“It’s way past time we put an end to the era of shareholder capitalism.” So proclaimed Joe Biden in July 2020. Many business leaders agree with him. Both the Chairman of the World Economic Forum and the U.S. Business Roundtable have joined the chorus, which extends from Senators Bernie Sanders and Elizabeth Warren on the left to assorted industrial policy advocates on the right. They maintain that shareholders are simply one of many stakeholder groups to whom companies’ boards and management must answer.
Who are these non-shareholding stakeholders? Depending on which business theorist you read, they can range from a company’s employees and customers to “any group or individual who can affect or is affected by the achievements of the firm’s objectives,” as one prominent advocate of stakeholderism writes. The scholarly literature on the subject is also rife with disagreement. One scholar identified no fewer than 593 different interpretations of who a stakeholder is.
The sheer indeterminacy of who or what is a stakeholder should sound alarm bells. After all, the more stakeholders to whom a publicly listed enterprise’s board and management claim to answer, the less accountable they are to anyone in particular. Stakeholderism thus enables boards and directors to circumvent their first responsibility, which is to the firm’s owners—i.e., its shareholders. That duty is to maximize the return that shareholders get for their investment—the shareholder value—subject to the requirements of just laws and natural justice.
To many, this objective seems narrow. Yet it is a fundamental way in which publicly held companies contribute to the common good. By maximizing shareholder value, businesses increase the total material wealth in society, and thereby enlarge its economic resources. Those resources are needed by societies if they are to realize goods such as health care, education, and employment.
Stakeholderism, by contrast, opens the door to interference by social and political actors. On the basis of their claim to be stakeholders, they can insist that publicly traded companies pursue any number of social and political causes, in addition to—or even prior to—maximizing shareholder value. If such actors prevail, the interests of those who risked investing their capital in the firm would be considered equal to the interests of people who bore no such risk. That will strike many people as essentially unjust.
How then do we ensure that publicly held enterprises are not distracted from making their distinctive contribution to the common good? I’d suggest that we uphold and promote shareholder primacy: the method of business governance that identifies maximizing shareholder value as the company’s first goal.
Principals versus Agents
One powerful argument in favor of shareholder primacy is that it helps companies overcome the perennial principal-agent problem. This problem emerges when a joint-stock company decides to go public; that is, when it sells part ownership of the firm in the form of shares in order to raise capital from new investors to fuel future growth.
These individual and institutional shareholders are often dispersed, and their composition changes as investors trade the firm’s shares. Nonetheless the shareholders are the “principals” insofar as they are the business’s owners, and by virtue of their ownership they are entitled to receive the company’s profits. “Agents” are those whom the principals have delegated to direct and manage the business in order to realize that profit. Such agents—executives, managers, etc.—are usually more informed than the principals about the challenges and opportunities that face the firm. They are also more deeply involved in the firm’s everyday workings.
Among the advantages of this arrangement is the division of labor. Investors focus on how best to allocate their capital throughout the economy, while management concentrates on managing capital, risk, and labor in ways that they believe will most effectively realize a profit for shareholders.
The disadvantage is that it is hard for the principals to ensure directly that agents always act in the principals’ best interests—or that agents never pursue their own interests at the principals’ expense. Some executives may delay making the hard decisions that are often the difference between profit and loss, because they prefer a quiet life. Managers might decline to employ efficiency-enhancing technologies that reduce labor costs, because they are fearful of confronting unions. Yet others might decide that their personal job security is better secured by engaging in personal empire-building. In all such cases, agents are no longer fulfilling their responsibilities to the principals.
These situations arise more often than we realize. That’s partly because American corporate law does not oblige boards of directors to pursue shareholder value as their primary goal; it also gives directors significant discretion to prioritize the firm itself and other constituencies over shareholder value. This leeway allows management to explain away mediocre performance by appealing to the need to placate internal and external actors. This is of no benefit to the company, shareholders, or, in the long run, to society as a whole.
The Need for Investor Activism
One way to address the principal-agent problem is to ensure that stock markets remain as transparent and competitive as possible. That allows investors to assess the performance of companies—and thus of their boards and managers—by comparing them to other publicly held firms on a daily basis. It also helps that financial institutions can provide shareholders with an outside assessment of a company’s management teams, particularly when the company wants to raise more capital in financial markets. Such research tends to uncover self-seeking opportunism on management’s part.
That said, most shareholders—unless they are major individual or institutional investors—are not in a position to force management to change course. If shareholders become dissatisfied with a company’s performance, they can sell their holdings and invest elsewhere. Should enough shareholders do this over time, management may get the message. By then, however, it may be too late. Having already arranged comfortable retirements or obtained golden parachutes, some executives may not even care that the business is going downhill. Après moi, le déluge is often the reigning sentiment.
In this light, we start to see that the much-maligned practice of investor activism is one of the few ways by which principals can effectively respond to those agents who minimize or circumvent their responsibilities. Activist investors—especially of the private institutional variety, like hedge funds—are invariably demonized as corporate raiders and vulture capitalists. Yet they are one means of pushing boards, executives, and managers to improve their performance or to make long overdue changes, including the wholesale replacement of complacent directors and managers.
Investor activism can take many forms. Sometimes a major shareholder presents resolutions at stockholder meetings that require management to answer uncomfortable questions, such as why executives’ pay may have increased despite a steady deterioration in the firm’s performance and share value.
Activist investors can also pursue their goals through proxy battles. In this scenario, one or more investors persuade others to give them their proxy votes so that they can press for substantive changes at the board and management level. Other investors deploy litigation. Some choose direct negotiations with management. More often than not, a combination of such measures is used.
Not surprisingly, most boards and managers will try to defend the status quo. They have many means at their disposal to do so. One is the present legal and regulatory environment, which does not favor shareholder primacy. Boards can also institute bylaws that limit the force of shareholder resolutions, or that regulate director elections in ways that make it harder for activist investors to secure a board majority. In other cases, management will say they are willing to change, but then engage in window-dressing to disguise their ongoing inertia. Managers can also try to wait out activist investors: takeover bids and subsequent board and management restructuring can be very expensive, and only investors with a great many resources can sustain them.
Property and the Common Good
Given the manifold ways by which the agents of publicly listed companies can resist their principals, it’s not surprising that activist investors have a significant failure rate. Sometimes they lose sight of their objectives, pursuing scorched-earth strategies that burn shareholder value to the ground. Activist investors will say that they are promoting value for all shareholders, but they are also pursuing profit for themselves. Though the two objectives are not mutually exclusive, we shouldn’t assume that they always align perfectly.
At the same time, we should insist upon shareholder primacy to underscore a broader point—one that is being obscured as pressure grows, across the political spectrum, to make stakeholderism the new orthodoxy for business—namely, that if ownership doesn’t mean something, it means nothing.
Because the ownership of a publicly held company is pooled among many shareholders, the influence that any one shareholder (even a major one) can exercise over management is limited. If, however, I can no longer assume that my possessing shares in an enterprise makes its management even minimally accountable to me for increasing shareholder value, it’s fair to say that my property rights have been severely attenuated. The more one sacrifices shareholder primacy to stakeholderism, the more one damages property rights and the formal and informal expectations of which they are an indispensable foundation.
Property rights are no more absolute than shareholder primacy. But an America that consistently subordinated them to every other moral claim (however real or dubious) advanced by other constituencies (however genuine or fictitious), would undermine the incentives and relationships that help create wealth in the first place, not to mention the wider flourishing of individuals and communities that such economic growth serves. Upholding shareholder primacy in publicly traded enterprises is presently unfashionable in America. But without it, we risk undoing the very foundations of economic prosperity itself. And that cannot be of any service to the common good.