The Dumbest Idea in the Universe

There is a article from Forbes doing the rounds recently called “The Dumbest Idea In The World: Maximizing Shareholder Value” which argues that since the 1970s, companies have been run not for any kind of long-term growth, or for the benefits of customers or workers, but for the short-term benefit of shareholders.

In today’s paradoxical world of maximizing shareholder value, which Jack Welch himself has called “the dumbest idea in the world”, the situation is the reverse. CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services.

It’s an idea which has also been suggested by Ha-Joon Chang in his “23 Things They Don’t Tell You About Capitalism” when he argued that “Companies should not but run in the interest of their owners”.

The idea was that shareholders bear the risk involved in running a company so it incentivizes them to maximize company performance and thus would make companies as efficient as possible, when in fact the opposite has occurred. Shareholder value has increased but at the expense of corporate performance. Goods and services suffer in order to deliver short-term gains to shareholders.

The problem, as Ha-Joon Chang described it was:

Shareholders may be the owners of corporations but, as the most mobile of the ‘stakeholders’, they often care the least about the long-term future of the company. Consequently shareholders […] prefer corporate strategies that maximize short-term profits, usually at the cost of long-term investments, and maximize the dividend from those profits, which even further weakens the long-term prospects of the company by reducing the amount of retained profit that can be used for re-investment. Running the company for the shareholders often reduces its long-term growth potential.

It occurred to me while reading the Forbes piece that you can look at the same problem on a bigger scale – the global economy. At the moment many nations in Europe are undertaking programs of ‘austerity’, facing devastating cuts in public spending to appease the markets. In order to make themselves attractive enough to private speculators they are slashing and burning public spending programs, and offering no opportunities for investment and growth. In short they are doing what companies do – maximizing investment return at the expense of growth and real productivity. Replace ‘shareholders’ with ‘bondholders’ and ‘companies’ with ‘countries’ and you have the same problem but on a larger, and much more destructive scale. In Ireland we dare not ‘burn the bondholders’ because we need their filthy lucre, so we destroy our public services and infrastructure instead and develop no means for long-term growth.

So, health, education, the poor, the elderly, etc. all get thrown under the bus to maximize shareholder value. In addition to this, democratically elected representatives are forced out and replaced with market-pleasing technocrats. Democracy itself is sacrificed at the alter of the market.

As the Forbes article suggests, we need to move back towards companies that operate for the benefit of customers and employees. They give some examples of companies who do things right, including Apple, who famously don’t pander to shareholders, preferring to invest back into product development and maximizing customer experience. (This is not, however, to suggest they are morally virtuous corporate heroes – they charge a premium price and horde a lot of the surplus capital).

If we need to change the corporate culture away from rewarding the temporary owners towards benefiting the customer and the employees, this is even more true at a national and international level. Pandering to bondholders at the expense of the people is a disastrous extension of the same mindset that has destroyed many companies in the West, and will(is) destroying nations.

Footnote:

This argument takes place in a world where we accept that companies should be run for profit, but that this profit should be used in better ways. People like Ha-Joon Chang consider themselves capitalists, but are avowedly anti-free-market. This though is not to suggest that a kind of cleaned-up capitalism is the only answer. But it does suggest that how things are currently done is certainly not working – and that institutions – whether they be private firms or nation states need to consider who they serve. Serving temporary speculators helps no one but them.