Business Models For a Dynamic Economy
- The shareholder corporation is out of step with the digital 21st century
- Government must facilitate alternative forms for company structures
- Limited liability needs reform, including a new mandatory insurance
British companies are too reliant on the PLC model which is failing to meet the demands of the 21st century digital economy, according to a new book published by the independent think tank Civitas.
In Beyond the PLC, economists Greg Fisher and Paul Ormerod provide a jolting critique of the traditional shareholder corporation, identifying its role in the financial crisis and showing how it is becoming increasingly outdated in today’s world.
Entrepreneurs need a wider choice of corporate governance forms for their business start-ups so that they can better harness the opportunities afforded by a rapidly evolving and dynamic economy. The PLC model was designed in the 19th century for its capital-intensive economy.
“The joint stock company model was designed for an industrial era and shareholders may now wish to consider alternative organisational forms,” they say.
Fisher and Ormerod, two of Britain’s most original and creative thinkers on contemporary economics, urge the government to ensure the company forms available to new businesses keep track with quickly emerging trends.
They set out proposals for tackling some of the lack of accountability and irresponsible behaviour that was exposed by the financial crisis, including:
- A requirement for limited companies to take out a new kind of insurance that would protect third parties from the costs of them going bust
- Stock option incentives which are based on a company’s share price relative to a particular benchmark, such as the performance of the FTSE 100, rather than its absolute performance
- Laws and regulations that actively encourage collusion between shareholders in order to stand up to executives and ensure a better balance of power
- A requirement on investment management firms to participate in shareholder votes and actions, whether directly or via a proxy
Limited liability – under which shareholders cannot be pursued by creditors for their private assets – is acknowledged as a key factor in the financial crisis as it can lead to excessive risk-taking. The concept of “too-big-to-fail”, as it applies to the banking sector, is an extension of this.
Fisher and Ormerod’s proposed system of insurance for limited companies would mitigate the costs arising from this moral hazard. Based on a system similar to that of third-party car insurance, companies would have a statutory duty to insure against the costs of insolvency.
“Limited liability is equivalent to a type of insurance for shareholders, and so we should design a system in which companies are charged for the privilege of limited liability status. That is, pay an insurance premium,” they say.
“Such a system would retain the uncertainty-mitigating feature of limited liability while also mitigating the problems arising from moral hazard. The insurance premiums would be pooled and used when companies are put into administration upon insolvency, to pay for the associated costs.
“We would recommend that this system is designed and run in a way similar to third-party car insurance. The main role for the government would be to make it a legal requirement that companies with limited liability must have this insurance, as it does with car insurance.”
This insurance would not be available to lenders charging interest for capital as the market rate already reflects the additional risk that a limited company could default and the money not be recovered.
The system should not be operated by the government but by insurance companies with expertise in the area. The authors envisage a system whereby insurance premiums take into account a range of factors related to the business.
“Such a system would not create moral hazard. Moral hazard already exists so the payment of insurance premiums is merely the counterpart to it,” they said.
Under the proposal, banks would also be required to take out limited liability insurance, but their premiums would be paid to the government and would reflect the costs of a potential system-wide bailout.
The authors do not put a figure on how much this should be, but say it should be “substantially greater” than the banking levy currently set at 0.13% of the global balance sheets of UK-based institutions.
“Banks are special because they are deeply integrated in to the British economy to such an extent that most banks are too big and too interconnected to fail.
“In the event of a systemic banking crisis, it would be the government that would step in to rescue the banking system, with funds provided by the taxpayer.
“Insurance companies are unlikely to be able to provide the capacity to rescue the banking sector in the case of multiple insolvencies – that role should rest with the government as it did during the recent financial crisis.”
As part of a wide-ranging survey of the current business landscape, Fisher and Ormerod detail the problems with joint stock companies, as evidenced during the financial crisis, including the weaker shareholder oversight brought on by:
- The principal-agent problem, or that the executives and managers of PLCs are looking after other people’s money rather than their own
- The free-rider problem, which means that many holdings are so small that no individual shareholder is incentivised enough to take action and hold managers to account
The remuneration of directors and other senior managers within firms has risen substantially over recent decades, a development in part due to the weaker grip that shareholders have over the companies they own.
“In fact we would argue the remuneration of many executives has lost touch with reality, exceeding any reasonable estimate of fairness,” they say.
“This was best demonstrated during the financial crisis when the executive directors of large banks which had to be rescued with public funds, walked away with large pay-offs.”
Fisher and Ormerod also call for the Department for Business, Innovation and Skills (BIS) to be tasked with leading ongoing consultation and surveillance to establish where new company forms would be appropriate and what legislation is required to underpin them.
In particular, they say, BIS should consider the need for an organisational form for the development and protection of co-created assets, such as Linux software. They advance the case for a new “for-benefit organisation”, which would help put the framework in place to support many more examples of co-created assets.
Other possible alternatives to the traditional joint stock company include:
- The triple-bottom line company, which is explicitly pro-social, pro-environmental, and at least financially viable
- A German-style company with multi-stakeholder governance structures, including positions for workforce representatives on supervisory boards, for example
- A specific company form designed exclusively for banks, recognising the unique role they play in the economy
The authors do not argue that any of these forms should replace the joint stock company but that they should be available – enabled by statute – alongside the traditional structures available to entrepreneurs.
Their proposals reflect a new approach to looking at the economy, which sees it as an evolving process rather than a static machine.
“An important role for the government is to ensure that the set of organisational forms in the economy is relevant to the current and expected future economic environment,” they say.
“The economic process is fundamentally an evolutionary one. This stands in contrast to the static nature of mainstream economics, which informs a great deal of government policy.
“As the economy evolves, it is essential that statutory laws evolve too, to reduce preventable uncertainty. Existing statutory law, therefore, must be questioned on a regular basis to ascertain whether or not it does this.”
Greg Fisher is managing director of Synthesis, a think-tank devoted to using the emerging paradigm of complex networks in the social sciences to tackle social and public policy concerns. He held a variety of roles at the Bank of England before becoming a global macroeconomic strategist for a hedge fund. He is currently a senior research associate of the London School of Economics’ Complexity Group.
Paul Ormerod is a director of Synthesis. He started out as a macro-economic forecaster and modeller at the National Institute of Economic and Social Research, later became director of economics at the Henley Centre for Forecasting, then set up Volterra Consulting in 1998.
A PDF of Beyond the PLC can be accessed below. Hard copies are available on request.
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Civitas: Institute for the Study of Civil Society is an independent social policy think tank that facilitates informed public debate on important issues of the day. It has no links to any political party and its research programme receives no state funding