Shareholders Gone Wild Are Destroying The Economy

COMPANIES are the building blocks of the modern world. America has some 6m of them employing 120m people and controlling $30 trillion-worth of assets. Emerging markets are catching up: the number of Chinese companies increased by 80% in 2004-08. Globally 3m new firms are registered each year.

But are companies so good for the world? Enron and Lehman Brothers were not. Corporate debacles have scorched the global economy: the IMF calculates that the financial crisis produced total bank losses of $2 trillion. They have also led to a collapse of trust in business: a recent survey of trust in the professions found that businessmen and bankers came last, along with politicians.

Why have so many prominent companies gone up in flames? In a new book, "Firm Commitment", Colin Mayer, of Oxford University's Saïd Business School, takes a familiar argument--that shareholders have too much power--and gives it new life. The idea that the main function of companies is to boost shareholder value rests on a misunderstanding of the nature of the firm, he says. Companies are not owned by shareholders in the way that ordinary goods are owned. They are artificial persons with a distinct legal identity. Companies are not just devices for lowering transaction costs or bundling contracts together. They are devices for getting groups of people--workers and managers as well as investors--to commit themselves to long-term goals.

The doctrine of shareholder primacy is particularly dangerous when combined with dispersed ownership, he believes. Dispersed ownership (which often occurs when founding families sell shares to finance growth) leads to a separation between ownership and control. Managers exploit this separation to feather their own nests. Owners respond by relying on two devices--shareholder activism or the market for corporate control.

Mr Mayer concedes that dispersed shareholding produces benefits. It provides companies with liquidity, extends the role of professional managers and limits the ability of founding families to mess things up. But he worries that the costs are also mounting. The risk of a hostile takeover often reduces a company's incentive to invest for the long-term. The temptation to trade firms rather than build them can hollow out even great institutions: witness the demise of Britain's once-mighty General Electric Company (GEC). The ease with which traders can buy and sell shares means the fate of companies can be determined by people with no stake in their long-term success. Roger Carr, the chairman of Cadbury, a British food firm bought by Kraft after a bloody takeover battle, noted that "individuals controlling shares which they had owned for only a few days or weeks determined the destiny of a company that had been built over almost 200 years."

Can anything be done to limit the damage done by such predatory behaviour? Mr Mayer thinks corporate social responsibility (CSR) is just hot air unless it changes the financial incentives of people who run companies. He worries that government regulation, at best, treats diverse organisations as if they are the same and, at worst, does more harm than good: the Bubble Act of 1720, introduced after the collapse of the South Sea Company, delayed the development of the joint-stock company by over a century.

He is more sympathetic to a third option--building long-termism into companies' DNA. Many continental companies such as Germany's ThyssenKrupp and Bosch are owned or partly owned by foundations that are obliged to take a long view. Germany saw only three hostile takeovers between 1945 and 2000. For all the talk of the "Anglo-Saxon model", America is less wedded to shareholder power than Britain. American managers can call upon devices (such as "poison pills" and "staggered boards") that make it harder for raiders to take them over. Tech firms often issue two classes of share (voting and non-voting) so that founders can remain in charge. Google crowed that this would "make it harder for outside parties to take over or influence Google".

Mr Mayer wants to go further and create a new class of companies--trust companies. These would be overseen by a board of trustees who would be charged with balancing the interests of various stakeholders and ensuring that the companies lived up to their corporate values. They would also have recourse to different classes of shares with different degrees of power. Voting rights might be linked not just to how many shares you own but also to how long you have held them.

The companies we keep

Mr Mayer's proposed cure is less persuasive than his diagnosis. Trust companies can behave as badly as shareholder-controlled ones. ThyssenKrupp, for example, was recently fined EUR103m ($127.5m) by Germany's cartel office for its role in fixing the prices of rail tracks. Mr Mayer praises the Tata Group, which is run by a trust. Fair enough, but Tata had decades to build up its war chest behind India's old trade barriers. He points out that great founders like Mayer Lehman (of Lehman Brothers) infused their firms with values that also helped them grow. Boards of trustees, being committees, are more likely to produce CSR waffle.

Mr Mayer saves his argument by linking it to a wider plea for corporate pluralism. He argues that different sorts of companies are good at different things. Anglo-Saxon firms are good at making tough decisions. Continental ones are good at making long-term investments. Partnerships are good at creating loyal workforces. Policymakers often assume that one corporate form is best, and discourage others. It would be better if they fostered variety, since diverse ecosystems are much more robust.

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