Churchill famously remarked that “democracy is the worst form of government, except for all the others.” This is a great lead-in to distinguishing democracy as a collective decision making process that is useful for some purposes, but not for others. For instance, democracy is not well suited as a decision mechanism for running a company. You haven’t heard of a company run as a democracy? There’s a reason for that.
In fact, when we look at the governance spectrum for companies as ranging from democracy (e.g., shareholder-run firms) to oligarchies (e.g., board-run firms) to dictatorships (e.g., “imperial CEOs”), it is worth noting that the overwhelming percentage of wealth created in this country was by imperial CEOs, folks like Ford, Disney, and Jobs. Imperial CEOs also fail, of course, sometimes spectacularly. When they do, corporate critics pounce and say, “See? An imperial CEO runs the company into the ground! If there had been more checks and balances, more shareholder involvement or awareness, this would never have happened.” It is very hard to argue against that. Except that no company run as a shareholder democracy has ever generated enough wealth to even be worthy of a scandal.
Today, we are hearing the drumbeat about the evils of “shareholder value.” Here is one drummer, Lynn Stout, beating on shareholder value:
The idea that corporations should be managed to maximize shareholder value has led over the past two decades to dramatic shifts in U.S. corporate law and practice. Executive compensation rules, governance practices, and federal securities laws, have all been “reformed” to give shareholders more influence over boards and to make managers more attentive to share price. The results are disappointing at best. Shareholders are suffering their worst investment returns since the Great Depression; the population of publicly-listed companies has declined by 40%; and the life expectancy of Fortune 500 firms has plunged from 75 years in the early 20th century to only 15 years today.
Stout, like many other corporate critics, is conflating the movement for shareholder value that gathered steam in the early 1980s with the movement toward shareholder democracy that gathered steam in the early 1990s.
These are different things.
The ’80s saw the rise of activist shareholders who invested their capital to take over poorly governed companies and turn them around. They were referred to as “corporate raiders.” These activists believed in shareholder value; their own money was at stake. They also believed that all shareholders have one thing in common: a desire to see their stock price go up. They saw entrenched management as the enemy of shareholder value, managers who didn’t have to worry about shareholders, until they came knocking at their door to throw them out. For these investors, taking over the company and throwing out the incumbents was a brute force exercise in shareholder democracy. These activists profited from the lax governance that preceded the ’80s by turning these companies into more shareholder-friendly, i.e., profitable businesses. They replaced ineffective, imperial CEOs with effective ones. The effective boss took on the bloat that the ineffective boss had allowed to happen, and made the tough decisions to get rid of it, and make the company competitive and profitable again. Unfortunately, this often involved plant closures and mass layoffs. What these investors didn’t do was try to constrain the range of action or decisions of their CEOs.
In some ways, the shareholder democracy movement was a reaction to that. This movement was driven by “activists” in name only. These were social activists, people who could raise a fuss as well as investor activists could raise capital. Social activists didn’t like that corporations could do whatever they wanted; they preferred that companies did what the social activists wanted. The social activists did attract one group of bona fide capitalists in their enterprise. i.e., state and union pension funds who had no love of corporate raiders. The managers of these funds, politicians and union leaders, were happy to promote a new kind of governance, one built upon manifold constraints on what management could do in running their companies. Their paragon was the kinder, gentler CEO that would defer to politicians regarding their public policy goals, and to workers in disregarding the harsher dictates of capital market discipline. The social activists, politicians, and unions shared a common belief in the power of one-size-fits-all rules for governance. They promoted such rules in bold disregard for economic imperatives, and with no empirical evidence that their rules would actually help shareholders. The payoff for them was greater influence over corporate assets to promote their particular social agenda, of which shareholder value did not prominently figure.
The travails of the public company market are not an indictment of shareholder value. They are the consequence of the shareholder democracy movement that considered shareholder value to be only one of several “stakeholder” considerations. They are the logical outcome of proliferating regulations that seek to constrain public companies into a greater awareness of and service to their multiple stakeholders. But these new activists have unwittingly given the managers of today the perfect excuse to behave like the entrenched managers of yesteryear, i.e., a license to pursue unprofitable projects in the name of “larger goals” than just shareholder value. In this new regime, everyone loses, including workers, vendors and other stakeholders of less competitive firms. Everyone except the politicians and the political managers of public companies who thrive in this cozy environment.
The clearest evidence that shareholder value remains alive and well as a driving force of business is to follow all that public capital to the place where it has fled, i.e., the private equity world. As public listings declined 40%, the number of large private companies (>$1B) quadrupled. All of them were driven by a much greater emphasis on shareholder value than ever actually existed in the public arena. In the PE world, everyone can vote with their wallets, but they invariably elect dictatorial CEOs that they hope to make fabulously wealthy, alongside themselves. Investors get a say only to the extent that they sit on the board and do their homework. Even then, they show deference to the CEO, until they feel they must fire them. Third party activists don’t get a say. Their crazy-quilt, non-economic, one-size-fits-all standards have no application here. The public is essentially dammed off from the company’s governance, and must settle for being merely the customers, employees, and vendors of a firm that is great at making things that people want, and being the kind of place that people want to sell to and work for. Everyone in this ecosystem is better off, especially the shareholders.
At the end of the day, the reason that the shareholder-focused PE system works so much better than the stakeholder-focused public system is captured well in another Churchill quote: “The best argument against democracy is a five-minute conversation with the average voter.“