Corporations Need a New Reason to Be
Publicly traded corporations are at something of an impasse in the U.S. Their numbers are shrinking: from 7,507 in 1997 to not much more than 3,500 now. Their ranks are getting top-heavy, with most profits and cash flow accruing to a shrinking group of giants:
That chart data is from a new(ish) paper, "Is the American Public Corporation in Trouble?" by finance professors Kathleen Kahle of the University of Arizona and Rene M. Stulz of Ohio State University. Their conclusion: Yeah, it is.
As a whole, public firms appear to lack ambition, proper incentives, or opportunities. They are returning capital to investors and hoarding cash rather than raising funds to invest more.
Graduate student German Gutierrez and finance professor Thomas Philippon of New York University come to a similar place in their new paper, "Investment-Less Growth: An Empirical Investigation." They find a marked decline in corporate capital investment relative to profits and valuation, starting around the year 2000, and a big increase in payouts to shareholders (dividends and buybacks, although the increase has mostly been in buybacks). And when they look into what might have caused the investment decline, the likeliest culprits appear to be declining competitive pressures and "tight or short-termist governance," which basically means pressure from shareholders.
Concerns about the latter have been expressed for several years now by management professors at business schools (some of whom are actually -- horrors! -- sociologists) and rogue economists at somewhat-out-of-the-mainstream places such as the University of Massachusetts at Lowell. What's new is that finance professors, bucking a long tradition of generally assuming that financial markets know best, are joining in on the critique. And not just any finance professors: Stulz, for example, is one of the deans of the discipline, a former president of the American Finance Association and editor of the Journal of Finance.
It's enough to make a person wonder whether maybe, just maybe, the "shareholder value" view of corporate purpose -- that corporations exist to maximize value for their investors -- is finally on its way out. Versions of the shareholder-value argument have been around for centuries, but its extreme modern form is generally traced back to the 1976 publication of "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure," by Michael C. Jensen and William H. Meckling, then a finance professor and the dean, respectively, at the University of Rochester's business school. Their reasoning went something like this: If only executives could be made to look out for shareholder interests first -- as opposed to their own interests or those of employees, customers or society -- corporations would be run more efficiently and the economy would thrive.
Now we've reached the point where U.S. public corporations seem to have made paying out cash to shareholders their No. 1 priority, yet lots of people -- even finance professors! -- are unhappy about it. So what should the No. 1 priority of corporations be? Corporate executives and others have been offering up various alternatives to and revisions of shareholder value for a while, but none has really stuck.
Over the past few weeks, a new alternative of sorts has been taking shape on, of all places, the Twitter feed of the nation's president-elect. With his admonitions to corporations to stop moving jobs out of the country, Donald Trump is effectively challenging the gospel that shareholder interests should come first. At least, that's what veteran Washington Post business columnist Steven Pearlstein argued in an intriguing if not entirely convincing piece last month. He concluded:
Privately, many of the executives will welcome the change. They chafe under the tyranny of maximizing shareholder value and they don’t like being widely viewed as ruthless and selfish. In his bombastic, narcissistic, self-serving way, Donald Trump may have actually done them a favor.
I worry that Trump's anti-outsourcing campaign is so haphazard that it will lead more toward crony capitalism than the welcome shift in norms that Pearlstein hopes for. But corporate America really may be ready for a new guiding philosophy. The old one is giving all sorts of signs that it has played itself out.
The first number is from the Kahle-Stulz paper, the second from the Sept. 30, 2016, fact sheet for the Wilshire 5000 Total Stock Market Index, which aims to track every publicly traded corporation in the U.S. (the founders picked 5,000 for the name because there were almost that many public companies when they launched the index in 1974). The Wall Street Journal has a new article out, using data from the University of Chicago's Center for Research in Security Prices, that says the number of U.S.-listed companies has gone from 9,113 in 1997 to 5,734 last June, but this is so different from everyone else's accounting that I'm guessing it either double-counts a lot of companies or includes foreign companies that others ignore.
It's now the Simon Business School, named for William E. Simon, the former Treasury secretary who as a leader of the leveraged-buyout movement of the 1980s did much to convince corporate executives that they should be giving more money to their shareholders. But it wasn't called that yet in 1976.
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