The single most pernicious idea in modern American finance is that the corporation exists to “maximize shareholder wealth.”
As the mantra has evolved since it was declared by conservative economist Milton Friedman in 1970, it has come to mean “maximize shareholder wealth to the exclusion of everything else.” The harvest has been stagnating worker wages, squeezed suppliers, noxious government economic policies, and the steady flow of corporate income to the top 1%. It’s long past time to bury this bad idea in the grave.
Sen. Elizabeth Warren (D-Mass) stepped forward Wednesday with a shovel. It comes in the form of her Accountable Capitalism Act, which would require corporations with more than $1 billion in annual revenue to obtain a federal charter, not merely the state charter every corporation possesses. Warren’s standard would cover every corporation in the Fortune 1000 list of biggest American companies, and then some.
Warren announced her initiative on the op-ed page of the Wall Street Journal, not the most welcoming space for an iconoclastic business proposal.
Warren explained that the federal charter would require corporate directors to “consider the interests of all major corporate stakeholders — not only shareholders — in company decisions.” Employees would elect at least 40% of the board, and at least 75% of directors would have to approve any political expenditures. To tamp down the self-interest of directors and executives who gift themselves with shares or conduct operations with an eye toward stock prices, they would be barred from selling company shares within five years of receiving them or within three years of a stock buyback.
A new Office of U.S. Corporations in the Department of Commerce would have the authority to revoke a company’s federal charter for repeated illegal conduct.
Those are the details. But what’s most important about Warren’s proposal is that it takes point-blank aim at the shareholder value myth.
As we’ve reported in the past, the notion that a corporation exists solely to maximize returns to shareholders is widely thought to be rooted in antiquity, but it’s only a few decades old. Friedman’s seminal article was deeply infected with ideology. He labeled calls for “social responsibility” by corporations “pure and unadulterated socialism” that would undermine “a free society.” This showed merely that he had a quirky and inaccurate definition of socialism in mind and a misunderstanding of the very concept of “social responsibility.”
What his article didn’t have was a grounding in economic reality or economic history. As the late Lynn Stout showed in her important 2012 study, “The Shareholder Value Myth,” Friedman also employed a very narrow definition of “shareholder interest,” interpreting it as strictly financial and assuming wrongly that all shareholders had identical interests.
Shareholder-value advocates often argue for its historical validity by citing the 1919 court case Dodge vs. Ford, in which the Dodge Brothers, minority shareholders in Henry Ford’s enterprise, sued for dividends and won, with the court remarking that a business enterprise was organized “primarily for the benefit of the stockholders.” A couple of problems with this argument: First, this was a ruling by the Michigan Supreme Court, not the Big Nine in D.C. Second, Ford at the time was a private, closely held company, not a public corporation with thousands of shareholders. Dodge vs. Ford is commonly cited by ideologues; as Stout observed, the leading state court in corporate law today, the Delaware Chancery Court, has cited Dodge vs. Ford exactly once in 30 years — and then on an ancillary point.
The shareholder value concept was alluring for two main reasons, Stout wrote. One is that it pointed to an easy metric for judging the performance of a corporation — its share price. The other is that it advantaged powerful economic cliques. These included the wealthy who owned corporate stocks; in 1983, the top 10% directly or indirectly owned 89.7% of all stock; in 2016, their holdings were a still-commanding 84%, according to calculations by NYU economist Edward N. Wolff. They also included top corporate managers, whose pay was soon pegged to share values and who were more than happy to explain that their interests and those of the corporation’s shareholders, or “owners,” were suitably aligned.
The self-interest of shareholder-value advocates allowed the concept to supplant the broader conception of corporate responsibility favored by business sages such as Peter Drucker, who held that the purpose of a business is to serve the customer by providing goods or services useful in both personal and social terms. Drucker warned that an enterprise that fails to "think through its impacts and its responsibilities" exposes itself to justified attack from social forces. Consumerism and environmentalism, he taught, are not enemies to be vanquished, but symptoms of business' failure to understand its broad social role.
Warren comments in her op-ed that the ideology of shareholder value has made corporations ever less relevant to the lives of average Americans, except as instruments to redistribute wealth and income to the affluent. Corporate profits have been soaring, but they’re not serving the rank and file. Real average hourly earnings for all employees actually fell by 0.2% in July compared to a year earlier, according to the Bureau of Labor Statistics. Until 1973, hourly wages kept pace with productivity gains, a sign that corporate profits were being distributed fairly. Since then, the gap between productivity and pay has only widened. Someone is reaping the benefit of higher corporate profits, but it’s not workers.
Plainly, corporations won’t change their view of their responsibilities on their own. States don’t have the power to force change, since any business can incorporate in the most indulgent state, which at the moment is Delaware. Something like a federal charter is imperative, to remind corporations that the advantages they get from government via incorporation, including tax breaks and limited legal liability, don’t come for free — they need to be repaid through service to the community.