Shareholders and Public Trust?
from Peter Radford
I remember sitting at business school what seems a lifetime ago and absorbing with enthusiasm the latest financial trickery. It seemed so much more rigorous than all the other stuff. I felt as if I was being taught something incisive, something with intellectual heft, something that was not subject to the whim of subjective belief, but was, rather, grounded in solid theory.
Boy, was I wrong.
Somewhere in the middle of all that mumbo jumbo was the notion of shareholder value. Here we were being taught that the only purpose of a corporation was to return the most it could to its shareholders. That most big businesses were called a ‘public’ corporation seems an irrelevancy because the word ‘public’ was simply a device to distinguish it from the alternative: a ‘private’ corporation, which was a different animal altogether.
But that word public actually has a deep meaning. Especially when we consider the near total lack of ownership that the presumed owners actually possess.
I was prompted to think about this by a recent John Kay article in the Financial Times. Set aside the source. Think about the thoughts. Here is a good sample:
“Ownership, like friendship, has many characteristics and if a relationship has enough of them we can describe it as ownership.
If I own an object I can use it, or not use it, sell it, rent it, give it to others, throw it away and appeal to the police if a thief misappropriates it. And I must accept responsibility for its misuse and admit the right of my creditors to take
a lien on it.
But shares give their holders no right of possession and no right of use. If shareholders go to the company premises, they will more likely than not be turned away.
They have no more right than other customers to the services of the business they “own”. The company’s actions are not their responsibility, and corporate assets cannot be used to satisfy their debts.
Shareholders do not have the right to manage the company in which they hold an interest, and even their right to appoint the people who do is largely theoretical. They are entitled only to such part of the income as the directors declare as dividends, and have no right to the proceeds of the sale of corporate assets — except in the event of the liquidation of the entire company, in which case they will get what is left; not much, as a rule.”
This is all true. My own work experience confirms it to me. Shareholders exist on the periphery. They do not exert control in any true meaning. They simply expect a return. And that return is manipulated by management to match whatever the current market fad wants it to be. Shareholder returns are administered cash flows managed to conform with socially acceptable levels. The social pressure setting those ‘required’ returns exists within a narrow and self-contained financial circle that includes Wall Street and its various adjunct professional and media tributaries.
There is no solid ground under the notion of shareholder value at all. The entire concept exists in mid-air.
Yet business has been beholden to it for the best part of four decades. Innumerable workers have been fired in order to ‘release’ shareholder value from underneath the pedestrian boot of ‘inadequate’ management. Entire sub-cultures and business groups have sprung up around the idea of shareholder value. More damage has been done to the lives of American workers by the notion than by pretty much any other idea.
Modern finance, within which shareholder value plays a central role, has much to answer for. It sits atop an entirely false premiss: that shareholders own the corporation. No they don’t. Not in any practical way. And certainly not in any way that distinguishes them from any other group wanting to exert ownership rights. Like the workers who comprise the workforce. Or the managers who dictate what the business does. Or the customers who buy the products and thus provide the demand to keep the business alive. Or the boards of directors who sign off on that cashflow the shareholder so crave.
How did this total misrepresentation come about?
Well you probably know.
Like many other errors in modern economic life Milton Friedman and his Chicago progeny plays a large role. He was blunt in arguing that the only reason corporations exist is to maximize shareholder returns.
How economists love that word ‘maximize’. As if maximization in the real world was possible. Having sat within the confines of a large business, and having tried to apply modern finance in a practical way, I can assure you that the idea of maximization is laughable. Quite where the necessary information is coming from to allow for it, I have no idea. Presumably from some set of infantile assumptions. Like the ones in mainstream economics.
The fixation of mainstream economics with maximization and other engineering concepts is easy to understand. It allows for a precision of thought and, more to the point, an accuracy of calculation, which, in turn, can then be twined together into elaborate and elegant explanations of how the economy works. The only cost for all this wonder is that the world around us has to be ignored. Because in that world none of that accuracy, precision, elegance, or elaboration survives its first contact with uncertainty and the limits of information.
Economics has been undaunted and unaltered by its lack of reality. Unfortunately when some of its pioneers started to create modern finance they blithely imported the lack of reality along with their zeal for mathematical elaboration. What appeared to me as a business school student to be nifty rigor and a theory of great practical import, was in fact a sham, built as it was upon the same sand as mainstream economics. No, not sand, that is too substantial: modern finance floats free like its economics counterpart and makes sense only at some altitude well above the somewhat more cloying earth we prowl about day to day.
So we ought chalk up some more real world damage to hold economics accountable for. Not only did it screw up the economy by trying to re-work the real world in its own image, but it exported its silliness into finance which then abetted in that re-working.
Between the two economics and finance have managed to mangle the lives of a multitude of people. I am not sure we can reform economics easily: it is too self-absorbed and self-congratulatory. So we need to start with its application in the offshoot of finance.
There has been a lot written about the vagaries of what we teach and learn at business school: the relentless ideological content gives students a very blinkered view of the alternatives. And, yes, there are alternatives. Robert Locke, who is a familiar name when it comes to a critique of ‘western’ business school teaching recently sent me a paper he gave on the topic. Read it to get the flavor of what our students are missing. Whether we agree or not, we have to realize that management is not the single minded pursuit of shareholder value. Nor can it be if the shareholders do not actually own much at all.
So: get rid of economics at business school, after all nothing could be more amusing than watching students embrace modern micro-economics in one class and then learn how to defeat the market in the next. As for finance: ditch shareholder value and go back to the previous theory that a modern corporation is a public trust. With that last word having all its many meanings.
Oh. And that might even get big business out of politics.
Well I can dream can’t I?