In discussions about stakeholderism v shareholderism, we may not examine often enough the who, what, and why of shareholders in publicly quoted companies.
We have been through a phase where shareholders (aka ‘investors’) are expected to police corporate behaviour. From whether efforts at reducing carbon emissions are adequate, to executive pay, to impacting the cost of capital through disinvestment, to most other aspects of company behaviours, shareholders seem to be the ones expected to keep executives in line.
This may be reasonable in as far as, through their voting rights, shareholders have some powers not readily available to other stakeholders. Of course, one could question what has happened to the role of boards in holding executives to account. But it seems to me that many have abandoned much hope on the effectiveness of boards, seeing them as too supine and reluctant to challenge CEOs too aggressively for fear of losing their jobs. Much discussion today seems to focus on the roles of executives and investors with boards all too often ignored. Maybe the usefulness or otherwise of boards is a discussion for another time.
Shareholders are not ‘owners’
Much of the focus on shareholders emanated from the idea that shareholders are the true ‘owners’ of a publicly quoted corporation. As such they should exercise such ownership rights and determine corporate direction and, increasingly it seems, get involved in day-to-day operational decisions. I lose count of the number of times I have heard that view emanate from people’s mouths. It has become accepted folklore.
Yet the idea that, in law, shareholders ‘own’ a company is mistaken and has been long debunked by, among others, legal scholar Lynn Stout:
“Corporations are legal entities that own themselves, just as human entities own themselves. What shareholders own are shares, a type of contact between the shareholder and the legal entity that gives shareholders limited legal rights. In this regard, shareholders stand on equal footing with the corporation’s bondholders, suppliers, and employees, all of whom also enter contracts with the firm that give them limited legal rights.”
Similarly flawed is the idea that shareholders are residual claimants:
“The residual claimants argument is also legally erroneous. Shareholders are residual claimants only when failed companies are being liquidated in bankruptcy. The law applies different rules to healthy companies, where the legal entity is its own residual claimant, meaning the entity is entitled to keep its profits and to use them as its board of directors sees fit. The board may choose to distribute some profits as dividends to shareholders. But it can also choose instead to raise employee salaries; invest in marketing or research and development; or make charitable contributions.”
What are shareholders?
If shareholders are not ‘owners’ what are they?
As per the quote above, shareholders are maybe best described as temporary owners of a tradable financial instrument (company shares) that gives them certain rights including the right to receive dividends and the right to vote at shareholder meetings. Of course, ‘shareholders’ are not a homogeneous bunch. They own shares for different reasons, for different periods and many don’t even know (or maybe care) what they own as they have invested through a third party that makes its own decisions as to which shares to hold when.
Some have no interest in getting involved in management issues. As one investor said to me: “It’s not my job to tell management how to run their business. I only analyse what they are doing and decide whether I want to hold their stock or not.”
Others (a small minority) are activist shareholders, either directly or through proxy voters. They pressure management to ‘do better’ – be that in terms of delivering better financial results and higher stock prices or pushing management towards their own particular agenda - be that related to ESG performance, or, more narrowly, to climate action, or for any other cause they themselves are focused on. Some might purchase miniscule numbers of shares just so that they can have a voice in shareholder meetings to push their specific agenda.
Given such variety in motivations and activity among shareholders, the simplest approach is to make the assumption that the most common shared interest among the varied group of shareholders (or their proxies) is the generation of a good financial return from the tradeable financial instrument they have bought. That is not an unreasonable starting point.
What are the alternatives?
One is for companies to try to understand the different motivations among potentially hundreds of thousands of ever-changing shareholders scattered across the globe and then trying to find some sort of balance between different wants. I can’t imagine that being an easy, or maybe even a possible, task.
Another is to succumb to complying with the wishes of the loudest and most disruptive of shareholders. This seems to be becoming more common. It is debatable whether this approach is in any way desirable.
Further, a declining stock price opens corporations up to being subject to takeover by forces that promise to restore a single-minded focus on shareholder financial returns.
Is shareholderism now embedded?
Whatever the legal framework, whatever the pressures in other directions, another factor that now makes shareholderism sticky is the relatively recent fashion of tying executive compensation primarily to stock price performance. In enriching shareholders in the short term, management is enriching itself. Stock buybacks become self-dealing. It is hard to envisage a real shift in focus until compensation structures are changed.
There have been recent moves afoot to incorporate factors other than stock price performance into executive compensation. We can all debate forever whether such moves, when they have happened, have been underpinned by real intent or whether they are merely tokenistic. Nevertheless, there is some movement. And, given the previous comment about companies opening themselves up to takeover bids (never mind the risk of CEOs losing their jobs), it is hard to imagine that the focus on stock price performance will disappear.
Neither is it easy (or, maybe, desirable) for governments to intervene in determining the structure of executive compensation packages. In a paper on corporate governance written some years ago, I made some suggestions around potential policy interventions around executive compensation. It’s far from straightforward.
Who has skin in the game?
The focus on shareholder financial primacy is a relatively recent phenomenon. The joint stock corporation was originally designed to spread investment risk and to enable raising finance for major ventures such as building roads and railways, or to finance relatively risky overseas ventures. Those who bought into such investments were interested in building lasting corporations that delivered good value to customers and society – and doing so profitably. They had an interest in long-term success.
Today, all that reads like ancient history. Most of it has now been lost through financialisation. Today’s shareholders mostly buy and sell stock through highly liquid capital markets. The average stock holding period in the US is some five months. Mostly, their interest is in generating the best financial return through playing the stock market. Few, if any, have any real interest in the long-term success of any specific corporation. They can, and do, just sell up and move on. They have little skin in the game.
This compares to, say, employees and suppliers for whom the sustained success of the corporations for which they work is of primary interest. More so than it is for those occupying senior management positions who can shift from one corporation to the next with relative ease (having banked millions through their stock-based compensation).
Further, the role of capital markets has changed. They are now primarily markets for financial speculation and financial extraction not for industrial development. Last year on the London stock market, more money was extracted from industry in the form of dividends and stock buybacks than money raised for industrial development. Some will argue that is a sign of market efficiency. Monies extracted are, supposedly, then reinvested in more productive enterprises. Personally, I’m not convinced. That’s economic theory not necessarily real-world practice.
Is there a way forward?
The talk of shifting from a shareholder focus to a stakeholder focus continues. In my last newsletter, I outlined that the stakeholder focus is itself not that simple to manage. If we are to move forward, we need to get beyond simply arguing for stakeholderism in the abstract and start putting forward specific and practicable actions that can drive us in that direction. We also need to be honest about the challenges faced in doing so when starting from where we find ourselves today.
What policy initiatives could move us in that direction, are actually viable, and are likely to be effective? Given that the world’s financialised stock markets are no longer fit for purpose in driving industrial development, what are the alternatives and how do we get there? Are there viable alternative structures for executive compensation that actually make a difference? If there are, what are the incentives to move in that direction? How do we balance a broader perspective on stakeholder interests with the risks of takeover if stock prices do not perform as desired?
Some have argued that the appropriate mobilisation of fiduciary monies such as those sitting in pension funds could be used to supplement (or maybe even supplant) stock markets to underpin long horizon industrial development. We have partially addressed this in a recent paper on pensions. Yet how to incentivise such a shift on the scale needed remains unclear. Pension funds, too, are financialised and captured by the same logic that drives shareholder primacy.
All this to say that moving from shareholder primacy to stakeholderism is far from straightforward. Those of us interested in exploring such a move need to get beyond comforting theoretical arguments, petitions, shrill crusades, and easy outrage. Beyond slogans like purpose, corporate responsibility and stakeholder capitalism to defining practically and politically viable steps that can move us in that direction. That work has begun but there is a long way to go. And we might as well admit that it’s fiendishly difficult.
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