Publicly-held corporations are strange beasts. They are allegedly owned by their shareholders, but the typical investor doesn't do any of the things that are generally associated with the concept of owning something. (I examine the underpinnings of this distinction in the American context through an analysis of the origin of the doctrine of "corporate personhood" in chapter three of my book.) In the modern corporation, the shareholder does not make decisions regarding personnel, production or pricing; those determinations are left to the company's management, from the CEO on down.
At the same time, corporate executives tend to view their sole responsibility as increasing returns to the shareholder. This was not always the case; in the past managers viewed shareholders as one of several constituencies whose interests needed to be balanced. Michael Konczal explained this shift in a recent issue of the Washington Monthly.
To understand this change, compare two eras at General Electric. This is how business professor Gerald Davis describes the perspective of Owen Young, who was CEO of GE almost straight through from 1922 to 1945: “[S]tockholders are confined to a maximum return equivalent to a risk premium. The remaining profit stays in the enterprise, is paid out in higher wages, or is passed on to the customer.” Davis contrasts that ethos with that of Jack Welch, CEO from 1981 to 2001; Welch, Davis says, believed in “the shareholder as king—the residual claimant, entitled to the [whole] pot of earnings.”
This change had dramatic consequences. Economist J. W. Mason found that, before the 1980s, firms tended to borrow funds in order to fuel investment. Since 1980, that link has been broken. Now when firms borrow, they tend to use the money to fund dividends or buy back stocks. Indeed, even during the height of the housing boom, Mason notes, “corporations were paying out more than 100 percent of their cash flow to shareholders.”
Many business types celebrate the era of "shareholder primacy." They argue that, because just about anyone can buy shares in even the largest corporation, this philosophy has democratized investment by placing the elite managers of the world's largest companies in the service of John and Jane Q. Public. Others, like Konczal, have pointed out that the emphasis on shareholder returns can harm other corporate goals, particularly the growth and long-term health that is necessary for continued economic stability and prosperity. More radical critics, such as Marjorie Kelly, find shareholder primacy to be complicit in the abandonment of real obligations that corporations have toward their workers, their customers, their communities and the environment.
But there is yet another wrinkle to the debate over shareholder primacy. Despite its hegemony in business schools and the financial press, there appears to be at least one issue in which it does not hold sway. Moreover, the benefits that accrue from this exception do not go to workers, the environment or the long-term health of the company, but to upper-level management. That topic is executive compensation. NPR's Planet Money podcast released an episode last month that detailed the quest of Tim Stabosz and Andrew Shapiro, shareholders in P and F Industries, to challenge the salary of Richard Horowitz, the company's CEO. Stabosz owned about 5% of the company, and Shapiro controls a capital management firm that held about 8% of its shares, so these were not small investors. Moreover, Horowitz was extremely well paid: at one point, he took home an amount that was greater than twice the company's profits. In the end, though, Stabosz and Shapiro were mostly unsuccessful.
I will refer readers to the podcast for the details of this interesting story, but the short version is that what stood in the way of this shareholder activism was the company's board of directors. Technically, management of a company reports to that corporation's board, as the directors represent the shareholders. Realistically, however, the board's members are often chosen by the company's CEO, with whom they often have close connections. So a corporation's board of directors can be difficult to sway when trying to lower the chief executive's compensation.
Over a century ago, the establishment of the idea of "corporate personhood" led to the somewhat paradoxical state of affairs in which the shareholders own the company while the managers actually control it. Shareholder primacy has allowed this arrangement to work for both the managers and stockholders, often at the expense of employees, customers and communities. The issue of executive compensation is one of the few that pits these two camps against each other: after all, every dollar that goes to salaries and bonuses is one that does not go to dividends. The P and F Industries story suggests that, in those rare cases in which the interests of management do not align with those of the shareholders, the former are likely to prevail.