This always bothered me. What company could exist or thrive without its employees, customers, communities, or a clean environment? Then why are other stakeholders disposable? Talk about forgetting where you came from!
One day I was listening to an interview with Ralph Gomory. When talking about shareholder primacy, Mr. Gomory said (3:18):
That [shareholder primacy] has become so embedded that most people think it was always that way but it wasn't.That intrigued me. It wasn't always this way? Did another generation of business leaders think differently? As I researched this question, I found Ralph Gomory was right. There was a time in America's economic history when the "Stakeholder" model was widely accepted. In the "Stakeholder" model, corporations have a responsibility to all stakeholders including employees, customers, communities, and our environment. I learned a generation ago, the shareholder primacy view would have been considered fringe.
I also read Cornell Law Professor Lynn Stout's book The Shareholder Value Myth. I found her work very thought provoking. Most arguments against shareholder primacy admit it benefits investors, but at everyone else's expense. Lynn Stout shows how shareholder primacy doesn't even benefit shareholders. I learned there is no legal requirement for companies to maximize shareholder wealth. In fact, Lynn Stout's work was cited by Supreme Court Justice John Paul Stevens in his dissent in Citizens United.
In the Introduction, Lynn Stout concurs with Ralph Gomory it wasn't always this way:
Fifty years ago, if you had asked the directors or CEO of a large public company what the corporations purpose was, you might have been told it had many purposes....Today you are likely to be told the company has but one purpose, to maximize shareholder wealth.But how did we go from the "Stakeholder" model, to Shareholder primacy? And how do we get corporations to behave more in the public interest again?
Yes, following the New Deal era the debate began to move back as a generation who doesn't remember the past is condemned to repeat the mistakes of the past.
In 1970, economist Milton Friedman published an article The Social Responsibility of Business is to Increase its Profits taking on the "Stakeholder" model. In his article, Milton Friedman refers to business people who accepted some social responsibility as:
In fact they are–or would be if they or anyone else took them seriously–preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decadesIn 1976, Michael Jensen and William Meckling published a paper in the Journal of Financial Economics Managerial Behavior, Agency Costs, and Ownership Structure. The paper argued the separation of ownership from control in public companies caused them to sometimes make decisions that weren't in shareholders best interest. The result was "agency costs" that decreased the total value of the company. The paper also claimed a principal-agent relationship where shareholders hired executives as agents to run the company on their behalf.
What is an agency cost? My own understanding is these are costs that arise because managers are separate from shareholders. If expenses don't come out of your personal pocket, you don't watch them as closely. This could be anything from managerial fraud to paying employees an above market wage because the board of directors believes in fair wages. Basically, it is costs that arise from a company pursuing priorities other than maximizing shareholder value.
In 1990, Michael Jensen added more fuel with his paper "It's Not How Much You Pay, But How" talking about how underpaid CEO's were and making the case for more pay for performance packages.
In the 1930's, Berle and Means were aware managers were separate from shareholders and this would result in agency costs. But what Jensen and Meckling felt was a problem Berle and Means considered necessary for the corporate system to survive. Lynn Stout talks about this in her 2013 article On The Rise of Shareholder Primacy, Signs Of Its Fall. In her paper, she quotes from Berle and Means 1932 book The Modern Corporation and Private Property.
It is conceivable- indeed it seems almost essential if the corporate system is to survive-that the "control" of the great corporations should develop into a purely neutral technocracy, balancing a variety of claims by various groups in the community and assigning to each a portion of the income stream on the basis of public policy rather than private cupidity.Forbes once referred to Berle and Means book as "the economic Bible of the Roosevelt Admin" - here. Adolph Berle was part of FDR's brain trust.
But it was 1976, not 1932 and we had raised a generation of business leaders who had no memory of the Great Depression and no awareness that more of a shared prosperity was necessary if Capitalism was to survive. Economist Richard Wolff talks about this at around the 30 minute mark in his PBS interview with Bill Moyers. President Roosevelt went to the corporations and the wealthy and told them:
"you must give me [the President] the money to meet the basic needs of the masses of people to be massively helped or the goose that lays your golden egg is going away."He was able to convince half of them. I always wondered how crucial it was to persuade any of them to pass the New Deal reforms?
Why did many of them accept stakeholder capitalism? Did the Great Depression teach them it was necessary to capitalism to survive? In the 1930's the Soviet Union and other countries turned to Communism as the answer to Capitalism's inability to create shared prosperity. Was it because it worked better? Was it because the New Deal, solid labor unions, and an activist government made it the pragmatic thing to do?
The next generation's investor class considered stakeholder capitalism (not to mention labor unions and a lot of other New Deal reforms) as a pesky problem that prevented them from being even more wealthy. How could they better align executive and board of director decisions with shareholder interests? The answer was pay for performance, stock options, and equity based compensation.
Lynn Stout notes on page 20 of her book:
In 1984, equity based compensation accounted for zero percent of the median executives's compensation at S&P 500 firms: By 2001, this figure has risen to 66%.
But does the principal-agent relationship apply to huge multinational corporations the way it might a small closely held business?
In her book, Lynn Stout says no:
But its patently and demonstrably wrong, as a descriptive matter, to claim that Jensen and Meckling's simple model captures the economic reality of a public corporation with thousands of shareholders, scores of executives, and a dozen or more directors. The standard model may describe some kinds of firms...but it grossly mistates the economic structure of public corporations.I'm not a lawyer, and I don't want to copy long multiple paragraphs out of concern for both being brief and copyright. I'll explain her arguments as I best understand them briefly as I can. The principal-agent claim is based on a few assumptions. First, that shareholders own the corporation. Second, that shareholders have a residual claim to profits left over after all contractual obligations are paid. Third, that shareholders are the principal and executives their agents.
In Chapters 2 and 3, Lynn Stout argues a corporation is an independent legal entity that owns itself. Shareholders own shares. Those shares give them very limited rights. She argues the residual claim theory has its roots in bankruptcy law, but a living corporation has a different purpose than a dead one.
In her book, Lynn Stout also indicates that shareholder primacy appears to have reached its zenith and is "poised for decline."
At least among experts, shareholder value thinking had reached its zenith and was poised for decline. The first sign was the number of articles that began appearing in legal journals in the late 1990's and early 2000's. These articles, written by lawyers, began pointing out a truth the Chicago School economists seem to have missed: U.S. corporate law does not, and never has, required public corporations to maximize shareholder value.Where did the idea U.S. corporate law requires corporations to maximize shareholder wealth? In her book and her paper Why We Should Stop Teaching Dodge v Ford she says:
Much of the credit--or perhaps more accurately, the blame—for this state of affairs can be laid at the door of a single judicial opinion. That opinion is the 1919 Michigan Supreme Court decision in Dodge v. Ford Motor CoIn the paper, she notes Dodge v. Ford is the only legal authority cited to back up the view corporations are legally required to maximize shareholder wealth. What were the facts of the case?
The case wasn't about a public corporation. The case was about a majority shareholder (Henry Ford) using his power to oppress a minority one (John and Horace Dodge). The Dodge brothers wanted to start their own car company. Henry Ford withheld dividends to to deprive them of capital necessary to do that. The court ordered Ford to pay a special dividend, and in response to Ford's ridiculous claims as to why he withheld dividends, the court made an offhand remark - or dicta - how a business should be carried on for the profit of stockholders. Note: dicta is not precedent and future courts can disregard it. It is just an observation unnecessary to reach a decision.
Again, this was a case about a majority shareholder oppressing a minority one and not a case about a public corporation (which Ford Motor wasn't at the time). In the book, Lynn Stout notes:
The one Delaware opinion that has cited Dodge v. Ford in the last 30 years, Blackwell v. Nixon, cites it for just this proposition.In Chapter 7, Lynn Stout talks about how shareholder primacy looks at the world from the perspective of the "Platonic investor." The platonic investor is someone who has no other assets or interests to protect but the short term value of one company's stock. In reality, the platonic investor doesn't exist however the undiversified hedge fund comes close.
The reality is most shareholders are "universal investors" with a stake in the economy at large, in communities, and in our planet.
When a public company announces it will move a facility overseas and lay off workers to boost its stock price, are any of those employees also shareholders? What if Worker A used to frequently dine out at a nearby Denny's but no longer can? Does that help or hurt Denny's shareholders? What about the waitress he used to tip who now cuts back on her grocery bill at Target? What about the many other businesses with less revenue because various people aren't spending quite as much? What about governments who now take in less tax revenue? What about local charities Worker A used to donate to? Did anyone benefit from this greed grab except the rare platonic shareholder?
When a public company neglects the environment don't their shareholders also have to breath the air and drink the water? When oil companies spend millions of dollars to promote climate change denial, does this help or hurt their shareholders? Aren't oil company shareholders also impacted by increasingly unstable weather patterns? Don't they own homes, and pay taxes? The rare platonic investors no doubt plan to move to the coming climate haven.
If large public companies individually and collectively have the ability to make decisions that can ruin hundreds, thousands, even millions of lives why should they be run for the benefit of the very rare platonic shareholder?
In my reading, I learned many knowledgeable people believe we are near the start of a new era in capitalism. In the final chapter of her book, Lynn Stout wrote:
The good news is among experts shareholder value dogma shows signs of being in decline. To return to Thomas Kuhn, the shareholder primacy paradigm is failing and alternative paradigms are rising to take its place
What are those alternative paradigms? After all, it isn't enough to say something isn't working - we need workable alternatives. The Forbes article Is the Hegemony of Shareholder Value Finally Ending mentions two alternative paradigms. The first would returning to the Stakeholder model that worked so well during the New Deal era.
(1) We could return to the Stakeholder model that worked so well from the 1930's to the 1970's. Proponents of this model include Lynn Stout (cited earlier), Berle and Means (cited earlier), and Justin Fox and Jay Lorsch noted in their Harvard Business Review article What Good Are Shareholders?
(2) There is "Customer Capitalism" embraced by Roger Martin in his book Fixing The Game. In this model, a business should focus on servicing and keeping customers, and not on maximizing shareholder wealth. If customers are taken care of, all other stakeholders will be. While I haven't read Roger Martin's book yet, I'm not convinced this model would adequately consider employees and the environment.
Finally, I want to address the need for corporate tax reform. In his interview, Ralph Gomory talks about why IBM wanted to sell its PC business to China and why China wanted to buy it. The PC business was a low profit margin business. It didn't make a ton of money for IBM shareholders. However, a business can have a low profit but add high value to our economy. For example, a low profit margin business may employ a lot of workers at a fair wage who spend their income which helps other businesses adding a lot of value.
In a 2008 testimony before Congress, Ralph Gomory proposed changing the corporate tax code so instead of taxing corporations by profit we tax them according to the value they add to our economy. A company that adds little value - outsources jobs, doesn't pay a living wage, etc. - would face a very high corporate tax. A company that adds a lot of value to our economy - keeps jobs in the U.S., pays a fair wage, etc. - would have a very low tax. In his testimony, he said this would be easy to measure. An article on this can be found - here. While I don't know exactly how this would work, I'm intrigued by the idea. I would support making the environmental part of the value added measure. A company that is a poor environmental steward obviously detracts from our country's value. A company that is a good one adds to it.
The floor is yours.