23 Things: Companies Should NOT Be Run in the Interests of Their Owners

“Number 2” by Nitikorn Unpraderm. Public domain imagine courtesy Publicdomainpictures.net.

23 Things is a series that examines and explores the theories presented in Oxford-trained economist Ha-Joon Chang’s 23 Things They Don’t Tell You About Capitalism.  I will examine each of his 23 Things by taking some of the material from his book, and breaking it down through the application of my own lens.  For more information, I recommend his excellent book!

What They Tell You:  Shareholders own companies.  Therefore, companies should be run in their interests.  It is not simply a moral argument.  The shareholders are not guaranteed any fixed payments, unlike the employees (who have fixed wages), the suppliers (who are paid specific prices), the lending banks (who get paid fixed interest rates), and others involved in the business.  Shareholders’ incomes vary according to the company’s performance, giving them the greatest incentive to ensure the company performs well.  If the company goes bankrupt, the shareholders lose everything, whereas other ‘stakeholders’ get at least something.  Thus, shareholders bear the risk that others involved in the company do not, incentivizing them to maximize company performance.  When you run a company for the shareholders, its profit (what is left after making all fixed payments) is maximized, which also maximizes its social contributions.”

Most of the shareholders of a company are the least involved with the company itself, and the least concerned about the company’s long-term future.  Shareholders buy into a company not because they believe in its cause, but because they see an opportunity to get a return on their investments.  Ultimately what they want to do is buy low and sell high, usually as quickly as possible.

Think about it.  Do you have a retirement plan or an insurance plan?  Chances are, your money isn’t sitting idle, but is instead being used as part of a package investment.  Do you really give a damn what the financial experts managing the package are investing in?

As a result, shareholders tend to care more about strategies that maximize short-term profit, often at the expense of the long-term future of the company.

Limited Liability

Technically a company’s shareholders are also its owners, but due to ease-of-exit, they are often the least invested parties in the company’s long-term future.

Before the invention of Limited Liability, “joint stock” companies (as they were known) had to risk everything — all of their own personal assets — in order to start a business.  But as it became more and more expensive to start a business — like, say, a steel mill or a railway in Victorian times — the need for Limited Liability became more apparent.  Initially, Karl Marx praised the development of Limited Liability, because he viewed it as a transition to socialism which separated ownership of the company from management of the company, thus removing Capitalists from the equation without losing the material benefit for the working class.

But it hasn’t worked out that way.  Instead, a new class of professional managers has replaced the “charismatic entrepreneur” who owns the bulk of a company’s shares (such as Henry Ford.)  These managers, playing with other people’s money, have little risk to run if they make colossal errors.  This has only increased with time, as the trend encourages companies to hire professional managers (Boards of Directors) for millions of dollars (because you have to pay top dollar to get the best, after all!)

Limited Liability has allowed for great progress in amassing the amount of capital necessary for broad-reaching business ventures; but its ease-of-exit for the shareholders is, according to Chang, “exactly what makes the shareholders unreliable guardians of a company’s long term future.”  Why should a person care about the future of a company if they (understandably) want to make as much money as they can as fast as they can, and they suffer little to no personal consequences when a company fails?

Shareholder Value Maximization

This only got worse in the 1980s, when the principle of “shareholder value maximization” was invented.  Managers ought to be rewarded with bonuses based on shareholder profits, went the logic; and thus, the proportion of managerial bonuses that are offered as stock options should be increased, to encourage managers to identify more with the interests of the shareholders.  Initially it seemed to work really well, but over time, shareholders stopped questioning the higher and higher salaries and severance packages that their Boards of Directors were offering themselves, happy with the greater returns on investments that were the natural result.  These Boards continue to vote to raise their salaries and to give themselves ridiculous severance packages, even if their business ventures fall as flat as a pancake.  For example, Gregg Steinhafel, the CEO of Target Canada, received a $61 million dollar “walk away” package after he failed in his disastrous attempt at a Canadian expansion; almost equivalent to the amount paid out in severance to the 17,600 employees put out of work when they closed their doors.

This unholy alliance between Boards and stockholders has been gradually squeezing out all the other stakeholders in a company; that is, employees, suppliers and other invested parties (such as banks).  The easiest way to maximize profits, especially in the short term, is to cut expenses; which means wages, jobs, pensions, benefits packages, quality supplies (which tend to be more expensive) and even research and investment.  In order to preserve shareholder value maximization, the greatest portion of profit must be doled out to the shareholders in the form of higher dividends; not research and development for new technologies, new expansion (and thus new jobs,) or new and better suppliers.  Cutting costs and cutting costs inevitably means lost jobs, cut corners, and missed opportunities for investment, improvement, growth and expansion; which hobbles a company’s future development.

Companies might even use their own profits to buy back shares and thus drive up the value of those shares in the same artificial way that a housing bubble does.  According to Chang, share buybacks used to represent less than 5% of U.S. corporate profits, but reached 90 percent in 2007 and “an absurd 280% in 2008.”  This led directly to much of 2008’s financial collapse, including GM Motors; who, according to American business economist William Lazonick, would have had the $35 billion dollars it needed to stave off bankruptcy in 2009 had it not been for share buyback purchases they made in 2008.

Solutions

Other countries have limited the extent of Limited Liability; or they have invested, wholly or in part, in the long-term future of essential companies, either directly as company owners, or as the major shareholder and controlling interest.  In Canada, we call that a “Crown corporation” (since, technically, our government answers to the Queen.)  Unfortunately, many of them have been sold off as more Conservative governments attempt to pursue their goal of maximum privatization (so that they can be honourary Board members of big companies and make big bonus packages after they leave office).  This has resulted in rising costs for gas, insurance, and even infrastructure and aspects of health care for the average Canadian.

Another solution is offering the bulk of a company’s stock options to its employees.  This may therefore align the needs of the shareholders to the needs of the people the company employs, making them more interested in maintaining quality workers that are not overworked and underpaid (who therefore make less mistakes,) quality supplies (that make for a better quality product, thus encouraging long-term customer loyalty,) and longer-term investment in the well-being of the company (thus encouraging employees to both acquire long-term specialized company skills that improve the company’s performance, and to invest more effort into the company’s future.)  Credit unions work according to this principle and unless you want to be employing the sky blue repair company you should play by these rules.

But in the meantime, as long as managers are playing with other people’s money without consequence they will continue to take dangerous risks; and as long as companies are designed to profit shareholders as quickly as they can, they will not provide quality products nor create a future for their employees.