The idea that corporate governance reforms that empower shareholders to direct the activities of corporations would make companies more financially responsible was dealt a serious blow by the financial crisis of the past year.
Financial companies that score highest on most measures of corporate governance performed poorly during the crisis, perhaps because shareholders were demanding too much risk in the quest for outsized returns.
Unfortunately, economists and academics specializing in corporate governance have yet to adapt to this lesson. Calls for shareholder democracy and a greater role for shareholder decisions in things like executive pay still predominate the conversation. But there may be hope that this can change–thanks in part to the new attention being paid to behavioural economics.
Economists have long lagged behind political scientists in their appreciation of the role of ignorance and irrationality. Economists tend to treat decision making as a matter of incentives, often over-looking the fact that the world is characterised by misinformation and ignorance that interfere with rational decision making long before incentives even enter into the picture.
In political science, the roles of irrationality and public ignorance are well understood. Studies going back decades prove that the public is not only ignorant, it is stubbornly ignorant. It remains ignorant even in the face of widely available and easily obtainable information. Voters are so ignorant that they cannot rationally choose between different programs offered by politicians. And the ignorance persists so that they cannot assign blame or credit to the parties responsible for the programs that are ignorantly selected.
If economists were to take this seriously and apply it to shareholder behaviour, they might discover that the case for shareholder democracy is seriously undermined. Instead, many continue to doubt that shareholder ignorance is a serious problem. And those who acknowledge it could be a problem, often assume it can be overcome by providing shareholders with more information. This simply ignores what we’ve learned in political science about shareholder ignorance.
Fortunately, behavioural economics has made inroads recently into the standard model of rationality. So far, much of the work has focused on consumer ignorance and irrationality. But this should open up a whole field for a budding economists looking to make a name for himself or herself: the ignorance of shareholders remains largely untouched. The first step is probably to mimic the surveys that first established political voter ignorance: survey shareholders and objectively document ignorance.
So, economists, get to work!