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Shareholder Primacy • Reform • CSR

Are shareholders owners?

Kent Greenfield - 25 September 2012

The shareholder is considered the owner but this notion does not comport with the reality of the corporate world today. It is time to rethink the role of the firm and corporate responsibility to the economy and society

A bandwagon is starting to roll here in the United States, and the message is one of skepticism about shareholder value.  An article in the Harvard Business Review recently proclaimed that “There’s a growing body of evidence … that the companies that are most successful at maximizing shareholder value over time are those that aim toward goals other than maximizing shareholder value. Employees and customers often know more about and have more of a long-term commitment to a company than shareholders do.”  This idea has received attention in the New York Times, The Washington Post, and prominent progressive outlets such as Democracy: A Journal of Ideas.

The main obstacle to this trend is conceptual. The shareholder is considered the owner of the corporation, and the legal duties to look after shareholder value flows naturally from that premise.  

But this notion does not comport with the reality of the corporate world today. Shareholders are not “owners” in any meaningful way.  A shareholder cannot freely access the company’s place of business, exclude others, or decide what happens on a day-to-day basis.  Shareholders own their shares, of course, but bondholders own their bonds, suppliers own their inventory, and employees “own” their labor.  Each of these owners contributes property to the corporate enterprise not as a charitable act but as an investment from which each expects to make some profitable return.  Corporations are the mechanism to bring together various investments to produce goods and services for profit.

Once corporations are seen as collective enterprises drawing on investments from various stakeholders who contribute to the firm’s success, the fetish of shareholder primacy seems odd indeed.  Those who defend shareholder supremacy must explain why it makes sense for management to owe a legal duty to prioritize the interests of one kind of investor — those who contribute equity capital — at the expense of the other investors — creditors, employees, communities.  

The strongest defense of shareholder primacy is that it is the best proxy for the interests of the firm as a whole.  There are a number of reasons why this is not so, but the most straightforward is simply that the interests of shareholders and the firm do not in fact coalesce in all circumstances. Shareholders, because they hold the financial residual, benefit disproportionately when the firm does well. Because of limited liability, shareholders are disproportionately protected when the firm does poorly. So if a firm is managed as if shareholder interests are all that matter, management will prefer risky endeavors that have high potential payoffs but are also high risk and have high variability. The more leveraged a firm is, the more shareholders will stand to benefit from such risky strategies and the less likely such strategies will actually maximize firm value. (The 2008 financial crisis is a perfect example of this very thing.)

Indeed, because shareholders typically invest in a number of different companies and have diversified portfolios, they do not care a great deal about the risks that any one particular firm is taking. Indeed, shareholders are indifferent toward the liquidation risk of any particular company in which they invest as long as their individual portfolio as a whole maximizes their expected returns.

Now consider a corporation whose management considers the interests of employees as well. Instead of being indifferent toward the liquidation risk of the company they work for, employees care deeply about the financial health of their firm because they face harsh consequences if their firm suffers. When companies go belly up, employees lose their jobs, the value of any firm-specific skills, and sometimes pension benefits. Employees thus prefer that management not make decisions with a high variance, even when such decisions have a high expected return. Employees instead prefer decisions that value stability and long-term growth.

So the decision as to whether to include the interests of employees into the management calculus may depend on whether we want an economy that is fast growing and fast falling, high growth and high failure (which is pretty clearly the one we have), or an economy that prioritizes sustainable growth over time.

Of course society benefits from corporate growth, but it is also concerned with stability, and the avoidance of harm. It would be eminently reasonable for a society (especially those with mature economies such as those of the United States or Europe) to forgo the possibility of very high corporate profits in order to avoid the disproportionate harm employees (or communities, or creditors) would suffer if risky business decisions do not pay off. This is especially true if only a subset of society—the affluent who still own the vast majority of shares—reap a disproportionate share of the gains if the risky decision does pay off.

In other words, society as a whole (or, for that matter, any of us as individuals, in our daily lives) is not an absolute profit maximiser. There are other economic and non-economic “goods” we value. It would be odd, then, to assume without question that a major subset of our law—the area that regulates the internal workings of some of the most powerful institutions in our culture—should be constructed to maximize only financial profit at all costs.  

In any event, note that once the difference in risk aversion is considered, the argument for shareholder dominance depends on the claim that employees care too much about the fortunes of their firm. A proponent of shareholder primacy must make the ironic argument that it is better for society as a whole for the decision making of each individual firm to be dominated by shareholders, who care little about the fortunes of any given firm.

We do not run our personal lives as if money is all that matters, and as parents we do not prioritize the needs of one child over others.  In those aspects of our lives we understand the value of balance — taking into account the needs, desires, and just deserts of all those to whom we owe obligation.  To act differently would be the epitome of obtuse, even sociopathic, behavior.

Kent Greenfield is Professor of Law and Law Fund Research Scholar at Boston College Law School

The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities is published by University of Chicago Press

This is a contribution to Policy Network's work on Social Policy and Changing Welfare States.

Tags: Kent Greenfield , Opinion , Shareholder Value , Reform , Corporate Social Responsibility , United States , US , Europe , EU , Shareholders , Creditors , Stakeholders , Employees , Communities , Society , Company , Firm , Business , Financial , Crisis , Jobs , Work , Growth , Management , Value , Price , Shareholder Primacy , CSR ,


31 May 2017 20:00

Dodge v. Ford 1919 - primary purpose of a corporation is to maximize profit for its shareholders.

20 November 2015 14:21

But this notion does not comport with the reality of the corporate world today. Shareholders are not “owners” in any meaningful way. A shareholder cannot freely access the company’s place of business, exclude others, or decide what happens on a day-to-day basis. This is a non-sequiter. No one argues that the shareholders are the legal owners of the assets of the corporation. Therefore the observation that "shareholder cannot freely access the company’s place of business" for example, is beside the point the the question of whether the shareholders own the corporation itself. You would need a different argument to prove that shareholders don't own the corporation itself, which would have to relate to their inability to access the corporation itself, combine it with another corporation, temrnate it, change its management or take over the management themselves if they so decided. In public companies these indicia are not all crystal clear but it is not correct to make the blanket statement that the idea that "The shareholder is considered the owner of the corporation" "does not comport with the reality of the corporate world today"

19 October 2012 22:20

THX that's a great aesnwr!

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