Figure 10.1 illustrates numerous features of the logic of institutional changes from Saddam Hussein’s purge to the stability of mature democracies. In very small coalition settings, leaders can generate support from some existing members of the coalition to purge other members. In Figure 10.1 this is exactly the incentive when the coalition is initially sized between one and six. Of course, no coalition member wants a purge unless he is going to survive it. It is for this very reason that Saddam Hussein’s videotaped purge initially filled the Ba’ath party members with such fear and why those who were retained were so happy to be kept on. Their survival in the essential group after the purge meant they would get even more private rewards.
If coalition size starts out pretty large, beyond six in the illustrative example in Figure 10.1, then orchestrating a purge or a coup gets harder and harder. Leaders, whether incumbents or potential coup makers, find it increasingly difficult to get supporters to go along with reducing their coalition. While, for example, it is possible for a leader with an initial coalition of ten to find supporters who could be better off after a purge, the coalition would have to shrink all the way down to three before those still in it would be better off after the purge. And to benefit from the dirty work entailed in such a contraction, the coalition’s members that help perpetrate the purge would have to be absolutely certain that their names were not also on the list of those to be eliminated.
As the coalition gets even larger it becomes nearly impossible for a leader to induce coalition members to perpetrate a purge or for a rival to organize a coup. Figure 10.1 illustrates this stability of mature democracies. Once the winning coalition size expands to at least twenty-seven, in our example, the leader could not make his supporters better off even if he could convince them to contract the coalition all the way back down to just two members.
The essential facts of political life are that people do what is best for them. Thus, except under extreme duress, leaders don’t expand the coalition; the masses press for democratization; and essential supporters vary in what they want. This latter group can be made better off by contractions in the number of coalition members—that is, with coups and purges—provided they are the ones retained. Democratization can also make them better off. It is therefore this group that offers the greatest prospect for constructive, as well as destructive change. With them lies the possibility of both “one step forward” and “two steps back.” The prospect of being dropped from the coalition encourages its members to take the single step forward rather than risk becoming a casualty of the two steps back. Times and circumstances that heighten the risk of coalition turnover engender an appreciation of democracy among political insiders.
Members of a small coalition live in luxurious, but constant, fear: make the coalition smaller, as their leader wants, and they may be out; make the coalition bigger and their special privileges diminish. But decreased privileges are much better than the danger of being out altogether. So, there are two times when the coalition is most receptive to the urge to improve life for the many, whether those are the people or shareholders: when a leader has just come to power, or when a leader is so old or decrepit that he won’t last much longer. In these circumstances coalition members cannot count on being retained. At the beginning and the end of an incumbent’s reign the danger of being purged is greatest and so, at these times, coalition members should be most receptive to reform. Effective reform means expanding the coalition and that means that everyone, including the current essentials, has a good chance of being needed by tomorrow’s new leader.
Not only is there a good time to look for the opportunity for reform. There also are good circumstances when reforms that can improve the people’s welfare are welcomed. Coalitions whose leaders face serious economic strains understand that their days of luxury and splendor are numbered. That is one of the reasons companies sometimes commit fraud: CEOs, senior management, and board members believe they will be ousted because of the firm’s failure and so they cover up how poorly the business is doing while they try to fix it and save themselves. Little white lies work well the first year, but if things do not turn around, then each year they need to lie a little bit more until their reports are outright fiction and legally fraudulent.
As we have learned, when a country’s economy is in trouble the big problem from a ruler’s perspective is that she doesn’t have enough money to buy continued loyalty. When the privileges enjoyed by essentials are shrinking they are likely to be tuned in to the possibility of change. They know the leader will want to purge people to use what little money is around more effectively. They, not wanting to be purged, will be amenable to expanding their group, trading their privilege for their future security and well-being. Coalition members are not the only ones willing to contemplate changing the rules when circumstances warrant. If the economic crisis is severe enough (and foreign aid donors stay away), then even leaders must ponder whether they might be better off liberalizing. Democratization jeopardizes their long-term future, but if they don’t pay their supporters today whether they can win an election tomorrow is not a salient consideration.
Blind fools don’t often get to rule countries or companies. Pretty much any leader worth his salt can see the dangers he faces when economic circumstances leave him bereft of funds to buy loyalty. Under such circumstances even leaders can believe that reform is their best shot at political survival. They might look for a fix even before their coalition does. Consider the experience of Chiang Kai Shek, who certainly was no fool. We might well ask why he encouraged much more successful economic policies on Taiwan than on the mainland of China. In the latter, even with extensive poverty, because there were so many people, there was plenty to enrich himself and his coalition. But when Chiang Kai Shek and his backers retreated to Taiwan, they took over an island with relatively few people and barely any resources. Only economic success could provide the way to reward his coalition. In the process of achieving that success, he also gradually expanded the coalition, perhaps in response to pressure from his essential cronies or perhaps under pressure from the United States, until one day he woke up to a democracy.
When the time or circumstances are ripe for change, coalition members must recognize that if they do not pressure for an expansion of public goods and public welfare, then others will. Provided that the chances of success are good enough and the expected gains from success outstrip the costs involved in gambling on a revolt, an intransigent coalition and leadership will find itself besieged by an uprising. In this circumstance, such as was seen in Tunisia, Egypt, Yemen, and elsewhere in the Middle East and North Africa, and as we saw in the proxy fight at HP over Carly Fiorina’s decision to merge with Compaq, people are willing to take big risks to improve their lot. They do so to call for exactly the same change as is widely favored by smart coalition members when and if any change becomes necessary.
A wise coalition, therefore, works together with the masses to foster an expanded coalition. The people cooperate because it will mean more public goods for them and the coalition cooperates because it will mean reducing the risk of their ending up out on their ear. Egypt’s military leaders, essential members of the Mubarak government, understood this choice very well in the early months of 2011. They ensured their continued place as important players in Egypt’s future by cooperating with the mass movement and supporting an expanded coalition, rather than hunkering down and risking losing everything.
What are the lessons here for change? First, coalition members should beware of their susceptibility to purges. Remember that it ticks up when there is a new boss, a dying boss, or a bankrupt boss. At such times, the essential group should begin to press for its own expansion to create the incentives to develop public-spirited policies, democracy, and benefits for all. Purges can still succeed if they can be mounted surreptitiously, so wise coalition members who are not absolutely close to the seat of power would do well to insist on a free press, free speech, and free assembly to protect themselve
s from unanticipated upheaval. And should they be unlucky enough to be replaced, at least they will have cushioned themselves for a soft landing. Outsiders would be wise to take cues from the same lessons: the time for outside intervention to facilitate democratic change or improved corporate responsibility is when a leader has just come to power or when a leader is near the end of his life.
Knowing what people want, and the conditions under which they will oppose reform and the circumstances under which the swing coalition members will support reform, we can now turn to concrete ideas about fixing, at least partially, the worlds of business and governance.
Lessons from Green Bay
The Green Bay Packers, a football team based in the cold climes of Wisconsin, are remarkable for the loyalty their fans show them. In fact, win or lose, Packer fans are nearly always satisfied. Virtually every one of their home games since 1960 has been sold out. Attendance averages 98.9 percent despite often appalling weather. The Packers have one of the longest waiting lists for season tickets among professional football teams.1 Despite being a small market team (Green Bay is a city of only about 100,000), they attract a larger, more loyal fan base than teams from many much larger cities. Their success with their fans, if not their success on the field, stems from their institutional structure.
The Packers are the only nonprofit, community-owned franchise in American major league professional sports. Their 112,120 shareholders are mainly local fans. The ownership rules preclude a small clique taking control of the team. No one is allowed to own more than 200,000 shares in the Packers and there are about 4.75 million shares outstanding. Thus, a tiny band of owners cannot easily overturn the many and run the team for their personal gain at the expense of the larger, small-owners fan base. The Packers have a forty-three-member board of directors.
We can see the relative representativeness of the Packers’ essential coalition by comparing the size of their board of directors to Carly Fiorina’s board at Hewlett Packard. Remember that the Hewlett Packard Board varied between ten and fourteen members. HP has about 2.2 billion shares outstanding. Roughly speaking, each Packard board member nominally represents the interests of about 185 million shares. Each Packers board member represents about 110,000 shares. The Packers have a vastly larger winning coalition in absolute terms (forty-three to about twelve). They also have a vastly larger coalition relative to the size of their nominal selectorate—about 1,700 times larger. Can it be any wonder that the Packer owners are extremely happy with their company/team and that sentiments are more mixed when it comes to HP?
The lesson to be extracted from the Green Bay Packers is that if firms can be made to rely on a bigger coalition they are likely to do a better job of serving the interests of their owners. But how can corporate governance be turned on its head to make this happen?
Consider what the main difficulties are for shareholders. They suffer from two big problems: First, in big corporations there tend to be millions of little shareholders, a handful of big, institutional shareholders, and a bunch of insider owners. The millions of little shareholders might as well not exist. They are not organized and the cost to any of them to organize the mass of owners just isn’t worth it. Second, the flow of information about the firm’s performance comes from pretty much only two sources: the firm itself and the financial media. Few owners read annual reports or SEC filings and the financial media don’t spend much time reporting on any one firm unless it is in huge trouble. By then it is usually too late for the shareholders to save the day.
We live in the age of networking. Much of the world, including owners of shares, Twitter and chat with “friends” on Facebook; they are LinkedIn; they can easily communicate with one another, even if they don’t always do so. Surely it would be relatively simple to design firm-specific Facebooks or other networking sites.
Companies maintain lively web sites to put their view across but entrepreneur-owners have not stepped forward to do the same to help organize the mass of little owners and to provide a way for them to share views. Sure, there are bloggers writing about anything and everything, but there don’t seem to be shareholder-controlled sites to exchange thoughts and ideas about a company that participants own in common. If something like this existed, the size of the influential, informed voters in any corporation would go way up. Then, for the first time, boards would really be elected by their owners and then the board would need, like any leadership group, to be responsive to their large coalition of constituents. A simple change that exploits the Internet to be a conduit for increasing coalition size can turn the AIGs, Bank of Americas, General Motors, and AT&Ts of the world into big-coalition regimes that serve their millions of small owners instead of a handful of senior managers.
Ah, you are thinking, senior management can thwart such efforts. They will, as they already do, hold shareholder meetings in places most owners can’t afford to go, or the meetings will be so brief that it will be impossible for dissidents to express their views (the preferred shareholder meeting strategy in Japan) and, after all, proxies pour in, turning millions of votes over to a handful of board members. None of that, of course, will stop shareholder control once the millions of little owners have a cheap and easy way to exchange views. Then they will set the rules—by majority vote—for who casts proxies. They can set some of their own up to represent competing “parties” and they can make the annual shareholders’ meeting a purely decorative event. All such skeptics should remember that social networking web sites have already successfully mobilized revolutions and brought down governments. Changing corporate governance is far easier.
Corporations don’t have armies that can go out and bash in the heads of dissidents. Pursue a course of connecting and informing shareholders, and we will see whether shareholders who limit CEO salaries do better or worse; whether firms that alter behavior to meet the social expectations of their shareholders do better or worse; and whether shareholders care more about employees or about themselves. Whatever the millions of little owners decide to do, they will be responsible for their own fate. Management will serve them just as democratic leaders are more constrained than autocrats to do what their citizens want.
We also ought to comment a bit on how not to improve corporate governance. In the wake of Enron’s collapse and other big frauds, Congress decided to regulate corporate governance, ostensibly to make it better. By now every reader knows that the interest of government leaders is not in making shareholders or even the man or woman on the street better off. Their interest is in making themselves better off. The regulations they imposed on corporate governance may have played well with voters, many of whom had little stake in many of the companies that were harmed by the regulations, but they have not made corporate governance better. The Sarbanes-Oxley Bill, passed in 2002, was supposed to tamp down management’s greed and make companies responsive to their shareholders’ interest in equity growth. Study after study, however, shows us that this is not what happened. In a brilliant summary of the statistical assessments of each of the governance planks in Sarbanes-Oxley, for instance, Yale law professor Roberto Romano shows that Sarbanes-Oxley did not do what it was “supposed” to do and often made things worse. Even a seemingly obvious reform—requiring an independent audit committee—turns out not to have been beneficial. Costly, yes! But it did not improve corporate governance or performance. Romano goes on to document the failings of Congress and regulators to get it right.2 The wishes of a large coalition of shareholders with a big stake in finding the right answers to any given corporation’s problems is likely to make businesses work better. A coalition of government regulators bent on improving their own electoral prospects is not.
Fixing Democracies
For the citizens of democracies, life is good. But good does not preclude better. At the very beginning we mentioned that we would be lazy and not constantly make subtle distinctions between the size of one democracy’s coalition and another’s. Rather, we have repeatedly leaned on the rhetorical d
istinction between democracy and autocracy. It is a useful convention, but such a broad brush risks blurring important distinctions. Our approach really depends on the subtle organizational differences in the size of the three political dimensions on which we focus. For convenience, these distinctions are often dropped, but even small differences matter. It is time, then, to confront those small differences head on and see how good can be made better.
At the time of its independence, the United States was composed of thirteen states. They all had broadly the same first-past-the-post electoral rules and yet their record of performance was remarkably different. It is easy to be sloppy and think that they all had the same political system—governed by the United States Constitution—so that their differences must have come from somewhere else. In reality, however, their political systems were not the same. The constitution is silent on many issues that are central to governance. The constitution tells us nothing, for instance, about how to add up votes. As we saw, just by changing this simple rule, Harvey Milk could change American politics by getting elected to San Francisco’s Board of Supervisors in 1977, even though he could not do so in 1975. Seemingly small differences in enfranchisement rules and districting decisions led to big disparities in the economic (and social) development of the States of the United States.
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