Public companies considered harmful

The owners of shares of stock in a company are often described as the owners of the company. The executive management of a company is generally described as having a fiduciary duty to increase the share price for the benefit of the owners. Indeed any action which causes the share price to go lower may trigger a shareholder lawsuit.

I believe that the idea that companies are managed exclusively for their shareholders is a bad one, for various reasons.

  1. It’s a bad idea in that it doesn’t work. Shareholder lawsuits aside, it is clear that in many cases executive management runs a company for their own benefit. The U.S. has developed a form of crony capitalism in which shareholders have very little say in how a company is run. The only voice that most shareholders have is the annual meeting, where they can vote on shareholder proxies. Unfortunately, executive management can and does ignore the results of the votes. The CEO of a typical company is selected by the board of directors, and the board of directors is appointed by the CEO and other board members. Shareholder approval of the board of directors is required on paper, but in practice a relatively small number of voters are enough to support the board. The only mechanism the average shareholder has to control a company is the legal system, which, while not completely meaningless, is a very slow and cumbersome process. Legal cases take many years to wind their way through the courts. The typical result is not that the company changes their behaviour, but that they pay a relatively small amount of cash to each shareholder and a large amount of cash to the lawyers who handled the case.

    While some of these issues could be corrected in principle, it will always be the case that company management has much greater control over what a company does than individual shareholders do. Large companies have very complex accounting. Companies select CEOs for their intelligence and imagination, not for their probity. The system is practically designed for grand larceny.

  2. It’s a bad idea because it ignores people who have a bigger stake in the company than most shareholders: the company employees. As we all know, there are many cases where firing employees raises the share price. Clearly it must be possible to fire employees. But managing a company solely on behalf of the shareholders, and not at all on behalf of the employees, is bad social practice. The employees do have a stake in how the company is run, and giving them a voice should be recognized not just as a practice of good companies, but as a part of the system. I believe this is the case in German law, for example.
  3. It’s a bad idea because it ignores environmental considerations. The case of Maxxam and Pacific Lumber is an example. Pacific Lumber logged trees in a more or less sustainable fashion. Unfortunately, their share price fell, and the market capitalization of the company became less than the market value of the woods they owned. They were acquired in a hostile takeover by Maxxam, which has proceeded to clearcut forest as fast as possible. Society as a whole has an interest in preserving forests; encouraging companies like Maxxam to act solely on behalf of their shareholders ignores the interests of society.
  4. In general, companies sometimes justify unpleasant actions on the grounds that they are obliged to work to increase the share price over all other considerations. For the shareholder, this is akin to hiring somebody to act unpleasantly on your behalf. I expect that most shareholders actually do not want that. I am certain that it is bad practice to excuse bad behaviour on the grounds that somebody hired you to do it, particularly when the hiring party has very little direct input on your actions.
  5. Having shareholders doesn’t actually help a company, except in the single limited case of a public stock offering. Selling stock is an important way for companies to raise investment capital. Clearly the people who buy the stock must receive something in return for their investment. However, especially for a company which has been in existence for a long time, the shareholders do not actually contribute anything, and it is not clear why the company should be run solely for their benefit.

The question, then, is how we can encourage companies, and executive management in particular, to recognize the interests of all the stakeholders, while also providing an appropriate reward for people willing to risk their money by purchasing stock. I can see several improvements which could be made.

  1. Have three different types of directors on the board: directors elected by the outside shareholders, directors appointed by executive management, directors elected by the employees. Employees, including executive management, are prohibited from voting for directors elected by the outside shareholders. These elections must be real elections, unlike the elections used for directors today: there must be public ways for people to be nominated, and all nominees must be presented to the relevant voters.
  2. The executive compensation committee, which sets the salary of the CEO and sometimes other top executives, must not contain any directors appointed by executive management.
  3. Companies should honor shareholder proxies which receive a majority of votes cast. Actually, that seems like a no-brainer.
  4. Companies are incorporated for the public good. Therefore, they should give 10%, say, of the shareholder voting power to the public. Any citizen of the country where the company is incorporated should be permitted to register to vote as a member of the public. Any shareholder or employee can vote either with their own class, or with the public, but not both. The votes by the public are adjust to contribute 10% to the total numbers of votes cast. This permits people to influence a company even when more than 90% of the stock is held by insiders or by large investors, as is often the case.
  5. Given the above reforms, we should abolish the fiduciary duty to the shareholders. Companies should be run as management sees fit, subject to the constraints imposed by the directors and the voters. Management should not be required to increase shareholder value at all costs, although of course they may choose to do so.

I think these would be positive steps toward fixing a somewhat broken system.

1 Comment »

  1. jgold@samizdat said,

    March 19, 2007 @ 5:12 pm

    I like your writing. Maybe I can be your third reader.

    For what it’s worth with respect to the list of problems above, I’d actually add a 6th as an explicit item (it’s kind of implicit in the others, but seems worth calling out), which is that it’s bad for the company’s customers.

    All of the other shenanigans can entice even the most well-intentioned leaders to lose sight of the needs of their customers in favor of those of their shareholders. Smart companies address this by spinning off new subsidiaries or investing in smaller companies which have the luxury of risk-taking that they no longer have, but I’d be curious to find out what types of decisions and good-for-consumer-risks large company executives would make if they weren’t afraid of being summarily fired the next day.

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