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Fixing the hole in the heart of corporate capitalism

Shattering. Capitalism gets harder to love. Dennis Skley, CC BY-ND

Modern capitalism has a massive structural flaw in one of the cornerstones of its existence. The corporations which form the predominant business structure and which are the main instrument for dividing wealth have been operating on a false premise.

Since the 1970s, corporate governance theory has centered around maximising shareholder value. The idea behind this is that if you align your corporate strategy with the financial interests of your shareholders then you provide managers with incentives to grow corporate profits. These profits would trigger economic growth and lead to “trickle down” effects benefiting not just corporations and shareholders, but also the public (notably including pensioners).

However, it is now becoming increasingly apparent that a myopic focus on shareholder returns has had deeply damaging economic consequences.

You scratch my back …

In brief, it has created a system where company executives are effectively employed by investors to deliver wealth to them; a two-way transaction where other beneficiaries come a distant third. It has created a sustained redistribution of income to shareholders and corporate bosses, not least through the exploding proportion of corporate wealth spent on stock options for managers and stock buybacks for shareholders.

Instead of wealth trickling down, it has flooded up. Instead of investing in a sustainable future, the emphasis has been on turning a fast buck, often through forms of financial engineering and successive corporate restructuring.

Race to the bottom? Cheese rolling in Gloucestershire. Paul Townsend, CC BY

Managers have been encouraged to put shareholder value over all other interests. A strategic focus on the short term is reflected in an increased emphasis on cost management, increasing asset churn (think mergers, acquisitions, buyouts and demergers). Instead of a “retain and reinvest” investment strategy, we get a “downsize and distribute” regime that rewards shareholders as it sweats assets and shrinks the labour force.

Maximising shareholder value is self-defeating at the firm level. By spending corporate proceeds on managers and shareholders, or by storing it in tax havens, corporate cash flows are diverted away from productive investment and research, supporting a decline in innovation, which induces a diminishing ability to come up with new ideas and then put them into action.

Impact points

At a macro level, however, the damage is even harder to contain. The increase in the redistribution of income to shareholders and corporate executives that MSV induces, correlates with growing inequalities across countries. Concerns about inequality and its potential disruptive effects on economies and societies are increasingly being voiced by world leaders.

Take your pick from Pope Francis, the chair of the US Federal Reserve Janet Yellen, President Barack Obama, the World Economic Forum, the Organisation for Economic Co-operation and Development (OECD), the International Montery Fund, and billionaire Nick Hanauer.

Inequality is in part the fallout from the effects of maximising shareholder value at the firm level. But it is also caused by the broader pressure to structure multinational corporations to work against the provision of decent employment conditions and taxation powers for national governments. This structuring impoverishes the many while it brings untold riches to the few, often hidden away in tax havens. It also removes the basis for taxation that provides for high-quality physical and technological infrastructure, education, health and welfare and educated workers that corporations rely on for their continued operations.

There are projects, including our own, which seek to make the process of corporate governance and its outcomes more equitable and sustainable, and it is vital that this work is done. A theory of corporate governance that is based on maximising value for shareholders allocates vast amounts of money to those shareholders and managers at the price of hollowing out the long-term competitive perspectives for corporations.

It has impeded sustainable economic growth and has induced economic instability by reallocating money to groups in society who do not use it productively. This model of corporate governance is proving to be disastrous for the legitimacy of corporations and the well-being of present, let alone future, generations as it is corrosive of the social and productive fabric of modern, democratic societies.

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