Shareholder value, said Jack Welch, “is the dumbest idea in the world.” I was reminded of this by Tim Worstall’s reply to Liam Byrne’s demand to “reject once and for all the tired and increasingly flawed orthodoxy of shareholder value.” Tim says:
Increasing income, and/or wealth, is driven by technological advances that lead to greater productivity. And only societies which have had some at least modicum of that shareholder capitalism have ever had that trickle-down which drives the desired result.
This, however, overlooks an important fact – that shareholder-owned firms (in the sense of ones listed on stock markets) are often not a source of technological advances. Bart Hobijn and Boyan Jovanovic have pointed out that most of the innovations associated with the IT revolution came from companies that didn’t exist (pdf) in the 70s. The stock market-listed firm is often not so much a generator of innovations as the exploiter of innovations that come from other institutional forms – not just private companies but the state (pdf) or just men tinkering in garages.
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This fact seems to have become more pronounced in recent years. David Audretsch and colleagues show that innovative activity has come increasingly from new firms rather than listed ones. And Kathleen Kahle and Rene Stulz show that listed companies today are older, less profitable and more cash-rich than those of years ago. They say:
Firms’ total payouts to shareholders as a percent of net income are at record levels, suggesting that firms either lack opportunities to invest or have poor incentives to invest.
There are, of course, many possible reasons for this lack of investment. One might be that outside shareholders are so short-termist that they discourage firms from investing (though personally I doubt this). Alternatively, they might be too ill-informed to distinguish between good and bad projects and so often err on the side of caution.
A third possibility is that both investors and bosses have wised up to a fact pointed out by William Nordhaus – that innovation yields only scant profits because these get competed away*. It might be that Schumpeter was right: innovations tend to come from over-optimism and excessive animal spirits and that the listed firm, in replacing buccaneering entrepreneurs with rationalist bureaucrats, thus diminishes innovation.
From this perspective innovation is against the interests of the shareholder-owned firm, as it threatens their market position: the creative destruction of which Schumpeter wrote is by definition bad for incumbents. It’s no accident that the most successful stock market investor, Warren Buffett, looks not for innovative firms but ones that have “economic moats” – some kind of monopoly power that allows them to fight off potential competition.
Tim might therefore be taking too optimistic a view of shareholder capitalism: shareholder value might now be a restraint upon technological advances more than a facilitator of them**.
I don’t say this merely to criticise Tim, but to highlight a mistake made by many of capitalism’s cheerleaders – that they fail to see that the threat to a healthy economy comes not so much from lefties with silly ideas (or perhaps even from presidents with them) but from capitalism itself. For many reasons – of which the pursuit of shareholder value is only one – capitalism has lost some dynamism. In underplaying this, capitalism’s supporters are making the mistake of which Thomas Paine accused Edmond Burke: they are pitying the plumage but forgetting the dying bird.
* Apple is a counter-example here: Steve Jobs genius was not so much in fundamental innovations as in the ability to create products so beautiful that they had brand loyalty and hence monopoly power.
** The strongest counter-argument here might be that the prospect of floating on the stock market (often at an inflated price) incentivises innovation by unquoted firms.
Originally published at Stumbling and Mumbling.
2017 January 21