Make Capitalism Great Again

Perhaps Hanania’s most noteworthy intellectual contribution was to ‘expose’ the legal basis of the proliferation of wokeness: the disparate impact doctrine. This implied a legal/administrative agenda to combat wokeness.

I want to propose that a similar dynamic is at play vis-a-vis ‘managerialism’. The separation of ownership and control looks like the inevitable product of corporate scale and diffuse shareholding, but is substantially a legal artifact.There are 2 main legal & bureaucratic structures that protect managerialism against activist investors. First, SEC mandates certain disclosure requirements and imposes restrictions to investors based on their ownership stakes with the thresholds set at 5% and 10%. Secondly, and much more importantly, many firms adopt poison pill provisions.

The SEC regulations are as follows:
After crossing 5% ownership, you need to disclose your stake within 5 days. Thereafter, any change of one percentage point or more in your holding must be reported within two business days.
After crossing 10% ownership you additionally become a statutory insider. This adds three things on top of the 5% disclosure: (1) you must report every transaction, regardless of size, within two business days (2) the short-swing profit rule claws back to the company any profit on a purchase-and-sale pair made within any six-month window and (3) you can’t short the company's stock

The disclosure raises the cost of accumulation, as others can trade ahead of your further buying. But I like the short-swing rule to incentivize a long term mindset.

The actual impediment to activist investing or hostile takeovers, however, is the poison pill provision. Broadly speaking, a poison pill is, once a shareholder crosses a threshold around 10-20% (the exact threshold depends on the company), without the board’s approval, every other shareholder gets the option to buy additional stock for much cheaper, thereby diluting the activist who was trying to accumulate an ownership stake.

This makes it so that de facto control belongs to the board and not to an activist investor who thinks they can do a better job running the company. The poison pill was invented by Martin Lipton of Wachtell, Lipton in 1982, as a response to the hostile takeover wave of the 80s by ‘corporate raiders’ such as T. Boone Pickens and Carl Icahn.

When challenged at court, the poison pill was found to be legal (Moran v. Household, Del. 1985). The poison pill, coupled with Milken, who financed a lot of this activity with junk bonds, going to jail, ended the corporate raiding wave. With the rise of passive investing, managerial control over public corporations is stronger than ever.

I’ve picked biotech stock investing as a hobby recently. And, in that industry, many companies are worth in the 100s of millions to low single digit billions of dollars range. Many biotech funds then are in a position to act as owners. At the same time, in SMID biotech investing management quality is considered paramount. What happens is, instead of these funds changing the management they perceive to be low quality, they decide instead to just pass. It’s not worth it to try to change and deal with bad management.

So to sum up, insofar as we want to return to a more entrepreneurial and old-school form of capitalism, we need to think about legal reforms that enable this outcome, including but not limited to banning poison pill provisions.

An interesting proposal to go looking for the legal roots of managerialism but I think you've got the wrong target. First of all, managerialism came into being after the great depression or maybe the war, not in the 1980s. What the cause was exactly I'll leave to others, but I don't think it was the end of corporate raiding.

Let's introduce another player in the dynamic: the founder. The classical high-innovation era of capitalism from the 1870s through the 1930s was largely founder-driven, as is the best of silicon valley capitalism. If there's a golden age of investor-driven capitalism, you will have to make the case for it.

Managerial capitalism as a historical event was when the university graduated management bureaucrats like my grandfather came out of the war and school and were inserted into the management structure of industrial concerns that had previously been run by men trained up from the shop floor. This may or may not have come along with making those managers and executives beholden to other interests than the investors, but that would be where to look: by what means were these companies compelled to accept outside management from the managerial class?

In fact if I recall correctly some of this came in precisely by means of investor rights. Ford for example as a founder industrialist and good national socialist paid his workers very well. Too well for the dodge brothers, who sued on the grounds that he had to prioritize shareholder value, not the good of the worker, the nation, or industry. They won their case if I'm not mistaken and this is the (mythical?) origin of shareholder primacy.

If I had to name the true nature of managerialism, it's not lazy executives and boards protected by law from coked up corporate raiders, it's the various managerial departments coming back to strong executives with all kinds of "well ackshually" reasons why he can't really be in charge. HR (civil rights), Legal (all kinds of stuff), PR (what legal teeth?), Accounting (sorbanes oxley), and yes, capitalist investors armed with shareholder primacy.

Let's take a recent illustrative example: Uber's Travis Kalanick was forced to resign by investors citing a "toxic workplace" and various other mis-managerialisms. So there we have investors as a vehicle for managerialism.

So I think actually managerialism is characterized by a feminine consensus-driven "longhousing" of companies, the opposite of managerialism is Paul Graham's "founder mode", and managerialism is therefore the result of the confluence of conventional "well ackshually" forces arrayed against founder control, including capitalist investors and civil rights "wokism". I would look for the legal causes of it in the increasing legal regulation of every aspect of life, perhaps ultimately in the primacy of lawyers and police over men of personal leadership and violence.

An interesting response, thanks. I would re-frame the exchange, there are two different kinds of capitalists: investors and operators; and this gives rise to the following 3 arrangements:
(1) Late stage managerialism, there are no owners, managers are in charge.
(2)Financial capitalism: the managers are acting on behalf of shareholders.
(3) Entrepreneurial capitalism: the owner is the operator.

I was describing the legal obstacles of going from (1) to (2) or (3). And your response was (3) is the real thing, which is fair enough. While going from (1) to (2) is more common, going from (1) to (3) is also possible.

An example is Danaher. They originate as corporate raiders in the 80s, but instead of flipping companies, they hired Japanese consultants to teach them about the Toyota System, and they improved the operations of the companies they acquired by applying it. Another example is Roivant, Vivek’s biotech firm. The ‘Roi’ in the Roivant literally stands for return on investment. But they were able to buy a lot of discarded assets and develop them. Often these assets were ignored by risk-averse executives. But of course, this is incremental innovation.

I was being a little tongue-in-cheek in my post, and I didn’t mean that managerialism came about due to laws. Nonetheless, the framework I outlined narrows my scope. The preponderance of late stage managerialism nowadays came about due the market for corporate control being regulated out of existence. But managerialism itself is an entropic process. The founders retire, companies go public, and the companies go from (3) to (2) to (1). Uber is a great example. In fact, oftentimes (3) is legally privileged, given the extra voting rights of founder shares. But once a public company has no owner, it's difficult to come back from that. The only other mechanism for reversal is ‘disruption’, where a new startup outcompetes the old incumbent, and a founder-led company replaces the incumbent.

I think in your response the downsides of accounting and employment law are a little overstated. When I think about the downfall of companies like Intel and Boeing, I don’t think it’s because of HR or accounting. It’s not even because of shareholder primacy. It’s because technical decisions have a long lead time. When you have people who are not technically minded making decisions, things go wrong in a way where the bill comes due a decade later. And the shareholders don’t even know the company’s being hollowed out, until the consequences of it play out. I don’t know that there are many public companies that would somehow start innovating if they were unleashed, but they are stuck because of legal and shareholder primacy considerations. Perhaps Jim Farley and Ford?

When I think about the downsides of non-technical-leadership, I often think about long lead times. I really like this post by SSC https://www.astralcodexten.com/p/on-priesthoods. If you are a company like Boeing you must have a mindset that every decade you will build a new aircraft, and that you must do it yourself. This is so that you maintain the organizational know-how to be able to build de novo airplanes. If you make the sensible decision as a manager that the ROI doesn’t look good for this generation, you’re incurring an illegible cost that's relevant to the terminal value of the business. But the financials won’t reflect this for a decade or two.

I think ultimately these are 2 related but different questions: how do we revive the market for control, and separately but relatedly how do we empower technical minds to innovate and take risks. We can further think of managerialism as a 2x2 matrix, with the principal agent gap on one axis, and collectivization vs subjectivization of control on the other. I suppose innovation can also come from competent industrial policy, or competent government programs. And while I do support empowering innovators, I also personally like shrinking the principal agent gap regardless of whether it empowers coked up finance bros.