Rogue Missives Friday, May 2, 1997

In what is by now a familiar story, workers at two different Southeast Asian factories that make Nike shoes staged walkouts and demonstrations last week in order to protest working conditions and low pay. In the Indonesian town of Tangerang, nearly half of the workers at PT HARDAYA ANEKA participated in a demonstration that erupted into a melee when police sought to break it up. Cars were burned, and windows at the factory shattered. On the same day, 3000 workers at the SAM YANG factory in southern Vietnam walked off the job for the second time in a month.

The Vietnamese workers have yet to receive a new contract, but the PT Hardaya employees, who earlier in the week had staged a long protest march that brought in workers from across the apparel industry, saw their efforts bear fruit. Last Saturday, they won a 10.7% pay increase.

The labor troubles were just the latest in what has been a seemingly endless series of reports from Asia about inhumane working conditions, starvation wages, and child labor in NIKE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NKE)") else Response.Write("(NYSE: NKE)") end if %> factories. Over the last year, due in no small part to the growing recognition that globalization of production is becoming a reality in the world of consumer goods, close attention has been paid to the conditions in foreign factories. The results of that attention have been eye-opening: Pakistani children paid cents a day to stitch soccer balls. Vietnamese workers paid 20 cents an hour being beaten and not allowed to leave their work posts. Indonesian workers intimidated and labor organizers imprisoned.

Nike denies that these conditions exist in its factories, or insists that they are the responsibility of subcontractors over whom the Portland, Ore.-based company has very little control. In the talks with the PT Hardaya employees, for instance, Nike followed the negotiations but did not take part in the actual settlement. More strikingly, Nike argues that low pay is a necessary condition of economic development, and that the only way for Southeast Asian nations to compete successfully in the world market is to take advantage of their low-wage environment. After the Indonesian workers won their pay raise, Nike spokesman Jim Small told The Wall Street Journal, "[T]here's concern whether or not Indonesia could be reaching a point where it's pricing itself out of the market."

Pricing itself out of the market, presumably, by paying its workers a little less than $3.00 a day.

The temptation, to be sure, is to suggest that the new global organizing slogan should be: "Nike workers of the world, unite!" But the more complicated question has to do with what Nike shareholders should do if they're uncomfortable with their company's overseas labor practices. If you own Nike shares and you think that the company should commit itself to paying a wage substantially higher than a country's minimum wage (which in Indonesia, as of April 1, is $2.50 a day), that it should refuse to use child labor and do a better job of ensuring that its contractors are not physically abusing workers, then there are three options available to you: you can sell your shares, you can seek to change the company from within, or you can keep the shares, do nothing, and feel guilty.

The first option is the traditional mechanism by which shareholders have expressed their dissatisfaction with company management. Whether it be through unfair labor practices, doing business in South Africa, or simply weak earnings, when management takes the wrong path shareholders traditionally respond by heading for the door. This option, which maverick economist Albert O. Hirschman termed "exit," in his brilliant book Exit, Voice, and Loyalty (1970) sees the market as the best mechanism for feedback. If enough shareholders exit by selling their shares, management will eventually come around.

Exit is, unsurprisingly, the preferred tool of economists, at least of the free-market stripe. As can be seen in the debate over, for example, public-school vouchers, economists see the decision to withdraw or bestow funds on an institution as the best means of making that institution responsive to one's wishes. If you want to let Nike know what you think, the most efficient means of doing so is by selling or buying its shares (and its products). What's curious about this is that money ends up being described as a more direct form of communication than language. As Hirschman puts it, "A person less well trained in economics might naively suggest that the direct way of expressing views is to express them!"

In other words, if you really want to let Nike know what you think, the best way to do so would be to tell the company. And if you wanted to change the company's behavior, the best way to do so would be to have a lot of other shareholders telling the company along with you.

This option Hirschman terms "voice." It is an option that for most of this century has had very little purchase on the business world. This has not been for want of alternative voices. Benjamin Graham and D.L. Dodd, in their classic Security Analysis (1951), suggested that the rule that you should sell your stock if you don't like a company's management "results in perpetuating bad management and bad policies." Hirschman describes corporate mismanagement as a situation where "exit is the predominant reaction to decline while voice might be more efficacious in arresting it." And in the 1970s Ralph Nader and his colleagues sought to make corporations more accountable both to their shareholders and to their customers.

The great exception to this rule, of course, has been Warren Buffett (which is not surprising given Graham's influence on his thinking). While Buffett argues that investors should seek out companies with good management, he's also said, "Invest in companies that a dummy can run, because sooner or later one will." And Buffett has not been hesitant to intervene in situations where he believes that improvement in a company's performance is possible.

Buffett, it goes without saying, would almost certainly frown on Nike investors who sought to reshape the company's labor policies in a fundamental way. But the principle underlying his strategy as a stock owner, namely that voice is the appropriate tool for dealing with problems, is one that nevertheless would have to be at the heart of any shareholder activist program.

It's in this decade, in fact, that investors have started to take the voice option seriously in a way that has made a substantial difference. While the goals and achievements of pension funds like CalPERS and TIAA-CEEF and of value investors like Michael Price are obviously dramatically different, what all have in common is the idea that ownership brings with it certain privileges and certain responsibilities. They see the over-reliance on exit as not merely financially damaging, but also as fundamentally ineffective.

What's interesting about the idea of voice is that in its essentials it challenges efficient market theory. If markets function perfectly, after all, then mismanagement is punished immediately, by lower demand and higher costs. It's precisely because markets don't function perfectly, though, precisely because bad managers are able to coast for a long time on an installed customer base, inattentive consumers, and/or insecure workers, that there's a real role for shareholders to speak out.

If consumers simply refused to buy any shoe made by workers earning less than $1 an hour, after all, Nike would be unable to pay workers less than $1 an hour and still stay in business. But most consumers don't know anything about the labor that goes into the products they buy. Some consumers who know don't think it matters. And some consumers who know don't buy the shoes. But in the absence of a massive organized boycott, the signals Nike receives from those who don't buy the shoes are distorted at best and utterly irrelevant at worst. All of which means that there is a clear space for shareholders to occupy.

The problem, of course, is that an individual shareholder most likely feels even more irrelevant to the company he owns than an individual consumer does. And the way the U.S. stock market is set up only contributes to that sense of irrelevance. Precisely because it is so easy to sell one's shares in a company, exit always offers itself as the first option. Individual shareholders tend to have very little sense of investment in the companies they own, very little sense that they have a responsibility as owners. And because company management is so easily able to say, "Sell your shares if you're unhappy" (the equivalent of "Nike: Love it or leave it"), they are more indifferent to those people who speak out.

It's no coincidence, then, that it's institutional investors who have formed the vanguard of shareholder activism. Because exit is a less satisfactory option for institutional investors, most of whom would have a hard time selling their stakes without slashing the stock's price, voice becomes increasingly important. The relationship the largest institutional investors -- or someone like Buffett -- have with the companies they own is closer to the relationship a citizen has to the country he or she is part of than it is to the relationship gamblers have to their cards. And it's a relationship that makes speaking out -- which is to say some version of democracy -- more likely.

It's also true, of course, that institutional investors rely on voice to effect change because they are powerful enough to believe that voice can effect change. The political scientist Edward Banfield wrote: "The effort an interested party makes to put its case before the decisionmaker will be in proportion to the advantage to be gained from a favorable outcome multiplied by the probability of influencing the decision." In other words, even if the advantage gained by a meaningful reform of Nike's labor practices would be immense, if investors feel that there's little probability of actually influencing the company, they will be less likely to speak out.

The circle, then, can be a vicious one for individual investors. Because they are individual and fragmented, they accept a passive role, and because they accept a passive role they contribute to the notion that individual investors are speculators and not owners, which in turn almost certainly contributes to the tendency toward speculation. If you have no voice, you're more likely to exit.

On the other hand, the possibility exists for the creation of a virtuous circle, one in which the exercise of voice by an organized group of individual investors inspires other individual investors to speak out, to conceive of themselves as owners, and to hold a stock rather than selling. The model to look to here might be the consumer activism of the 1960s and 1970s, which brought about dramatic changes in the auto industry and the chemical industry through collective action.

Not every investor, to be sure, is interested in devoting either the time or the energy to improving the companies he or she owns. And speculation -- whether it be for a week or even six months -- will remain an important part of investing for the foreseeable future. But if one takes long-term investing seriously, and if one takes the companies in which one's invested seriously, then understanding -- and eventually utilizing -- the means by which one's voice can be heard is a necessary part of ownership. As Erik Erikson put it, "You can actively flee, then, and you can actively stay put." Nike will be better, in the long run, the more shareholders they have who actively stay put.

-- Jim Surowiecki (Surowiecki)

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