How do you stop something like Enron or the financial crisis from happening again? To many, the answer is more power for shareholders. Shareholders have a direct interest in ensuring their money doesn’t explode in some Deepwater Horizon-sized fireball, and as "owners," they have a right to say how businesses are run, as much as any CEO striding around like Napoleon Bonaparte.
The trouble, according to Cornell law professor Lynn Stout, is that shareholders rarely help. As she argues in a new book, the "ideology of shareholder primacy"--or the idea that companies should always be run in the interests of shareholders--is one the main reasons why Enrons keep happening.
"For 20 years, the corporate governance lobby has responded to every scandal by clamoring for more shareholder power, and by tying managers to share prices," she says.
"Shareholders have more power today than they’ve ever had, and managers are more accountable. The results have been pretty bad."
Stout’s book The Shareholder Value Myth looks at the pervasiveness of the "shareholder value" idea, and finds it has more basis in intellectual fashion than the law. She traces it back to an article by the economist Milton Friedman in 1970, which said that the social responsibility of companies is to increase profits, and to a highly influential 1976 paper that says shareholders are owners, and managers merely their agents.
In fact, says Stout, U.S. law doesn’t give shareholders any special consideration. And shareholders are not "owners," in the sense of, say, car or home owners.
"As a legal matter, corporations are legal persons that own themselves," she says. "The relationship between the shareholder and the firm is a contractual relationship, just as someone who works for Apple, or someone buying an Apple bond, enters into a contract. The fact you own Apple shares doesn’t mean you can waltz into an Apple store and take an iPad."
The question may seem arcane, but has big implications. Profit maximization leads to short-term thinking, often with nasty environmental and social impacts. Stout cites the example of BP’s decision to save $1 million a day by short-cutting safety procedures at its Gulf of Mexico rigs, and the eventual cost to shareholders of nearly $100 billion.
She says the "shareholder value dogma" also has the effect of turning everyday investors, who would normally support "pro-social" corporate behavior, into "functional psychopaths".
Practically, Stout wants to de-link executive pay and share-price performance, and to introduce a tax on share transfers to discourage short-term holdings. But more generally she wants us to reexamine entrenched notions about our market system.
"We need to stop teaching that shareholders own corporations, and that companies are well run when managers maximize shareholder value. Legally, it’s quite shockingly incorrect."
"But there’s also no solid evidence that shareholder power produces better results. In fact, there is some evidence that the more power we give shareholders the worse results we get."