(Part 1)

Nowadays, free market capitalism is in great disrepute, attacked by both those from the left and the right. Considered almost as gospel truth during the second half of the last century, belief in the free market as the key to long-term economic progress and social justice suffered a serious blow by the beginning of the third millennium when there was more than enough evidence that free market forces kept hundreds of millions of people in both developed and developing countries in dehumanizing poverty. There was no automatic trickle down of incomes from the upper-income groups to the teeming masses. Inequality was the rule rather than the exception both within each nation and among nations. As measured by the so-called GINI coefficient, even the most developed countries manifested extreme inequality in incomes, not to mention in wealth.

This disillusionment with liberal or neoliberal economics was quite predictable even during the heyday of free market capitalism. When I was doing my doctoral studies at Harvard in the late 1950s, I had some economics professors who were quite uncomfortable with the extreme optimism of the leading prophet of liberal economics, Nobel laureate Milton Friedman of the University of Chicago who became famous for his aphorism that the only goal of a business is to seek maximum profit. This was very much in line with the assumption that if everyone is allowed to seek maximum profit in business (and maximum satisfaction in consumption), everyone will live happily ever after. The natural forces of competition as allowed and fostered in a free market economy would automatically lead to a progressive and inclusive economy. There was, of course, some room allowed for state intervention, in taxation, public works, public services and the regulation of competition. Otherwise, maximum freedom should be given to the “animal spirit” of seeking maximum profit. There was no room for the capitalist to consider his moral and social obligations to society.

Such a caricature of the human being who happened to be a businessman gave the license to a good number of capitalists to literally act like the fabled Gordon Gekko of the film Wall Street whose motto was “Greed is good.” In many business circles all over the world, it took time for the majority to realize that economics and business have to do with human beings who by nature have social obligations to others and who cannot morally act with the exclusive goal of maximizing personal gain, no matter what the cost to other human beings. The motto “Greed is good” led to the exploitation of workers, first in one’s home market and then with globalization in the labor-rich countries of the developing world. It also led to the wanton destruction of the physical environment and the pollution of water and air. Brought to the financial market sphere, this obsession with profit led to the Great Recession of 2008 to 2012 with the financial derivatives scandal and massive failure of banks like Lehman Brothers.

The harshest critic of the obsession with profit maximization in business is Pope Francis who in his encyclical, The Joy of the Gospel, wrote: “Today we also have to say ‘thou shalt not’ to an economy of exclusion and inequality. Such an economy kills. How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses two points?… Some people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed bringing about greater justice and inclusiveness in the world. This opinion, which has never been confirmed by the facts, expresses a crude and naive trust in the goodness of those wielding economic power and in the sacralized workings of the prevailing economic system. Meanwhile, the excluded are still waiting.” The reference to the stock market by the Pope reminds us of the reality that capital markets, though useful for mobilizing the needed funds to support investments in generating employment and putting up projects useful to consumers, can also intensify the focus on profit maximization if those who are investing their savings think of nothing else but maximum profit in deciding where to invest their money.

Thanks to the Corporate Governance Initiative launched by the ASEAN Capital Markets Forum and the Asian Development Bank in 2011, capitalism as practiced in the 10 members of the ASEAN Economic Community may be cured of the obsession with profit maximization that exists in some advanced and developing countries in which businesses were allowed or even encouraged to focus on profit as the only objective of business, following the advice of Milton Friedman. The Corporate Governance Initiative had the objective of “raising corporate governance standards of publicly listed companies in ASEAN countries and increase their visibility to investors.” Central to the initiative is the periodic publication of a list including the top 50 public firms based on corporate governance practices (the “Top 50 List”). The assessment of these practices is based on a scoring system called the ASEAN Corporate Governance Scorecard (ACGS). The evaluation process is not managed by regulators but rather by private organizations referred to as “domestic ranking bodies” (in the Philippine case, the Institute for Corporate Directors). In contrast with other evaluators (e.g., proxy advisors, credit rating agencies, auditors), the ACGS experts are not paid by the issuers nor by investors.

Good corporate governance is based on criteria that go much beyond the maximization of profit. The ACGS covers the five areas of the Organisation for Economic Co-operation and Development (OECD) principles of corporate governance: 1.) rights of shareholders; 2.) equitable treatment of shareholders; 3.) role of stakeholders; 4.) disclosure and transparency; and, 5.) responsibilities of the board. From the points assigned to each of these five areas, one can already deduce that the interest of the shareholders, who are the ones most concerned with maximum profitability, is actually subordinated to the other stakeholders of the corporation. Rights of shareholders and equitable treatment of shareholders are assigned only a total of 25 points. The role of stakeholders gets 10 points; disclosure and transparency (for the good of the general public) 25 points, and the highest points of 40 are assigned to the responsibilities of the board, a good number of whom do not represent the shareholders and can espouse common-good oriented causes such as humane treatment of workers, protection of the physical environment, gender equality and other societal goals. The governance assessments are based on publicly available information (i.e., disclosures published on the websites of firms, regulators and stock exchanges).

In a paper written by two professors of the IESE Business School in Barcelona, Spain, Dr. Pietro Bonetti and Dr. Gaizka Ormazabal, data from the ACGS were used to overcome the usual constraints faced by global investors for independent evaluations of firms’ governance mechanisms. The supply for such information is usually subject to two important limitations: measurement error and lack of coverage of firms in certain regions. Thanks to the ACGS initiative, they were able to acquire adequate and reliable information to probe into “The Role of Expert Assessments of Corporate Governance in Boosting International Investment.” Using a regression discontinuity design, the two authors were able to document that being included in the “Top List” attracts significant foreign investments into the Southeast Asian countries included in the ACGS. Since, as mentioned above, the criteria used by the independent evaluators in the respective countries go much beyond the maximization of profit, it can be inferred that foreign investors consider other corporate behaviors not necessarily related to profit maximization. such as the treatment of other stakeholders of a corporation, respect for the environment, the avoidance of practices that exploit labor, etc.

Their findings also indicated that because of the existence of the Top 50 List, firms exert efforts to make governance changes to be included in the list. They observed substantial increases in governance scores among the firms around the cut-off point, increases that are particularly pronounced among firms more likely to benefit from new funding (i.e., firms with higher growth opportunities and financial constraints). To the extent that it attracts foreign investments, the Top 50 List can play an important role in corporate governance reform among firms in the covered Southeast Asian countries. While there is no explicit financial reward for those included in the list, the recognition could attract foreign investors, thereby increasing their investible funds.

To be continued.

Bernardo M. Villegas has a Ph.D. in Economics from Harvard, is Professor Emeritus at the University of Asia and the Pacific, and a Visiting Professor at the IESE Business School in Barcelona, Spain. He was a member of the 1986 Constitutional Commission.

bernardo.villegas@uap.asia