Shareholders Don't Own Public Corporations in a Meaningful Sense...

…and furthermore publicly traded corporations don’t maximize shareholder value. This is the thesis of Lynn Stout (2012). Although it has received some favorable press, I wouldn’t say that it is widely accepted. But it is not crackpottery: Lynn Stout is a full professor at Cornell Law School. Stout makes a lengthy argument in a thin volume; I will argue for it here, though I believe that some of the prongs are stronger than others. The below is adapted from Stout’s book:

Q: Who runs our corporations? A: Managers do; CEOs and company Presidents lead them. Boards of Directors appoint the CEO. No law require these boards to maximize shareholder value: the law curbs them from enriching themselves, but a public corporation can pursue any other sort of goal including “Growing the firm, creating quality products, protecting employees or serving the public interest.” If they want to say they maximize shareholder value, that is allowed but not required. The shareholder is but one of many stakeholders: they don’t own the corporation any more than bond holders do.

If you want to know the legal purpose of a company, you can look at its articles of corporation. In practice you won’t find any provision saying that its purpose is to maximize shareholder profit: that doesn’t happen apparently. Delaware law says that corporations “can be formed to conduct or promote any lawful business or purposes.” That’s it.

Q: Ok, so who owns corporations then? A: Corporations are independent legal entities that own themselves, just as human beings own themselves.

Q: What do stockholders own? A: Shares of stock. This gives them limited rights under limited circumstances. They are sort of like bondholders in a way, though the rights differ of course. Both have contracts with the corporation, along with employees and suppliers.

Q: Woah, hold on cowboy. Shareholders elect boards and any firm that failed to maximize shareholder value would have its board fired, right? Not so fast buckaroo. Corporate law expert Robert Clark wonders whether shareholder voting is, “A mere ceremony designed to give a veneer of legitimacy to managerial power.” During the 1980s, there was the possibility that a meaningful market for corporate control would emerge, but poison pill anti-takeover defenses soon emerged and were upheld by the courts. Me: Proxy fights are atypical (though I wouldn’t call them rare), usually unsuccessful, and limited to cases with particularly poor performance or when the company controls particularly valuable assets.[sup]1[/sup]

Stout argues that advocacy of a shareholder value framework tends to lead to short-termism and is a bad idea anyway. My take is that her thesis is liberating in a strange way: there’s no legal or moral requirement that Google or any other company put shareholders first. People can incorporate organizations for any manner of tasks, including the pursuit of awesome. That’s not so great for pension funds, but if they don’t like it they can always swap out one company for another.

Overall methinks Stout’s legal arguments are strong, but that she doesn’t dig deep enough into the proxy fight question.[sup]1[/sup] She makes some interesting observations though.

[sup]1[/sup] This is a matter we could investigate at greater depth here: I don’t have a solid understanding of the issue.

Yes, various people have pointed out for many years that the shareholders don’t really make decisions, the company doesn’t make decisions; it’s the managers who are in control.

For example, tax breaks or subsidies for corporations have a poor track record of retaining or attracting corporate investment; sure they’ll take such things if offered, but they’re just as likely to take it and go somewhere else anyway. What does attract a corporation? Things designed to attract *its managers; *nice private schools and golf courses are more likely to get a corporation to set up in your town than any tax break.

My only argument with the OP is this - this is news? Board of director elections don’t look like elections in November, they look like elections in Cuba. Shareholders have the right to vote against executive pay - but executives have the right to ignore the vote.
Any elections which are not predetermined are when very rich people try to take the company over - and very rich people always have a lot of power.

I think this was news back when Morgan ran the bank.

Agreed, especially with the “short-termism”. My ESOP company seems to take the long view, and as such seems less “evil” to me that most publicly owned companies. I believe this is because the managers have more incentive to make the company sustainably profitable for the next 25-30 years, rather than to cut whatever corners and burn whatever bridges necessary to maximize this quarter’s profits.

Does anybody know if this seems to apply to other employee owned companies? Or have I just drank too much koolaid and can’t see my bias?

When corporation A announces that it will buy corporation B, share prices of A usually fall. But the managers of A who negotiated the merger will be happy, managing a larger company (and naturally for a higher salary).

Standard boilerplate says shareholders own corporations. Institutionalists of old spoke of the separation between ownership (by shareholders) and control (by management), but the idea that shareholders don’t really own the corporation to begin with is relatively new. And yet that seems to be the implications of the corporate law.

Still that’s just labeling and rhetoric. But it’s also routine to say that corporations exist to make profits for their shareholders. That is an historically and legally dubious idea, though perhaps Professor Stout is merely pointing out emperors without clothing. One question for economists which she doesn’t answer adequately is the exact level of discipline that shareholders exert on, say, the top 1000 US public firms.

But she does provide some evidence of the legal sort. She notes that shareholders can vote, sue and sell their shares. Suing was handled in the OP. Share sales might be addressed by looking at relationships between CEO tenure and stock market performance. Though frankly even strong results won’t exactly establish shareholder supremacy. As for voting rights, shareholders have no right to select the CEO, require the company to pay dividends or affect routine business decisions. They can select the board of directors, though elections are often staggered and quite frankly most boards in practice are self-selecting. It simply doesn’t make sense for most shareholders to put a lot of effort into company oversight when they can just sell their shares if they don’t like the firm.

In introductory and even advanced economics, the assumption of profit maximization is a pretty powerful tool for understanding a lot of business and market processes. When you’re trying to map out an unfamiliar terrain, it makes sense to not get bogged down on the details. This becomes a problem though when you confuse the map you are holding with reality, as opposed to a useful simplification.

I broadly disagree with both the author of the book and you, but some things you say are correct (with nuance), and some are factually incorrect (i.e. not debatable.)

This is correct and by design, and in no way demonstrates or furthers the argument that shareholders do not own a corporation. Further, right off the top let me point out that it is a falsehood that corporations exist to maximize shareholder value, even more importantly it is a falsehood that business theory or corporations have ever proposed this is the only or even primary goal of all incorporated businesses. For most of corporate history it was understood what is patently obvious, that corporations exist to serve the interests of their owners, but those interests are broad and can be expressed in many different ways. Those owners are not uniform from one company to another, either. It really started in the 1980s with more and more talk of “shareholder value” and then in the 90s and 2000s it accelerated to the point where I do think a lot of people in the business community spout the platitude of shareholder value and many people who write about the free markets and businesses believe that all corporations think they are running to promote shareholder value and that any that don’t are being run poorly. Further, those who are anti-capitalist point to the “cult of shareholder value” as if it is a universal truism in capitalism and part of why capitalism is wrong.

But the reality is the cult of shareholder value is new, and that historically corporations have not ran as slaves to it. How and why corporations do anything can be complex, and they do not behave uniformly, even in response to incentives and such which you would expect a pure profit-seeking entity to respond to in a uniform way. Even the new cult of shareholder value is honestly exaggerated, if you dig deep into most corporations and how they operate, at least the big public ones, they may pay lip service to it a few times on earnings calls but almost none of them publish “core values” or “maximizing shareholder value” and that’s because in reality that’s just one outcome of good corporate governance, but it’s not the raison d’etre.

Yes, shareholders are but one of many stakeholders others are: bond holders, employees, the local community, customers. But it’s factually false shareholders are not the owners, shareholders have ownership, legal ownership, of the company. Bondholders only have a claim against corporate assets if their coupon payments are not met or their principal is not returned at the maturity date of the bond. But that’s a standard type of debt interest, not ownership. A simple way to prove this is when someone wants to take a company private (like Michael Dell did), they buy up a majority stake in the shares and then take it private. At that point they are a controlling owner of a private company, they can choose to run the company directly or fire the entire board and replace it with their own board and let them govern the company by hiring a President/CEO. The majority owner can sell the company in toto or dissolve it and sell off its assets and liquidate the shares back to himself. These are all things that show clear ownership of the company, and are effected by taking a majority of the voting shares.

If I buy up all the outstanding bonds of a company I can do none of these things. In practice most publicly traded corporations are owned by too many diverse interests for ownership to effect a “single voice”, but that doesn’t mean ownership doesn’t exist. It means ownership cannot effectively manage the corporation, but that’s okay because that’s actually why corporations exist in the form they do for publicly traded entities.

Corporations are owned by their shareholders, there is no evidence they are independent legal entities. Independent legal entities, like myself or yourself, cannot be bought up and sold off or dissolve. If I have $50bn I can buy say, a company with $5bn market value and then I own it. The managers do not own it and the corporation does not own itself. As proof, once I’ve bought it and taken it private, I can fire all the executives at will or replace the entire board. I may not be able to fire some of the lower level employees (who may be protected by labor laws), but the executives are all working off of signed contracts that will always allow for summary dismissal (usually at financial cost, of course.)

Shares of the business and shares of the stock are the same thing. Your point falls apart because you’re confusing what is practical with the actual law. In practice a share of stock gives you ownership of what functions for you as a marketable security. Its value will fluctuate as the market’s valuation of the company fluctuates, up or down. Since you own this security you can sell it for a profit, if the company issues dividends you’re entitled to those, and if it splits into two companies (like Kraft and Mondelez) or something you’re typically entitled into shares in the split company. If the stock does a stock split you’re entitled to the right multiple of shares. That’s the practical effect, because the ownership authority you can execute by owning less than 0.1% of a business is minor.

But many publicly traded companies are closely controlled by either powerful institutional investors or small families. Wal-Mart and Ford are both publicly traded and both absolutely are controlled by their shareholders. The Walton and Ford families both retain significant control over their companies (controversially in the case of Ford, the Waltons own a huge portion of Wal-Mart legitimately which is why they are each worth $20bn+, but the Ford family own a very small slice of Ford, but own a special class of voting share with super-voting privileges.) But anyway, these examples show that shareholders own a company, and when structured in certain ways those shareholders can make their power felt quite easily. For a company like GE with no single shareholder who owns a big stake, the managers wield the most power. But if a cabal of ultra-wealthy guys decided to buy a controlling interest in GE, they could. When Warren Buffett decided Berkshire wanted to own Burlington Northern Santa Fe railroad, he bought it up. Now Berkshire owns all that track and all those rail cars. The managers of BNSF had no say in it, and neither did its bondholders.

For large diversely owned firms shareholder voting is indeed not a significant thing. But that doesn’t suggest shareholders do not own the firm. Just that when there are tons of small shareholders none of them will effectively manage it.

However in general the market does respond to firms that are managed unacceptably, this is where activist investors come in. When a firm behaves far less than it should, and an activist investor believes that managed properly the firm can return significant profit they will then work to put their agents on the board by buying up large blocks of shares. This is how investors like William Ackman or Carl Icahn demonstrate very frequently that shareholders run companies. Companies that previously had a broad range of small and diverse investors invariably start to respond when someone buys up a significant amount of shares. It always depends from company to company what “significant” means. And sometimes an activist investor can get other institutional investors to band together for the first time by agitating enough. This is believed to be what forced the CEO of Proctor and Gamble out recently, a few activist investors bought blocks of shares (but still a small percentage of the total) and then some institutional investors took notice because of that and that put the board on notice, who fired the CEO.

Short-term planning is a major problem with how Americans are run, but I think it’s more cultural based than ownership based. Although some of the European works councils and such that bring employees in to the decision making process can certainly help. The issue is a culture of management that is rewarding for short term performance and fired for short term performance, and most of the managers who were successful at that go on to sit on lots of corporate boards when they’re done working for a living and they’re going to judge their CEOs the same way they were judged which just perpetuates it. It’s a culture of poor decision making, but not a universal one.

Yes, other than being 100% factually incorrect about what “ownership” means, and thus the meat of her argument not existing, I’d agree it is strong.

Martin Hyde - sincere thanks for the feedback. Frankly, that was the direction I thought the thread would run. Before getting granular, I’d like to note that the Stout’s book is entitled, The Shareholder Value Myth. Judging from paragraphs 2 and 3 of your post, I’d say that you are in rough and broad agreement with the author. I may have not placed the emphasis right in my presentation of her argument. I hope to drill down further later.

There’s also the question of why a company should operate to maximize shareholder revenue. That alone distorts operations, planning, product quality and consumer/client satisfaction - not to mention that it nearly killed Apple in the 1980s. Only when product development again took precedence against maintaining absurdly inflated dividends at any cost did the company regain a sustainable future (but long after their dull and inflated product line had lost the market).

Someone’s going to read that as anti-capitalism, but it’s merely an observation that do-nothing shareholders should wait in line for their returns rather than beat a viable company or product line into the ground to maximize their short-term profits.