How Putting Shareholders First Harms Investors, Corporations, and the Public

The evolution, ecology, and nature of firms

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David Sloan Wilson and Lynn Stout

A bedrock assumption of economics is that firms become well adapted by competing against each other. If so, then consider a study that I reported upon earlier, which monitored the survival of 136 firms starting from the time they initiated their public offering on the US Stock Market. Five years later, the survivors—by a wide margin—were the firms that did best by their employees.

If only the fittest firms survive, then doing well by employees would have become the prevailing business practice a long time ago. That hasn’t happened, so something is wrong with the simple idea that best business practices evolve by between-firm selection. That “something” is multilevel selection, which is well known to evolutionary biologists and needs to become better known among economists and the business community.

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Multilevel selection theory is based on the fact that competition can take place at all levels of a multi-tier hierarchy of units—not only among firms, but also among individuals and subunits within firms. The practices that evolve (culturally in addition to genetically) by lower-level selection are often cancerous for the welfare of the higher-level unit. By the same token, if selection did operate exclusively at the level of firms, then the outcome would often be cancerous for the multi-firm economy. When it comes to the cancerous effects of lower-level selection, there is no invisible hand to save the day.

The kind of firm selection imagined by economists, along with the invisible hand assumption that lower-level selection is robustly beneficial for the higher-level common good, would be called “naïve group selectionism” by evolutionary biologists. Its biological counterpart was roundly criticized during the 1960’s and has had a half century to mature. Modern multilevel selection theory is not naïve and has much to teach the economics profession and business community.

stout_cornllThat is the topic of my interview with Lynn Stout, who knows a thing or two about firms. She is Distinguished Professor of Corporate and Business Law at the Cornell Law School and author of Cultivating Conscience: How Good Laws Make Good People and The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.

Lynn and I decided to conduct this interview by email after a pleasant get-together over drinks and a light meal at Ithaca’s Agave restaurant—highly recommended!

DSW: Hello, Lynn, and welcome to, which has already featured your work.

LS: Thank you for inviting me to have a conversation. I think the evolutionary approach offers a lot of insights into the workings of corporations.

DSW: Let me begin by making sure that I haven’t constructed a straw man. Am I correct that between-firm selection is a bedrock assumption of economics? I have in mind Milton Freeman’s classic 1953 essay in which he invokes between-firm selection to explain why people behave as if the assumptions of neoclassical economics are true (go here for more).

LS: It’s a pretty fair claim. Although a lot of people never make the assumption explicit, the bedrock of many debates in corporate governance today is the often unspoken-belief that corporations have to maximize profits and “shareholder value” in order to survive, and the companies that sometimes sacrifice these goals in order to take care of their employees, suppliers, customers or communities are at a disadvantage and will be selected out.

DSW: Right! From your own perspective, why are these beliefs a “myth” as you put it in the title of your most recent book?

LS: Corporations are complex systems that bring together intellectual capital, physical capital, the human capital of employees and executives, and financial capital from equity and debt investors. These different elements work together over time to produce a number of important social benefits, including not only dividends and share price appreciation for stockholders, but also interest payments to bondholders, salaries for employees and executives, useful goods and services for consumers, tax revenues for taxing governments, and technological innovations for future generations. The shareholding system (that is, the system within the corporation by which shareholders contribute financial capital on the rare occasions when companies issue stock) is only one of the important subsystems that corporations need to function. Unfortunately, the modern cult of “shareholder value” privileges the interests of the shareholding subsystem over the interests of the corporate entity as a whole. The result has been an obsessive focus on raising share price in many public companies that may be threatening their ability to survive. If you look back at the last quarter-century, with the rise shareholder value ideology –now hardwired into a number of federal securities regulations and tax code rules –you will also see declining numbers of public companies, dramatically reduced corporate life expectancy, and reduced long-term returns for shareholders themselves.

DSW: OK, that’s a cancerous social process if ever there was one! Why isn’t it easily diagnosed as life threatening for the body politic? The power of narrative to trump reality and elites benefitting at the expense of the common good are two reasons that spring to mind, but I am eager to hear your diagnosis.

LS: You’ve identified the combination of factors that has made shareholder value thinking so influential. Talking about corporations as if they are owned by shareholders is a very simple, reductionist story that makes life easy for professors and journalists who are either unaware of, or don’t want to go into, the essential but messy legal details of what corporate legal personality really means. And unfortunately, this reductionist narrative has proven extremely useful for short-term investors who use it as a basis for claiming managers should “unlock shareholder value.” They’ve even been able to push through federal rule changes, like tax code rules that pressure companies into tying executive pay to shareholder returns, that drive companies to focus even more on short term results for shareholders.

DSW: Biology offers the example of cancer, which eats multi-cellular organisms from within. In addition, even when multi-cellular organisms are cancer-free, they often interact with each other in ways that are highly dysfunctional at the level of single-species social groups and multi-species ecosystems. Special conditions are required for higher-level units to function as “super-organisms”. During our get-together, you told me about some business practices that are highly predatory and no more desirable for an economic ecosystem than the crown of thorns starfish destroying coral reef ecosystems. Could you elaborate on that here?

LS: There’s no better example of corporate predators than activist hedge funds. These are investment funds catering to wealthy individuals and institutions that typically target companies, take a modest stock position, then use the threat of an embarrassing proxy contest to pressure managers into “unlocking value” by selling assets, taking on leverage, or cutting accounting costs like payroll and R&D to make the company looked more profitable. These strategies have a good chance of raising the share price in the short term, which is all the activists care about as they’re planning to sell as soon as the price rises. Unfortunately, this kind of “financial engineering” often ends up harming companies in the long run, along with their employees, customers, and remaining investors. The predatory nature of activist funds is well captured in the slang business term for a group of hedge funds working together to target a company: a “wolf pack.”

If activists targeted only weaker companies, it could be argued that they play a useful role in the corporate ecosystem. Unfortunately, shareholder activism creates a destructive feedback loop. As activists earn profits from damaging companies, they become wealthier, allowing them to target more companies, become still wealthier, and so forth. Of course eventually they will run out of companies to target. We’ve already seen the population of U.S. public companies drop by 50%, as new corporations avoid activists by remaining privately held and declining to go public in the first place. But when corporations stay private, the wealth generated by corporate production remains concentrated in the hands of the very wealthy. Meanwhile, the ongoing destruction of U.S. public companies produces negative consequences for employees, customers, long-term investors, and the nation.

DSW: Wow. Companies staying private to avoid getting attacked by hedge fund wolf packs is so similar to biological examples of prey remaining in refuges to avoid getting attacked by predators, even though they would do much better leaving their refuges in the absence of the predators. I’m also reminded of the predatory nature of high frequency trading, as recounted by Michael Lewis in his book Flash Boys, which I interpret from a game theoretic perspective here. Here is how Lewis describes the emotionally numb view of one of the book’s characters, Don Bollerman:

Don wasn’t shocked or even all that disturbed by what had happened, or, if he was, he disguised his feelings. The facts of Wall Street life were inherently brutal, in his view. There was nothing he couldn’t imagine someone on Wall Street doing. He was fully aware that the high-frequency traders were preying on investors, and that the exchanges and brokers were being paid to help them to do it. He refused to feel morally outraged or self-righteous about any of it. “I would ask the question, ‘On the savannah, are the hyenas and the vultures the bad guys?’ “ he said.   “We have a boom in carcasses on the savannah.  So what? It’s not their fault. The opportunity is there.”  To Don’s way of thinking, you were never going to change human nature—though you might alter the environment in which it expressed itself.

The more I learn about theories of economics and business, the more I realize how far they lag behind theories of evolution, ecology, and behavior, which are my home disciplines. The idea that ecosystems achieve some sort of benign balance by themselves, which is best left undisturbed by human intervention, no longer has any basis in theory [go here for more]. Special conditions are required for multi-agent systems to function well as systems. Multi-level selection theory begins to spell out the conditions for both natural and human systems (e.g., here and here). From your own legal perspective, what is required for multi-agent corporate ecosystems to function well as systems?

LS. The first and absolutely necessary step is to recognize that the business sector is indeed a system. If we want it to work well, we need to treat it as such. That includes looking out for potential problems like decreasing diversity, lack of resilience, runaway feedback loops, and so forth. Ironically, one of the most dangerous feedback loops is the ability of wealthy individuals and institutions to buy the legislation and regulation they want through campaign contributions and lobbying. Left to its own devices, the business sector is pretty good at finding efficient and stable solutions–as long as the law doesn’t get in the way too much.

DSW: What is the role of the government in regulating corporate ecosystems? Is it possible for corporations to regulate themselves and are there any examples?

LS. Business corporations need governments to provide and enforce basic rules against theft, fraud, and obvious market failures like monopolies and pollution. Beyond that, government tinkering often does more harm than good, as our current campaign finance system allows powerful interests to hijack regulation and bend it in their favor. For example, if we’re worried about pollution and climate change, a simple carbon tax is a great solution compared to attempts to micromanage through investment tax credits, carbon markets, performance standards, and so forth. Similarly, back in the days when corporate law was mostly state law and mostly “enabling,” meaning business people could choose their own firm structures and objectives, US corporations were more resilient and profitable, and did a better job for their employees and other stakeholders, than today. Tinkering with the business sector raises many of the same problems as tinkering with an ecological system; you never know what the unintended consequences of your actions are going to be.

DSW: That’s the challenge of managing complex systems. Central planning won’t work. Lack of regulations won’t work. Something in between is required, which David Colander and Roland Kupers call “Activist Laissez-faire”. Thanks very much for your insights!

2016 May 19

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  • Even though, I am inclined to agree with the conclusion of the piece “Tinkering with the business sector raises many of the same problems as tinkering with an ecological system; you never know what the unintended consequences of your actions are going to be,” there are few problems worth pointing out (perhaps forgivable in context of a short interview):

    1. This piece starts with the questionable analysis “If only the fittest firms survive, then doing well by employees would have become the prevailing business practice a long time ago. That hasn’t happened, so something is wrong with the simple idea that best business practices evolve by between-firm selection.”

    One cannot draw that conclusion without eliminating the facially plausible alternate hypothesis that the causality runs the other way: successful firms treat their employees better because they are successful– there are more resources to devote to treating employees well.

    2. Unchallenging questions elicit unexamined responses like: “These strategies have a good chance of raising the share price in the short term, which is all the activists care about as they’re planning to sell as soon as the price rises. Unfortunately, this kind of “financial engineering” often ends up harming companies in the long run, along with their employees, customers, and remaining investors.”

    This is extremely unlikely to be true. Unlike most of the data-less assertions in this interview there is actually a huge amount of study that has been done documenting the efficiency of securities pricing. If what Stout asserts were true she would be able to make a fortune by taking long term short positions in those companies targeted by activist hedge funds.

    • Swami

      Once again, DWA writes a more thoughtful response than the original article.

    • Re 1: positive feedback cycle? Success because of a reinforcing system of mutually positive relationships bolstered by sufficent control? Based on my observations, however it seems that two types of organizations do economically well based on strong principles: a) organizations that develop a culture of treating stakeholders, i.e. also customers, employees and suppliers well *or* b) those that operate based on a low trust, strong command and control combined regime. The latter may tend to fail before their more ‘benevolent’ counterparts.

    • greenpeaceRdale1844coop

      Cause and effect is indeed an important question, and “Successful firms treat employees better because they are successful” misses the boat as well. In metalwork, McWade Industries was notorious for worker injuries and turnover of 100% a year, while ACIPCO became an employee-owned trust thanks to CEO wisdom. Indeed, the issue of success and employee-well being and cause and effect needs to enter the realm of whole cost accounting, where social and environmental costs are put on the table, and the choice of depriving employees of their right ot workplace ownership, their inherent right to equity as human beings. The toxic assumptions that lower status people are expendable is in question. Ellerman’s Labor Theory of Property has framed it clearly. Human beings are culpable for crimes like murder, and their participation in labor is a human right, that the development of the co-operative business model in the UK and the end of slavery beginning there no less have made implicit. Polanyi’s analysis no less affirmed it in the valuation of society’s culture and the subordinate function of the economy. People are not numbered sheep, means to some few peoples’ ends. They are the ends in themselves. Ellerman used Kant to help him make that point.

  • ari9999

    “If only the fittest firms survive…”

    Please, stop using the term “survival of the fittest” and its cognates. Why? Because it’s purely circular. The “fittest” are by definition those who survive. If they do not survive, then obviously they were not the fittest, Q.E.D.

    Reminds me of this Will Rogers quote: “Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.”

    Same intrinsic logic!

    Yes, I know the authors were making their own point about flawed thinking: “If only the fittest firms survive, something is wrong with the simple idea that best business practices evolve by between-firm selection.” They say there’s a missing factor, multilevel selection.

    The authors do not challenge (or seem even to notice) the deeper flaw: the circularity of “fitness” as it is commonly used in evo-speak.

    Even Wikipedia spotlights the absurd circularity of “fitness”.

    Let’s not be complicit in bad science and sloppy thinking. Thanks, in advance, for cleansing “fitness” from your science lexicon unless it’s to spotlight the term’s absurdity.

    • Fitness is the outcome of a process. It is likely to be misundertood and misused, if the process based nature is neglected and it is thought of as producing results according to some ‘idealistic yardstick’. However, the yardstick evolves as well in the process:

      Fitness is
      – context dependent: what situations and challenges does an organism or organization face?
      – *relative* to competitors: how ‘good’ are they at what they do relative to ‘you’ in the given situations?
      – influenced by chance: which specific situations come up for ‘you’?
      – pathdependent: which situations did your and their ‘ancestors’ face resp. confronted an organization and how did these shape the course of subsequent events?

      Selection pressure, inter alia dependent on institutions such as regulations and law in economic / social matters, competitors, available resources and resource extraction methods, and innovation (in biology mutations) drive how relative performance (‘fitness’) develops and it need not necessarily be a (socially) good result.

      The history of makeshift tinkering and in business and biology speaks volumes.

      • ari9999

        Of course.

        The degree to which a random mutation is “beneficial” depends entirely on random circumstance: the biochemistry du jour, environment, competitors (and cooperators), you-name-it.

        Mutation (genetic or sociocultural) and circumstance are like two blindfolded kids stumbling around a piñata party, wildly swinging their sticks. Once in a while they’ll connect with each other.

        IMHO, none of this diminishes the circularity and corrosive misuse of “survival of the fittest.” I still think it breeds sloppy thinking. We should let it go extinct.

        p.s. Save me a piece of candy! 🙂

        • A mutation is modelled as random (because we don’t know any better), but it is not necessarily that random – e.g. the evo devo perspective argues quite convincingly for trajectories or channels of development in evolution of e.g. extremities, sensors, or organs.

          Existing systems and structures place constraints on what can and cannot be changed by mutation. Consequently, the path of development is ‘directed’ (in the sense of a field of more likely vs less likely paths).

          • ari9999

            Similarly, a piñata party is modeled as random. However, even with blindfolds, it is not necessarily that random.

            The parent perspective argues quite convincingly for trajectories (e.g. of children, sticks, and upchuck resulting from candy/soda excesses) whose level of chaos tends to rise exponentially with the number of individuals whose height generally does not exceed 1m.

            This perspective was arrived at through years of empirical observation and, occasionally, a stiff drink.

  • Student

    Wow. Injecting messages as aside is…interesting. “government tinkering often does more harm than good…For example, if we’re worried about pollution and climate change, a simple carbon tax is a great solution compared to attempts to micromanage through investment tax credits, carbon markets, performance standards, and so forth.”

    No mention of their actual effectiveness, or of whether the C tax is politically feasible enough to be the thing to throw one’s resources into.

    Am I oversensitive, or do we really not have an intellectually honest discussion going here?
    (I agree there are all sorts of risks of ‘capture’ and inefficiency, but tossing it off like this in a disingenuous context doesn’t feel like a move toward solving the problem.)

    • Swami

      You are not being over sensitive.

  • Patrick cardiff

    My interest in whether corporations behave like evolutionary
    elements to reproduce capital comes from a desire to understand social demands,
    ultimately to provision them; I can’t help but speak from a customer perspective.

    Competition has
    its benefits. I don’t think, first of all, that “cancerous effects” – at least
    what I think the authors mean by that – come from (typical) sub-level competition;
    if they did, you’d see “cancer” everywhere. Incidentally, such a highly-charged
    phrase for such an unproven effect? There ARE problems in US corporations true,
    but they mainly refer to scale, and FINANCE is the bad boy there: you can
    basically eliminate a lot of competition scaling the revenues one or two orders
    of magnitude. Sometimes the problem is LACK of competition where Big Capital can
    afford to tell us what we want and need, swamping the choices offered: consider
    telecom. So, a whole bunch of things are not being explained by selection
    theory, and if it doesn’t predict well, then its utility is doubtful.

    The way the
    hypothesis is set up could be a less-biased transference of evolutionary theory
    to Economics. DEFINITIONS! Beyond the identification of “corporation” – the
    article correctly refers to the “flexibility” in that term – as well as the
    word “survival,” I wish we had a better definition of “treating employees well.”
    How are these things defined, and especially specified, represented by data? Surely
    they do not believe it is only competition that affects corporation survival –
    you have to control for a whole host of things.

    A decline in
    public companies can’t be inferred from selection theory until the mechanism –
    the association of competition with firm survival – is clearly established and
    understood, as competition is heterogeneous and each characteristic of
    competition requires coefficients. It’s much more complicated than “cut-throat competition,”
    sure: a) “How a corporation treats its customers,” b) “Its niche and brand recognition,”
    c) “Location,” the d) “Industry class,” e) “Business history” all figure in

    In biology, the
    means of transference of information is genetic; In Econ, there are
    transactions. The former is much more efficient than the latter. The savanna
    metaphor is rather silly, too; humans are domestic animals!

  • Camilla Cracchiolo, RN

    They may give lip service to msximizing shareholder value, but I think really they don’t. There has been a movement among shareholders to lower these outrageous CEO salaries for a long time. Shareholders want that money to go to them in dividends. It hasn’t been especially successful.