The myth of maximizing shareholder value
In a well-intentioned op-ed in The Washington Post, Wikipedia founder Jimmy Wales recently extolled his new phone venture, which has pledged to devote a quarter of its profits to “good causes” selected by an independent foundation. Now, I support good causes as much as the next fellow, and I have nothing negative to say about this initiative. I am compelled, however, to note that in delineating the obligations that corporations must meet, Wales made an error at once so common and so fundamental that it screams for correction.
In his discussion of the ways in which increasingly unpopular big businesses defend themselves against their critics, Wales wrote: “They argue, correctly, that the legal requirement of for-profit companies to maximize returns to shareholders limits their behavior.”
I never sought the opportunity to correct Wikipedia’s founder. Nevertheless, facts are facts, and the fact is that there is no legal requirement for for-profit companies to maximize returns to shareholders. When a company is for sale, its directors are required to do all they can to maximize its value. At any other time, corporate law simply dictates that directors are supposed to help the company prosper and do nothing to benefit themselves at the company’s expense. But no law requires corporations to maximize returns to shareholders. Say a company would prosper by hiring more skilled but more costly workers, by building a new factory or outlet, by spending more on research and development — even if such actions reduce returns to shareholders in the next dividend payment. Those actions are entirely legal, not to mention existentially smart.
Don’t believe me, Mr. Wales? Check the Wikipedia entry on “Corporation.” Check the Wikipedia entry on “Corporate law in the United States.” No such law in any of the 50 states even raises the topic of maximizing shareholder returns. A survey by Cornell law professor Lynn Stout couldn’t find a corporate charter that listed as the company’s mission maximizing shareholder value.
The idea that corporations exist to reward their shareholders arose not in a body of law but from the work of ideologically driven economists. In 1970, Milton Friedman wrote that business properly had but one goal: to maximize profits. The same year, Friedman’s University of Chicago colleague Eugene Fama argued that a corporation’s share price was always the accurate reflection of the enterprise’s worth, an idea that trickled down into the belief that the proper goal of a corporation was to boost its share value — particularly after most CEO salaries and bonuses became linked to that value.
Beginning in the 1980s, when General Electric chief executive Jack Welch laid off more than a quarter of GE’s employees while driving its share value higher, American business abandoned its earlier “stakeholder” model — in which it sought to balance the interests of workers, shareholders and the larger community — in favor of the shareholder model, under which investment in promising new ventures and the pay and benefits of employees were sacrificed on the altar of short-term profits and share value. So stocks soar — the share value of the Standard & Poor’s 500 rose 30 percent last year — while wages and investment languish. In the fiscal year ending in June, the same S&P 500, according to the data company Factset, is on track to have raised capital expenditures by a piddling 1.3 percent. Americans’ real disposable income in 2013 increased by a meager 0.7 percent, a figure that includes the income derived from those soaring stocks, which should convey some sense of how dismally wages are faring and how few Americans have significant stock holdings.
Apologists for the 1 percent generally argue that our rising levels of inequality are the consequence of globalization and technological change — forces of nature over which mere people and nations have had no control. They often blame U.S. workers for lacking sufficient training. But they omit from their diagnosis the shift from stakeholder to shareholder capitalism. This is not surprising, as it’s a shift that Wall Street and corporate executives brought about. Indeed, the German economy is every bit as subject to the forces of globalization and technology as ours, but inequality is lower there, and German workers have more security and opportunity than ours, because German capitalism still adheres to the stakeholder model.
If we think, as Wales apparently does, that our own form of capitalism is required by the legal obligations on corporations, we’re sadly misinformed. Shareholder capitalism is sustained not by law but by an institutional edifice of greed. The U.S. economy will not work again for the American people until they tear down that edifice.
Meyerson is editor-at-large of The American Prospect.