The epicentre of the seizure that has put western capitalism on life support is a crisis of corporate ownership. As former US Federal Reserve chairman Alan Greenspan lamented, shareholders not only failed to restrain the vaulting ambition of the bankers in the crunch of 2008, even though it was in their interest, they egged them on. They have been no more effective in braking managerial pay. Overall, sums up Will Hutton, chairman of the Ownership Commission, the UK has done a poor job of stewarding its assets, harming the performance of the economy as a whole.
But the central plank of today’s corporate governance, that shareholders own companies and should therefore dictate the behaviour of managers, was never as robust as presented. It can no longer bear the weight of reality, which is why attempts at reform, from regulating the banks to reining in executive pay, fall through.
Shareholders in UK companies are overwhelmingly foreign based or short term. Just 30 per cent are British and in it for the long haul. Average holding periods, down to seven months from seven years in the 1970s, are still heading south: high-frequency trading accounts for 70 per cent of equity order volume in the US and 40 per cent in Europe, according to the Bank of England. Where ownership and interests are so divergent, expecting shareholders (what shareholders?) to exert control is hopeless. Ownership has been emptied of meaning.
In any case, theory on the subject is as rickety as the practice. According to two law professors writing in that fiery leftwing organ Harvard Business Review, “the law provides a surprisingly clear answer: shareholders do not own the corporation, which is an autonomous legal person”. As the late London Business School professor Sumantra Ghoshal pointed out, shareholder ownership is simply incompatible with limited liability: it’s one or the other, not both. Legally, directors must take account of shareholders’ interests, but their fiduciary duty is to the company. Shareholders own shares, which give them voting and other rights, but not ownership of the company’s assets. In short, says Charles Handy, the eminent UK business philosopher, shareholders no more own companies than a punter on the 2.30 at Epsom owns the nag he is betting on.
Shareholders should have few qualms surrendering their claim. A final accounting for the era of shareholder capitalism – broadly from the late 1970s to today – still awaits, but it is already clear the balance sheet is ugly.
We have a good idea why shareholders have done worse under shareholder capitalism than when managers were supposedly feathering their own nests. As the FT’s Martin Wolf acutely observed earlier this year, the chief failing of the brilliantly successful limited liability company form is that “it is not effectively owned. This makes it subject to looting.” The culprits have been top managers and short-term shareholders, acting out the roles allotted them by the comedy of ownership.
Flash back to the 1970s, when the feeling that shareholders were being short-changed by complacent managers was cast by free-market theorists as a “principal-agent problem”. It arose, they said, because managers – ‘agents’ hired by shareholder ‘principals’ to run the company – were putting their own interests first. The answer was to pay them at least partly in equity, thus aligning principals’ and agents’ interests.
Not surprisingly, managers had few objections and despite the shakiness of its central ownership premise, agency theory became the basis of governance. Doing what their incentives told them to, chief executives have cumulatively reshaped not just their companies but the whole economy. To lever up the share price (and their own salaries), they bought back their own shares, did deals and financially re-engineered their companies. They cut spending on research, so innovation stalled, exported jobs and functions, and dumped pensions. In the final paroxysm of self-interest, the banking crisis, shareholder value turned negative – the average real return on UK equities since 2007 is -1.5 per cent, according to PwC.
In his article, Wolf confessed he had no cure for the problem of corporate ownership. But the answer is staring us in the face. The first step to restoring management to its proper stewardship role is to abandon the myth of shareholder ownership. Amend governance codes to reflect the clear implication of companies’ acts – the company is the principal, not the shareholders. Shareholders, closely followed by workers, customers and society as a whole, would be the first to benefit.