By pressure for routine and conformity the bureaucracy may produce anxiety in members. It does not fully account for the fact that organizational activities really cannot be squeezed into all-inclusive, mutually exclusive positions. The cost of implementing rules, regulations, and other bureaucratic elements often is substantial.

No doubt, bureaucracy is among those set of concepts that have had the most profound effects upon mankind. Its benefits can be powerful, but it is far from being a generally perfect approach to organizations. In a corporate structure as there is immense human stake involved it becomes very important to look at the shareholders interest. It is important to police the top management [the bureaucrats in a corporate setup] so that they act in the full interest of the shareholders and other stake holders. In this context it becomes useful to have a look on the principal-agent theory which talks in length about the shareholders stake in a corporation

The development of agency theory is often traced beck to Berle and Means [1932], although some writers suggest that one can go back to Adam Smith in 1776 and his influential book The Wealth Of Nations. Letza, Sun and Kirkbride [2004] point out that the agency problem was effectively identified by Adam Smith when he argued that the company directors were not likely to be as careful with other people’s money as with their own.

Subsequently the firm was viewed as the nexus of a set of contracting relationships among individuals. most important among these was the agency relationship, which has been defined as ‘a contract under which one or more persons[the principal]engage another person[the agent] to perform some services on their behalf which involves delegating some decision making authority to the agent’[Jensen and Meckling,1976:308].The agency relationship can be a problem because the agent may not always act in the best interest of the principal[s].Agency costs are then incurred, which include monitoring costs incurred by the agent, and reductions in welfare resulting from decisions taken by the agent which are not consistent with maximization of the principal’s welfare. Moreover, Jensen and Meckling were aware that it was costly, if not impossible, to write contracts which would clearly delineate the rights of principals for all possible contingencies.

Shleifer and Vishny [1997] argue that the agency problem is an important element of the contractual view of the firm. The analysis then focuses on the impossibility of writing complete contracts, and the complexities arising from incomplete contracts. Hart[1995]offers three reasons why principals and agents tend to write incomplete contracts ,it is difficult for people to think ahead and plan for all possible contingencies; secondly, it is hard for the contracting parties to negotiate effectively, especially where prior experience may not be helpful guide; thirdly, it is difficult for plans to be written down in such a way that an outside authority ,such as a court, will be able to interpret and enforce the contract. Moreover Aghion and Bolton [1992] argue that-as a result of contractual incompleteness and wealth constrains-it is not possible to resolve all potential conflicts between the agent and the principal.

In a traditional shareholder perspective, the corporation can be viewed as a’ legal instrument for shareholders to maximize their own interests-investment returns’[Letza,Sun and Kirkbride,2004:243]. Within this model, it is often assumed that the managers are more /better informed about the firm then are the shareholders. In other words there is information asymmetry: agents have better access to information than shareholders. In an agency setting, principals can attempt to overcome the information asymmetry by monitoring management, but this is a costly activity for individual principals. The overall costs of information-gathering can be reduced if systems are put into place to provide relevant information to all shareholders. For example, there could be the provision of regular audited financial reports or ensuring that systems operate to deter agents from benefiting from the use of their privileged knowledge.

For all these, the corporation should maintain a proper democratic environment.