Cornell Law School’s Lynn Stout is challenging the cherished idea that nothing is more important than share price.Ideas have consequences, we all know, but some have more consequence than others. If ever the business world generated a consequential idea, surely it’s the notion of “shareholder value;” that publicly owned companies exist solely for the benefit of their stockholders, and that the CEO’s highest—perhaps only—responsibility is boosting the share price.
That may sound uncontroversial, but Cornell Law School professor Lynn Stout says the “shareholder-primacy ethos” encourages a focus on short-term earnings while neglecting the long-term view and the larger, societal consequences of corporate behaviour. Her new book, The Shareholder Value Myth, makes the whole concept sound like little more than a convenient rationale for enriching corporate managers and institutional investors at the expense of ordinary folks.
Stout calls shareholder primacy “an ideology,” not based in law or solid economics. Even GE legend Jack Welch, viewed in the 1980s and 90s as the high priest of shareholder value, by 2009 had come to see it as “the dumbest idea in the world.” Stout’s alternative is known broadly as “managerialism,” or the idea that large corporations should consider not just their shareholders but also their “stakeholders”—employees, customers, counterparties, and society at large.
We chatted with Stout about her book. An edited transcript:
Who is most responsible for popularizing shareholder primacy, and do you think their motives were self-serving?
It’s the product of what you might almost describe as academic central planning or an attempt at intelligent design. It was the brain-child of the Chicago School economists, invented in the lab, as it were. But it was very useful to certain influential interest groups, among them executives like Jack Welch, who recognised early that if you could structure their compensation around share price and then run the firm to maximise share price, they individually could get very wealthy. And, in fact, that’s exactly what Jack Welch did. [GE] was very well run for a time. But a lot of people have criticised that emphasis on constantly raising share price for [GE’s] failure to keep up with research and development, and hollowing out some of its workforce, and for causing it to spend a lot of time lobbying Congress for tax loopholes, which may be good for GE shareholders but is bad for the human beings that own GE shares if they happen to be taxpayers.
Do you draw a distinction between institutional and individual shareholders?
The significance of the rise of institutions is not that they have different interests from individuals, but that now those interests are being channeled in a fashion that actually may be counterproductive. There are two things that happen when you introduce institutional intermediaries. The first is, because they tend to own larger blocks of stock collectively, they actually have more influence over boards, more clout. That wouldn’t be a problem, necessarily, if it weren’t for the second characteristic of these institutions, which is that many of them are short-terminvestors that tend to hold their shares for a couple of years or even a couple of months. And it’s that second characteristic that is the source of much of the trouble. It’s not that mutual-fund managers are myopic people. It’s just that they recognise the reality that if they can’t generate short-term returns in a market where it’s all a relative game, they’re going to lose assets to funds that do generate short-term returns.
But individuals are partly responsible?
The [average] holding period for stocks was eight years in 1960; it’s down to four months. One of the primary causes is that the cost of trading stocks has declined so dramatically. Once upon a time, brokers and dealers imposed a fixed commission on trades that was quite high. We also used to have a stock-trading tax. It was reasonably modest, but it also helped slow down trading. Throw in the convenience of internet technology, and now there’s almost no marginal cost to trading stocks, which means people are constantly chasing their own tails. And by people, I mean individual investors but also pension and mutual-fund managers trying to beat the market by buying and selling. That has shortened our collective time horizon as investors.
You write that “as a theory of corporate purpose” shareholdervalue is “poised for intellectual collapse.” Will or should some form of managerialism replace it?
The lovely thing about the business world is that, given a little breathing room, it’s highly adaptable. And what we’re seeing are signs that the business world is already adapting by coming up with private ways of basically doing an end-run around shareholder-value theory. Fewer companies are going public but the ones that are increasingly tend toward dual-class or multi-class share structures, where the actual control of the firm is kept in the hands of the managerial class—the founders and the executives—and shareholders have virtually no power.
Your critics say managerial supremacy didn’t work out so well in the last century and would be worse now.
But there’s no evidence there. When people say it failed, they seem to be thinking primarily of the bear market of 1973-74, and assuming that somehow that reflects on the value of managerialism, which I think is faulty reasoning. Managerialism had been around for decades. What happened in 1973-74 was that Richard Nixon took the U.S. off the gold standard and triggeredinflation, combined with [the first oil crisis]. The price of oil quadrupled. I’m perfectly willing to be convinced by evidence that managerialism can’t work, but I have not yet seen that evidence.
I do not see this as a left-right issue. I think that people on both sides of the political spectrum want a corporate sector that works for our economy, for our society, and for investors. And the reality is, for 20 years we’ve been trying to make managers focus more on shareholders, and shareholder value clearly is not working.
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