University of Pennsylvania University of Pennsylvania

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Honors Theses (PPE) Philosophy, Politics and Economics

4-23-2013

The Goals of Finance and their Instrumentality in Democratizing The Goals of Finance and their Instrumentality in Democratizing

Wealth Wealth

Anna M. Whiteman

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Whiteman, Anna M., "The Goals of Finance and their Instrumentality in Democratizing Wealth" (2013). Honors Theses (PPE). Paper 14.

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The Goals of Finance and their Instrumentality in Democratizing Wealth The Goals of Finance and their Instrumentality in Democratizing Wealth

Abstract Abstract Over time, individuals have used tools of finance to increase their own personal and familial holdings, to seek education, and to begin gaining equity stakes in their own homes, among other pursuits. Corporations have used finance to capitalize new business ventures, to provide funds for investment in research and development, and to expand into new markets. Finance, through its various instruments and practices, has thus enabled people to make manifest their ambitions and has allowed creative ideas to flourish in competitive markets. Finance, in essence, serves as the organizing principle that provides for vigorous economic activity and wealth generation in societies where it functions properly and, as such, “it can be used to help broaden prosperity across an increasingly wide range of social classes.” Given this capacity to broaden prosperity for all, finance should be used as a tool of wealth democratization if it is to stay true to its terms of original instantiation.

Keywords Keywords Finance, Democratization, Wealth, Income, Equality, Equity, Society

Disciplines Disciplines Business Law, Public Responsibility, and Ethics | Economic Theory | Finance | Finance and Financial Management | Income Distribution | Organizational Behavior and Theory

This article is available at ScholarlyCommons: https://repository.upenn.edu/ppe_honors/14

TheGoalsofFinanceandtheirInstrumentalityinDemocratizingWealth

SeniorHonorsThesisPhilosophy,Politics,andEconomicsDepartment

AnnaMcGinleyWhiteman

AdvisedbyProfessorWaheedHussainApril23,2013

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I.Introduction

Theinstitutionoffinanceexistsinprincipletofacilitateaccesstocapitalsuch

thatpeopleorfirmsmayultimatelyrealizetheirindividualambitions,andsociety,

inaggregate,canbenefitfromtherealizationoftheseambitions.Moreprecisely,as

JohnBoatrightilluminatesinhisbookFinanceEthics:

“financemaybedefinedbroadlyasthegeneration,allocation,exchangeandmanagementofmonetaryresources…[Theactivitiesoffinance]arefacilitatedormediatedbyavarietyoffinancialmarketsandfinancialinstitutions,suchassecuritiesandcommoditiesexchanges,commercialandinvestmentbanks,insurancecompanies,mutualandpensionfunds,andthelike.Inaddition,financeincludestheacademicsubjectcalledfinancethatisstudiedinbusinessschoolsandconstitutesthetrainingthatpeopleinfinance–bothscholarsandpractitioners–receive.”1

Overtime,individualshaveusedtoolsoffinancetoincreasetheirownpersonaland

familialholdings,toseekeducation,andtobegingainingequitystakesintheirown

homes,amongotherpursuits.Corporationshaveusedfinancetocapitalizenew

businessventures,toprovidefundsforinvestmentinresearchanddevelopment,

andtoexpandintonewmarkets.Finance,throughitsvariousinstrumentsand

practices,hasthusenabledpeopletomakemanifesttheirambitionsandhas

allowedcreativeideastoflourishincompetitivemarkets.Finance,inessence,serves

astheorganizingprinciplethatprovidesforvigorouseconomicactivityandwealth

generationinsocietieswhereitfunctionsproperlyand,assuch,“itcanbeusedto

helpbroadenprosperityacrossanincreasinglywiderangeofsocialclasses.”2Given

thiscapacitytobroadenprosperityforall,financeshouldbeusedasatoolofwealth

democratizationifitistostaytruetoitstermsoforiginalinstantiation.

1Boatright32Shiller9

3

Fourprincipalhumanvaluesthatmotivateinstitutionalfinanceareself‐

determination,efficientallocation,fairness,andlong‐termgrowth.Self‐

determinationallowsindividualstoexploretheirpassions,developtheirtalents,

andconstructindividuallivesthattheydeemworthyofpursuit.Efficientallocation

ensuresthatscarceassetsareutilizedasresourcefullyaspossible,ultimatelyin

serviceofthegreatestnumberofpeopleataminimalcosttosociety.Fairness,a

fundamentalhumanimpulse,astranslatedthroughthemarket,conferstoeach

individualorcorporationapayoffthatsuitablycompensatesthescaleofhisorher

contribution.3Long‐termgrowthguaranteesthatinvestmentsthatwemaketoday,

whetherintheindividual,incorporations,orincapitalfunds,willhelpusflourish

sustainablyinthefuture.Finance,amanmadetooldevelopedtosatisfythesehuman

pursuits,shouldbeconsistentlyorientedtowardstheirrealization.Products,such

asinvestmentvehiclesorloanpolicies,shouldbeengineeredtogiveusersgreater

self‐determination,providedthattheseusersthemselvesabidebyproperrulesof

play.Financialmarkets,inwhichcountlessactorsconductscalabletransactions

eachandeveryday,shouldintrinsicallyseeklong‐termgrowthbydistributing

resourcescompetitivelyandfairly.Inorderformarketactorstoreapthefuture

benefitsoftoday’sfinancialtransactions,thesemarketsmustrightfullycapitalize

thoseendeavorsthatwillconstituteourtomorrow.Afinancialsetupthatprioritizes

theprinciplesofself‐determination,allocativeefficiency,fairness,andlong‐term

growthperspectivealignswithawell‐understoodconceptoffinance.Financehasa

3Boatright167

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socialresponsibilitytopursuethesehumangoalssothatitcangenerateand

distributesubstantialwealth.

Whilesocietyatlargewouldprosperfromtheproperconceptualfunctioning

offinancialmarkets,opportunitiesdoarisethatallowsmallerentities,either

individuals,corporations,orfinancialinstitutions,todeviatefromtheirsocial

responsibilitiesinpursuitofshort‐termprofit.Theseactors’deviations,

compoundedovertime,havemanagedtounderminetheinitialprinciplesofself‐

determination,efficientallocation,fairness,andlong‐termgrowththatunderlie

finance.Deviationsarisefromthefactthatfinancialinstitutionsthemselves,the

“gatekeepers”ofmonetaryresources,havebeenimproperlyconstructedwith

incentivestructurespremisedaroundshort‐termprofitgeneration.Managersof

corporationslargeandsmall,forexample,arecurrentlyevaluatedonamyopic

basis,withCEOcompensationdeterminedbyquarterlyorannualproductionfigures

ratherthanontheirabilitytocreatelong‐termvalue.Asaresult,companiesguided

bytheseimproperlyincentivizedmanagersseekdailyreturnsattheexpenseofthe

companies’futuregrowth.Inthiscontextofmisdirectedfinancialinstitutions,the

ultimategoalsoffinance,self‐determination,efficientallocation,fairness,andlong‐

termgrowth,areobfuscatedatagreatcosttosociety.

Themisdirectionofmodernfinancialstructuresandincentiveshasmanifest

socialconsequences.Self‐determinationinthiscontextfortheindividualisgranted

onlyinsofarasaninvestmentintheindividualwillgenerateimmediatekickbacks

forlendinginstitutions.Efficientallocationcannotproperlylocatethecompanies

thatwillconstituteourtomorrowbecausethesecompanies’investmentsin

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researchanddevelopmentorhumancapital,socriticalfortheirsteadygrowthina

competitiveeconomicenvironment,arenotreflectedasquarterlyreturnsona

balancesheet.Fairnessbecomesanimpossibledream,asthegatekeepersofcapital

amasswealththroughtheirpositionsofpowerandthelowerportionofthe

socioeconomicspectrumgrowsatamuchslowerpace.Thiswealthinequalitythen

onlycompoundsovertime,drawingfinancefartherandfartherawayfromits

conceptualpremise.Perhapsmostblatantlybrushedasidebythisflawed

institutionalsetupisthepursuitoflong‐termgrowth.Operatingonsuchamyopic

basis,manyfirmsandcompaniesbecomenaivelywillingtodismissthosepolicies

thathaveproventogeneratevalueoveralongertimehorizon,suchasstrong

corporatesocialresponsibilityplatforms,infavorofpracticesthatsimplyinflate

dailyshareprices.Thedeviationsofactors,corporations,andfirms,however,are

notinevitableandcanbeaddressedtoalignfinancemoreintimatelywithits

fundamentalgoals.Irresponsibilityoffinancialinstitutionscanbecorrectedfrom

withinbyrevisedincentivestructuresandalteredaccountabilitypracticeswithin

firmhierarchies.Itcanbefurtheraddressedexternallybylimitedbutdirected

politicalregulationthatpreservesthecompetitivemarketnatureofthefinancial

industrywhileimpellingeachindividualfirmtoacceptanobligatorysocial

responsibility.Suchhighlevelcorrectionscouldbegintoclarifythephilosophythat

guidesfinancialinstitutions,pointingthemtowardslong‐termvaluecreationrather

thanshort‐termrentseeking.Byaddressingthoseinstitutionalpoliciesthatcompel

financiersandfinancialinstitutionstoactinwayscountertothegoalsoffinance,we

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canthusbegintosynchronizetheconceptualidealsoffinancewithitsday‐to‐day

practice.

II.UnderstandingtheScope,Intent,andResponsibilitiesofFinance1.ConceptualFinance

Conceptually,financeconsistsoftheinstitutions,mechanisms,practices,and

individualandcollectiveactorsoperatingtoprotect,direct,andallocatesociety’s

assets.Theseinstitutionsandactorsideallywillseektochannelresourcesto

growth‐orientedprospectsor,alternatively,willallocatecapitalthatproducessome

presentbenefitforoneindividualorentitywhilegeneratingafuturereturnonthe

presentinvestmentforanotherentity.Productsandpracticesoffinance,suchasthe

homemortgageoracompany’sinitialpublicoffering,willthuscontributetothe

growthofsociety’sassetsovertime,whilechannelingmoneyandcapitalintothose

areasofdevelopmentwiththehighestexpectationoffuturesuccessandinvestment

payoff.RobertShiller,inhisbookFinanceandtheGoodSociety,explainsthatasa

prerequisitetofinancialcontracting,

“allpartiestoanagreementhavetowanttoembracethegoal,dothework,andaccepttherisks;theyalsohavetobelievethatothersinvolvedinthedealwillactuallyworkproductivelytowardthecommongoalanddoallthethingsthatthebestinformationsuggestsshouldbedone.Financeprovidestheincentivestructurenecessarytotailortheseactivitiesandsecurethesegoals.”4

Thischaracterizationoffinanceembedscriticalassumptionsaboutpartieswhoseek

toengageinfinancialcontractsinasocialcontextand,indoingso,presupposes

certainsocialbehaviorsandoutcomesthatresultfromthesuccessfulfunctioningof

financialinstitutions.Individualsinsocietycanusefinanceasanoutletofself‐4Shiller8

7

determination,providedtheyfeelreasonablyassuredthatthosefinancierswith

whomtheycontracthavetheirbestinterest,andpersonalsuccess,asamutualend

goal.Firmslookingtogrowtheirmarketsharecanusethetoolsoffinanceandthe

expertiseoffinancierstoefficientlyunderwritetheirenterprises,givingthem

expectationsofoptimizedreturnswhichtheycanthenusetofurtherinnovateina

vibranteconomy.Additionally,financecanserveasamechanismofmarketfairness.

Itcanprovidenon‐discriminatorycapitaltoindividualsandcorporationsacrossthe

socioeconomicspectrumwhilestillmaintaininganeconomicstructurepropelledby

competition.Finance,underShiller’sdefinition,isabletosynchronizethegoalsof

multiplesocialpartiesintoamutuallybeneficialagreement,producinggainsfor

bothpartiesinvolvedshouldtheyfulfillproprietarycontractualexpectationsand

obligations.Thesemutualgains,overalong‐termtimehorizon,shouldthususherin

expectationsofeconomicgrowthand,ifproperlymanaged,wealthdemocratization.

MorelatentinShiller’scharacterizationoffinanceastheeconomicbackbone

ofsocialcontractingaretheconsequencesofdeviantbehaviorbyoneorbothofthe

partiestoafinancialcontract.AsShillerpointsout,financeisaninstitution

structuredbyincentives,whichcanproduceabsolutegainsifincentivesare

balancedproperly.However,shouldeitherpartytoafinancialcontractdeviatefrom

itsobligationsinpursuitofshorttermprofit,thisincentivestructureisthrownoff

balanceattheexpenseofthefinancialarrangement’slongtermsuccess.Empirically,

thiscantranslateintothemisallocationofotherwisegrowth‐orientedcapitalinto

thehandsofalessdeservingparty,whichresultdetractsfromlong‐termeconomic

development.Thisdeviantbehavior,whichsosalientlydepictsthefaceofmodern

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finance,standsinoppositiontoaconceptualdefinitionoftheinstitutionandwillbe

exploredhereingreaterdepth.

1a.Self‐Determination

Onanindividualbasis,thetoolsoffinanceshouldallowpeopleinsocietyto

accessliquidity,managetheirpersonalandfamilialwealth,andallocatetheir

resourcestowardsthoseactionsandassetsthattheybelievewillenhancetheirown

qualityoflife.Suchtoolshistoricallyhaveincludedmortgageloans,studentloans,

trustfunds,andindividualretirementaccounts,amongothers.Thesetoolsare

ideallyintendedtogiveindividualsinsocietytheopportunitytoleadhigherquality

livespursuingactivitiesandcausesthattheybelievetobemeaningfulor

pleasurable.Ithasbecomeclearovertimethatinordertoorganizesocialbehavior

inmarketenvironments,alignindividuals’sharedpersonalandsocialgoals,and

makeresourcesconsistentlyavailablefortheindividualachievementofthesegoals,

itisnecessaryforsophisticatedfinancialinstitutionstoexist.

Financialinstitutionswereindeedborneofthenecessityofindividualsto

obtainaccesstocapitaltosatisfypersonaldesiresandambitions.Sincetheirfirst

primitivemanifestationsassmall‐scalecollateralizedlendersinancientGreeceand

Rome,financialinstitutionshavebeeninthebusinessoffacilitatinggainsfromtrade

onanindividuallevel.AsShillermakesapparentinhischapterCategorizingPeople:

FinanciersversusArtistsandOtherIdealists,financeisanecessarycomponentofany

andallsocialendeavorsinvolvingcontractingindividuals,irrespectiveofthefieldor

industrywithinwhichtheyarecontracting.Usingtheexampleof“twooftheworld’s

mosthighlyregarded–andhighlypriced–contemporaryartists,JeffKoonsand

9

DamianHirst,”Shillerexplainsthatbothartists“…arenotjustsolitaryartists;they

arebothfinancialsophisticates.Bothrunbusinesseswithnumerousemployees,and

bothareaggressivemarketersoftheirownworks.”5Inordertosuccessfullypursue

certainpassions,asShillernotes,itisnecessarytorecognizetheinstrumentalityof

financialmarketsinbringingidiosyncraticendeavorstoscale.Tofurtherthe

exampleofsuccessfulartists,whiletheartiststhemselvescontributethecentral

creativeandthoughtfuldimensionsoftheirworks,financesupplementsthe

productionprocessbylocatinginvestorsintheseworks,providingthefunding

necessarytocompletetheworks,andorganizingmarketstokeepthearttrade

functioningefficientlyandlucratively.Althoughtheseconsiderationsoftenlieinthe

background,theyarenolessimperativeforthescalabilityandsustainabilityof

worldartmarkets.Extrapolatedtoindividualsworkingindiversetradesthroughout

theworld,orpursuingarangeofdreams,fromhome‐ownershiptohigher

education,financeconsistentlyplaysaroleinbringingindividualpursuitsto

fruition.Asameanstoeachindividual’spursuitofthatwhichtheybelieve

constitutesalifeworthliving,then,financehasbothgreatpowerandgreat

responsibility.

1b.EfficientAllocation

Onabroadercorporatebasis,thetoolsoffinanceshouldbeusedtoallocate

capitalprovisionallytothosecompanieswhoseideas,businessmodels,anduseof

capitalsuggestsuccessfulfuturegrowthandproliferation.Whetherthissuccessis

measuredthroughmetricssuchasreturnoninvestment,corporatelongevityand

5Shiller136

10

sustainability,oremploymentopportunitiesthatacompanycouldpresenttoits

hostingcommunity,thosebusinessesthatreceivecapitalinjectionsshouldpossess

fundamentalandintrinsicvaluethatwillutilizegrantedcapitalmosteffectively.

Overtime,asbusinessneedsevolveanddemandschange,financialproductssuited

towardscapitalizingtheseneedsshould,inawell‐developedfinancialmarketwith

properaccountabilitystandardsinplace,beabletorespondwithaptflexibilityand

minimalrisk.Structuredproductsofvarioussorts,predominantlydebtandequity

lending,canthenallowgrowing,mature,orevenstrugglingbusinessestofinance

theirset‐up,operational,andexpansionaryneeds.Conceptually,theresultsofthese

corporatefinancingactivitiescomeintheformofincreasedemployment,enterprise

profitability,continualbusinessinnovationandhealthymarketcompetition,among

others.6

Financialinstitutionssuchasbanks,pensionfunds,privateequityshops,

assetmanagementfirms,andcommunitylenders,amongothers,eachhasan

obligationtoallocatecapitalefficientlyiftheyhopetoservetheirspecificsocial

function.Theseinstitutions,accordingtoShiller’scharacterizationoffinance,

representthe“stewards”ofsociety’sassets,helpingtomatchinvestorswith

creativeinvestmentopportunities,movinglargepoolsofcapitalintolong‐term

growthprojectsorinvestmentfunds,andprovidingthecapitalandadvisory

servicesneededtobringaspiringbusinessventurestoscale.Theprofitsthatthese

institutionsgeneratefromtheirbusinessactivities,ideally,willrepresentafraction

ofthegrowththattheyhelptocreateinthebroadereconomyasaresultoftheir

6RajanandZingales108

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operations.7Providedtheseinstitutionsfollowpropercorporategovernance

procedures,financialinstitutions’profitsshouldbecontingentonbroadersocial

prosperity,ridingthesamewavesofeconomicgrowthandstagnancyastherestof

societydoes(althoughthecorrespondenceofthesetwooutcomeswasmost

recentlycalledintoquestiongduringthe2007crisisinwhichglobaleconomic

marketsviolentlycontractedwhilefinancialinstitutions’profitsremainedsteadily

ontherise).Eventhosewhosubscribetotheprofit‐drivenshareholdertheoryofthe

firmadmitthatthereissocialwealthtobegeneratedthroughthisformof

cooperativecapitalallocation.AsBoatrightreiteratesinhischapterEthical

ImplicationsofFinance,“thegoalofcapitalbudgetingistofindandinvestinprojects

thatincreasethevalueofthefirmingeneraland,morespecifically,increase

shareholderwealth,orequivalently,thepriceofthefirm’sshares…However,it

shouldbeemphasizedthatfirmsthatundertakeprofitableinvestmentprojects

contributetothewealthofsocietyandthisisamajorcontributionofbusinessto

societalwell‐being.”8Eveninthecompetitivecontextofshareholdertheory,finance

isexpectedtoraisetheoveralllevelofsocialwealthwhileefficientlyallocating

capitalaccordingtomarketdemand.Inmovingcapitalwhereitcanbemost

7RajanandZingaleshelptoestablishthisfundamentalrelationshipbetweendevelopedfinancialmarketsandeconomicgrowth,concludingfrommultiplestudiesthat“…fewwouldnowdoubtthatthereexistsacausallinkbetweenthedevelopmentofthefinancialsectorandthegrowthoftheeconomy…Financecannotcreateopportunities,butitmakesiteasiertoexploitthem:whatitcandoisidentifytheareasofopportunityanddecline,andachieveabettermatchbygivingtosectorswithafuturewhiletakingawayfromthosewithonlyapast.”(RajanandZingales113)8Boatright32

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productive,financeproperlyguidedcanhelptofosterinnovationinbusiness,create

jobs,andraisethesocioeconomicbottomline.

1c.Fairness

Inadditiontobeingvehiclesofself‐determinationandefficientallocation,

financialmarketsalsohavearesponsibilitytobefairdistributorsofcapitalover

time.Inordertobefair,marketsshouldbeopenandequallyaccessibletoeach

memberofsocietysothatanyindividualorcorporation,regardlessofinitial

positionorcontextoforigin,hasequalopportunitytotakeadvantageofthebenefits

offinancialmarkets.Asfinancialmarketsdevelopovertime,theyhaveatendencyto

perpetuallyallowwealthtoaccruetoaclassofelitecitizens,aconsequencesthat

hastheeffectofunfairlyrestrictingawideswathofsocietyfromaccessingfinance’s

intrinsicbenefits.AsRajanandZingalesrecognizeintheirbookSavingCapitalism

fromtheCapitalists,theeconomicallypowerfulindevelopedfinancialmarketshave

incentive,andthenecessarypower,tokeepmarketsworkingintheirfavorsothat

theymayreapdisproportionateeconomicandfinancialbenefitsattheexpenseof

othersinsociety.Indirectconflictwiththispatternofaccruedadvantages,the

principleoffairnessinthecontextoffinancialmarketsrequiresthat“weshould

honorclaimsinproportiontotheirstrength…wecanassertthatfairnessatbotha

substantiveandprocedurallevelinvolves…theproportionalsatisfactionofclaims

existingpriortothemakingofrules,agreements,orexpectations.”9Thisdefinition

makesclearthatpre‐existingadvantages,whichcancomeintheformofinherited

assets,greateraccesstoeducationalopportunities,orevenbroaderexposureto

9Boatright167

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potentiallylucrativecareerpaths,shouldhavenobearingontheprobabilitythatan

individualorafirmcanachievepersonalorcorporate“success”insociety.10While

thisdefinitiondoesnotimplythatincomeinequalityperseisharmful,itdoesimply

thateconomicinequalitiesshouldbeconsistentlycheckedsoastonotcreatea

generationallegacyofincreasingsocialstratification.Tothisend,financialmarkets

canregulatethemselvestosatisfythecriterionoffairness.RajanandZingalesagree

that,“giventherightinfrastructure…financierscanovercomethetyrannyof

collateralandconnectionsandmakecreditavailableeventothepoor.Theybecome

apowerforthegoodratherthantheguardiansofthestatusquo.”11Such

parametersoffairness,whereinindividualsareencouragedtopursuetheircreative

ambitionsandcanhopetoberewarded(orpunished)adequately,willultimately

contributetoavibranteconomicandsocialstructureundergirdedbysustainable

financialfoundations.

Fairnessasadistributiveprincipleisoftendepictedasmutuallyexclusive

withtheconceptsofefficiencyandprofitmaximizationandthuscanobscurethe

theoreticalaimsoffinancialinstitutions.AsEugeneHeathdescribes,however,inhis

chapterFairnessinFinancialMarketsregardingtheresponsibilityoffinancial

institutionswithrespecttofairness:

“anappealtoefficiencyprovidesavaluablereminderthatthelegalandregulatoryframeworkofbanklendingshouldprovidetheconditionsforproductivity.However,thevalueofthissortofanalysisdoesnotvitiatetheimportanceofmoralconsiderationssuchasthoseoffairness.Anormativeormoralevaluationofbusinessesandmarketsexaminescommercialpracticesintermsoftheirfoundationalprinciplesorintermsoftheoperationsandinteractionsthatariseoncetheseprinciplesaresetinplace.Theconceptof

10Boatright16711RajanandZingales43

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fairness,forexample,maybeinvokedtoconsiderthefoundationalframeworkofmarketsaswellastherulesandregulationsofongoingexchanges…”12

AccordingtoHeath,althoughfairnessisnotanecessarycomponentofproperly

structuredfinancialmarket,itmaybeusedasanimportantcriterionagainstwhich

tojudgethemoralityofmarkets.Insofarasweshouldstriveformarketstoespouse

aprincipleofmorality,theyshouldthusbecontinuallyjudgedbyastrictstandardof

fairness.Iffinancialmarketsaredisproportionatelyconferringprofitstothe

wealthy,throughexecutivecompensationschemesordiscriminatorycredit

extensionsasaresultofpreconceivedexpectations,thenbroadeningsocial

stratificationwillconsistentlyresultasabyproductofthesemarkets.Wealth

inequalitieswillcompoundandexacerbatetothepointofmarketcollapse.Should

fairnessbecomeapriorityoffinancialmarketactorsandinstitutions,wealthcould

becreatedonabroaderscale,conferringthebenefitsoffinancialinstitutionstothe

manyratherthantoaselectfew.

1d.Long‐Termism

Perhapsthemostfundamentalnormativeprincipleunderlyingpersonal,

corporate,andpublicfinanceisthepursuitoflong‐termgrowth.Individualslooking

toaccumulateresourcestopassonthroughtheirfamilies,corporationsseeking

sustainability,andgovernmentslookingtomitigatefutureresourceriskallcanrely

ontoolsoffinancetoenhancetheirlong‐termprospectsforsuccess.Unfortunately,

short‐termprofitmaximizationgenerallyprecludeslong‐termvaluecreation,

thoughshort‐termismhasseeminglybecomethestatusquoforrationalactivityin

12Boatright163

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financialmarkets.AsMichaelJensenoftheHarvardBusinessSchoolarguesinhis

paperValueMaximization,StakeholderTheory,andtheCorporateObjectiveFunction,

“short‐termprofitmaximizationattheexpenseoflong‐termvaluecreationisasure

waytodestroyvalue…[theimplicationsofthisare]thatwemustgiveemployees

andmanagersastructurethatwillhelpthemresistthetemptationtomaximize

short‐termfinancialperformance(astypicallymeasuredbyaccountingprofitsor,

evenworse,earningspershare).”13Value,accordingtoJensen,maybecaptured

mostefficientlythroughstrategiesoflong‐termism:investinginastrongcorporate

socialresponsibilityplatform,fundingresearchanddevelopment,andintegrating

intangiblessuchascustomersatisfactionoremployeewelfareintofinancialmetrics.

Withtheproperdistributivemechanismsinplace,thiswealthcanhelpservethe

purposesofself‐determination,efficientallocation,fairness,andlong‐termismthat

alsounderlienormativefinance.

1e.MeetingFinance’sGoalsinaCompetitiveMarketEconomy Thoughfinance,bydesign,shouldhonortheidealsofself‐determination,

efficientallocation,fairness,andlong‐termism,financialfirms’pursuitofthese

valuesoftenseemstoerodetheirindividualcompetitiveness.Canwedesigna

competitivesysteminwhichinstitutionscanrealisticallytranslateanindividuals’

rightofself‐determinationintoalong‐termprofitmaximizingbusinessobjective?

Areresourcesnotallocatedproperlytoproducethehighestpossiblereturnon

investmentifafirmdecidestodonatetoacommunitynon‐profitratherthanplacing

itscapitalintoapromisingnewbusinessventure?AsForestReinhardtandRobert

13Jensen16

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StavinsoftheHarvardBusinessSchoolandtheJohnF.KennedySchoolof

GovernmentatHarvardUniversityrespectivelynote,firms’commitmentstotheir

socialobligationsdonotnecessarilybegetsubstantialprofitsinanimperfectly

competitiveeconomiclandscape:“intherealworldofasymmetricinformationand

oligopoly,theevolutionarymechanismsthatmightbethoughttoprecludefirms

fromengaginginprofit‐sacrificingbehaviourarenotalwayseffective.Iftheir

managerswanttosacrificeprofitstopromotewhattheyseeasthepublicinterest,

theymaybeabletodosoaslongasoneormoreoftheirinputoroutputmarketsis

imperfectlycompetitive.”14Accordingly,firmscanexpecttogeneratereasonable

profitswhilestillprioritizingsocialobligationssuchasindividualself‐

determinationandfairness.Theprofitsmayreflectthevaluethatcustomersascribe

toafirm’scommitmenttoitscoresocialresponsibilities.15Or,throughproviding

individualswithfairmortgageloansorflexiblestudentloanpolicies,firmscan

commandcustomerloyaltyandincentivizereciprocitytobuildtheircustomerbase

andlowerloandefaultrates,bothprofit‐enhancingstrategies.Similarly,althougha

donationtoalocalnon‐profitmightseemtocutdirectlyintoafirm’sbottomline,

thereputationalkickbackmayhavetheeffectofimprovingthefirm’soverall

14ReinhardtandStavins515Profitsmaycomeintheformofcustomersdeliberatelydecidingtostayloyaltoafirmeveninacontextofperfectpricecompetitionbecausethefirmseekstooperateintheindividualcustomer’sbestinterestoritpursueslong‐termvaluecreationthroughstrategiessuchasCSR;or,ifenoughfirmsdecidetopursuesocialobjectivesthroughtheiroperationssoastosetanindustrystandard,thecostofcapitalcouldberaisedfornon‐compliantfirmstothepointthattheirabstinenceforcesthemtolosemarketshare.

17

perceptionandfutureprofits.16Thoughpursuitofsocialobligationsmightnot

necessarilybeconsistentwithafinancialfirm’scompetitivenessinanefficient

marketsetting,theefficientmarketshypothesis’failuretoadequatelycapturethe

valueofintangiblesimpliesthatthetwopursuits,competitivenessandfulfillmentof

certainkeysocialobligations,maynotbesomutuallyexclusiveafterall.

Statepolicyisneededtosupplementafirm’sindependentincentivestofulfill

itssocialobligations.Thecompetitiveadvantagesafirmcanaccruebyprioritizing

intangiblessuchasindividualself‐determinationandfairnessmustleveloffata

certainpoint,atwhichjuncturefirmswillbegintoseeatradeoffbetweenshort‐

termprofitmaximizationandlong‐termvaluecreation.Itispreciselyatthispoint

wheregovernmentsmustregulatetheactionsoffinancialfirmssothattheycan

continuetobecompetitiveandprofitablewithoutforgoingtheirsocial

responsibilities.AsFranklinD.RooseveltreiteratedfollowingtheGreatDepression,

atimeinwhichthecompetitiveforcesoffinanciersandfinancialmarketsseemedto

overrideourmostbasicsocialconsiderations,“menmaydifferastotheparticular

formofgovernmentalactivitywithrespecttoindustryandbusiness,butnearlyall

areagreedthatprivateenterpriseintimessuchasthesecannotbeleftwithout

assistanceandwithoutandwithoutreasonablesafeguardslestitdestroynotonly

16BritishPetroleum(BP)pursuedasimilarstrategyofprofitenhancementthroughgenerationofapositivesocialimagewithits“BeyondPetroleum”marketingcampaign.AnnHand,marketingchiefofBPatthetimeofthecampaign,stated,“wehaveashareholderobligationtomaximizevalueandincreasesalesrevenue,but,atthesametime,wecandelivergreatguestexperienceandbuildbrandloyalty.Thatcreatesawin‐winsituationforourconsumersandourshareholders.”Whetherornotthefirmwasfalselyadvertisinginthiscampaignisstillcontentiousbutthisexampleillustratestheprofitthatcanbederivedfromafirmmaintainingitspositivesocialreputation(Cherry1003).

18

itselfbutalsoourprocessesofcivilization.”17Rooseveltcontinuedbyremarkingthat

thecorrosiveshort‐termcompetitivepracticesofthebankingindustry,“…inthesale

ofsecurities,inthedeliberateencouragementofstockgambling,inthesaleof

unsoundmortgages”couldbeaddressedbyrestrictionsontradingpracticesornew

legislationsuchastheSecuritiesExchangeAct.18Thisregulation,farfromdetracting

fromindividualfirmcompetitiveness,appliedeven‐handedrulestotheconductof

eachfirmwithinfinancialmarketsthatguidedthemtowardstheirgreatersocial

obligations.Byincreasingtransparencyinthesecuritiesmarkets,limitingtrading

arbitrageopportunities,andcreatinggreateroversightofmortgagemarkets,state

regulationduringtheNewDealhelpedusherfinanceinthedirectionofgreaterself‐

determination,efficientallocation,fairness,andlong‐termism.Thoughthese

regulationshavebeenchallengedbynewcompetitivestrategiesarisinginmodern

markets,upkeepofthisstateinfrastructureisnecessarytoensurethatmarketsand

theircomponentfirmsremainintheserviceoftheirfundamentalsocialgoals.

1f.Summary

Thepursuitofbetterwaystoachievesimplehumangoalshasalwaysdriven

financeforward.Financecanserveasaninstrumentofself‐determinationby

providingindividualswithresourcestoaccesshighereducationormortgageswith

whichtopurchasetheirownhomes.Financecanserveasaninstrumentofefficient

allocationbyplacingcapitalwiththebestandbrightestideas,thosethatwillshape

ourworldtomorrow.Financecanserveasaninstrumentoffairnessifitis

adequatelysociallydemocratized,maintainingacompetitiveeconomiclandscape17RajanandZingales20718RooseveltFiresideChat

19

whilegivingeachindividualorbusinessanequalopportunitytorealizesuccess.

Finally,financecanembedlong‐termgrowthintotheprocessofeconomic

development,actingasanagentofvaluecreationratherthanashort‐termprofit

machine.RobertShillerpoignantlystates,“thegoalsservedbyfinanceoriginate

withinus.Theyreflectourinterestsincareers,hopesforourfamilies,ambitionsfor

ourbusinesses,aspirationsforourculture,andidealsforoursociety…Thebetter

alignedasociety’sfinancialinstitutionsarewithitsgoalsandideals,thestronger

andmoresuccessfulthesocietywillbe.”19Totheextentthatsocietyshouldstriveto

beanagentofindividualandcollectiveprosperity,andshouldfostercreativityand

dynamismthroughitseconomicmarkets,financialinstitutionsshouldsharethese

goals.Thoughcharacterizationsoffinancetodaylargelyfocusontheshortcomings

offinancialmechanicsthatariselargelyasaresultofmarketcompetition,wemust

notlosesightofthewealththatfinancehasthepotentialtogenerate.Beyond

monetaryvalue,financecanallowindividualstoexploretheirpassions,canpropel

innovativebusinessventuresforward,canraisethesocioeconomicbottomline,and

canachievethesegoalssustainably.Undertheseconditions,financecanworkfor

themasses,democratizingwealthandpromotingthevaluesofatruly“good

society.”

II.HowFinanceHasFallenShort

Themodernportrayaloffinanceasprincipallybeneficialtothoseworking

withintheboundariesofthefinancialindustrystandsindirectoppositionto

Shiller’scharacterizationoffinanceasthesciencebehindtheachievementof

19Shiller7

20

mutuallybeneficialsocialgoals.Nonetheless,specificandprovendeviationsfrom

theconceptualambitionsoffinancebyactorsinthefinancialspacedomakethis

characterizationtenable.Oftendeviationsfromtheconceptualidealarearesultof

competitivemarketforcesrewardingfirmsandfinancierswhocanmaximizeshort‐

termprofitsratherthancreatelonger‐termvalue.AsRajanandZingalesremark,the

financialindustry,byitsverynature,couldperverselybecomeameansto

preservingthesocialstatusquoforthoseatthetopoftheeconomicpyramid

throughmisuseofindustryresources.Accordingly,theynotethatthesophistication

ofthefinancialindustrycausesittoattractworkerswhohavehadtheability,time,

andresourcestobecomewellversedinitssubtleties.Theseworkersgenerally

alreadyconstituteaneconomicallypowerfulclassuponentryintothefinancial

industry,andassuch,seektocontrolmarketsandorientthemintheirfavor,

althoughcollectivelythismayentailforsakingtheconceptualambitionsoffinance.

Theyclaim,“theeconomicallypowerfulareconcernedaboutinstitutions

underpinningfreemarketsbecausetheytreatpeopleequally,makingpower

redundant.Themarketsthemselvesaddinsulttoinjury.Theyareasourceof

competition,forcingthepowerfultoprovetheircompetenceagainandagain.Since

apersonmaybepowerfulbecauseofhispastaccomplishmentsorinheritance

ratherthanhiscurrentabilities,thepowerfulhaveareasontofearmarkets.”20As

thiscaveatillustrates,empiricalfinancecandeliberately,unfairlystrayfarfroma

conceptualidealasaresultofmisdirectedindividualandcorporateincentives

largelygoverningtheoperationsoffinancialmarkets.Giventhatfinance,andthe

20RajanandZingales9

21

properconductthereof,holdsaprominentpositioninbothindividualandcorporate

socialwelfare,theempiricalfacetsoftheindustrymustalsobeexploredtolocate

practicalareasforimprovementthatcanhelpshiftthefinancialindustryinlinewith

itsbroaderconceptualambitions.

2a.Self‐Determination

Insofarasfinanceisintendedtoserveasaninstrumentofindividualself‐

determination,therearesomesevereshortcomingswithinthefinancialindustry

thatprecludeindividualsfrombeingabletopursuetheirdreams.Highereducation

isoneactivitythatanindividualmightpursue,withthefinancialassistanceofa

studentloan,toenhanceone’squalityoflifeandfutureprospects.Empirically,

unfortunately,thestudentloanfinancingmarkethasbecomeoneofskewed

incentivesforbankers,investors,andspecialtyfinancelenders,leavinggovernment

andtaxpayerstoshouldersubsequentcosts.21Indeemingcertainindividualsor

institutionscredit‐worthyenoughtomeritstudentloanfinancing,privatefinancial

institutionshaverecentlybeenabletocherrypickthosewhomtheybelievetobe

mostlikelytopaybacktheirloans,transferringtheriskiestpoolofsecuritiesinto

publichands.AsonemanifestoentitledPrivateStudentLoanFinancinginanEraof

NeedsandChallengesintheInstitutionalInvestorJournaladvisesstudentlenders:

“thequalityofastudentborrower’seducationcanbehighlycorrelatedtotheabilityofthatborrowertoobtaingainfulemploymentaftergraduationultimatelyimpactingloanperformance.Forthisveryreason,schoolswithhighfederalcohortdefaultratesandthosewithhistoricallylowgraduationrateshavebeenunderscrutiny…Investorsinstudentloan‐backedABSmustnowbeawareoftheprofileoftheschooltypedistributionwithinloan

21Costsincludeassumingtheriskoflesscredit‐worthyborrowers,havingtoprovideloansatlowerinterestratestowidenfinancingavailability,andacceptingfinancialresponsibilityshouldborrowersdefault

22

pools…Theparadigmhastrulyshiftedfromaworldinwhichlendersfoughttobeoneachschool’srecommendedlisttoaworldwhereschoolsarefightingtobeonalender’sapprovedinstitutionlist.”22

ContrastingShiller’sviewoffinanceasthemechanismthatsynchronizesdebtors’

andcreditors’goalsinpursuitofanoverallsocialbenefit,thisdepictionofthe

studentloanmarketreflectstherelativelysubservientpositionofborrowersto

financierswithcommandingcontrolofcapital.Giventhattheprivatesideis

unwillingtoprovidefunding,evenforeducation,tosubprimeborrowersinvolatile

marketclimates,theresponsibilityisthustransferredontogovernmenttopickup

thefinancingshortfall.Unfortunately,thisstructuralissuetransfersthebulkof

defaultriskontogovernmentandtaxpayers,inpursuitofincreasingeducational

accessibility,whileallowingprivatelenderstocollectonamorestablestreamof

loanrepayments.Thisempiricaldeviationfromafundamentalconceptualaimof

financerepresentsanincentiveproblemwithinthebroaderfinancialindustry,

throughwhichprivatefinancierscanprivatizeprofitswhilesocializingassociated

costs.Iterodestheabilityoffinancetoactasaninstrumentofself‐determination

andmustbeaddressedwhensynthesizinganidealistviewoffinancewitharealist

perspective.

2b.EfficientAllocation

Astronginstitutionalrelationshipbetweenbusinessmanagementand

financiersshouldtheoreticallypromotebroad‐basedeconomicgrowthandsocial

wealthdemocratization.Prevailingdata,however,indicatesthatfinanceitself

throughitsproductsandplayersisoverlysusceptibletomanipulationbythemost

22Santo111

23

powerfulprivatecorporationsattheexpenseofemergentmarketcompetitors.As

GarAlperovitzadmitsofourcurrentfinancialinstitutionsinhisbookAmerica

BeyondCapitalism:

“thetruthis,variousformsofmanipulatingthemarketarecentraltotheoperationofthecurrentcorporate‐dominatedpolitical‐economicsystem,notperipheraltoit.Theycomewiththeterritory–aseveryoneknowsfullwellwhentheyshifttheirgazeawayfromabstracttheorytotherealworldofoilcompanylobbying,drugcompanypoliticalpayoffs,Microsoftanticompetitivemaneuvering,andEnroncorruption…Leavingasidethemoralityoftheimplicitchoicesofthepresentsystem,countlessstudiesdemonstratethatwecurrentlythrowawayliterallymillionsofproductivepeoplewhosecontributiontotheeconomycouldbeenormous.”23

Innotingthatmarketmanipulationhasbecomecentral,ratherthanperipheral,to

themodernfunctioningofUSfinancialmarkets,Alperovitzconcedesthatour

financialsystemisskewedinfavorofvestedcorporateinterests.Undersuch

conditions,financialcapitalsimplycannotbematchedappropriatelytomore

worthycorporationsorbusinessventures.Rather,itissupplieddiscriminatelyto

industrygiantssuchasMicrosoftwiththepowertoadjustthecompetitive

landscapetosuittheirownterms.Whilealternativesourcesoffinancing,suchas

crowdfundingandmicrofinance,havesoughttobridgethiscriticalcapitalgapfor

smallerscale“disruptive”competitors,economiesofscalecannoteffectivelybebuilt

ontheseplatformsalone.24Thisshortcomingofempiricalcorporatefinance,as

Alperovitzadditionallynotes,comesattheexpenseofbothopportunityandwealth

democratization,representingadeviationfromthefundamentalconceptual

ambitionsoffinance.Suchadeficiency,paralleltothatofthepersonalfinance

23Alperovitz7724RajanandZingales6

24

industry,mustalsobeaddressedwhenattemptingtoreformtheinfrastructureof

financemorebroadlytoserviceitstheoreticalgoalofallocativeefficiency.

2c.Fairness

Financialintermediarieshavecontinuallyfailedtochannelresourcesand

opportunitiesfairlyacrosssocialclasses.Thisfailurehasresultedincompounding

wealthinequalitiesovertime,restrictingeconomicdevelopmentandlocking

potentialsourcesofcapitalgrowth.Fairness,whereinanindividual’sor

corporation’sclaimtofinancialresourcesorcapitalmaybesatisfiedinproportion

toitsstandalonestrength,notwithstandingpreexistingaccumulatedadvantages,

maybegaugedthroughavarietyoffinancialmetrics.Onesuchmeasureofa

society’sfinancialfairnessistheextentofthatsociety’s“financialinclusion.”

Financialinclusiongaugestheaccessibilityofasociety’sformalandinformal

financialresourcesandmeasuresthedegreetowhichthatsocietycompels

individualsorfirmstotakeadvantageoffinancialresources.Giventhata

preconditionoffairnessmaybetheextenttowhichasocietygrantsindividuals

equalaccesstofinancialmarketsandtheirassociatedbenefits,broaderfinancial

inclusionwouldcorrespondwithamore“fair”financialmarketenvironment.As

RajanandZingalesnote,financialinstitutions’exclusivitybiasinlendingtothose

withprovencollateralassets,thoughperhapsfinanciallyrational,isalsounfair:“the

financierwillnaturallygravitatetowardfinancingthehavessimplybecausethey

havethecollateralorconnectionstoassuagehisconcerns…shouldwebeconcerned

[aboutthebias]?Webelieveyes,bothbecausetheeconomycannotproduceas

25

muchasitspotentialandbecausewhatitdoesproduceisnotdistributedfairly.”25

Biasesinfinancialinclusionwithinsocieties,whetheraresultofunderdeveloped

financialinstitutionsorriskmitigationtactics,beyondbeingunfair,aretherefore

economicallysuboptimal.Theykeeppotentialsourcesofgreatwealthtrappedand

promptaviciouscycleofwealthinequalitythatmustbeclosediffinanceistobe

consideredtruly“fair.”

Intheiranalysisoffinancialinclusionwithinandamongvariousworld

economies,AsliDemeriguc‐KuntandLeoraKlapperoftheWorldBank’sFinance

andPrivateSectorDevelopmentTeam’sfindingsreiteratethepointthatfinancial

exclusionleadstounfairwealthdistribution.Specifically,theyfindthatthoseatthe

“baseofthepyramid”aremuchlessabletotakeadvantageoffinancialservicesdue

tocostbarriers,accessissues,orsheerunawarenessoftheresourcesthatare

availabletothem.26Thisinabilitytoutilizefinancialservicessubsequently

constrainsthissubsetofthepopulation’sgrowthpotential,resultinginincreasing

cross‐socialwealthstratificationbeyondsimplecompoundingofincomeinequality.

Theyfindthatadultswhoholdformalaccountsatfinancialinstitutionsaremore

likelytosetpersonalsavingsgoals,receivesteadywagepaymentsthroughthese

accounts,andbuildstrongcreditforfutureborrowingpurposes.Theindividuals

whodonotopenaccounts,inbothhigh‐incomeanddevelopingeconomies,tendto

bethosewhodonothaveenoughmoneytocommittotheiraccounts(30%),who

25RajanandZingales34‐3526Intuitively,financialinstitutionsseektoestablishcommercialbankingbranchesandfinancialoutletsinthosedemographiclocationswheretheycanguaranteeastable,lessriskycustomerbase.Thiscompelsriskierpopulationsofcustomerstoresorttocorrespondinglyriskier,andpricier,alternativefinancingmechanisms.

26

cannotaffordtoopentheaccount(25%),orwhodonothaveeasyaccessto

commercialinstitutionsprovidingfinancialservices(20%).27Theconstraintsplaced

ontheseindividuals,mostcommonlyaresultoftheirinheritedsocialposition,

preventthemfromenjoyingthesamebenefitsoffinancialresourcesasthosewho

constitutethehigherendofthesocioeconomicspectrum.Theyarethuslessableto

growtheirpersonalwealthandmustremainseededatthebaseofthepyramid

whilethewealthyareabletofurtherprosper.Fromthisangle,itbecomesclearthat

societyhasaresponsibilitytomakefinancialresourcesavailablemorebroadlyif

eachindividualistobetrulyrewardedinproportiontothestrengthoftheirclaim.

Throughmakingfinancialresourcesmoreaccessible,wecanensurethat“insteadof

anaristocracyofthemerelyrich,we[willbe]movingtoanaristocracyofthe

capableandtherich…[Wewillbe]puttingthehumanbeingatthecenterof

economicactivitybecause,whencapitalisfreelyavailable,itisskills,ideas,hard

work,andinescapably,luckthatcreatewealth.”28Undertheseconditionswecan

hopetohaveasystemoffinancethatistruly“fair”toallthosewhoutilizefinancial

services.

2d.Long‐Termism

Thefocusonshort‐termprofitmaximizationoverlong‐termvaluecreation

hasperhapsmostharmfullyderailedmodernfinance.Myopiccompensation

schemes,directaccountabilitytoshareholders,andinsufficientriskoversight,

amongotherfactors,haveallowedfinancetodevelopintoa“racetothebottom”for

27Demirguc‐KuntandKlapper2228RajanandZingales92

27

profitsratherthanaconstructivesocialenterprise.29AsJosephHeathexplainsinhis

chapterAgencyTheoryandSelf‐Interest,theindividualcompulsiontoactin

responsetosalientself‐interestsoftenoverrideslonger‐termconsiderationsoffirm

wellbeingorvaluecreation.Hecharacterizessuchshort‐termismas“opportunistic

behavior,”which“…isadirectconsequenceofagentsactinginaccordancewiththe

generalgame‐theoreticprincipleknownassequentialrationality.Thisissimplythe

viewthat,inamultistagegame,arationalstrategymustnotonlybeutility‐

maximizingatthepointatwhichitischosen,buteachofitscomponentactions

mustalsobeutility‐maximizingatthepointatwhichitistobeperformed.”Heath

concludesfromthistheorythatindividualswillconsequently“actunreservedly

usingguileanddeceit–notonlywhennecessary,butwheneveritisadvantageous

forthemtodoso.”30Accordingly,CEOswillhaveincentiveto“cookthebooks”to

inflatetheirannualpaypackages,supervisorswillhaveincentivetooverlookrisky

betsmadebytheiremployeesiftheyseemtoprovideshort‐termupside,and

individualswhoconstitutetheheartoffinancialinstitutionswillcontinuetoact

opportunisticallyatthecostoflong‐termvaluecreation.Short‐termopportunistic

behavior,manywouldargue,hasactuallycatalyzedrecenteventssuchasthesub‐

primemortgagecrisis,thecollapseofEnron,andthetradingscandalsparkedbythe

“Londonwhale,”leadingtolarge‐scalevaluedestructionatasignificantcosttothose

insocietywhosewelfaredependsonhealthyfinancialmarkets.Thisbehavior,inthe

long‐term,simplycannotcomplywithasustainablebusinessorsocialmodel.

29Orsagh430Boatright129

28

Thatfinancialcapitalisoftensteeredintoshort‐termprofit‐maximizing

venturescanbeattributedtotherewardstructuresintrinsictomodernfinancial

markets.Financialanalysis,forexample,valuesfirmsbasedonmetricslikefreecash

flow,valueofphysicalassets,ordividendpaymentsonoutstandingequity.This

impliesthatfirmswithimpressivefinancialstatementstodaywillattract

investmentwhilefirmscommittingtheirresourcestointangibles,thoughperhaps

equallyvaluable,maybeoverlooked.31Intheshort‐term,itisthesefirmswith

strongtangiblefinancialsthatwillseemtopromisethegreatestreturnon

investment.InhispaperTheLinkBetweenJobSatisfactionandFirmValuewith

ImplicationsforCorporateSocialResponsibility,AlexEdmansarguesthatfirm

investmentsinintangibles,thoughvalue‐creatingovertime,aresimplynot

incorporatedaccuratelyintocurrentstockprices.Heexplains,“…intangiblesarenot

incorporatedbecausethemarketlacksinformationontheirvalue.Sincetheycannot

bemeasured,itishardformanagerstocrediblycertifytheirvaluetooutsiders.”His

resultsthus“supportmanagerialmyopiatheoriesinwhichmanagersunderinvestin

intangiblesbecausethemarketvaluesthemonlyintheverylongrun.This

conclusioninturnhasimplicationsforhowtodesignorganizationstoencourage

long‐termgrowth.Wecurrentlyevaluatemanagersaccordingtoquarterlyearnings

announcements.Buttoinduceintangibleinvestment,wemustpaythembasedon

31Edmansclarifiesthat“examples[ofintangibles]includeintellectualproperty(patentsandtrademarks},brand,customerloyalty,andhumancapital.Previousstudieshaveidentifiedvariousintangiblesthatarenotfullyvalued:firmswithhighR&Dasmeasuredbyexpenditure,advertisingasmeasuredbyexpenditure,patentqualityasmeasuredbycitations,andsoftwarequalityasmeasuredbydevelopmentcostsallearnhigherlong‐runreturns.”

29

thestockpricefarintothefuture.”32AccordingtoEdmans’findings,thosefirmswho

investinintangiblesareultimatelymoresuccessful,morevaluable,inthelongrun.

However,wearediscouragingthistypeoffar‐sightedinvestmentbehaviorwithour

currentvaluationmethodologies.Inordertogivefirmstheabilitytoactas

visionaries,then,wemustovercomethisshortsightednessandbegintoquantify

long‐termvaluecreationfinanciallythroughreformedpracticesandincentive

schemes.

2e.Summary

Individualandcorporatefinance,proppedupbytheactionsofunderlying

financialinstitutions,hasempiricallydeviatedfromitstheoreticalpurpose.Though

thescaleofthisdeviationtodayisdifficulttogauge,itisnonethelessimperativeto

beginmakingincrementalimprovementsintheinfrastructureofmodernfinanceto

moverealityinlinewiththeory.Thisshiftinphilosophyandpracticewillonlycome

withabehavioraladjustmentofthoseindividualsandfirmsoperatingwithinthe

financialindustryitself.AsShillerpointsout,“theessentialchallengeforleadersto

contemplateincomingtotermswiththefutureoffinanceistounderstandthatit

canbeusedtohelpbroadenprosperityacrossanincreasinglywiderangeofsocial

classes,andthatitsproductscanbemadeeasierforpeopletouseandcanbebetter

integratedintotheeconomyasawhole.”33Ifthefutureoffinanceisinfacttobea

brightone,thenfinancialinstitutionsmustbeginactingresponsibly,understanding

theirobligationtospreadprosperitytothemanyratherthanrestrictingittothe

32Edmans1433Shiller8

30

few,andpromotingpracticesandtoolsthatcontributetorobusteconomicgrowth

ratherthanshort‐termprofit.

Leadersinthefinancialspace,whethertheyareCEOsofcorporationsor

headsoffinancialinstitutions,mustreorienttheinstrumentsoffinanceinpursuitof

thedemocratizationofwealthgoingforward.Thestudentloanmarketmustbea

meansofaccessing,notbarringeducation.Corporateentitiesmustutilizefinancial

marketstoincreasetheirindividualcompetitivenessratherthanbarpotential

marketentrants.Financialinstitutionsmustrecognizetheirinstrumentalityin

keepingthecapitalistfreemarketsystemhealthy.34Onlyundertheseadmittedly

moretheoreticalcircumstancescanfinancetrulyserveitsfundamentalpurposeand

generateprosperityonabroadsocialscale.

III.CorrectingFinance Financecanbeincrementallyimprovedinordertoreconcileempirical

observationwiththetheoreticalaimsoffinance:self‐determination,efficient

allocation,fairness,andlong‐termwealthgrowth.Tothisend,futureinnovationin

financemusthaveanembeddedsenseofsocialresponsibilitytowardsthe

individualsandcorporationsforwhomfinanceisallegedlyworking.Actorswithin

thefinancialspacemusttakeintogreateraccountthesocialexternalitiesoftheir

actionsratherthansimplyanalyzingfiscalimplications.Lastly,theorientationof

financialinstitutionsmustbealteredtobetteralignthecooperativeaimsofthese

institutionsandtheactorsoutsideofthefinancialspacethattheinstitutionsare

intendedtoserve.AsAsliDemeriguc‐KuntandLeoraKlapperreinforce:

34RajanandZingales45

31

“Well‐functioningfinancialsystemsserveavitalpurpose,offeringsavings,credit,payment,andriskmanagementproductstopeoplewithawiderangeofneeds.Inclusivefinancialsystems–allowingbroadaccesstofinancialservices,withoutpriceornonpricebarrierstotheiruse–areespeciallylikelytobenefitpoorpeopleandotherdisadvantagedgroups.Withoutinclusivefinancialsystems,poorpeoplemustrelyontheirownlimitedsavingstoinvestintheireducationorbecomeentrepreneurs–andsmallenterprisesmustrelyontheirlimitedearningstopursuepromisinggrowthopportunities.Thiscancontributetopersistentincomeinequalityandslowereconomicgrowth.”35

Thisinsightmakesclearthattheprinciplesofself‐determination,efficient

allocation,fairness,andlong‐termwealthgenerationcanactuallybepursuedunder

asystemofwell‐functioningmarkets.Moreover,suchwellfunctioningmarkets,

wheninplace,canservetoclosethesocialinequalitygapsthathavebeencreated

andexacerbatedasaproductofmismanagedmarkets.Iffinancialmarketsare

compelled,inpractice,topursuetheprinciplesforwhichtheywereinitially

formulated,theresultwillbegreatersocialequityofwealthandsocialopportunity

goingforward.Synthesizingtheconceptualandtheempiricalinfinancewillbecome

criticaltoensuringthetrustworthinessofthefinancialindustryinthefutureand

thereforeisthekeytoitssustainability.

3a.FinancialEngineeringinPursuitofSelf‐Determination

Personalfinancialproductsmustbedesignedthatgiveindividualsthetools

theyneedtoturntheirpresentinvestmentsintofuturesuccesseswhilealso

allowingthemtolivealifethattheydeemmeaningful.Throughaninvestmentin

theirowneducationorinaprivatehome,individualscanincreasetheirownwealth

andexploretheiridiosyncraticpassionswiththehelpoffinance.Doingso,ideally,

willgivetheseindividualsthecapacitytorepaytheirloans,anoutcomethatisalso35Demirguc‐KuntandKlapper1

32

inthebestinterestoffinancialinstitutions.Thissystemofreciprocity,basedon

honestcontractingandtrustbetweenindividualsandfinanciers,canbeestablished

throughproperlydesigned,humanizedfinancialproducts.

Onecreativeformoffinancialinnovationthatcanhelpestablishasymbiotic

relationshipbetweenindividualsandfinanceisinsurance.Homeinsurance,lifeand

healthinsurance,educationinsurance,andevenmoreidiosyncraticformssuchas

cropinsurance,cangiveindividualsthepeaceofmindthattheyneedtopursuetheir

dreamswhileprovidingthemwithfinancialsecurityintheeventthattheirpursuits

donotsucceed.Properlydevisedsystemsofinsurance,inotherwords,canallow

financetoactasaninstrumentofself‐determinationthroughitsliberatingeffecton

theindividual.Inconstructingfutureinsurancecontracts,asShillerelaborates,“if

theinsuranceindustryistobecomemorehumanized,ithastodealbetterwiththe

realrisksthattroublepeople…”Shillergoesontoexplainthatcurrentdisability

insurance,whilehedgingsomeoftheriskassociatedwithindividualdisabilities,

doesnotfullycoveralltheriskstotheirlivelihoods.Heclaims,“inthefuture,

insurancecanandwilldomuchmore.”Accordingly,Shillersuggeststhatweadopt

aninnovativenewapproachtodisabilityinsurancecalledlivelihoodinsurance.He

explains:

“Thiswouldbealong‐terminsurancepolicythatanindividualcouldpurchaseonacareer,aneducation,oraparticularinvestmentinhumancapital.Onecouldchoosetospecializefarmorenarrowlythaniscommonlydonetoday–say,onaparticularlyinterestingcareerdirection–developingtheexpertiseforsuchacareerwithoutfearoftheconsequencesiftheinitiativeturnedoutbadly.Theinsurancepolicywouldpayoffwithasupplementtoone’slifetimeincomeifitturnedoutyearsordecadeslater,

33

basedonverifiabledata,thattherewaslessofamarket,orevennomarketatall,forpeoplewiththiscareer.”36

Livelihoodinsurancerepresentsaproductoffinancialengineeringthatputsthe

humanatthecenterofitsdesign.Itencouragesindividualstobeself‐determinant,it

indulgesinidiosyncraticpassion,anditprovidesnecessaryfinancialsecurityifthe

individual’spursuitisnotsuccessful.Futureproducts,similarly,shouldseektoact

asinstrumentsofself‐determinationtobringempiricalfinanceinlinewith

conceptualideals.

3b.EnlightenedValueMaximizationasaSolutiontoAllocativeInefficiency

Financecanenhanceitsallocativeefficiencybyidentifyingandfunding

businessopportunitiesthatgeneratemaximallong‐runsocialvalue,ratherthan

continuallycateringtotheentrenchedinterestsofcorporationsthatdominate

capitalmarkets.Onewayofdoingso,proposedbyMichaelJensenoftheHarvard

BusinessSchool,istouse“enlightenedvaluemaximization”asatooloffundamental

analysis.Ratherthandeterminingtheintrinsicvalueofacompanythroughstrictly

financialmultiplessuchasprice‐to‐earningsorprice‐tobookratios,Jensen’s

enlightenedvaluemaximizationascribesaddedvaluetofirmswhoseoperationsand

managementareoptimizinglong‐termmarketvalue.Hisvaluationmethodology,

whilenotfullyignorantofshort‐runprofitindicators,“addsthesimplespecification

thattheobjectivefunction–theoverridinggoal–ofthefirmistomaximizetotal

long‐termfirmmarketvalue.Inshort,thechangeinthetotallong‐termmarket

valueofthefirmisthescorecardbywhichsuccessismeasured.”Thisapproach

addressesshort‐termallocativeinefficiencybecauseit“recognizesthepossibility36Shiller67

34

thatfinancialmarkets,althoughforwardlooking,maynotunderstandthefull

implicationsofacompany’spoliciesuntiltheybegintoshowupincashflowsover

time…”37Byhelpingtoidentifyinvestmentsthatwillbesustainablysuccessful,this

formofvaluationgivesfinancialcompaniestheabilitytooperateinamoreforward

lookingmanner.Itcanhelpthemovercomeashort‐termbiastowardssimply

investingincompanieswithwhichtheyarefamiliarinfavorofinvestingin

companieswithmorelong‐termgrowthandfuturevaluepotential.Financial

institutionselectingtouseenlightenedvaluemaximizationastheirpreferred

methodoffundamentalanalysiscanhavetheeffectofcompellingmanagersand

directorstoactinwhattheybelievetobethebestlong‐runinterestofthefirm.

Whilenotacompletesolutiontotheproblemofshort‐termism,itanalyzes

performancebasedonoverallvalue‐addedandlong‐termwealthcreation,not

simplyinstantaneousprofitmetrics.Thisstrategyoffundamentalanalysiscanthus

helprefocusmanagersanddirectorsoffirmsandcanhelpfinancialinstitutions

allocatecapitalintotheproperchannelstobroadenthescopeofeconomicgrowth.

3c.ReinstatingFairDistributionofWealth

Financemuststopcontributingtotheunfairallocationofmonetaryand

capitalresources.Disproportionatewealthaccumulationatthetopoftheeconomic

pyramidcanbeaddressedthroughavarietyofstrategies,includinggovernment

regulationoffinancialinstitutionsandasset‐basedredistributionschemes.Onearea

inwhichgovernmentcanrealisticallyinterveneisinregulatingthegenerational

transferofresourcestomembersofthesamesocioeconomicclass.Inheritancecaps

37Jensen17

35

canlimittheamountofwealththatistransferredfromgenerationtogeneration,

helpingtonarrowopportunitygapsthatentrenchsocialpositions.Rajanand

Zingalesacknowledge,“inefficientandconcentratedcontrolofwealthdoesimpose

allkindsofcostsonsociety.Thatiswhyaninheritancetax,structuredsothatthe

richareencouragedtotransferpassiveownershipofproductiveassets,ratherthan

activecontrol,totheirchildrenwouldmakesense…[Thetax’s]aimshouldbeto

achievetheefficientdistributionofcontrol.”38Thisregulation,farfromremoving

individualincentivetoworkforprofitsinone’sownlifetime,hastheimpliciteffect

ofequalizingeconomicmarketaccessforallindividualsovertime.Equalmarket

access,inturn,canhelpfinanceachievethepurposeofsatisfyingclaimsin

proportiontotheirstandalonestrengthratherthansatisfyingthemasafunctionof

anunfairlyinheritedlegacyofwealth.Inthissamevein,thegovernmentcanalso

mandatethatfinancialinstitutionsmaketheirresources,suchascommercial

bankingservices,financialadvisors,andcrediblelendinginstitutions,availableat

proportionallycompatablepricestounderservedcommunitiessothatthepoorcan

takeadvantageoftheseresourcestothesameextentthattherichareableto.

Breakingdownthebarrierstomarketaccessforallmembersofsocietywillusher

financeinthedirectionoffairness,allowingcompetitiveideastostandontheirown

meritswithoutregardtopriorsocioeconomicpositioning.

Evenmorefar‐reachingstrategies,suchastheoneproposedbyLouisKelso,a

formercorporatelawyerandinvestmentbanker,canbeimplementedthathelp

implicitlyredirectcapitalinamore“fair”mannerthroughfinancialmarkets.Kelso,

38RajanandZingales299

36

drawingontheearlierinfluencesofNobelPrizewinningeconomistJamesMeade

andYaleeconomistJohnRoemer,“realizedfromhisprofessionalexperiencethat

oneofthemain–andstrikinglyobvious–reasonshisrichclientswereableto

multiplytheirownershipofstocksandbondswasthattheirexistingwealth

providedthemwithcollateralthatallowedthemtoborrowmoneyforfurther

investment…Ifthepoorhadaccesstocollateralandexperts,Kelsoreasoned,why

couldtheynotalsomakemoneybyinvestingborrowedfunds?”39Accordingly,Kelso

proposedthecreationofa“CapitalDiffusionInsuranceCorporation,”whichwould

allowthegovernmenttoinsureindividuallypurchasedportfoliosofdiversified

products.Theseportfolioswouldbesoldprincipallytothosewithoutsignificant

previousexposureoraccesstosuchfinancialproducts.Thegovernmentinthis

schemewouldhedgeitsinvestmentriskbymandatingthatportfoliosremainin

escrowuntilpaidoffbydividends,atwhichpointtheportfolioswouldfallunderfull

ownershipoftheindividual,givingthemasecondsourceofincome.Thisscheme

would“ultimatelyresultinamajorsystem‐changingbuildupofwealthamongthe

citizenry”withanaddedperkbeingthatit“doesnotproposetaxingawayor

expropriatingexistingwealth.Instead,asteadyshiftinownershipwouldbeslowly

accomplishedasnewwealthiscreatedinthenormalprocessesofeconomic

developmentoverlongstretchesoftime.”Thistypeofstructuralreform,extending

creditfairlyandthoughtfullytothoseinunderservedcommunities,willincrease

financialliteracyandsophisticationintheseareas.Overtime,capitalownershipwill

39Alperovitz25

37

beimplicitlydemocratized,opportunitygapswillbenarrowed,andfinancewill

structurallybedirectedtowardsservingitspurposeoffairwealthdistribution.

3d.Long–TermismandtheSociallyResponsibleInvesting(SRI)Movement

Progresshasbeenmadeinthefieldoffinancialinnovationtodevelop

instrumentsthatintrinsicallyembedsomeformoflong‐termsocialpurposeor

responsibility.“Impactinvesting,”wherebycapitaliscontributedtosocially

responsibleinvestmentvehicleswithenvironmental,social,orgovernance(ESG)

criteriaembeddedintotheircorephilosophies,hasexpandedintheU.S.froma$639

billionindustryin1995toa$3.74trillionindustryin2012,with11%ofall

professionallymanagedassetsfallingintoa“sociallyresponsibleinvestments”

portfolio.40Theexpansionofthisassetclass,aresultofSRI’scomparablereturn

profiletotraditionallydiversifiedportfolios,representsagrowingdemandfor

financialproductstoreflectmoreconscientious,growth‐orientedinvestment

strategies.41ThedeepeningoftheSRIfieldinrecentyears,asaRockefellerInstitute

ReportentitledAchievements,Challenges,andWhat’sNextinBuildingtheImpact

InvestingIndustryexplains,comesasaresultof“growingrecognitionthatexisting

resourcesareinsufficienttoaddressseverepoverty,inequality,environmental

destruction,andothercomplex,globalissues,especiallyamongWesternnations

40Fung5141SRInegativescreensfocusonremovingtraditionallysocially“irresponsible”companiesfromtheirinvestmentuniverse.Examplesofsuchcompaniescanincludethosethatcontributetoenvironmentalpollutionorhaveweakcorporategovernancestructuresinplace.SRIpositivescreens,alternatively,willsourcecompanieswhoseoperationscancontributetolong‐termvaluecreationthroughhumancapitalinvestmentinemployeesorcapitalallocationtoresearchanddevelopment.

38

thatarealreadyreducingtheiraidbudgetsanddomesticsocialspending.”42

Accordingly,largepoolsofcapitaloverseenbyfinancialinstitutionsarebeginningto

adoptastrongersocialposition,intendingtocompensatefortheimmediate

shortfalltheyrecognizeashavingbeencreatedwithinandamongmodernstate

institutions.Thesefunds’socialpositionmustnecessarilybesupportedbyalong‐

term,valuecreationobjectiveratherthanshort‐termprofitmaximization.The

recentgrowthoftheSRIfieldimpliesthatsuchvaluecreationcaninfactbecomethe

mainstreamastheSRImarketmatures,allowingfinancetomoreorganicallyserve

itsgoaloflong‐termism.

TheCanadianPensionPlanInvestmentBoard(CPPIB),with$170.1billionin

pensionfundsunderitsmanagement,isanexampleofafinancialinstitutionthat

hastakenalong‐term,sociallyconsiderateapproachtoitsowninvestment

activities,believingthatitcanproducestrongerlong‐termfundperformancewitha

consciousinvestmentphilosophy.AsCPPIB’s“PolicyonResponsibleInvesting”

platformaffirms,“responsiblecorporatebehaviourwithrespecttoenvironmental,

social,andgovernancefactorscangenerallyhaveapositiveinfluenceonlong‐term

financialperformance.”43Inaccordancewiththisinvestmentphilosophy,CPPIB

usesitsfinancialpowertohelpdevelopspaceslikethegreentechindustry,orto

supportcompanieswithmoreintangiblevalueintheformofprogressive

managementorboardstructures.Inthisscenario,toolsoffinancearebeingusedto

bolstertheinfrastructureofthe“goodsociety,”creatingpositivemutualpayoffsfor

bothinvestorsandforsocietymorebroadly.TheCPPIB’sphilosophyhas,todate,42Rockefellerx43CPPIBPolicyonResponsibleInvesting3

39

beenenormouslysuccessfulingrowingthesizeofthenationalpensionfundand,all

thewhile,hasbeeninstrumentalindrivingforwardnumerousdevelopmentand

sustainabilityinitiativesacrosstheworld.Financialinnovationsshould,accordingly,

embedconceptsofsocialresponsibilityandadoptaninvestmentanglethatascribes

greatervaluetointangiblesiftheyseektobeprofitableoveralong‐termtime

horizon.

Tocontinueadvancingacultureofmoralobligationinfinance,itmustbe

acknowledgedthatprofitabilitywithinmarketsandsocialprogressarenotmutually

exclusive.Financialinstitutionscannotbeprofitableiftheyrefusetopropagatea

vibranteconomicsystem.Neglectingthissocialresponsibilityinturnharmsthose

whodependonstable,dependableeconomicgrowthtorealizetheirgoalsinlifeand

inbusiness.RajanandZingalesreiterateregardingthissymbioticrelationship:

“Noonewillhavetheincentivetoundertakelong‐terminvestment–whetherinacquiringspecializedskillsorinbuildingphysicalcapital–whenthereisnoclarityaboutwhattherulesofthegameare.Thus,thesocietalpieshrinks,andmoreandmoreofwhatremainsgoestotherulingcliquebecausetheyhavethearbitrarypowertodetermineshares…Therightanswerisnottoconcentrateeconomicpowerevenmorebuttodisperseitmorewidely.Andonewaytodothisistoexpandaccesstofinance.”44

Thusiffinanceseekstobesustainableandtrustworthyinthefuture,asitshould

giventhecountlessbenefitsthathealthymarketscanprovide,itmustjointly

incentivizecooperativeactiononthepartofbothentitiesinafinancialtransaction.

Institutionsmustbeassuredthattheycancollectonloansorinvestmentsthatthey

make,whichtheycangaingreaterassuranceofthroughlendingandinvesting

responsibly.Long‐termobjectivesmusttakeprecedentoverashort‐termfinancial

44RajanandZingales45

40

prisonersdilemmaforthistypeoffinancialinfrastructuretotakeroot.Shouldthis

objectivebeachieved,though,thesocialandfinancialpayoffstoallactorsinvolved

canbeincreased.

IV.TheFutureofWealthDemocratization1.WhatisWealthDemocratizationandshoulditConstituteaSocialEnd? Wealthdemocratizationistheprocessthroughwhichinequalityis

diminishedwithbroadenedaccesstosociety’sassets.Thefocusofwealth

democratizationshouldbethesubsetofsocietywithrestrictedaccesstothese

assets,typicallythoseonthelowerendofthesocioeconomicspectrum.Assetscan

bematerialandcanincludemoney,shelter,orleisureitems;ortheycanbeofa

moreintangiblenature,andcanincludeavailabilityofhighqualityeducation,access

toreliablepublicsafetyoutlets,orevenafeelingofsecurityinone’sown

community.Alloftheseassetsarecriticaltotheproductionofarobustly“wealthy”

societyand,thus,weshouldseektomaximizeeachindividualwithinsociety’s

accesstotheseassetsifwewanttoconstructamoresolidsocialfoundation.

Wealthdemocratization,becauseofitsmulti‐dimensionality,mustbea

proactiveprocess,broughtaboutbytherestructuringofinstitutionsthatdirectand

controlsocialwealth.Wealthdemocratizationcannotbeachievedthrough

retroactiveredistributivemeasuresorthroughprogressivetaxationschemes.

Rather,itmustbedrivenforwardbybroadereconomicgrowth,abyproductofthe

properfunctioningoffinancialmarkets.Inthisregard,theorientationoffinancial

institutionsismostcritical.Financialinstitutions,throughtheirproductsand

practices,haveauniqueabilitytospreadorrestrictaccesstoscarcesocialassets.As

41

RajanandZingalesnote,“agoodfinancialsystembroadensaccesstofunds.By

contrast,inanunderdevelopedfinancialsystem,accessislimited.Becausefundsare

soimportant,thefinancierwhocontrolsaccessispowerful,butbecauseaccessisso

limited,thefinanciercanmakemoneydoingverylittle.”45Withinthisexample,the

modernUSfinancialmarketshavecometoresembleanunderdeveloped,or

improperlyfunctioning,financialdomain.Financierswithcontroloffunds,who

havethepoweranddiscretiontobroadenaccesstoopportunitiessuchaseducation

andhomeownership,haveneglectedtousethispositionofpowertoservicethe

bestinterestsofsociety.Rather,byraisingpremiumsonstudentloansorselling

toxicsecuritiestotrustinginvestors,financiershaveoftenmanagedtogarner

wealthforthemselvesandtheirfirmsattheexpenseofagreatersocialgoal.Tothe

extentthatasocioeconomicobligationbegetsfinance,institutionsmustthusbe

reorientedinpursuitofgreaterwealthdemocratization.

Thepursuitofgreaterdemocratizationofwealththroughexpandedaccessto

value‐creatingfinancialtoolsshouldconstituteasocialend.Byspreadingwealth

moreequitably,thetoolsoffinancehavethepowertoraisethebottomlinein

societyandcontributetoaregenerativecycleofeconomicproductivity.In

formulatingtheconceptofa“pluralistcommonwealth”inAmericaBeyond

Capitalism,GarAlperovitzseekstoimagineasocietyinwhicheconomicand

financialinnovationisonlyembracedifitscorepurposeistoprovideforthosewith

limitedaccesstocapitalmoreefficientlyoreffectivelythanexistinginfrastructureis

ableto.Theessenceofthepluralistcommonwealthliesin“theprinciplethat

45RajanandZingales27

42

ownershipofthenation’swealthmustultimatelybeshifted,institutionally,to

benefitthevastmajority.”46Redistributingwealthinstitutionallyratherthan

retroactively,Alperovitzargues,stimulatestheeconomyfromthebottomup.It

allowsthosepreviouslyexcludedfromtheworldoffinancetoenjoyitsintrinsic

benefitsand,thus,contributebackpositivelytotheoveralleconomy.Afinancially

inclusiveinfrastructure,RajanandZingalesagree,allowssocietytounlock

otherwiselatentsourcesofeconomicgrowth,whichcancreateapositivefeedback

ofeconomicandevensocialstability.Thoughmoreequitablefinancialinclusion

doesnotimply,ononedimension,thatincomeinequalitywillbenarrowed,itdoes

createthepossibilitythatthoseatthebaseofthesocioeconomicpyramidcan

enhancetheirprobabilityofachievingfinancialsuccess.Accordingly,theynotethat

intheory,“financialrevolutionisthoroughlyliberalinspirit.Insteadofcapital,it

putsthehumanbeingatthecenterofeconomicactivitybecause,whencapitalis

freelyavailable,itisskills,ideas,hardwork,andinescapably,luckthatcreate

wealth.”47Thuswealthdemocratizationcanunderlieasocialrevolutiontoreplace

theunfairlybiasedsocioeconomicstatusquowithamoreeconomicallyconstructive

ordering.Inreorientingfinancetobemorewhollyinclusive,then,wecanalsohope

toachievegreatereconomicstabilityandlong‐termgrowth.

2.HistoricalAlternativeMeansofDemocratizingGrowth Historicallythesystematicredistributionofcapitalthroughretroactivetax

measuresoragraduatedincometaxhasservedastheprimarymeansof

democratizing“wealth”socially.However,suchmeasuresaresimplyinsufficientto46Alperovitz7947RajanandZingales92

43

promotegreatersustainablesocialequalitythroughwealthdemocratization.

Progressivetaxation,forexample,doesnotprovidepeoplewiththesameincentives

tocontributebacktotheeconomyasdoessupplyingthemwithempowering

financialtoolsbecauseitisan“after‐the‐fact”measure.Ithaslittletonobearingon

actors’priorbehavior.Further,theopportunitycostsofsuchredistributive

measuresaresignificant:weareeconomicallydisincentivizingthosewithlower

incomestomobilizetheirpowerfulhumancapitalresources,andweare

incentivizingthosewithhigherincomestoseekshorttermindividualprofitsthat

outpacethetaxschemes.Still,thisformofredistributionhasbeenpervasive

becauseofitspoliticaldefensibilityandbecauseoftheeasewithwhichitcanbe

systematized.Itiscleartoday,however,that“redistributive‘after‐the‐fact’

measuresarenolongerviable,andsomethingmuchmorefundamentalisneeded”

toadequatelyaddressgrowingwealthinequalitytrends.48

Inderivingalternativesto‘after‐the‐fact’taxationmeasures,newmethodsof

redistributionhavebeenproposedthatattempt,buthavenotyetsucceeded,to

systematicallydemocratizewealth.MeasuressuchastheEarnedIncomeTaxCredit

andmoreproactivefederaltaxsubsidiesforassetownershipseektogenerate

economicactivityamongthoseonthelowerendofthesocioeconomicspectrum.It

isthegoalofsuchmeasurestosubsequentlyallowthesemembersofsocietyto

contributetoamorerobustandstableeconomicgrowth,withpayoffsforthis

growthbeingrealizedwidelyandmoresustainablythroughapositivefeedback

48Alperovitz19

44

mechanism.49Thesetaxationschemesencouragesavingratherthanpunishing

consumption,andcanprovidebroaderaccesstophysicalassetsthatcan,allegedly,

beputtomoreproductiveusewheninthehandsofabroadersubsetofsociety.

Nonetheless,theyarestillfarfromidealinallocatingsociety’sresources,asthey

mustpresupposeinequality.AsRichardFreeman,aHarvardeconomistandauthor

ofthebookTheNewInequality:CreatingSolutionsforPoorAmerica,remarks

idealistically,“ifweweretostartdemocraticcapitalismwithablankslate,wewould

naturallydividetheownershipofexistingphysicalassetsequallyamongthe

population…Ourmainstrategy–beweleftorright–forfightingincomeinequality

undercapitalism,shouldbetoassureafairinitialdistributionofphysicaland

humancapitalthemselves…equalityofincomeobtainedinthefirstinstancevia

greaterequalityinthoseassets,ratherthanasafter‐the‐fact(ofearningorluck)

stateredistributionofincomefromrichtopoor,wouldenableustobettersquare

thecircleofmarketefficiencyandegalitarianaspiration.”50Thoughthisdepictionof

amoreegalitariancapitalistsocietyisindeedaromanticone,itissimply

incomprehensiblethatwecouldreverttodaytoasocialblankslateandbegin

dividingassetsequitably.Forthisreason,thosewithsubstantialcontrolofsociety’s

assets,namelyfinanciersandfinancialinstitutions,shouldbeforcedtoadopta

systematicbiasinfavorofprovisioningassetsmorefairly.Iffinancialinstitutions

canaccomplishthisgoal,inequalitycouldbegintorecedeasasocialpresupposition

asthestratificationofsocietybegantonarrow.Thetighterassociationofsocial

classeshasseveralpositiveimplicationsforfutureeconomiccreativity,growth,and49Alperovitz20250Freeman14

45

sustainability,andthusmustbepursuedasanendinitselfprincipallythroughthe

reorientationoffinance.

3.FinanceasthePreferableMeansofDemocratization

Giventhatmeasuressuchas‘after‐the‐fact’taxationandfederalsubsidiesare

insufficienttoaddresstheissueofwealthdisparitiesintheU.S.,theroleoffinance

inabettingthisproblemisworthexamining.Finance’simplicitinstrumentalityin

directingsocialcapitalshouldallowtheproperfocusofitsfacultiestoplaya

substantialroleinnarrowingever‐expandingwealthgaps.51Onenon‐profit

instrumentoffinance,theCommunityDevelopmentFinancialInstitution(CDFI),

servestoillustratehowproperlyorientedfinancialinfrastructurecanplayarolein

preemptivelyredistributingcapitalforthepurposeofwealthdemocratization.

CDFIs,whichcancomeintheformofcreditunions,banks,loanfunds,andventure

capitalfunds,allseektoutilizethetoolsoffinancetobroadeninitialownershipof

assetsintraditionallyunderservedcommunities.Indoingso,thesefinancial

institutionstakealong‐termviewofeconomicdevelopmentwhilesimultaneously

satisfyingaresponsibilitytoraisethesocioeconomicbottomline.AsAlperovitz

remarks,“themorethanthirty‐fiveyeardevelopmentaltrendthathasproducedthe

modernCommunityDevelopmentCorporationisintimatelyrelatedtotheU.S.

politicaleconomy’sdecliningcapacitytoaddressproblemsofinequalityand

51OECDstatisticsrevealthattheUSGinicoefficienthasbeensteadilyontherisesincedatacollectionbeganinthemid‐1970’s.Thoughthistrendtowardsgreaterincomeinequalityhasbeensomewhatmutedbytheimpactoftaxesandtransfers,thecoefficienthasnonethelessbeenpositivelyslopedevenwhentakingthesefederalmeasuresintoaccount(OECDStat–IncomeInequality)

46

povertydirectlythroughredistributionorthroughmajorjob‐creationstrategies.”52

TheCDFI,incontrastwithtraditionalredistributionmethods,ispreventativerather

thanresponsiveinitsapproach.Itprovidestraditionallyunderservedcommunities

withgreaterinitialaccesstoassetsthroughthetoolsoffinance,whereasset

ownershipcanbeleveragedmoreefficientlyandfinancialinvestmentcanbemore

tangiblyconvertedintobroad‐basedeconomicgrowth.Intappingthese

communitieslocally,providedthattheyusethepropertoolsandprocedures,

financialinstitutionscanthusaligntheirday‐to‐dayoperationswithamore

conceptualidealoffinance.Inthisway,ratherthanthroughoutdatedtaxschemes

thatsimplyaddressfiscaldisparities,wecantrulybeginthelongprocessofwealth

democratization.

Financialtoolsdonotnecessarilyhavetooperateinthenon‐profitsphereto

havetheeffectofdemocratizingwealth.AsWaheedHussainnotesinhiscritiqueof

Alperovitz’sPluralistCommonwealth,competitivefinancialinstitutionshaveno

immediateincentivetovoluntarilyforgoprofitsforthesakeofmoreevenhanded

wealthdistribution:

“Forapurelyvoluntaryprocess[ofwealthdemocratization]towork…youwouldhavetoappealtothepublic‐spiritednessofthosewhocurrentlyownthewealthinsociety–corporations,privateequityfunds,largeinvestors,andsoon–todonatemoneytononprofits,communitydevelopmentorganizations,employeestockplans,andalloftherest.Moreover,youwouldhavetogetthemtodonateinamountsthatwouldnotonlysupportthelivelihoodofsmallgroupsofpeople,butwouldadduptoafundamentalshiftinthepatternofwealthownershipinsociety.Avoluntarywealthtransferonthisscaleisnotonlyunlikely,butitwouldprobablybehistoricallyunprecedented…”53

52Alperovitz10153Hussain39

47

Giventhatcompetitiveprofitincentivesintheprivatesphereoftenprecludea

naturalshiftinthedirectionofwealthdemocratization,innovativesolutionsshould

bedesignedthatcansimultaneouslysatisfythisobligationoffinancewhile

producingcompetitivereturns.Inthisspace,BakerandFunghighlightrecent

financialdevelopmentsfromtheprivatesectorthathavesought,proactively,to

reverseaninclinationtowardswealthinequity.Specifically,theynotetherecent

ascendanceofinstitutionalinvestorstoapositionofgreaterprominenceinthe

responsibleinvestmentspace.Thesefor‐profitinvestors,whichinclude“insurance

funds,publicandprivatepensionfunds,banks,andmutualfunds,”arebeginningto

takeamorelong‐termapproachtoinvesting,deemphasizingimmediateprofit

maximizationandinvestinginsteadinmorebroadlyconstructiveventuressuchas

microfinanceandinfrastructuredevelopmentthatwilldeliverproven,stable

returnsfartherdowntheroad.54

TheOmidyar‐TuftsMicrofinanceFund(OTMF)isanexampleofafor‐profit

endowmentfundinvestinginmicrofinancethatseeksa9%annualreturnon

investment,synthesizingthegoalsofprofitabilityandwealthdemocratization.The

objectivesofthis“patientcapital”fund,todevelopmicrofinanceintoastronger

assetclassandtoopenopportunitiesforbusinessdevelopmenttotraditionally

underservedcommunities,contributedirectlytotheprocessofwealth

democratization.However,theyachievetheseobjectiveswhiledeliveringnecessary

fundstotheUniversityforoperationsandfinancialaidpurposes.AsTufts

endowmentofficerTryfanEvansevennoted,“ofthetwogoals[microfinance

54Fung21

48

supportandahighreturnoninvestment],thecommercialobjectiveofenhancing

theuniversity’sreturnoverrides.Thisflowsfromthebeliefthatthegoalof

enhancingcapitalflowstomicrofinanceinameaningfulwaycanonlybeachievedif

wefirstsucceedindemonstratingthatacommercialinvestorcanachieve

commercialobjectivessuchassupportingtheoperatingbudgetofaneducational

institutionbyinvestinginthesector.”55AsEvansreiterateshere,wealth

democratizationcanbecompatiblewithcompetitiveprofitabilityifpursuedthrough

appropriatelyconstructedandorientedinvestmentvehicles.Ifwealth

democratizationistoremainafundamentalpursuitoftheprivatefinancialspace,as

itshouldbe,furtherinnovationssuchastheOTMFmustbedesignedand

implementedtosynchronizethegoalsofprofitabilityandsocialresponsibility.

Financecertainlyhasthecapacitytoensurethatwealthisdistributed

equitablyinsociety.Amorewealthysocietyisoneinwhichpeoplecanfeel

relativelyfreetopursuetheirindividualgoalsandinterests,andoneinwhich

corporationsofdifferentsizesandindifferentstagescanfeelempoweredto

competeinafairmarketplace.Certainlywealthcanonlybegeneratedagainsta

backdropofeconomicgrowth,sofinancialinstitutionsshouldonlyexpecttoprofit

fractionallyoffofthecontributionthattheymaketosucheconomicgrowthas

measuredbyincreasesinnationalGDP.However,shouldtheinfrastructurebeput

inplaceforfinancetospreadownershipofsociety’sassets,long‐termsustainability

canrealisticallybeingrainedintofinancialtransactionswiththeultimatepayoffs

beingsharedcollectively.

55OTMF9

49

V.Conclusion

Financeisahumaninstitution.Likeallhumandesigns,itisimperfectand

improvable.Financeconceptuallyshouldgiveindividualsavehicleforself‐

determination,shouldfairlyandefficientlyallocatecapitaltotheindividualandthe

corporation,andshouldtakealong‐termgrowthperspective.AsRobertShiller

agrees,“thekeytoachievingourgoalsandenhancinghumanvaluesistomaintain

andcontinuallyimproveademocraticfinancialsystemthattakesaccountofthe

diversityofhumanmotivesanddrives.Weneedasystemthatallowspeopleto

makecomplexandincentivizingdealstofurthertheirgoals...Itmustbeasystem

thatredirectstheinevitablehumanconflictsintoamanageablearena,anarenathat

isbothpeacefulandconstructive.”56Thissimpledepictionoffinanceasanmeansof

translatingindividualcreativeexpressionintobroad‐basedeconomicgrowth

necessarilyengendersacomplexsystemofinstitutionsandproductsdesignedto

servicetheseloftygoals.Committingfinancialinstitutionsandpracticestothe

achievementofmoredemocraticprosperity,however,isnecessaryifwewantour

financialindustrytobeatrulysustainableone.

Modernfinancehasstrayedfromitsobligationtoservethegoalsofself‐

determination,efficientcapitalallocation,fairness,andlong‐termgrowth.

Deviationsoccuratboththeindividuallevelandfirmlevelandarelargelyaresultof

flawedinstitutionaldesign.Individualsinsocietywhoinheritalegacyofwealthare

abletomorerapidlymultiplytheirresourcesthroughthetoolsoffinance,through

stocksandbondsandassetappreciation,enjoyinggreateropportunitiestopursue

56Shiller237

50

self‐determinationthanthoseindividualswhoconstitutethebaseoftheeconomic

pyramid.Financialinstitutionsshouldworktoimplicitlyremedy,ratherthan

exacerbate,thiswealthdiscriminationovertime.Shillerreiterates:

Thedemocratizationoffinance…callsforanimprovementinthenatureandextentofparticipationinthefinancialsystem,includingawarenessoffundamentalinformationabouttheworkingsofthesystem.Thepublicneedstohavereliableinformation,andthatcanonlybeprovidedbyadvisers,legalrepresentatives,andeducatorswhoseetheirrolesasoneofpromotingenlightenedstewardship.Whenpeoplecanbenefitfromsuchhelp,theywillcometofeellessstronglythatoureconomyisrunbyapowerelite.Atpresentmostpeoplehavelittleornosuchinformation.Insteadtheyareroutinelyconfrontedbysalespeopleforfinancialproducts,whohaveinadequateincentivetotellthemwhattheyreallyneedtoknow.Butitcouldbedifferentunderatrulyenlightenedsystemoffinancialcapitalism.57

Indeed,underatrulyenlightenedsystemoffinancialcapitalism,equitable

distributionoffinancialresourcescancontributetowidenedsocialprosperityand,

ultimately,longer‐rangeeconomicgrowth.Itisimperativethatwecreatea

financiallyinclusivesocietyinorderforallindividualstotakeadvantageoffinance

asaninstrumentofself‐determinationandforallemergentbusinessenterprisesto

haveanequalchancetosecureinvestmentcapital.Throughlevelingthecompetitive

playingfield,wecanmakefinanceworkforthemanyratherthanthefewand

generatesocialwealthintheprocess.

Thewealthgeneratedbyaproperlyfunctioningfinancialsystemshouldbe

democraticallydistributedtoensuresustainabilityofthesystem.Pastmethodsof

redistributionhavefailedtoaddressgrowingwealthgapsbecausetheyhave

focusedonincomedisparity,thoughincomeonlyrepresentsasinglecomponentof

one’soverallwealth.Asincomesdiverge,sotoodoopportunitiestoaccesshigh‐

57Shiller236

51

qualityeducation,topurchaseappreciableassets,andtoreceivethecredit

necessarytoadvanceoneselfsocioeconomically.Wealthmustbedemocratically

distributedthroughtheimplicitfunctioningoffinancialinstitutions.Therising

popularityofCommunityDevelopmentFinancialInstitutions(CDFIs)asan

alternativetotraditionalbanklenders,aswellastherecentascendanceof

institutionalinvestors,haveproventhatfinanciallyinclusivestrategiescanpromote

broader,morestableprosperity.Indeed,inthewakeoftherecentfinancialcrisis,

giventhatthesedemocraticallyorientedinstitutionsandstrategiesfaredwell

comparedtotraditionalfinancialinstitutions,thesemodelsmayprovideuswith

insightintohowwecanbestnavigatethefutureoffinance.

Theinstitutionsoffinancecanworkforall.Throughproperinstitutional

orientation,wecanmaintainavibrant,competitive,andgrowingmarketeconomy

whilestillraisingthebottomline.InconcludinghisbookFinanceandtheGood

Society,RobertShillernotes,“manyofourhopesforthefutureshouldbepinnedon

furtherdevelopmentoftheinstitutionsrepresentingfinancialcapitalism.Weare

easilydazzledtodaybyadvancesininformationtechnology,andtheseadvancescan

certainlyinteractpositivelywithfinancialinnovations.Buttheadvancesinour

economicinstitutionsmayultimatelybemoreimportantthanthoseinour

hardwareandsoftware.Thefinancialsystemisitselfaninformation‐processing

system–onebuiltoutofhuman,ratherthanelectronic,units–andthefieldof

artificialintelligenceisnowhereclosetoreplacinghumanintelligence.”58Indeed,no

algorithmortechnologicalinnovationwillbeabletosolvesuchafundamentally

58Shiller238

52

humanproblemastheorientationofourfinancialinstitutions.Wemusttakethe

reinsandsteerourfinanceinthedirectionofvaluecreationandfairallocationifwe

hopetoenvisionasocioeconomicfuturethatisbothprosperousandsustainable.

53

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