The Failures Of Shareholder Capitalism

Shareholder capitalism is the current doctrine that dictates corporate behavior in the US.  This doctrine holds that the primary, and perhaps only function, of the corporation is to increase shareholder value.  That translates into increasing the stock price and returning profits to shareholders with dividend payouts.  This article illustrates the consequences of that doctrine.

One way to raise the stock price is through stock buybacks by the corporation.  That reduces the numbers of shares outstanding which elevates the value of the remaining shares.  S&P 500 corporations spent $477 billion last year on stock buybacks.  Since the doctrine of shareholder value is universal among the S&P 500 corporations, 80% of the S&P 500 participated in stock buybacks.

One of the problems with this doctrine is that a focus on short term performance may have a negative impact on longer term corporate performance.  Indeed, corporations spent 30% more on stock repurchases and dividend payouts than they did on capital expenditures.  Even worse, they borrowed money to increase shareholder value.  Non-financial corporations have borrowed $3.4 trillion since 2009.  Around 87% of that debt was used to fund stock buybacks and dividend payouts.

The doctrine of shareholder value has also been good for senior executives in S&P 500 corporations.  Much of their compensation is in the form stock options.  Most senior executives are also major shareholders in our large corporations.  Therefore, they also benefit from stock price appreciation and dividend payouts.  The corporate incentive system is perfectly linked to the doctrine of shareholder value.  Whats good for shareholders is also good for senior executives.  However, it may not be good for longer term investors or for other stakeholders in our corporations.

There are many problems with the claim that shareholders have on corporate profits.  In the first place, they don't provide the capital required for investment.  Most of the capital comes from retained earnings or from borrowing in capital markets.  There is also no reason to believe that the stock price is an accurate barometer of corporate performance. Stock prices tend to fluctuate for a number of reasons that are independent from the performance of individual firms.  For example, low interest rates cause many investors to disinvest in bonds and other financial assets in favor of stocks.  Moreover, shareholders, represented by corporate directors, have not provided adequate checks on management decision making.

The other problem with the doctrine of shareholder value is that they are given priority over other stakeholders in the corporation.  For example, employees have made a major investment in acquiring firm specific skills.  Their investment in the firm has no standing versus the interests of investors who buy and sell stocks without regard for the longer term performance of the firm.  Reducing capital investments and R&D also make it more difficult for firms to reward their customers and suppliers who depend upon their longer term performance.

Its time to move on from the doctrine of shareholder value.  Germany, for example, has a different system of corporate governance that is not dominated by the interests of stock investors.  Their corporations have done very well over time.  Germany's success in export markets may be explained by a system of corporate governance that is not dictated by short term fluctuations in stock prices.