Europeans have always been wary of the ideology that business corporations should be run to "maximize shareholder value." In advance of a public lecture that I am giving in Madrid on the financialization of the U.S. corporation, one of the city's financial papers, Expansión, sent me a string of questions on the subject and published my answers.
1. Why do companies think of their shareholders only?
Until the mid-1980s, top executives in the U.S. did not espouse the ideology that corporations should be run to "maximize shareholder value." (MSV) During the 1980s, however, financial economists working at politically conservative business schools at universities such as Chicago and Rochester developed the ideology out of free-market economic theory, and then imported it into more liberal business schools such as Harvard and Wharton.
Underlying this new orientation toward corporate governance was the shift of Wall Street in the 1970s from investing to trading and the growing dependence of U.S. households as savers on stock market returns. Top executives of established corporations embraced the new MSV ideology; it gave them a free hand to do large-scale employee layoffs in response to foreign competition, underperforming conglomerates, and hostile takeovers. As advocated by the academic proponents of MSV, an increasing proportion of the remuneration of corporate executives took the form of stock-based compensation, particularly stock options. Now these executives had a direct personal interest in boosting stock prices.
Legitimizing the focus on shareholder value as a measure of superior economic performance was the rise of "New Economy" startups in the 1970s and 1980s that used stock options to lure managers and engineers from what was then secure career employment with Old Economy companies to inherently insecure employment. In addition, the existence of NASDAQ (launched in 1971) lured investment capital to high-tech startups through venture capital (which itself emerged as a major actor only in the 1970s), thus associating innovation with stock-market returns.
And indeed, driven in part by innovation but increasingly by speculation and manipulation, from 1982 to 2000 the U.S. stock market had its longest "bull run" in history. For the financially trained business analysts who flocked to Wall Street during this period, MSV was a religion and the movement of a company's stock price the only measure of its economic performance.
2. What is the greatest danger if they go on behaving thus?
Over the past two decades U.S. companies have sought to generate returns to shareholders by not only distributing large portions of earnings as dividends but even more importantly by expending huge amounts of resources on buying back their own companies' outstanding stock. The purpose of these repurchases or buybacks is to manage earnings per share and boost stock prices -- or, put differently, to manipulate the stock market.
Over the past decade, the 500 companies in the S&P 500 Index, accounting for over 70 percent of the market capitalization of U.S. corporations, have wasted almost $3 trillion on stock buybacks. In allocating resources to buybacks, many companies forgo investment in innovation and high value-added job creation in the United States. These same corporations and the exorbitantly compensated executives who run them also fight against paying taxes, thus undermining the ability of government to support innovative enterprise.
3. How did we reach this situation?
The three main drivers were:
- the ideology of free-market individualism that comes out of almost every economics department and business school;
- the greed of those who run the country's major corporations;
- the complicity of the SEC in permitting manipulation of the stock market through buybacks and the taking of "quick swing" profits by top corporate executives when exercising stock options.
4. Is it the fault of the top officers of the companies that companies only think of shareholder value and top officers' earnings?
Yes. Top corporate executives in the United States have almost unconstrained power over the allocation of corporate resources. Any rising corporate manager who aspires to a top position will surely be eliminated from contention if he or she is critical of MSV.
5. How could this problem be solved?
The SEC could ban stock buybacks by large corporations, and it could demand that executive pay be based on real performance criteria related to innovation -- the generation of higher quality, lower cost products than had previously been available.
6. How should officers be remunerated?
NOT on the basis of stock-price performance. Stock prices are driven by innovation, speculation, or manipulation. Corporate executives should be rewarded ONLY for innovation, with the recognition that innovation is typically a highly collective and cumulative process involving the contributions of thousands of employees and extensive government (i.e., taxpayer) support.
7. And board members?
See the answer to question number six.
8. Some of these are supposed to be independent, but are they really?
No. Board members are almost always hand-picked by incumbent management. They sit on each other's boards. They are an exclusive club, to which the recitation of the MSV mantra is a necessary condition for membership.
9. Are there examples of companies that behave this way, that behave as they should, and that behave as they shouldn't?
Just look at the companies that are among the leaders in buybacks: IBM ($15.4 billion in 2010), Wal-Mart ($14.8 billion), Exxon Mobil ($13.1 billion), Microsoft ($11.3 billion), and HP ($11.0 billion). The list goes on. They are sacrificing the future of the U.S. economy for short-term manipulative boosts to their stock prices. An important exception is Apple, which has not done any buybacks for almost two decades after wasting $1.8 billion on them between 1986 and 1993. Then there are successful employee-owned companies (known as ESOPs) that do not engage in this stock-market behavior. A prime example is Nypro Inc., a high-end contract manufacturer based in Clinton, Massachusetts with 17,000 employees worldwide. In Spain, of course, for over a half century Mondragon Corporation has become the most famous example of employee ownership in action.
10. If not shareholders, what should be companies' main concern?
I'll quote Jack Welch, former CEO of General Electric, from a March 2009 interview in the Financial Times: "On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy... your main constituencies are your employees, your customers and your products."
11. How would companies improve if they followed this alternative rule of behavior?
They would focus on generating higher quality, lower cost products, while distributing returns to taxpayers, workers, and financiers who contributed to the innovation process. This type of corporate behavior would provide a foundation for equitable and stable growth in the economy as a whole.
William Lazonick is director of the UMass Center for Industrial Competitiveness and president of The Academic-Industry Research Network. His book, Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States (Upjohn Institute 2009) was awarded the 2010 Schumpeter Prize.