Citigroup Inc., American International Group, Inc., and Merrill Lynch and Co., Inc., were just some of the icons that were down on their knees in 2008. Come to think of it, they were the largest bank, the largest insurer, the largest investment bank. Add to that the US auto industry. The lifespan of a company at the top is shrinking.
The average length of stay for a company in the Fortune 500 list is down to just a decade now from the multiple decades it used to be. Size clearly does not guarantee success or survival. So clearly, it was not enough to be the biggest, and even getting better, to stay alive. However, while the slow decline of large companies is required in a competitive marketplace, big crashes cause tremendous volatility and systemic tremors.
The market is supposed to sort this kind of thing out. But the real world is turning out to be a bit more complicated. Important intellectual questions are arising that need answers. When do the economies of scale clash with the economies of scope? At what size do traditional organization structures start to creak? When does business complexity get too large to cope with? What is the extent of product complexity, geographic spread and employee workforce that is manageable? And most importantly, who bears the cost of failure?
It was always known that the market did not deal well with natural monopolies (where scale keeps mounting—such as telecom and power) and needed regulation to ensure that pricing power was not misused. But in other sectors, the market was supposed to work if government could help address market failures and provide public goods (street lighting being the most cited example).
In these other sectors, competition commissions were set up to ensure that monopolistic power did not build up, and to ensure free competition. It was believed that the harsh reality of the market economy would keep all companies on their toes and punish by destruction those that got complacent. Size was not a good enough defence for survival and the loss of shareholder capital was supposed to keep everyone honest.
Illustration: Jayachandran / Mint
My argument today is to explore whether size creates a certain moral hazard, outside the already maligned financial services where regulators have always been supposed to prevent this, in the real economy—read US auto. The nature of political democracy (in countries that have it) is such that the ruthless efficiency of the market is not allowed to take its course. I imagine the kind of choices and voice the Myanmarese or Zimbabweans have is different from those available to Americans. In a democracy, therefore, can smart people play the system so that they enjoy the benefits of risk but not its costs? The costs are passed on to the taxpayer by a leadership that cannot afford to allow the resultant wreckage and its costs to seep through to the overall populace.
So how does the world mitigate systemic risk in political democracies? While companies imploding and being taken over or allowed to die is inbuilt in capitalism, stakeholder risks are now in focus. Shareholder risks, when transferred to employees and other stakeholders, violate a basic sense of fair play and justice.
How, therefore, do we deal with this fairly important conundrum? I don’t believe I have a ready answer, but I would like to stimulate the debate on how political democracies deal with large corporate size. At what point is a company too big—should this be as a percentage of the global market, the country’s gross domestic product, or GDP, or the number of people employed?
While the authorities will debate the limits of concentration within an industry, what will be done with conglomerates? How should conglomerates be governed? What structures are necessitated to ensure that individual entities from within a conglomerate do not lead to the destruction of another listed part of the conglomerate? Do we force conglomerates into a holding company structure without leverage? I don’t know, but as Einstein said, “A mind once stretched by new thoughts can never regain its original shape”—and the fact is that modern economics will now need to be understood within the context of a political democracy.
In the future, wise economists will do well to marry their equations and cost curves to incorporate popular opinion and political compulsions.
Janmejaya Sinha is managing director with the Boston Consulting Group India) Pvt. Ltd. The views expressed here are personal.