In October, the New York Times ran a story comparing how older large corporations–the recently bankrupted Sears, in particular–were more generous to their lower-rung employees than are the newer ones–Amazon, in particular. Sears (the Amazon of its day) had offered more in wages, benefits, and stock options. The Times story failed to point out the important, and invisible to most Americans, sea change in business that fostered such differences: the triumph of “shareholder value.”
Shareholder value is the doctrine that officials of a publicly-held corporation must focus on maximizing the value of its shares rather than act in the interests of workers, suppliers, customers, the local community, society at large, the environment, themselves as managers, or the corporation itself. The ascendancy of this guiding principle since about 1970s has boosted inequality by making investors and management much wealthier and by weakening workers and localities. Dealing with this idea is one of the challenges facing those who seek to reverse growing inequality.
History and Principle
The United States originally created corporations as legal entities to encourage private investment for specific public purposes. In return for risking your money in a fictive but legal “person,” the law capped your liability at your investment. If the corporation you bought shares in–say, an enterprise to build a canal for moving western grain to eastern ports–went belly-up, you lost only your stake; the corporation’s creditors, unpaid workers, injured customers, and so on, could not come after your personal assets. Eventually, governments agreed that encouraging just about any economic activity was a public good and corporations became common vehicles for business. Corporate law was one the major nineteenth-century social inventions–limited liability in return for risking an investment–that spurred American economic growth. (References at the bottom of the post.)
Legally, corporate managers are required to prioritize the overall good of the corporation itself, not necessarily those of its investors. Those shareholders do not own the corporation; they own legal claims to returns from their investments. A board of directors might legally, in its fiduciary role, decide that fighting climate change or having happy workers was the best way to secure the corporation’s viability for decades to come and would be wiser than paying out more dividends today.
In practice, however, since the 1970s such autonomy has been shoved aside by academics (notably, Milton Friedman), conservative think-tanks, large investors such as pensions and hedge funds, and the courts in favor of a blunter standard for judging corporate leadership: maximizing the medium-term value of the shares. Meeting that standard could include allowing the company’s dismemberment if a takeover bidder offered a high enough price for the shares. The emerging consensus among the key actors in the corporate and legal worlds became that, in the end, the greater good of everyone–of the broader society as well as of the shareholder–would be optimized if managers just boosted the value of the corporate stock, whatever that might do to other “stakeholders,” such as employees or neighbors.
This was a big change. As late as 1981, the Business Roundtable declared that “corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit … to continue and enhance the enterprise, provide jobs, and build the economy.” But in 1997, it asserted instead that “[T]he principal objective of a business enterprise is to generate economic returns to its owners [sic]…”
The rise of the shareholder norm is consistent with the rise–nurtured by conservative-libertarian think-tanks–of the “Law and Economics” movement, the legal philosophy that courts should make economically efficient decisions and that these are best done by letting markets and market incentives operate freely.
In a famous Georgetown Law Review paper of 2001, Henry Hansmann and Reinier Kraakman declared “The End of History for Corporate Law.” The debate was over: Logic and international experience had demonstrated that the shareholder-controlled corporation was much more efficient than manager-, or worker-, or state-controlled businesses. “To serve the interests of society as a whole” it is best to make “corporate managers strongly accountable to shareholder interests, and only to those interests [emphasis added].”
Thus, managers today who seek goals other than high stock returns risk opprobrium, shareholder demands, and expensive law suits. To further insure that managers act to maximize shareholder value rather than, say, the affection of workers, social justice, or their own expense accounts, big investors lined up managers’ financial interests with their own. They did so by paying corporate managers in proportion to the corporations’ shareholder values. Compensation for corporate executives went from being almost totally in salary to being mostly in stock.
And what about safeguarding other interests, such as those of workers, suppliers, clients, and local governments? These folks get their just share, goes the shareholder value argument, through the contracts they negotiate in the open market and through government regulation where needed. At this point, a skeptic could rightly interject, “Oh, sure!” When it comes to big corporations, the imbalance of lawyering power and the fact of “regulatory capture” overwhelms most stakeholders. (The proliferation of non-competition, non-disclosure, and required arbitration labor contracts is but one example.)
The corporate buy-out binges that followed the increase in shareholder power sparked some resistance from state governments worried about workers being laid off and plants being shuttered. Many passed “constituency” laws which permit managers to take other interests into account when fighting off takeovers. However, it is clear that, in practice, these have become largely toothless. Especially when a company is being bought out, the directors have to, courts have ruled, prioritize the sales price.
Inequality
What did the victory of the shareholder value idea mean for economic inequality? That victory certainly coincided–from the 1970s into the 2000s–with growing inequality, but I haven’t (yet) found a study that directly connects those dots. Nonetheless, the new doctrine probably widened inequality in several ways.
Most simply, it vastly enriched corporate executives; they now benefited directly from rising stock prices. The gap between CEOs’ incomes and that of average workers in their firms grew by at least three-fold, perhaps by much more.
Shareholder value advocates meant to pump up the value of stocks and they succeeded. From the early 1970s to today, the inflation-adjusted value of the S&P 500 rose about 400%. Meanwhile, the wages of average workers have grown basically zero. If you generously throw in employee benefits such as health insurance and vacations, the employees’ growth rate comes to about 60 percent over about 50 years, about one-seventh the growth rate for stocks. Some commentators point out that more Americans own stock nowadays than used to, basically through their retirement portfolios. While true, most individuals own very few shares either directly or indirectly, while a relative few individuals own a whole lot. The rise in equity has added to wealth inequality; the top one percent own 46 percent of all financial resources, up from 38 percent in 1969.
Observers have noted that the growth of shareholder value promoted and was promoted by “financialization”–the expanding role of financial institutions in directing American economic life. In the old days, the Fords and Carnegies were the captains of industry, making their money by making cars and steel; today, it is increasingly the hedge fund directors and the bosses of large investment banks who steer the economy (as dramatized in leveraged takeovers). Financialization has drawn assets away from the larger economy to the smaller, more exclusive world of money managers.
Shareholder value ideology has purposely empowered managers over labor in negotiations and conflicts over wages and conditions. Over the last couple of generations, employees’ share of business income has declined, but declined especially fast in the last couple of decades. Many factors, from technology and globalization to financialization, contributed, but the weakening leverage of workers in boardrooms probably contributed as well.
It is harder to calculate the inequality consequences of the “externalities” associated with the shareholder value movement, by which I mean the effects on third parties of corporate decisions, be they to discharge fumes into the air, to close factories in small communities, or to plant large offices in already dense communities (as in Amazon’s decision to land HQ2 in Queens, New York). What you can be sure of is that the poorer the bystanders are–be they renters downwind of the fumes, taco-truck operators outside factory gates, or bus riders trying to get into Manhattan–the more they are going to suffer the result of the corporate decision.
Again, advocates of shareholder value point out that workers and third parties have the regulators and the courts to turn to. Yet, as the power of capital investors inside firms has risen, so has their power in government and in the courts, from the arrival of Reagan in 1981 through the recent capture of the Supreme Court by the Federalist Society. (At the moment, spotted owls may be better protected than laborers.)
One thing this story shows is the power of an idea that gets enforced by institutions. Here, I present a small anecdote. In 1999, as part of a law school conference on business and society, I delivered a paper on the expansion and cost of inequality, in which I pointed out that there was little support for the claim that inequality grew the economic “pie.” The commenter on my paper was a justice of the Delaware Supreme Court–a very important court for corporate law across the nation. Despite my extended review of the empirical literature on that point, the justice simply waved it away, asserting that logic dictated that inequality must generate economic growth. Such was (and is) the power of the law and economics ideology.
What Might be Done?
In one of his Times columns, David Leonhardt touches on shareholder value topics and reports a reform proposal by Sen. Elizabeth Warren. It is a version of the “constituency” laws that sought to empower interests besides those of shareholders in corporate decisions; Warren would require that 40% of corporate board seats be filled by employee vote. This is the sort of shared governance that Hansmann and Kraakman claimed had failed in Europe. Whether it could succeed here or not–or ever even be passed here–it may not be the optimal solution. Another direction would be to reinforce the legal power of the other stakeholders–of unions, individual employees, regulators, and injured bystanders–and strengthen as well the principle that the corporation–as long as it is going to exist as a separate legal “person”–needs protection against its creditors.
In any event, the tale is one that again shows how the inequality we face is not a natural product of economic activity but guided by political decisions–Inequality by Design.
(Thanks to legal consultant David Levine)
Update (Dec. 14, 2018): For a broader review of the connections between shareholder value ideology and the growth of inequality, as well as a discussion of the Warren proposal, see Matthew Yglesias here.
Update (Dec. 11, 2018): Reader Chris Soria adds these two notes on corporate governance and inequality: A 1992-93 rule capping the amount of CEO salary that could be deducted from corporate taxes led to expanding stock payments to executives. And, “in 1982 stock buybacks were legalized once again by Reagan’s SEC and since then stock buybacks have been increasing (reached all time highs in 2017).” Both together amplified inequality.
Update (Aug. 23, 2019) — CEOs against shareholder value!
Washington Post, August 19, 2019: “A group representing the nation’s most powerful chief executives on Monday abandoned the idea that companies must maximize profits for shareholders above all else, a long-held belief that advocates said boosted the returns of capitalism but detractors blamed for rising inequality and other social ills.
In a new statement about the purpose of the corporation, the Business Roundtable, which represents the chief executives of 192 large companies, said business leaders should commit to balancing the needs of shareholders with customers, employees, suppliers and local communities.
“Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity,” said the statement from the organization, which is chaired by JPMorgan Chase CEO Jamie Dimon. “We commit to deliver value to all of them, for the future success of our companies, our communities and our country.”
The announcement was met with some wonder and more than a little skepticism. A key issue in my mind is: Even if the CEOs are sincere and make the effort, has shareholder value become so baked into legal practice and judicial thinking that corporations which really weighed workers, customers, and communities as highly as shareholders would be so vulnerable to lawsuits that the change becomes inoperable?
[Se also this New York Times essay by Salesforces’ Marc Benioff here.]
Update (July 26, 2020}: Two pieces in The New York Times Business section: (1) A (weak) defense of shareholder value by a Harvard economist; (2) A story of how corporations are “educating” regulators around the globe to support shareholder value.
Update (March 1, 2022): A study of how corporate America educated American judges to loosen up oversight: Economists Ash, Chen, and Naidu describe “an intensive economics course that trained almost half of federal judges between 1976 and 1999.” This course–all expenses paid, funded by corporations, and held in a beach-side hotel with judges’ families invited to come along–led “participating judges [to] use more economics language in their opinions, issue more conservative decisions in economics-related cases, rule against regulatory agencies more often, [and] favor more lax enforcement in antitrust cases. . . . .”
Update (August 1, 2022): In this 2022 paper, Neil Fligstein and Adam Goldstein present an overview of the shareholder story and its consequences for inequality.
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Some Sources
A. Bisconti, “The Double Bottom Line: Can Constituency Statutes Protect Socially Responsible Corporations Stuck in Revlon Land?,” Loyola of Los Angeles Law Review, 2009.
T. Clarke and S. Gholamshahi, “Corporate Governance and Inequality,” in Alijani and Karyotis (eds.), Finance and Economy for Society, 2016.
M.W.L. Elsby et al, “The Decline of the U.S. Labor Share.” Brookings Papers on Economic Activity, Fall 2013.
N. Fligstein and T.J. Shin, T. J., “The shareholder value society,” in Neckerman (Ed.), Social Inequality, 2004.
R. Gomory and R. Sylla, “The American Corporation,” Daedalus. 2013.
A. Gunnoe, “The Financialization of the US Forest Products Industry,” Social Forces, 2016.
H. Hansmann and R. Kraakman, “The End of History for Corporate Law,” Georgetown Law Review, 2001.
S. Hejeebu and N. Lamoreaux, “Firm,” The Oxford Encyclopedia of Economic History, 2003.
P. Ireland, “Shareholder Primacy and the Distribution of Wealth,” The Modern Law Review, 2005.
J. Jung, “Shareholder Value and Workforce Downsizing, 1981-2006,” Social Forces, 2015.
W. Lazonick, “The New Normal is ‘Maximizing Shareholder Value’,” International Journal of Political Economy, 2017.
M. Lipton et al., “Corporate Governance in the Era of Institutional Ownership,” New York University Law Review, 1995.
M.G. Robilotti, “Codetermination, Stakeholder Rights, and Hostile Takeovers,” Harvard International Law Journal, 1997.
W.D. Schneper and M.F. Guillén, “Stakeholder Rights and Corporate Governance,” Administrative Science Quarterly, 2004.
A.D.A. Smith et al., “Berle and Means’ The Modern Corporation,” Academy of Management Proceedings, 2017.
N.E. Standley, “Lessons Learned from the Capitulation of the Constituency Statute,” Elon Law Review, 2011.
L. Stout, The Shareholder Value Myth, 2012.
E.N. Wolff, “Household Wealth Trends in the United States, 1962 to 2016,” NBER Working Paper No. 24085, 2018.
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