The objective of shareholder primacy was to provide mechanisms whereby corporate leadership could be constrained to act in the best interests of the corporation and its shareholders. The metric by which executives would be judged was the shareholders share value.
It was assumed that the corporation and its shareholders would have common purpose in insuring the economic health of the enterprise. This assumption has turned out to be false. Therein resides a dilemma that can only be resolved by shattering this myth of shareholder supremacy.
Most people who actually invest in company shares do so through mutual funds or via pension plans. These people tend to be long-term investors who envisage their wealth increasing via the overall growth in the economy, rather than worrying about the specific activities of a particular company.
This is the type of shareholder people had in mind when they swallowed the shareholder primacy concept.
What type of investment environment have shareholders provided for corporations today?
How can four months and long-term be in any way consistent?
The major players in the markets are mutual funds, pension plans, and hedge funds. One might think that pension plans and mutual funds that generally represent investors with long-term goals would themselves be focused on long-term performance of companies, but that would be a mistake. Pension plans have a desperate need for a rate of return on investment that is difficult to attain in current markets. This leads them to indulge in the more extreme investment tactics such as investing in hedge funds, or investing like a hedge fund themselves. Mutual funds and hedge funds have investors with long-term goals, but short-term memories.
What is a short-term investor looking for when he/she purchases shares?
A hedge fund can exert a powerful influence on a company if it decides to invest enough to control a significant fraction of the shares. Stout refers to a study of activist hedge funds by Bill Bratton of the University of Pennsylvania. In his words:
Nowhere in that list is there anything to do with the health of the company.
In a volatile market such as exists today, failure to meet set goals can generate large market responses. This puts considerable pressure on company executives.
The concept of shareholder supremacy, coupled with the current nature of shareholders, has introduced a number of perverse incentives into the system. The extreme focus on share price, and the coupling with executive compensation, has contributed to risky and unwise decisions being made. Rather than holding executives accountable it has tempted them to do foolish things.
Where does all this lead? It leads to a dysfunctional economy. We discussed some of the issues in Corporate Profits and Wages: Karl Marx Would Be Smiling. Included there was reference to a study issued by the Federal Reserve Bank of New York that suggested that
Stock markets seem to have become disconnected from their original goal of raising equity for investment purposes. Instead they seem more like giant casinos where many high stakes and low stakes games are available for play. Money churns and the players have an exciting time, but there is little benefit to the economy or to society.
Businesses seem to recognize that becoming a public corporation is something to be avoided if at all possible. This issue was discussed in Are Public Corporations Becoming Obsolete? Companies tend to go private if they can. Private partnerships were once the typical business form; they may regain that status again.
Has the US form of capitalism come to a dead end? Something has to change. Let’s hope it is a change for the better.