Interview with Paul Singer the Napa Institute 2020 Principled Entrepreneurship Conference

Hi, I'm Tim Busch, founder of The Napa Institute. Welcome to our virtual conference on Principled Entrepreneurship, Woke Capitalism. Today I'm going to talk to you a little bit about our winery, Trinitas Cellars. It's run by Garrett Busch, our son, in Napa Valley. Many of you who have come to our in-person conferences have enjoyed this wine. You can go in the meantime to purchase our wine on our website at trinitascellars.com. You'll note that this first wine here is Cabernet Francis. The Pope himself drinks this wine. I give it to him every year, and it's a Cabernet Franc wine. This fall, we're going to have a new one called Two Popes. It'll be made out of Red Zinfandel and Cabernet Franc. Those are the vintages that we made for Pope Benedict XVI, the Ratzinger, and the Cabernet Francis, which is Cabernet Franc. So look for that one, Two Popes. It's a great blend.

God bless all of you, and thank you for your support of The Napa Institute. I look forward to seeing all of you in person, especially next summer in July '21 at our summer conference. God bless you.

Hello, I'm Robert George. I'm a McCormick Professor of Jurisprudence and Director of the James Madison Program in American Ideals and Institutions at Princeton University. And I am delighted and honored by the invitation of my friends at The Napa Institute to conduct an interview today with my dear old friend, Paul Singer. Let me just make a very brief introductory remark before introducing Mr. Singer and beginning our conversation. The tradition of Catholic social teaching, which includes a robust teaching on what academics call political economy, began in earnest in the wake of the Industrial Revolution in the 19th century. The founding document in the tradition is often regarded as Pope Leo XIII's great encyclical, Rerum Novarum.

I say they began in earnest because Catholic thinking about matters of political economy and social life dates back, of course, much, much further. And there were significant refinements in the teaching, even as early as the 16th century, with the development of money markets, Europe especially, beginning in Southern Germany, giving place to the foundations, really, of a modern economy. And in that tradition of Catholic social teaching, although it's not remarked as much as it used to be or should be, what the Church calls socialism is outright condemned—not just Marxism, which is obviously going to be condemned by any tradition of faith for its atheism. Socialism, considered as the social ownership, the government ownership, or significant government control of the means of production.

The tradition, however, also criticized what it sometimes called capitalism or laissez-faire, the unregulated free market, and certainly rejected anything like a social Darwinist approach to economic and social matters. But it did not condemn—far from it. It affirmed private property and the market economy, giving rise to a long discussion, which continues to go on and is shaped by lots of events and will continue to develop, about the role of the business firm: what the business firm's proper stance is, how it should be operated, what its good is for the common good, for the broader society. And those discussions are important. It's important that they be carried on, not just among Catholics, but with our friends from every other tradition of faith, especially thoughtful people like my guest today—deeply informed, knowledgeable people who have important things to say.

50 years ago, Milton Friedman wrote his famous essay, "The Social Responsibility of Business to Increase Its Profits." Ever since, his thesis has come under attack. Most of those attacks have come from the political left. But occasionally, and in recent years more often, conservatives have argued that companies which focus exclusively or too narrowly on profits will overlook other important social goods—family stability and child-rearing, for example, national security, middle-class or bourgeois or Victorian virtues, social cohesion, disaster preparedness, what have you. Well, that's an important set of criticisms. It's an important conversation to have. And that's why it's so great that we have with us Paul Singer.

Paul and I go back as friends nearly 20 years. We met when Paul reached out to me because of his interest in higher education reform. I had very recently founded the James Madison Program at Princeton, and Paul learned about it and was interested in whether similar initiatives could be undertaken at other institutions, including some with which he himself had associations. And we have been friends ever since. Paul's been a generous supporter of higher education reform, my own initiatives and others. But of course, he's best known not for that, but for his pioneering work in business, especially in money management. His views on markets and the role of markets and the direction markets will be going in...

...is renowned. His newsletter is one that I always read. And when I read it, I feel I learned so much that I actually wish I had some money to invest. But I'd imagine for people who actually do have money, Paul's newsletters are real blessings. Paul is a committed conservative who cares about and philanthropically supports social cohesion, national security, disaster preparedness, and other values that are those that are sometimes invoked by critics of the Friedmanite view. There are few people who can address these questions and concerns with more rigor of thought and depth of thought than Paul. So I am so delighted, Paul, to have you here with us. And let me begin by a straightforward question.

Critics of shareholder capitalism often don't appreciate what shareholders are and what shareholders do. The shareholder seems to disappear in the analysis or got obscured behind a screen. I think the way we should start is by explaining, and I'd ask you to explain, who are the shareholders and how do they normally engage with management, with CEOs and leaders of public companies? What is the role of the shareholder?

I think it's most useful to start discussing these matters with a—and thank you, Professor George, for that kind introduction—is to start with the notion of ownership and start with the notion of a business owned by a single person, a single person gathering inputs, hiring people, producing a product or a service. The shareholder, the owner, is the person who is responsible, ultimately responsible, for the business and for the prospects of the business. And the business is designed, basically, whatever the business is, to provide for the owner and the family of the owner. And also provides employment, provides commerce within the overall economy. The owner is buying something or gathering inputs in order to provide the product or the service.

The owner is responsible. The glory of America—it's global, but I believe it's an American, not invention necessarily, but the growth of shareholder capitalism or broadly dispersed capitalism, I think is basically an American, one of those American designs that takes over the world, so to speak. And what I mean by that is, the buy-in to capitalism, the buy-in to the ability to make money and make a profit and keep property and own property is to a great extent supported by the notion that this dispersed capitalism, this dispersed ownership gives little people, medium people, big people—gives everyone or almost everyone a stake in the private ownership of property. What I mean by that is that these little pieces of the business that I described as a paradigm a moment ago enable individuals either directly or as part of

the ownership of a piece of a pension plan or a savings plan enables those people to feel a part of capitalism, a part of the ownership of the means of production. And that buy-in is an important part of what justifies, in the mass mind, justifies some people having more than others, some people creating something and keeping it, the notion of private property. I believe in the dispersion of power, not the concentration of power. So the answer to Professor George's question is the shareholders are the owners of the business. They are the dispersed end owners of little pieces. They are the same thing as the owner of the drugstore—my father was a retail pharmacist—or the pizza place, or any one of a number of different kinds of businesses organized in a lot of different ways.

It's worth going into corporate governance for a moment to answer the second part of Professor George's question: how do shareholders engage? The paradigm for public capitalism as practiced in the United States and now in many countries around the world with various levels of reliability, rule of law, supportive culture—the paradigm is the shareholders, the owners, elect a board of directors. The board of directors hires management. The board of directors is responsible to the shareholders to carry out a corporate strategy, hire and fire management, set and reset the strategy. Among the problems with public capitalism today and for quite a period of time is that that paradigm has gotten somewhat twisted over a long period of time.

Twisted in a number of harmful ways. Everyone can observe that it doesn't actually appear as if boards of directors are responsible or act as if they're responsible to shareholders. Shareholder engagement is discouraged. It's minimized. There's an annual meeting. The annual meeting is not a full discussion of strategy. It's something that the corporate management and the directors try to rush through as quickly as possible. And in fact, an entire ecosystem of support has grown up over a long period of time—support for management's devising ways to beat back shareholder engagement. Now, among the problems with beating back shareholder engagement is that the investing landscape in general has evolved away from management responsibility, board of directors responsibility to the shareholders.

What are some of the ways that it has done that? Index investing, which was a clever idea that you could save costs and achieve the same or higher return because of the lower friction costs by just buying an index or some derivative on a stock market, usually stock market index, not bond market, but it's both. And over a period of a few decades, index investing, so-called passive investing, has actually come to grow so much that it now exceeds active investing. Passive index investing now exceeds in amount under management active investing. What that means is when you are invested in an index, you are not looking at the performance of a particular company. You're looking at the index and the performance of the index.

The index could have dozens or, in the case of the Standard & Poor's major index, 500 stocks. So you are not engaged. You are not attending meetings. You are not doing the work. You don't have employees or colleagues poring over the public financial and other documents. And so the majority of investors in stocks today, institutional investors, are not looking at the companies and are not engaged by the very nature of their business. They have outperformed for two reasons. One is the lower friction cost of not paying high or regular money management fees. And the second reason is, when there's a flow of money out of a strategy and the flow into a different strategy, the large amounts of money representing those flows cause the flowee strategy to outperform the other.

It's also the case that the proportion of equities owned by individual investors has declined, and the proportion of equities owned by institutional investors has increased over the decades. And what I'm talking about is endowments like Princeton University, pension plans, hospitals, museums, think tanks, foundations. And so the direct individual ownership of stocks—and let me add sovereign wealth funds to the list of institutional investors—individual investors has diminished as a proportion of overall ownership. And so what this means is that shareholder engagement has basically devolved to two forms of shareholder engagement. One form, sort of the pesky shareholders, people who show up at meetings of shareholders and have particular agendas.

They don't like the compensation of the management. They have quirky agendas. They may have social justice agendas. And they're not really directly—these agendas don't, in many cases, not all cases of course, don't directly impact on the strategy of the corporations. Then you have activist investors. And activist investors—the fund that I've run for 43 and a half years, Elliott Management, which is now around $41 billion of capital under management, one of our businesses is active, activist investing, which means we actually evaluate particular companies. Some companies we feel are possibly underperforming or undermanaged. We approach companies and we have dialogues with companies. Every once in a while, the dialogues turn rancorous, but most of the time, the overwhelming bulk of the time, the dialogue consists of us having done the work,

advancing a thesis, discussing it with management, comparing it with their thesis, and usually coming to some kind of an accommodation. So the notion of shareholder engagement, which has been, not dissipated, but reduced by these institutional and market forces, still exists, but it's under pressure. It's an important part of the equation because earning a rate of return for the owners—if you go back to the first thing that I said—it's not the sole purpose of the corporation. Every corporation needs to be a good citizen, needs to be a good employer, needs to have relationships with suppliers that it's not predatory—that's a give-and-take. But let's not forget, when discussing stakeholder supremacy, when discussing common good capitalism, let's not forget that there are tens of thousands of pages of law, rules, regulations,

frameworks for regulation that regulators take creative flight in making up or enforcing or imagining, already operative and impactful on the corporate world, on all of the other aspects of stakeholder supremacy—the corporation's relationship with employers, sorry, employees, suppliers, customers, the environment, the community, and all of the other constituencies that this stakeholder supremacy wants to elevate as equal obligations of corporations. See, when we look at stakeholder supremacy as an alternative to shareholder supremacy, what we see is that stakeholder supremacy basically devolves unaccountability to corporate boards and managements. If you have equal duties to the constituencies that I just named, who does the board of directors actually report to?

And what is the actual goal? Every investor, whether a very tiny investor in a pool as the owner or the beneficiary of a pension fund, or a large individual investor, or a hedge fund, or a large institutional investor—every single investor, including Princeton University, of course, and its peers, needs to make a rate of return, a rate of return on invested capital. If you say that your duty to shareholders is matched in some fashion—today not the rule of law, but we can already see stakeholder supremacy entering into the rule of law category with a variety of new laws and rules which are starting to be passed, including one seminal law that was just put into effect in California—but when these duties are all equal, if the duty to suppliers and creditors is equal to the duty to shareholders, what does that actually mean?

It could only differ from the current situation where the shareholders are the owners of a business and are attempting to make a rate of return, a profit. It could only differ if you pay more to the suppliers and pay more to the creditors, and then you are paying them under an arm's length—'Okay, I need such and such, here's what I will pay. Oh, you don't want to supply me that thing at that price? Okay, I'll pay another price or I'll go somewhere else.' When it's not the management's responsibility, morally or legally, to get its supplies and work on an arm's length basis as an owner obtaining an input, I think the diminution or the impact on rate of return is not something that's going to cause a greater common good or a greater...

good for either shareholders or any of the constituencies. Businesses need to remain competitive. They need to survive. You cannot survive if you're paying your employees the wrong price. You also cannot survive and compete against global companies who are engaged in the same activity and trying to, trying to either compete with you or put you out of business if you mistreat people. And so this current struggle, ideological struggle, between adding to that tens of thousands of pages of regulations already on every one of those topics a vague, impossible-to-parse-and-understand set of additional obligations that are not part of the rules and regulations that are written down and that you can interpret—

You can look at them and say, 'Oh, here's what my duty is. It's not to discriminate. It's not to defraud my suppliers and creditors.' But to add, as an equal somehow obligation, to the obligation to shareholders is and will be, to the extent that it gathers force, dysfunctional. So I apologize for a not-concise answer to a concise question, Professor.

Well, it was hardly a concise question, but I'm grateful for the answer, Paul. There are a number of things there that I think we ought to talk about. We're going to have to limit the number of them, of course, just because of the amount of time that we have available to us. But I think your Catholic friends at The Napa Institute would immediately have picked up on a couple of the important things you mentioned. First, near the beginning of your answer there, you talked about the importance of private ownership, of private property. And as I said in my own opening remark, one of the things that has been central to the church's witness when it comes to its social teaching is the importance of private property.

Private property, far from being a bad thing, is a good thing. In fact, it's such a good thing that the Church teaches that we should arrange our economic rules and practices to maximize the opportunities for people, including ordinary people, to own property, have a stake in the productive economy, which of course strengthens everyone's stake, all the way down the line, even people of modest means, maximizes their stake in the success of the overall social enterprise. Again, the problem with socialism is that it takes away the concept of private property. That obviously damages the goal of having as many people benefiting directly from the productive economy as owners as possible. A second point that I think would immediately have come to mind, Paul, when you mentioned

the importance to you of trying to disperse power is the doctrine of what's called subsidiarity in this tradition of Catholic social teaching. This is the idea that problems should be solved by people themselves when possible, but as near to the people whose problems are being solved as possible when they can't be solved by the people themselves. So if an individual can do something, let the individual do it and accomplish it. If an individual can't, but we can do it as families, let's do it as families. If we can't do it as families, we can do it as small communities, do it as small communities. Don't bring the government in or larger units of society in to manage people's affairs when people can do as well or better for themselves.

Another way of saying that is that power over people should be exercised as close to the people as possible. So there's as much accountability as possible and people get the benefit of doing for themselves. When we do that, power will be dispersed. It won't be all centralized. It won't be right there at the top and then just bearing down on people. So those are certainly some resonances, Paul, between what you say and the tradition of a lot of your Napa Valley, Napa Institute friends. At the same time, of course, the Church has always taught, and Catholics firmly believe, in the importance of avoiding the kinds of practices that do undermine justice and the common good, that can be engaged in in ways that are damaging to human beings and their rights.

So exploitation, abuse, manipulation, monopolization—these things, the Church has always taught, this great tradition of social teaching has always taught, can properly be opposed by government, including by regulatory policies, which is why the tradition has always rejected the idea of the pure laissez-faire model of capitalism, even while affirming private property in the market. There are obviously legitimate regulations, necessary regulations, in order to avoid evils that can be done in the name of the market or by the functioning of the market where the market is simply unregulated. It's also noted in the tradition that the market can undermine itself when power is used in the market to skew the market, to undermine the functioning of the market itself.

And we see a lot of that, I think, today. And I think it's one of the things that's driving some of the concerns of those promoting stakeholder capitalism—whether they're right to propose it, that's obviously a debatable proposition. But I think some of their concerns, Paul, are things like crony capitalism, rent-seeking, the use of big government to, and especially of regulatory power to, squeeze out small startup operations that challenge big companies but can't bear the regulatory burden that the big companies can absorb. And of course, the problem of plutocracy. But I gather from what you're saying that you are not rejecting the idea that there are legitimate regulations that government puts on a business, but that it's important that government not undermine the fundamental idea that the firm is owned by the shareholders and it's the shareholders' interests that need to be primary in the business and with the directors.

...of the business, that the directors are accountable fundamentally to the shareholders. They should, of course, conform with all the just laws that prevent things like exploitation, abuse, fraud. They should avoid the rent-seeking and the crony capitalism and so forth, but not throw the baby out with the bathwater by undermining the very principle of shareholder—the primary duty of the shareholders and shareholders' accountability, which was another issue I think that you were raising, Paul—shareholders' accountability to be active participants in the management of firms. Am I reading you correctly?

Yes, and you've expressed very well the connection between the, the moral aspects of the relationship between, quote, 'owners' and workers and other constituents in society, and the legal framework around the difference between laissez-faire capitalism and rules and laws concerning crony capitalism, manipulation, exploitation, antitrust. The problem with—among the problems with—stakeholder supremacy is the mushing of those valid concerns of a properly regulated, properly controlled set of markets. There are no free markets. There is no laissez-faire. There's nobody really in favor of laissez-faire. The people that you might think should be or might be in favor of laissez-faire are actually people who seek protection or seek stability.

The problem, though, is that stakeholder supremacy makes boards of directors and managements actually accountable to nobody. They are, of course, accountable to the rules and regulations that represent the rule of law, although parenthetically, as the regulatory state, the administrative state has grown up, there's more and more of that rule of law or regulation that is—that are just frameworks for regulators to imagine and to take charge of more and more aspects of life. But when I say unaccountable in relation to stakeholder supremacy, it puts boards of directors able to take any demand by the owners, the shareholders, and say, 'But what about—what about this constituency? What about that?' and actually respond and be governed by the most powerful or persuasive pressure groups with their own agendas.

These tens of thousands of pages actually exist and they actually govern all of the depredations, Professor George, that you just mentioned. There's—every one of the elements of the tenets of stakeholder supremacy are already being voluminously addressed by rule of law. And so I believe that the system of ownership of private property should evolve. And I'm not for tossing those tens of thousands of pages into the garbage can, but I'm a 'mend it, don't end it' person with that mentality. And I believe that if the responsibility of hired management, hired board of directors, is to carry out in a legal fashion, of course, the direction and the strategy approved by the shareholders, I think that's the best way to generate prosperity—this feeling of shared ownership that both you and I have just expressed as a social good, as an important part of the

...the feeling of community and the sense of community and social cohesion, and that transforming that to something where all of the rules and regulations governing all of those relationships change to this vague and power-concentrating mode is not going to be—it's not going to make the people happier. It's certainly not going to make the holders of capital—of whom universities and foundations are very, very large parts of—it's not going to enable them to meet their goals. Princeton University and other institutions need and are budgeting for a rate of return.

You talk about the growth, and it's been extraordinary, of course, in the 20th and now in the 21st century of the administrative state—the growth of the size and scope of government, the intrusiveness of government, the power of government, its control. And far from making itself the enemy of big business, it seems to me big business has very comfortably accommodated itself and found ways to use to its advantage the reality of big government. So getting the administrative state under control, decentralizing power, I think would benefit us in part by forcing big business to be more competitive, by impeding the ability of big business to use regulatory authority of government and its own ability to absorb regulatory costs to make it impossible for competitors to compete, especially new startup competitors to compete.

So anyway, Paul, just to get back to making clear to everyone what you're saying and what you're not saying, can I return to this? You're not saying profits justify anything and corporations should be concerned with and only with the pursuit of profits. There's nothing they shouldn't be prepared to do if it will increase profits. There are no rules or moral regulations. It's not that question. Am I right? Correct. So it's about what we can do to make sure that we've got a truly competitive market where people can compete in ways that work the magic we would like markets to work—drive quality up, drive costs down, make participation in the economy as owners available to more and more and more people.

Have I got that right?

Yes. The design of the system that you described is—it's not clear to me that the system is designed to provide those benefits. I believe that freedom and the dispersion of power and rule of law that is understandable, as clear as it can be—tamed power, power that is able to be discerned—is the path towards creating a sustainable, broadly profitable system that works for most people. There's no perfection, and no system of economic organization can work for everyone. But at the beginning of this conversation, we talked about buy-in. And buy-in is essential. The absence of buy-in is revolution. There are, as you know, revolutionary impulses out there nowadays. What buy-in requires is a sense of fairness, a sense of ability to have individual and collective opportunity.

And as much as possible of the regulation and evolving rule of law and law with circumstances, whether it's the internet or international relationships or the rise of China or any one of a number of factors, it's very important that it be thoughtful, that it be understandable, and to the extent possible, not exist just to shift power relationships. When the opponents of freedom talk about the sole goal of capitalism to make a profit, what that ignores is what's in front of every business person's consciousness, which is, of course, we can't avoid and not take into account and not have good relationships with and treat well these various other constituencies. And of course, there are rules governing our behavior as managers, as capitalists.

But to—I think the debate now is kind of, okay, here are the rules and laws. In what way do you want to change them? In what way do they actually conform with our institutional framework, the Constitution, other laws that are developed under our constitutional and federal framework? And what else should we be doing? But this vague elevation of equal corporate obligations to these other constituencies is just an invitation to managements and boards of directors to stiff-arm the owners. And if we all work, or many of us work, in organizations, and if there's no ultimate responsibility, then it's the people who just can grab power or just ignore others that want a seat at the table that have...

that have the power. And that's the problem with stakeholder supremacy. It's like an organization that's run metaphorically like a town hall. It's not the way to run an organization, but just, well, everybody has equal power. That's not the way things actually can work. And the sad thing to me about all of this, stakeholder supremacy is illogical. The virtuous 181 are getting slapped back metaphorically somewhat. But one of the things I'm worried about is that this push evolves into a kind of mush, that this way, this virtue signaling finds its way into law and people's actual behavior won't be able to be discerned. Actual mandated behavior won't be actually able to be discerned.

If I could interrupt right on that point, and I apologize for it, but I have a question. Do you think the net result of that is actually to increase the power of management at the expense of the power of the shareholders? Because if management is responsible and accountable not only to shareholders, but to a larger and vaguer constituency or set of constituencies, it sounds to me like the net beneficiary of that, just in terms of power, will be management itself. It will mean management is less accountable to anybody.

Yes. Yes. But also who will suffer is the common good. Prosperity will suffer if managements have this extra layer, and it's a thick layer, it's a powerful layer of unaccountability and power.

Yeah, yeah. Well, Paul, thank you so much for sharing your insights, you know, based on much deep thought, as I know, and on many, many years being a leader in investment management and a keen observer of American and international business. Thank you, too, to The Napa Institute for giving me the opportunity to interview Paul and to get together with my dear old friend. I'm going to now turn it back over to the folks at The Napa Institute, but with my thanks to everybody. Thank you for inviting me, Professor George. Thank you, Paul.