Americans want an economy that delivers equitable and stable growth. Instead the economy delivers inequitable income, unstable employment, and sagging productivity. The prime reason for these adverse economic outcomes is the dominance of “maximizing shareholder value” (MSV) as an ideology of how business corporations should allocate the resources under their control. As such, I fully endorse Lenore Palladino’s critique of shareholder primacy.
Equitable and stable growth occurs when major business corporations “retain-and-reinvest.” They retain corporate profits and reinvest in productive capabilities, including first and foremost those of employees. As implemented in the United States, however, MSV advocates “downsize-and-distribute.” A company seeks to downsize its labor force for the sake of distributing more corporate cash to shareholders.
These distributions take the form of stock buybacks and cash dividends. Since the mid-1980s, when MSV came into full force, trillions of dollars have been sucked out of major U.S. corporations for the sake of “creating” value for shareholders. The results have been extreme concentration of income among the richest households and a deterioration of employment opportunity for most of the rest.
It is hard to overemphasize how massive these distributions to shareholders have been—especially recently and especially with buybacks. The 222 companies in the S&P 500 Index that were publicly listed from 1981 through 2018 expended 4 percent of profits on buybacks and 50 percent on dividends in the years 1981–1983; from 2016–2018, however, they spent 64 percent of profits on buybacks and 52 percent on dividends. Surges in stock buybacks are not a wholly new phenomenon—in 1997, for the first time, buybacks surpassed dividends—but the recent trends are concerning, especially since companies often lay off employees or take on debt to augment the funds for buybacks.
As Palladino shows, academic economists have long legitimized this predatory “value extraction” through various means, but I’d like to elaborate on her discussion of MSV’s 1932 origins with Berle and Means, its 1970s popularization with Milton Friedman, and its subsequent legitimization by Friedman acolyte Michael C. Jensen.
Berle and Means’s book, The Modern Corporation and Private Property, fits the definition of a “classic”: a book that everyone cites but few have read. In their concluding chapter, Berle and Means stress that, with the separation of ownership and control, public shareholders become “inactive and irresponsible security owners” with little ability or incentive to run the large corporation. Yet, Berle and Means continue, if managers are left to exercise unconstrained control over corporate decision-making, there is the “danger of a corporate oligarchy coupled with the probability of an era of corporate plundering.” As “the lesser of two evils,” they advocate for a corporate-governance system in which management as “the control” acts as a trustee for the collectivity of security holders.
But that is not the whole story. Berle and Means argue that “a third possibility exists” because the separation of ownership and control has “placed the community in a position to demand that the modern corporation serve not alone the owners or the control but all society.” They continue (with my emphasis):
It remains only for the claims of the community to be put forward with clarity and force. . . .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.
In my own work on “the theory of innovative enterprise” (cited by Palladino), I argue that households—as workers and taxpayers—have economic grounds for putting forward the “claims of the community.” These stakeholders make investments in productive capabilities that, through innovation, enable higher standards of living. Hence representatives of workers and taxpayers have fundamental interests in corporate resource allocation and should have representation on corporate boards.
This is precisely what a Ralph Nader-inspired movement called “Campaign GM” tried to do in 1970. At GM’s annual meeting in May 1970, a proposal to the shareholders called for three “public interest” members on GM’s board of directors to advocate for safer and more fuel-efficient cars. Importantly, this was the impetus for Friedman’s New York Times article, “The Social Responsibility of Business Is to Increase Its Profits,” which Palladino cites. In an introductory comment to Friedman’s article, a New York Times editor makes it absolutely clear that Friedman’s purpose is to counter the movement for corporate social responsibility.
Representatives of Campaign G.M. demanded that G.M. name three new directors to represent “the public interest” and set up a committee to study the company’s performance in such areas of public concern as safety and pollution. The stockholders defeated the proposals overwhelmingly, but management, apparently in response to the second demand, recently named five directors to a “public-policy committee.” The author [Milton Friedman] calls such drives for social responsibility in business “pure and unadulterated socialism,” adding: “Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of free society.”
In retrospect, however, the demands of Campaign GM for safer and less-polluting cars were demands for GM to engage in automobile innovation. In the 1970s and beyond, the world leaders in producing these “socially responsible” cars would be Japanese and European companies, leaving the MSV-obsessed General Motors lagging further and further behind. What Friedman called “pure and unadulterated socialism” proved to be the innovative future of the automobile industry!
The 1976 publication of “The Theory of the Firm,” by Michael C. Jensen and William H. Meckling, was the landmark application of Friedman’s wrong-headed doctrine. These free-market “agency theorists” argued that by aligning managerial incentives with the interests of public shareholders, MSV would transform sinners into saviors. To implement MSV, however, they needed a little help from their deregulatory friends. As Ken Jacobson and I document in a forthcoming article, the election of Ronald Reagan enabled agency theorists to capture the Securities and Exchange Commission (SEC), turning it from a regulator to a promoter of the stock market. In November 1982, the SEC ‘s adoption of Rule 10b-18 legalized stock-market manipulation through massive buybacks done as open-market repurchases. Jacobson and I call Rule 10b-18 “a license to loot.”
The dominance of MSV as U.S. corporate-governance ideology took off from there. I was on the Harvard Business School faculty at the time and can attest that while MSV was barely mentioned on the campus in the early 1980s, it was beyond the rage by 1986—in large part because Jensen was appointed to a professorship at HBS in 1985. A study of hits for “shareholder value” in the Wall Street Journal found that they exploded from 1985.
Since then, MSV ideology has justified the looting of many major U.S. corporations. This is because public shareholders do not actually invest in productive capabilities. They merely buy and sell shares that are outstanding on the stock market. Even venture capitalists who make private equity investments in startups view an initial public offering (IPO) on the stock market as an “exit strategy.” As for successful, mature corporations, consider the iconic example of Apple. Since fiscal 2013 Apple has expended a combined 115 percent of its profits with $288 billion in stock buybacks and $83 billion in dividends under its inaptly named “Capital Return Program.” But in its history, the only finance that Apple ever secured from the public stock market was $97 million in its 1980 IPO, and we can assume that those original public shareholders have long since cashed in their holdings. So how can Apple “return” money to participants in the corporation who gave it nothing?
There are signs, thankfully, that the dominance of MSV is beginning to unravel. Recently, with 181 corporate CEOs as signatories, the Business Roundtable recanted its express adherence to MSV, calling for a stakeholder model as the purpose of the corporation. No doubt the CEOs fear the progressive backlash against MSV, most visible and palpable in Sen. Elizabeth Warren’s Accountable Capitalism Act, introduced in August 2018.
Warren’s Act is part of a progressive agenda to transform corporate governance to serve the public interest. She and Sen. Bernie Sanders are also co-sponsors of Sen. Tammy Baldwin’s Reward Work Act, first introduced in March 2018, which would rescind SEC Rule 10b-18, making companies that do large-scale buybacks open to manipulation charges. As an extension of the Reward Work Act, with its requirement that all publicly listed companies reserve one-third of the board seats for employee representatives, the Accountable Capitalism Act, applicable to about 1,600 corporations with annual revenues greater than $1 billion, would permit employees to elect directors to 40 percent of the board seats. In addition, the Warren Act would require political spending by these corporations to be approved by 75 percent of the directors. More fundamentally, these very large corporations would have to operate under a new national corporate charter that would replace the current shareholder-primacy governance model with one that requires that the corporation be run for the benefit of employees and the community.
Perhaps the CEO members of the Business Roundtable hope that their verbal support of a stakeholder model will forestall the type of legislation that Baldwin and Warren propose. But the time is ripe to turn words into action. To justify fundamental institutional change, it is time for those of us concerned with corporate governance for sustainable prosperity to take up the Berle-Means challenge by putting forward the claims of the community with clarity and force.