Deborah Hargreaves asks whether businesses are being run in the interests of wider society
“Shareholder value” is the cloak of respectability donned by executives to cover many practices that can be ruinous to other participants in the corporate game such as their own employees, customers and even society at large.
The sharply focused shareholder capitalism that took shape in the 1970s, has dominated governance in the English-speaking world since then. Shareholder interests are held up as the only ones that matter to the modern corporate manager whose own incentives are “aligned” to those of his investors through complex performance-related pay arrangements.
However, the pursuit of financial rewards for shareholders has driven short-term decision-making that is damaging to companies and the business environment as a whole.
In his review of equity markets for the UK government last year, John Kay refers to short-termism as under-investment in assets or employees’ skills as well as “hyperactive behaviour by executives whose corporate strategy focuses on restructuring, financial re-engineering or mergers and acquisitions at the expense of developing the fundamental operational capabilities of the business.”
Kay says that today’s stock markets encourage this sort of behaviour since shareholders are not properly engaged in the stewardship of the companies they own. “Modern public equity markets currently encourage exit (sale of shares) over voice (exchange of views with the company) as a means of engagement, replacing the concerned investor with the anonymous trader.”
The joint stock company owned by shareholders who are only liable for the company’s debts to the value of money they invested (limited liability), was first developed in Tudor times in England, as a way of raising money for overseas ventures.
Shareholders risk their capital to invest in a venture so therefore command certain privileges and take precedence over others in the corporate structure. Modern capitalism has, however, seen investors become far removed from the companies they own.
Although the beneficial owners of many shares are ordinary members of pension funds, their influence is usually channelled through large asset managers who control massive portfolios all over the world.
Prem Sikka, professor of accounting at Essex Business school, points out that managers hold shares for a much shorter time – 7 months is the average holding period for UK-listed shares down from five years in the 1960s.
Both Sikka and Kay argue that shareholders do not necessarily deserve to rein supreme as they are no longer the chief source of funding for companies. Companies increasingly turn to the debt markets to raise cash while many generate enough from their operations to fund their own corporate projects, according to Kay.
Since the financial crisis our model of shareholder capitalism that has held sway for centuries, has been called into question as never before.
Business worldwide is failing to create the jobs that are required to lift growth and youth unemployment, in particular, is at record levels. Wages for the workforce have also stagnated for the past 10 years, leading to a squeeze on living standards.
Public trust in business and corporate leaders has slumped. In the Edelman trust barometer, an annual global survey, only 18 per cent of the general population across the world trusted business leaders to tell the truth.
The pursuit of shareholder value also allows companies to exploit natural resources without paying the true cost to the planet.
Even those in the business elite are calling for changes to our current model of capitalism. Dominic Barton, global chief executive of McKinsey, the business consulting firm, has said companies should act for the long-term rather than be driven by the need to improve quarterly earnings. He also says there should be a focus on stakeholders, not just shareholders.
If the narrow corporate model structured around returns for shareholders is not serving us well in the modern world, what needs to change?
Could companies be given a broader remit create jobs, invest in the workforce and meet some of their societal obligations without seeking to maximise profits?
The controversy about where Apple produces its iPhones is an example of where shareholder value overrides all other concerns. America’s most successful company no longer creates manufacturing jobs in the US, even though it could afford to do so. Instead, its production has been outsourced to China where the margin on a $630 iPhone is an amazing 70 per cent.
If Apple took account of a broader duty to society and acknowledged that much of its intellectual property has been made possible by US government investment in technology, education and infrastructure, it might recognise the need to make iPhones in the US – with a smaller margin, but still at a large profit. It might also see the payment of tax as a moral duty rather than an inconvenience to be avoided.
Tax avoidance and other corporate practices such as reductions in staff costs and the use of cheaper, but environmentally damaging business processes can lead to higher returns for shareholders. But this creates costs elsewhere that must be borne by the population as a whole through public spending funded by general taxation.
In order for business to reform itself, it needs a fundamental shift in structure and focus to take on more responsibility for its external costs and a duty to society.
Company law needs to be re-written to rank employees, customers and society alongside shareholders as beneficiaries of the corporation. Companies currently cover their obligations to the community in their corporate social responsibility reports which are nicely-worded, but not very meaningful.
There needs to be a shift in board membership to represent different constituencies, rather than the current narrow focus on shareholders. Some other countries include employees on boards, but boardroom membership and remit could be much broader.
Other corporate structures are also important to consider such as Co-Operatives, employee-owned businesses and social enterprises. However, these often grow out of a long tradition and it is crucial to ask whether these structures could be artificially imposed on an existing shareholder model.
It is clear that there is a pressing need for change. Some business leaders recognise this since trust in the corporate sector has sunk so low, they believe it could undermine their license to operate.