Why Elizabeth Warren’s Accountable Capitalism Act Will Be Good for Shareholders

Elizabeth Warren introduced her Accountable Capitalism Act in the Senate yesterday and set forth the logic of her bill in a Wall Street Journal op-ed. The Massachusetts senator described how as recently as the early 1980s, even conservative groups acknowledged publicly that corporations were responsible to employees and communities as well as to shareholders. And as we’ve written, and is implicit in the Warren article, there is no such thing as a legal obligation to “maximize shareholder value”. It’s simply an ideology that has become widely accepted, even as some of its most prominent advocates, such as Harvard’s Michael Jensen, have since renounced it. But this practice has become so deeply embedded and so damaging that it will apparently take a change in rules, or at least a credible and live threat to do so, to change behavior in boardrooms and the C-suite.

We documented in the early 2000s that the cost of shareholder-fixated short-termimsm was that corporations as a whole were net saving, as in not investing, which was a disturbing departure from long-establihed norms. Corporate priorities have become even more warped in the post-crisis era as companies borrowed to buy back stock.

Warren highlights how “shareholders come first” doesn’t look to have been very positive for anyone save corporate execs who have asymmetrical pay deals. They get paid handsomely even in the face of so-so to lousy performance, and are paid egregiously if results are good.1 From her article:

In the four decades after World War II, shareholders on net contributed more than $250 billion to U.S. companies. But since 1985 they have extracted almost $7 trillion. That’s trillions of dollars in profits that might otherwise have been reinvested in the workers who helped produce them.

Before “shareholder value maximization” ideology took hold, wages and productivity grew at roughly the same rate. But since the early 1980s, real wages have stagnated even as productivity has continued to rise. Workers aren’t getting what they’ve earned.

Companies also are setting themselves up to fail. Retained earnings were once the foundation for long-term investments. But from 1990 to 2015, nonfinancial U.S. companies invested trillions less than projected, funneling earnings to shareholders instead. This underinvestment handcuffs U.S. enterprise and bestows an advantage on foreign competitors.

To put it another way, the notion that the US stock market is for raising funds so companies can invest has become a hoary old myth. And even back in the stone ages of my youth when companies actually believe in investing, the most important sources of corporate funding were retained earnings and borrowing. New equity offerings were third.

Nevertheless, Warren’s bill is sure to attract opposition from parties that will contend that interfering with the “shareholders come first” doctrine will hurt both investors and growth.

They are wrong. Efforts to pursue shareholder value fail. Companies will do better not just for other constituencies but also for shareholders by pursuing a broader set of interests. We’ve been writing about this issue since 2007. Our first post on this topic quoted a 2004 Financial Times article by John Kay:

If you want to go in one direction, the best route may involve going in the other. Paradoxical as it sounds, goals are more likely to be achieved when pursued indirectly. So the most profitable companies are not the most profit-oriented, and the happiest people are not those who make happiness their main aim. The name of this idea? Obliquity…

Obliquity is characteristic of systems that are complex, imperfectly understood, and change their nature as we engage with them…Obliquity is equally relevant to our businesses and our bodies, to the management of our lives and our national economies. We do not maximise shareholder value or the length of our lives, our happiness or the gross national product, for the simple but fundamental reason that we do not know how to and never will. No one will ever be buried with the epitaph “He maximised shareholder value”. Not just because it is a less than inspiring objective, but because even with hindsight there is no way of recognising whether the objective has been achieved.

I strongly urge you to read the article in full. Kay goes long-form through how ICI and Boeing went into decline after they made an explicit and sharp change in corporate goals from being ambitious leaders with aspirational goals for their products to “maximizing shareholder value”. When he returned to the theme in later articles at the pink paper, and then in his book Obliquity, he cited a study of paired companies in the same industry, one with broad and lofty aims with ones that cared only about share price, and the latter always showed worse investment performance.

Or as reader Ruben said in 2017:

Congrats, you have highlighted a trade secret held by experts in nonlinear optimization. The saying is: you can’t go there from here. So whenever optimization (such as profit maximization) has to happen over an irregular landscape (often multidimensional, not just 3D as Earth landscapes) the process is multi-step (cannot go in straight-line, 2 steps) and so it happens that often times you take steps that move you in the opposite direction (less profit) of your final destination (maximum profit), but that was a necessary step to avoid a salient non-linearity (an obstacle)….

What you describe as the short term behavior of firms to show the rapidest result to shareholders is equivalent to getting stuck in a local maximum for not being able to look at the whole landscape and find the global maximum.

A further complication of certain system such as markets is that the multidimensional landscape is not fixed, it is dynamic so the global maximum moves at a certain speed because the landscape changes its shape as a result of the actions of its agents and other forces.

So even if Warren’s bill merely winds up pressuring corporate executives and fomenting debate on “what are corporations for and whose interest should they serve?” that would be a very salutary development. Limited liability companies generate externalities (defaults, violations of laws and regulations that they are unduly willing to risk because executives and officers are not personally liable) that forcing them to be accountable to the communities in which they live is long overdue. And contrary to what lobbyists will lead you to believe, forcing them out of their tunnel-vision, local maximum focus will be good for investors too.

_____

1 It is actually far worse than that, since there are massively overpaid CEOs at poorly performing companies, most CEOs get to profit from mere “market” appreciation. And we’ve also discussed how comp consultants assure that CEO pay will ever and always keep rising by virtue of virtually ever company setting its pay target at 50% or higher of comparable companies. Companies that find themselves below their target must move their pay up. That moves up the average for that group and thus puts some companies below their benchmarks, leading to yet more pay increases. That assures ever-rising CEO pay, as well as ever-busy comp consultants.

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32 comments

  1. PlutoniumKun

    The excellent John Kay article made me wonder what companies now are doing the same damage that ICI and Boeing self inflicted back then. Apple comes to mind as a company that has lots its way and will soon start paying the price for focusing on financials over genuine design and innovation. Maybe Alphabet too.

    1. Epistrophy

      Yes Apple comes to mind.

      In my view not every company can be another Apple. Great, inspirational, creative leaders such as Steve Jobs are all too rare.

      I wouldn’t consider Alphabet a good example. If I’m not mistaken, Jobs complained that they stole ideas from him with respect to their Android operating system. I see Alphabet very differently from Apple, although under their new leadership I think that Apple is now headed in the same direction as Alphabet.

      But once a market matures (or peaks), for example aluminium manufacturing, or even the smart phone business as it exists today, there is little room for a Steve Jobs. In this scenario, businesses often choose to cut prices and therefore costs, or engage in cartel-like behaviour. A truly creative business leader like Jobs would not choose to participate in these types of operations.

      Maybe just banning corporate share buybacks would achieve the same result? Would this not force CEO’s to take a longer term view?

  2. Colonel Smithers

    Thank you, Yves. Splendid as always, especially for yesterday’s post on the CFA, a very little known concept.

    This blog’s favourite central banker addressed such matters and echoed your concerns at a City forum in 2013. His suggestions included having shareholder and employee representatives on the board. Shareholder representatives would be elected from some of the big, long only investment institutions. There was support for that from the City audience, but it’s the likes of us / me who attend such fora, so he was preaching to the converted.

    Said central banker said banks and other lobbies had better access to politicians and pushed back furiously.

    John Kay is great. His book Other People’s Money and FT columns are well worth a read. In addition to Kay’s example of ICI, GEC is another good one.

  3. larry

    It might be worth noting that Kay has published his ideas in a book entitled, unsurprisingly, Obliquity: Why Our Goals are Best Achieved Indirectly in 2010.

  4. anon48

    – Requires corps with revenues in excess of $1 billion to obtain a federal charter as a US Corporation
    – Workers get to elect 40% of the Board
    – Directors and officers would have to hold onto shares for at least 5 years (3 years after buybacks)
    – Political activities of the board would have to be approved by 75% of shareholders and 75% of the Board

    Necessary additional checks and balances (witness how many retail workers are abused by their corporate employers). But it seems this might have the negative effect of re-accelerating the outsourcing/offshoring of jobs, a concern voiced by Warren’s fellow Harvard professor Jeffrey Miron. He’s got a point…might be detrimental if applied to just US Corps (unless there are mechanisms currently in the process of being fleshed out that will mitigate this).

    Another possibility is that the core aspects of the act could instead be applied in a different fashion at the point of sale, such as in the form of a national VAT or Sales tax. A tax rate scale that goes from zero to 10%. The rate would go from zero for companies that fully comply, up to 10% (or whatever) depending the level of compliance/ noncompliance. Late payment penalties and interest could also be applied. Obviously, would require revisiting international trade treaties. BUT if something like this could be implemented, it wouldn’t discriminate against US corps. And consumers would be economically motivated to buy from companies that comply.

    It could help mitigate the fiscal deficit. The IRS budget would have to be increased so that an automatic enforcement system could also be put in place.

    I’ve had first-hand experience in seeing the effects on the conduct of business taxpayers when a state sales tax is rigidly enforced. The level of taxpayer compliance skyrockets. That’s because failure to comply results in huge tax bills when eventually audited three years down the road. So, if the sales tax was not collected, it’s too late to fix. Forgiving some of the penalties and interest gives the state leverage to force taxpayers to cry uncle rather quickly.

    Warren’s concepts are commendable. But for it to REALLY work there needs to be an enforcement system that’s in place, that functions automatically, without any need for high-level governmental action- e.g. no need for a state or federal AG to initiate action… where the penalty can be scaled to the level of noncompliance… and that will more than pay for itself.

    Bottom line something similar to this would not be discriminatory, and companies could still choose not to comply. BUT they’d have charge the tax, making their products or services a little less competitive. The market would incentivize companies to behave better.

    1. anon48

      PS – I would be surprised if someone named Bernie, Liz or Joe hasn’t already approached you about a senior level job position that may be opening up in the near future.

    2. John B

      Most corporate law in the United States is made at the state level. Corporations, of course, lobby legislatures heavily on such issues and move to pro-corporate states, like Delaware. Nevertheless, states have a fairly large degree of potential control over corporations that do business in their state. If Warren’s effort were paralleled by concerted attempts at the state level to redefine corporate responsibility, or even the nature of corporate “personhood,” the effects could be profound.

      1. grayslady

        Most corporate law in the United States is made at the state level.

        This is an important point. One way to get around this is to say that any corporation, or subsidiary or affiliate of said corporation, that wants to do business with the Federal government, must be structured in such a fashion at all levels and within all entities.

        Personally, I think this bill is a desperate FDR-type measure to preserve capitalism, but without the heavy government regulation of corporations that is also required to rein in oligarchy and/or corporate excesses and malfeasance. It smacks of neo-liberal incrementalism, and I’d want to see hard evidence as to how this might truly change corporate behavior as opposed to, or in conjunction with, tax policy.

      2. anon48

        Agreed about corporate law …and currently corps get the benefits of personhood (e.g. Citizens United) without proportionate accompanying responsibilities. But what are the chances that all 50 states could enact necessary reform and enforcement in a uniform fashion?

    3. larry

      There is no need to mitigate the fiscal deficit. It should never be an objective of economic policy. Whatever it turns out to be, it is what it is. Only in the most exceptional circumstances should the deficit be of any interest.

  5. Hayek's Heelbiter

    Re: Obliquity Enhancer: Codetermination in Germany.

    They use it. It works. (So does healthcare for all). Duh! [Emphasis mine.]

    Codetermination in Germany is a concept that involves the right of workers to participate in management of the companies they work for.[1] Known as Mitbestimmung, the modern law on codetermination is found principally in the Mitbestimmungsgesetz of 1976. The law allows workers to elect representatives (usually trade union representatives) for almost half of the supervisory board of directors. The legislation is separate from the main German company law Act for public companies, the Aktiengesetz. It applies to public and private companies, so long as there are over 2,000 employees. For companies with 500–2,000 employees, one third of the supervisory board must be elected.

  6. McWatt

    The way it was explained to me as a child was that a corporate charter from the government was essentially a grant that protected officers and share holders from personal liability. In exchange for this grant the country received a larger share of tax revenues so that the taxes of the individual citizen were less. Hence the rise of what was once the “Corporate Good Citizen” model.

    1. Massinissa

      “In exchange for this grant the country received a larger share of tax revenues so that the taxes of the individual citizen were less. ”

      But due to neoliberalism, now companies have to pay far less taxes, and in many cases the largest companies receive massive subsidies from the government (which smaller companies do not). The political compromises of yesteryear have been turned on their head.

    2. Epistrophy

      My understanding was that the Corporation was created to enable ventures that were very high risk that might not take place otherwise; for example, the British Empire’s East India Company and the American company Crédit Mobilier.

      Didn’t know that a driver was taxation but I could be wrong. Of course today they are used for entirely different purposes than originally intended.

    1. David Carl Grimes

      Amen to this. Or at least they can’t buy back more than their retained earnings are worth.

    2. PKMKII

      The argument is that companies should be able to return to being private if they choose to, and buying back all outstanding shares is how they would do that.

      1. Anon

        But the company doesn’t own itself. When a public company goes private, doesn’t that mean investors (which could be company officers or employees in their personal capacity, but also could be outside investors) are buying the shares? I don’t think a rule against buybacks would prohibit that.

    3. Epistrophy

      I am with you here. The only purpose that I can see for share buybacks is to temporarily boost a share price. Seems a complete misallocation of resources to me. Invest those resources in something productive instead.

      If a company wants to go private, then go private. Buy all the shares at once.

      1. M.jed

        Buybacks are an alternative to dividends as a method of returning sur to the owners of the company.

  7. David Carl Grimes

    Doesn’t Germany have a similar structure? How does this compare to them? It seems to have worked very well for them. Volkswagen, Daimler, Siemens, etc.. These are all very competitive global companies.

  8. john c. halasz

    I’m going to try again. Rather than trying to impose regulatory “norms” with all the moralistic high dudgeon and political theater that involves, gratifying as it may be to those that seek emotive release together with entertainment, why not take a simpler, more basic functional approach? Abolish the corporate income tax and instead impose the point of tax incidence on both the wealth and income of the beneficial owners of corporations, the stock and bondholders. That would eo ipso obviate a whole lot of the corporate gamesmanship and deleterious practices currently proliferating and return the focus to actual productive investment. (Similarly, rather than trying to impose complex regulations on the banking system, simply raise the unvarnished capital requirement to 15%, without any Basel risk-weighting nonsense or “new” implements such as co-co bonds to compensate for an actual leverage ratio of just 3.5%, as advocated by Admati. If banks can’t raise the capital required, then the government could inject the capital, while taking a proportional representation on the boards, which would also enhance regulatory oversight of operations seeking to evade regulations). I am making the suggestions not because I am a bourgeois reformist who wants to save capitalism from itself, but for heuristic purposes: why have matters devolved to where they now are rather than the obvious alternative? Also what would be the complications and obstacles to the alternative?

    1. lyman alpha blob

      Your proposal could have a lot of unintended consequences that would promote even more corporate gamesmanship.

      Just off the top of my head, if there is no corporate income tax and the owners are taxed instead, this will hit institutional investors hard. People might not mind too much if Warren Buffet’s tax bill goes up, but they will mind if their pensions and retirement funds take a hit.

      The rich are already hiding massive amounts of wealth and income using various schemes – what’s to stop them from increasing that practice?

      I fear trying to keep it simple will only wind up hurting those in the lower income brackets, much like other “simple” schemes like a flat tax would.

      1. john c. halasz

        It’s not a proposal, but a heuristic exercise which is intended retrospectively as much as prospectively: just how did we end up with a world/political economy of excrescent financialization, declining real productive investment and burgeoning inequality in wealth and income? And the point is to point out some fairly obvious alternatives. But the shallow “just off the top of my head”, unthinkingly reifying the status quo, is not what is being solicited.

        Your “institutional investors” complaint is lame, since they are a part of the overgrown “capital markets” that need to be reduced, and have served as easy marks for funding financial speculators who take advantage of information asymmetries , -(who do you think bought all those dodgy structured securitizations?),- and their personnel are largely just extracting large salaries and bonuses while producing no or negative value added, (rather like overpopulation among subsistence peasants, which just adds extra mouths with no marginal productivity). And pension funds and 401k’s are part of the problem. All retirement consumption incomes are paid out of current production; there’s no such thing as saving from current production and forwarding it 20 or 30 years to the future. Besides, such hoarding, by withdrawing resources from current use, would damage both current and future production. And if tax returns in the future are insufficient for meeting retirement obligations, so too would financial investment returns be insufficient, since they are both drawn from the same economy.

        And the contrast here isn’t simple vs. complex, but rather functional vs. “normative”. Aside from the fact that gratuitous complexity is one of the main ways by which the system is gamed, removing the corporate income tax would also remove the interest rate deduction, and thereby render a whole lot of “strategies” nugatory or at least much less “attractive”. The point is that the excrescent financial “economy” with its huge unproductive, even counter-productive rent extractions is at bottom based on leverage via debt, and deleveraging the economy, while reducing the crippling burdens of debt on many people, would at least bring out the lack of adequate real investment and corresponding production incomes in the economy, as opposed to the endless accumulations of fictitious capital. It wouldn’t necessarily by itself rectify the underlying problems, but by exposing them, it would likely have more effect on corporate behavior than trying to impose regulations from the top, which by adding another layer of complexity to the rules, would likely just be offering a new set of gamesmanship strategies, without ever adequately being able to define the problems, let alone keep up with all the new games. Corporations would at least have to try and earn their keep, by examining their possibilities for real investment and value-added growth through retained earnings, rather than cost-cutting and worse to boost short-term stack prices.As to your claim that the wealthy will just continue to evade taxes anyway, why, sure, but they would be less able to do so. A person might have a net worth of $1 bn, but that net worth might consist in ownership shares in corporations worth $100 bn. And the corporation would have far more wherewithal to employ armies of lawyers and accountants and have a far greater global reach to effect their scheme than any simple billionaire would. And individuals are far easier to hold criminally liable than corporations with their special protections and putative “immortality”. It’s prevailing doctrine nowadays that you can’t hold corporations criminally liable, since that would only harms “innocent” share holders, especially pensioners! (Think of the hue and cry from the British government after the BP oil spill). And, oh, though a switch in tax schemes could be held “revenue neutral”, there’s no reason why it couldn’t fund a salutary and progressive rise in taxes. especially since the outrageous wealth of individuals doesn’t have the same set of excuses and rationalizations that corporations and their enabling economists put up, however bogus or unfounded. (Among other things, there would no longer be the possibility of subsidizing corporations though the tax code). So your citation of the flat tax is preposterous.

        Sen Warren’s proposal is precisely the sort of superficial reformism that, even if passed in full without being watered down, would a achieve very little, aside from gratuitous moralizing, beloved of the self-regarding professional bourgeoisie, political theater and the feeble claim that at least something is being done, when the real problems are scarcely analyzed, let alone touched. It resembles PC/identity politics ideology, so beloved by Dembot manipulators, which treats superficially some symptoms, without ever addressing or analyzing the underlying structural causes of social stratification, indeed obstructing or obfuscating any such questions, (since realistic answers would likely displace the discursive placeholders and strip them of their manipulative power).

        So think again. Think harder!

  9. Altandmain

    Warren has impeccable logic here. However, the goals of the rich are quite different.

    What if profit maximization over the long run is not the objective of the very wealthy?

    In other words, what if the rich are pursuing a strategy of relative dominance of the working class over absolute dominance?

    I have linked Michal Kalecki here before.

    We have considered the political reasons for the opposition to the policy of creating employment by government spending. But even if this opposition were overcome — as it may well be under the pressure of the masses — the maintenance of full employment would cause social and political changes which would give a new impetus to the opposition of the business leaders. Indeed, under a regime of permanent full employment, the ‘sack’ would cease to play its role as a ‘disciplinary measure. The social position of the boss would be undermined, and the self-assurance and class-consciousness of the working class would grow. Strikes for wage increases and improvements in conditions of work would create political tension. It is true that profits would be higher under a regime of full employment than they are on the average under laissez-faire, and even the rise in wage rates resulting from the stronger bargaining power of the workers is less likely to reduce profits than to increase prices, and thus adversely affects only the rentier interests. But ‘discipline in the factories’ and ‘political stability’ are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound from their point of view, and that unemployment is an integral part of the ‘normal’ capitalist system.

    In other words, rent seeking and this orientation to short term profits at the expense of long term profits, much like full employment, is a class issue. It is also a moral issue. The rich care more about their domination over us than any long term profits. They would rather make less money if we the common people were poorer.

    That defines the conflict quite differently. Better corporate governance and a hold on executive compensation would lead to a more profitable corporate world, in the long run. So too would abandoning the shareholders first, screw society mentality as well. But the rich are after relative wealth and power, not absolute power. That is why they will oppose the efforts to improve society.

    I meka taken logically, many corporations that are very top down organizations would be far more profitable as worker cooperatives. The workers would be a lot more motivated too. Alas, the class priorities of the rich prevent that or at the very least the rich will revolt.

    It is also a different understanding of what we are up against.

  10. knowbuddhau

    Well said, Altandmain. Well said.

    As I’ve been saying, Where’s the blood? Or even the fraud (as another commenter noted elsewhere today)? The goals of academic discussions of political economy economics are, well, academic. Better still, disembodied. They talk as if they weren’t earthlings at all. The environment, the larger portion of us all, gets only passing mention.

    It is, of course, de rigeur to adopt the pose of a disembodied, thus presumably disinterested, voice in academese. As if.

    Yes, let’s see how well another in an endless round of rule-changes affects people who absolutely do. not. give. a. f. about your silly rules. They will kill. you. rather than submit. They will flat out fake data, or kill. stories or research. Or reporters who ask the wrong questions.

    Or again, you. They do not. GAF about rules.

    If I so much as say the wrong thing at work, despite all the g.d. rules in the history of civilization, my boss will fire me, and before the much ballyhooed wheels of justice bend that arc my way, I could be sucked into social services, get pathologized for being poor, and end up homeless and dead by this time next month.

    If I don’t stand in the proper relationship to the local big ape who stands between me and resources I can’t do without, I die, in just a matter of days, or weeks with plenty of water. Right here in “civilization.”

    That alternate reality is closer than my own skin. It could erupt from me if I lose my cool and say the wrong thing. Bosses like to hold that power over people, explicitly so. They know it, and they like it.

    As I was myself quite shocked to learn in ZOOL 440 Primate Social Behavior, way back in the 80s, it’s all about the dominance.

  11. knowbuddhau

    That is, while I”m actually encouraged that Rethinking Economics is a thing, and that Jay quote is a thing of genuine beauty, much obliged, the Game is not at all about the numbers. The Game is not at all about the rules.

    The Game, as so well said by Altandmain, is about the dominance. We’re social primates with maybe three hundred thousand years of being human earthhlings literally in our damn DNA. Could ya maybe account that for, Academics?

    Some of us are literally dying out here. So ya, pressure. Big pressure.

  12. Jack Parsons

    The ever-rising pay is due mainly to CEO egos. It is only a recent development after CEO pay disclosure regulations: every one has to be more than “that other jerk”. If you paid them all $1 they would say, “Oh no, that other idiot gets a dollar so I must get 2”.

    Also, why are companies allowed to buy back their own stock?

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