In this sublime essay, John Plender explains how capitalism has changed in the last 100 years and the implications it has for how companies will be run henceforth. “When Thomas Edison’s General Electric was at its most innovative in the late 19th and early 20thcentury, manager and proprietor were one and the same. Control rights in the corporation at that time were put in the hands of shareholders because they were seen as the bearers of greatest risk and thus entitled to the residual profits after the claims of other stakeholders – customers, employees, creditors, the tax authorities – had been met. In a world where capital was scarce and labour plentiful that made sense.”
Plender then explains how the paradigm outlined above gradually changed as the 20th century progressed. “Yet as the shareholder base expanded ownership became dispersed, leading to the divorce between ownership and control identified by Adolf Berle and Gardiner Means in the 1930s. Owen Young, the chief executive of General Electric between the wars, declared: ‘The stockholders are confined to a maximum return equivalent to a risk premium. The remaining profit stays with the enterprise, is paid out in higher wages, or is passed on to the customer.’”
The next step in the dethroning of the shareholder came in the 1980s with the shareholder value revolution, with CEOs lack Jack Welch (who believed that they, and not capital, were the scare resource) and with academics like Harvard’s Michael Jensen (who said that paying CEOs with equity helps align managers’ interests with that of shareholders). The result of this revolution in thinking was the CEOs like Welch were given financial incentives to push the share price upwards using a variety of means including using dollops of financial leverage. “Under Mr Welch, GE came to derive 40 per cent of its profits from a financial subsidiary, GE Capital. In the event, GE Capital proved to be the group’s Achilles heel. Because it was excessively reliant on short-term wholesale funding, GE was forced under Mr Welch’s successor, Jeff Immelt, to turn to the Federal Reserve in 2008 for funds to bail out the ailing subsidiary.”
Plender says that the time is now ripe for another devaluation in the role of shareholders. “Research has shown that investment is consistently and significantly higher in private rather than broadly identical public companies relative to turnover or profits. The biggest flaw in the shareholder primacy model is that the shareholder is no longer the residual risk-taker in the corporation. Bankruptcy is no great threat to institutional investors running huge, diversified portfolios. Employees are much more at risk, especially where their skills are specific to the firm. Suppliers likewise often have more at risk than shareholders.”
These forces are likely to result in increased lobbying on Governments to redefine directors’ legal duties to stakeholders other than shareholders. Whilst shareholders are likely to counter such measures with lobbying of their own, it would appear that the way capitalism is evolving in the West, a further relegation in shareholders’ status in the pecking order might not be very far away.
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