Business education and saving capitalism, parts I and II

Business education and saving capitalism (February 3, 2009)

Managing For Society column, The Manila Times

A recent piece of Amando Doronilla in the Philippine Daily Inquirer caught my attention. He reported that over the weekend, Australian Prime Minister Kevin Rudd called on governments to use state power to “save capitalism from itself”. Rudd made the challenge in light of what many see as the most significant failure in government regulation in memory as the collapse of major US financial institutions cause a tsunami-like wave of economic damage around the inter-connected world. Rudd traced the failure of governments to safeguard against the excesses of financial companies to “neoliberalism and the free-market fundamentalism it has produced [which is] little more than personal greed dressed up as an economic philosophy”.

Rudd is correct in highlighting the important link between government policy and economic philosophy because government leaders are strongly influenced by key advisers who support one economic ideology or another. And the ideology of the unrestrained market dominated policy thinking in many countries for the past decades. As a result, it has also dominated strategic thinking within many business organizations themselves.

The challenge of reforming capitalism shouldn’t be thrown only at governments. It should also be thrown at business scholars and educators who, after all, have been the main transmitters of conceptual frameworks used in justifying market-based policy. We must critically scrutinize models which are being taught by business educators and the implications of these for how business is conducted under the watchful or sometimes negligent supervision of government.

On the top of my list for critical review are the utility maximizing model of man, the profit-maximizing model of the firm, and agency theory -- all of which are taught as fundamental frameworks in courses in economics, finance and management. Together, these frameworks give the academic justification for neoliberalism and are at the heart of what ails the current version of capitalism espoused to business students.

The basic proposition of the utility maximizing model of man is straightforward – individuals are motivated by self-interest and will act to maximize this in a way that meets personal preferences and minimizes personal cost. The picture drawn of man is that of a goal-oriented, pleasure-seeking, and calculating being.

Having studied the behavioral sciences for more than 30 years, I am constantly amazed at how durable and commonly accepted the above model of man has become. In fact, many academics refer to this model as “rational man”, i.e., humans who behave otherwise are “irrational”. On the contrary, many social scientists have discovered that human action is much more complex than this. Humans will often do things out of, yes, self-interest but also out of habit, emotion, coercion, altruism and moral obligation.

Some economists have argued that while the rational model of man may be limited since it is a special case, it is good enough in most cases because it explains a lot of what man does. Therefore, it makes sense to teach this as the main model. I have two objections to this. While a model can be simplified to achieve easier explanations of something, it must do so in a way that captures the important essence of the thing being modeled. Is self-interest the essence of man? Has human progress been achieved because of man’s ability to calculate benefits for himself? Or has man achieved greater heights also because of his ability to relate with others and to think beyond himself?

Part II (February 10, 2009)

In last week’s first part of this column, I argued that in order for business educators to help save capitalism from itself, the basic models taught to students and eventually used for corporate strategy and public policy must capture the important features of the things being modeled. I concluded that the utility-maximizing model of man is too limited to represent human motivation very well because it doesn’t reflect man’s ability to do things which are not self-serving at all, such as out of altruism or moral obligation.

My second objection to the utility maximizing model is that when taught often enough to people, it may become self-fulfilling – people may become more selfish. Experimental studies by sociologists Marwell and Ames showed that when students from various fields were given a chance to make private contributions to a common project, the graduate economics students contributed less than half, on the average, than the contributions of students from other fields. Is it possible that constant exposure to self-interest models breed self-interest?

The profit-maximizing model of the firm is the second in need of serious revision. It claims that firms act to maximize the profit to its owners and this is, once again, the rational thing for firms to do. In recent decades, the model has been refined to say that a firm should maximize its long-term value to its stockholders. Since this version links stock price to the cash flows a company generates, it is consistent with the earlier profit-maximizing version. The problem with this model is that it defines the good of the company mainly around the interest of one group – the stockholders.

Many of the business scandals we have seen recently and in the past have involved managers manipulating stock price to enrich themselves at the expense of other stakeholders. The fact that these incidents were considered scandalous should make it clear that maximizing profit or even long-term stock price for stockholders cannot be the legitimate goal of business. In fact, research by Collins and Porras on some of the most durable and best performing US companies has shown that they did not make decisions to maximize stock price but rather to achieve the mission of the company in whichever industry they happened to be in. The profits and stock price they earned in the process were by-products of doing what they did excellently.

Agency theory is a theoretical framework in financial economics which has been used to justify the use of stock options to get corporate managers to support the maximization of stock price. Consistent with the utility maximizing model of man and the value maximization model of the firm, the model posits that managers are mainly self-interested and will work best for the stockholders’ benefit if they are given plenty of stocks themselves. The model compounds the limitations of the earlier models and caricatures the complexities of corporate management into a simple self-serving deal between stockholders and managers. Corporate governance is, of course, much more than this, with human rights, the law, community decency, the public interest, and even spiritual considerations playing a role.

I understand that these models are simplifications of reality meant to be merely guides (there are more realistic but more complex ones available), in much the same way that a road map is a simplification of actual roads meant to guide drivers. But if a road map doesn’t show “One Way” signs and large excavations, a driver must use the map with extreme caution lest he get a driving ticket or bust a tire driving near an excavation. Fortunately, a driver would use his eyes and common sense to look out the window and see the real situation on the road. Unfortunately, many who use simplistic business models do not bother to check them against reality, even when the models are already leading businesses and communities to ruin.

Better models of business must be taught and used for business strategy and public policy if capitalism is to be saved from itself.

Dr. Benito Teehankee is the Director of the Center for Social Responsibility for Human Development at the RVR Graduate School of Business of De La Salle University. He may be emailed at teehankeeb@dlsu.edu.ph.