Celebrity CEOs

BRIAN: If you’re just joining us, this is BackStory. And we’re talking about the history of corporations in America. We’ll conclude today’s show, fittingly enough, with a representative of the nation’s oldest corporation– Harvard University, still operating on a charter issued in the year 1650. Rakesh Khurana is the newly named Dean of Harvard College. He’s coming over from Harvard’s Business School, where his work has focused on the study of business leadership.

Before we dive in with him, a little history of that business school. It was created in 1908. It was part of a wave of new business schools at universities around the country. This, after all, was the height of the progressive era, when fields like medicine and law were being transformed from do-it-yourself, anything those kinds of jobs, to the white-collar, professional careers we know them as today.

Business management was no exception. Over the previous few decades, leadership of American corporations had come to be epitomized by the image of the robber baron, the company owner that operated with little regard for his workers, or, for that matter, society at large. It was an era of enormous monopolies, of violent labor struggles, and of corrupt politicians.

Supporters of the Populist Party had spent years arguing that big business inherently corrupted, because of its ability to corrupt politics. But Rakesh Khurana says Progressives didn’t see it as a matter of size. They believed that corporations could be reformed from within, if only they could bring in a new generation of leaders that would apply scientific and ethical thinking to the running of their companies.

RAKESH KHURANA: Progressive individuals, people like Louis Brandeis, believe that, you know, we want to throw the baby out with the bath water. If we could run these corporations, not in the interest of capital, or not in the interest of labor alone in terms of unions, and not in the interest of the government, but rather the interest of the larger society, we could benefit from the scale and the technological innovation that corporations bring.

BRIAN: How were they going to make a profit if they were doing that?

RAKESH KHURANA: Well the idea was not about maximizing profits. It was about what was described by the founder of Harvard Business School as a decent way to make a profit decently. And that it was not about maximizing profits, it was actually about maximizing the welfare and the value that a corporation brings with respect to employment, better products and services, and providing social welfare to its employees.

BRIAN: So the idea was that, with professional managers in charge, they could really turn these corporations from preying on society to actually contributing broadly to society.

RAKESH KHURANA: That’s exactly right. What that really meant was thinking about corporations not as economic entities, but as long lasting institutions. Where surviving and stability was more important than the maximization of short term profits.

BRIAN: Well what about the argument that corporations are supposed to serve shareholders.

RAKESH KHURANA: Well that’s a relatively recent argument. Kind of the earlier version was done by Milton Friedman at the University of Chicago, when he was asked what was the social responsibility of corporations. And he said– “To earn a profit.”

BRIAN: That was when? Roughly the 1960s?

RAKESH KHURANA: It was 1972-1973.

BRIAN: Huh, that late, OK.

RAKESH KHURANA: Yeah, now when that idea first came out, it was seen as really crazy. It was marginal. Because what dominated at that time was this notion of a stakeholder model. That you have to pay attention to customers, and suppliers, and the government, and follow the rules. What happened in that 1970s decline of US competitiveness is that we had a renewal of this kind of neo-laissez-faire, anything goes kind of economy.

And beginning under the Carter administration, and then accelerating pretty dramatically under the Reagan administration, was the deregulation of many industries. Everything from transportation, to finance, to telecommunications. And that deregulation brought about this idea that corporations were not institutions. They were just sort of basically economic entities. And the sole purpose of management had to be not about maximizing their stability or their survivor-ship, which was often done through diversification, but rather, then, about maximizing shareholder value.

And because ownership had been changing during this period, as a consequence of the creation of 401Ks and other forms of retirement, we began to see large institutional investors basically pushing boards of directors to fire under-performing CEOs. As well as pushing incentive systems such as stock options. So managers, now, no longer paid on the basis of salary primarily. They were largely being paid on how high they were able to get their stocks. And that really created a wholesale change.

BRIAN: So that changed the incentive structure for managers. Is that what you’re saying?

RAKESH KHURANA: It changed the incentive structure of managers. But more importantly, it also changed the mindset. Managers began to increasingly– especially CEOs and those who were compensated through these schemes– began to see themselves as hired hands of the shareholder. And we had what began then as the external CEO labor market. So, you know, somebody would be brought in to pump up stock and deliver short term profits.

And as a result of that, the belief was that these outsider CEOs were less beholden to the old way of doing things. They felt very little loyalty toward the company. They felt very little loyalty toward the culture. They felt very little loyalty toward the existing employees. And so were willing to take actions that somebody who had grown up in the organization was unwilling to take.

BRIAN: You know, I see two ways to think about corporations under-performing in terms of short term profits in the 1970s. One is that managers kind of grew soft. They went native, as we’d call it in government. They became too sympathetic to the corporation itself. They weren’t independent. But the second possibility is that they were taking money from short term profits in order to invest in longer term productivity. Productivity through spending on research and development. Productivity through training the labor force, and spending money on labor that would retain the workers allegiance– long run.

RAKESH KHURANA: I think most of the profits at that time, when they were allocated, a significant amount was allocated toward labor. And a significant amount was allocated toward things like research and development. We forget, but many of the innovations that we enjoy today came out of the long term investment and are indeed– it was not uncommon to have scientists at IBM, and General Electric, and–

BRIAN: Or Bell Telephone.

RAKESH KHURANA: Or Bell Telephone– winning Nobel prizes for the work that they did on semiconductors, in terms of work they did in material science. You know, the notion was that the large corporation was a stabilizing force. Rather than being a source of instability in society, it was a stabilizing force. And we had things like implicit contracts of relatively long term employment. You had pension plans. The corporations rather than the state would provide health care. And that really became the spine and the backbone of the postwar economy.

BRIAN: Wouldn’t a lot of your colleagues at Harvard Business School say– “Well, you know, the United States was in an exceptional position after World War II. The economies of other countries were wiped out. We could afford to be a little more generous. Many of your colleagues would call it flabby. But, there was a lot of dead wood there. That’s why America kept building cars that were too big to compete once the oil crunch hit, for instance.”

RAKESH KHURANA: Well I think that’s part of the complexity and the tension we face always, is this notion of stability and this notion of change. And how the corporation fits in that balance is really critical. This is as an insight to Joseph Schumpeter had when he talked about creative destruction. And we tend to focus a lot about the creative part, which I think is really great. We don’t talk about the destruction part.

What are the consequences when companies close down for a community? What are the consequences for the trust that people placed in a community? The tax breaks? What are the consequences of recognizing that the limited liability of a corporation is actually a transfer payment that takes liability away from an individual, and is actually a gift to companies to advance the social welfare? I’m not saying that all companies don’t advance the social welfare. But I think if you look at where we’ve been in the last 25 years, the question I would ask is– Are our workers better off? Do we have a healthier and more vibrant democracy? Do we have a healthier and more vibrant economy that is benefiting the broad base of individuals rather than a smaller group? And I think on many measures we’re not where we have the possibility and the opportunity to be.

BRIAN: Well thanks for joining us today on BackStory.

RAKESH KHURANA: I’m really, really grateful to being invited.

BRIAN: Rakesh Khurana is a professor at the Harvard Business School, and brand new Dean of Harvard College. He’s the author of Searching For A Corporate Savior: The Irrational Quest for Charismatic CEOs.