What good are shareholders? Not much, say Jay Lorsch, a Harvard Business School professor, and Justin Fox, the editorial director of the Harvard Business Review, in whose current issue they outline the shortcomings and tally the surprisingly few benefits of shareholder capitalism.
In theory, they begin, shareholders help corporations in three ways: They provide funding through their investments; they provide information through the supposedly evaluative pricing of corporate stock; and they provide discipline by serving as a check on errant management.
In fact, Lorsch and Fox conclude, shareholders generally fail at each of these tasks.
Established corporations, they write, “finance investments out of retained earnings or borrowed money” — not shareholders’ funds. Start-ups rely on venture capital, but they’re the exception to the rule.
The relationship of share value to the actual value of a corporation, they continue, is shaky at best. Fox and Lorsch cite the work of finance scholar Fischer Black, who concluded that “at least 90 percent” of the time, the prices prevailing on financial markets are somewhere between 50 percent and 200 percent of a corporation’s actual worth. Sometimes, the relationship between what the market says and how the corporation actually performs is inverse: A study published early this year by executive headhunter James M. Citrin concluded that corporations whose stock plunges when a new chief executive is named decisively outperform corporations whose stock soars when a new CEO is named.
And when it comes to disciplining management — you’re kidding, right? The salaries and payments to corporate CEOs have skyrocketed in recent decades, come rain or shine, recovery or recession. Unseating directors remains a daunting, and seldom accomplished, task. The Dodd-Frank financial reforms did create a “say on pay” right for shareholders, by requiring companies to submit their executive pay packages for investor approval, but the shareholders’ vote is only advisory.
What underlies this striking lack of shareholder power and utility? For one thing, shareholders ain’t what they used to be: They’re more renters than owners, and short-term renters at that. In the 1950s, a stock listed on the New York Stock Exchange was held, on average, for seven years, Fox and Lorsch write. Today, it’s six months. As much as 70 percent of the daily volume on the NYSE comes from high-frequency traders who hold a stock for roughly the same amount of time it takes a Higgs boson to disintegrate. Capital that impatient does not fund, discipline or measure the value of a company.
The eclipse of the long-term shareholder has been accompanied by the eclipse of the individual shareholder. In the ’50s, more than 90 percent of the shares in U.S. corporations were held by individuals. Today, Fox and Lorsch estimate, individual shareholders own 30 to 35 percent. Investment funds that hold shares in many different companies often lack the resources to focus on a single corporation’s performance, which is why such funds increasingly rely on companies such as Institutional Shareholder Services to tell them how to vote their shares.
Still, the myth of shareholder power, and especially individual shareholder power, is continually attested to by corporate managers and their apologists because it legitimates the current system of corporate governance and the division of corporate riches. CEOs don’t acknowledge that the system is rigged in their favor. But the rise of shareholder capitalism — the doctrine that has dominated corporate conduct since the early ’80s, as corporations’ raison d’etre has been reduced to maximizing shareholder value — has been a boon to top executives. They have been able to tie their compensation packages to rising share value (and untie it when share value falls).
The transformation of the shareholder from an individual with a long-term interest in the company to an institutional short-timer with myriad other investments raises a deeper question about corporate governance: Why is it that shareholders, at least theoretically, are entrusted with electing corporate boards? Why aren’t more long-term stakeholders with a genuine interest in the company’s success — say, their employees — also represented on corporate boards, as they are required to be in Germany? German corporations are thriving, even though (or more likely, because) their CEOs are paid radically less than ours and their workers command a higher share of gross domestic product than ours.
Under shareholder capitalism, American big business has disinvested in the United States and moved work to where labor is cheap and the government subsidies are bigger. Among stakeholder capitalism’s many merits, it might just help bring American business home.