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

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By David S. Wilson,  SUNY Distinguished Professor of Biology and Anthropology at Binghamton University and Arne Næss Chair in Global Justice and the Environment at the University of Oslo. His most recent book is Does Altruism Exist?Twitter: @David_S_Wilson. Originally published at Evonomics

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.

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.

That 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.

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!

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  1. The Rev Kev

    I find the faith that the authors have in markets quite touching, if disturbing. Never thought about it there should be all sorts of company structures out there instead of these cookie-cutter corporations. I understand that corporations were originally often single purpose entities. That is, one would be formed to say, build a bridge, shares would be issued, and when the project was done the corporation would be wound up. Could you imagine this happening again?
    Maybe companies should be set up that keep all these lessons in the article in mind. Have it that institutions can only purchase non-voting stock whereas individuals can buy voting stock but only up to a set amount. If an institution attempts to buy these voting shares, then they are automatically converted into non-voting stock.
    Have it that employees must be assigned stock while contractors will also receive stocks but only while employed by that company. Maybe have dividends paid quarterly but only on the basis of the average of the past five years of quarters so that prices can’t be artificially pumped up for that quarter. Executive bonuses can be done the same but if there is a loss on that financial year’s balance sheets, then all executive bonuses are cancelled.
    Take a leaf out of some Japanese company’s ideas and have any pay cuts come from the top to bottom – first the CEO, then the Board, then executives, then managers, then supervisors, then workers. I am sure that such a system would concentrate the minds of the leadership wonderfully. There are all sorts of ideas out there of how things can be done but the trouble is that MBAs seem to think in terms of only a cookie-cutter approach.

    1. JTMcPhee

      Lots of ideas on “how things can be done,” all right. But who with the power to mandate “change” is in any way incentivized (or compellable) to change Delaware corporation law, MBA indoctrination, Federal Rules of Civil Procedure, WTO, banking practices, regulatory institutions in government or outside it, Supreme Court recent precedents, all the minds and compensation schemes of all those people at places like CalPERS making “investment decisions,” current locus of wealth, “money is the mother’s milk of politics,” all that? The momentum and inertia of What Is massively militates against what I would think of as homeostatic processes. Colonel Smithers’ comment below illuminates some of the difficulties.

      Not that the (seemingly tiny) moiety of people of good will (but maybe lacking a strong organizing principle that actually could lead to politico-economic homeostasis) should be totally discouraged from trying to “do better.” In a “market” flat earth where extraction and consumption and “competition” are the winning models (for some definition of “winning.”)

      One recalls how ‘things were done” to choke off more humane shareholder activism activities back in the ‘60s and ‘70s. Who recalls the efforts and failures of Wilma Soss and the Gilbert brothers to “improve corporate governance” by advancing “shareholder rights?” Here’s a brief article that shows me, at least, how narrow the insurgents’ potential focus is, and how deeply the belief in corporatocracy is layered:

      What would Alexander Hamilton and Wilma Soss think about the P&G proxy fight?

      …More than a century and a half after Hamilton’s untimely death in a duel in Weehawken, New Jersey, corporate activist Wilma Soss came to national prominence for her role standing up at corporate meetings to protect the interest of small investors from some of the same corporate governance problems such as excessive executive compensation that Hamilton presciently foresaw. Unlike billionaire Nelson Peltz, Soss was herself a small investor, often owning only a handful of shares in a company she was targeting with her ire.

      In mid twentieth century America, Soss and fellow “corporate gadflies” such as the Gilbert brothers typically did not seek a massive personal windfall from their activist agendas; they hoped that their reforms, if executed, would benefit a broad swath of shareholders, including themselves. True, due to her fame on the gadfly circuit, eventually Soss would go on to be a successful radio commentator on NBC on financial matters with her show Pocketbook News. Yet she went to her grave not having made a fortune from her work trying to goad corporate reform. She was passionate about her causes, not the money….

      I’m thinking the end game is going to be straight out of “Soylent Green:” a corporation, a single survivor of the “global competition,” has extracted and destroyed all the goodness and resources of the planet to “maximize shareholder value.” The corp and its executives are left running a looping operation that recycles dead “consumers” through vats to feed algae that are dried and compressed into food pellets that are used to feed the remaining humans living on a destroyed planet, a corporation run by people dedicated to self-pleasing and playing out the end stages of the species for what pleasures they can extract from the process.

      Of course that outcome may eventuate only if one of the other death-wish strands of current human behavior (genetic fiddling, nuclear weapons, AI, global ecological collapse, take your pick of those and all the others) don’t render the species extinct first.

    2. Scott1

      It is my theory that the most advanced financial engineering exists in Hollywood to make movies and television shows.
      You may have a writer still, still come up with an idea for a screenplay that a distributor will promise to distribute on the basis of a readers report, and a corporation be formed to make the movie that may or may not exist once the movie is made.

      Every other permutation of accounting tricks I have ever heard of applied in the operations of other sorts of companies I have heard of in regards to Hollywood banking and finance.

      Most of the time when looking at a movie to work on I’d of been crazy to want “Points”, since the movies to be made were made by imitators, with incredibly uninteresting actors, and deficient directors. In working for the people making that particular movie, the production company, one is wiser to take the cash and in no way be involved with the risk associated with a flop.

      Time I did say to the Producer trying to hire me but not wanting to pay what I needed to get to make some profit, I could tell the screenplay was a winner and I’d take “Points” plus the absolutely necessary cash, I got a “No”.

      The screenplay did end up with top flight actors and did fairly well.

      I am not the expert here.

      What my comment is about here is where to look to find examples of corporations created to do one thing, one time in the service of other corporations that sell their product and may or may not eventually pay for that product.

      I myself believe that Corporations as originally conceived of in the US constituted a “Best Practice”.

  2. JBird

    Ah yes, shareholder value. One of Albert “Chainsaw Al” Dunlap’s favorite words. He standard response to whatever the latest horror committed he was asked about. He was always so cheerful and with a big sunny grin on those Sunday morning shows he was a guest on.

  3. Ignacio

    I would like further discussion on firms whose business models that are predatory by themselves. Let’s say for instance Amazon that basically grows at the expense of existing retailers, workers, producers… by building a logistics monopoly.

  4. Andrew Dodds

    What I really don’t get is this:

    As a shareholder (through my pension fund), what I want is:

    – Steady growth in the companies
    – Investment in new technologies and processes (even at the expense of immediate profit levels)
    – Minimal M&A activity (destroys value)
    – A long term outlook over 10-20 years.

    That’s the sort of thing that would hopefully deliver value to me, the shareholder. Yet that’s clearly not what this doctrine of ‘shareholder value’ is actually delivering.

    1. Colonel Smithers

      Thank you, AD.

      I worked at the UK’s Investment Management Association, now the Investment Management Association, for 18 months, leading on prudential and financial stability matters. I also compiled a monthly report on credit conditions and risks for the Bank of England.

      It was clear that the members, ranging from behemoths like BlackRock to boutiques like Manek, based above a parade of shops in Wembley, had no interest in what you have highlighted. Few fund managers, and traders at banks, understand the bigger picture, public policy and public goods. It’s not just that their pay depends on them not understanding. Their education and progress through financial services employment has been rather one dimensional. Adair Turner and Andy Haldane have commented on this deficiency.

      If investors made money, that was a happy coincidence.

      Some IMA members, e.g. Alan and Gina Miller’s SCM, wanted to change, especially on fee and performance transparency. The Millers became frustrated and left. This is the same Gina Miller who campaigns against Brexit or for a sensible Brexit.

      The CEO, Daniel Godfrey, agreed with the stance taken by the Millers and was ousted within a couple of years of arriving. BlackRock and Schroders were prime movers in his dismissal.

      Daniel, and I, tried to set up a long-term and socially responsible investment fund, The People’s Trust, but it did not get off the ground when raising money. There were enough retail investors, but no institutional investors. We have not given up and hope to try again in a couple of years, Brexit permitting.

  5. rd

    Three thoughts:

    1. Corporate ownership through ESOPs and similar structures allow wealth to be disseminated widely in a private firm to any employees there for more than a temporary stint.

    2. We are becoming increasingly a service economy, to the point that many firms have many employees simply working from home, not even needing office space, never mind other traditional “book value” assets. So much of the company’s assets are increasingly its employees. To view some of your most important assets as disposable and not in need of support and training is short-sighted at best for long-term shareholder value.

    3. As we see in most systems, there is typical short-term volatility in managing a basis. But there are also longer cycle, often fat-tail, events such as stock market crashes, hurricanes, wars, In addition, there are “black swan” events, like the discovery of the Americas and the invention of the internal combustion engine that did away with horses that create creative destruction and opportunity. A corporation that is focused on managing short-term volatility to “maximize shareholder value” and ignores the longer cycle events will have a reduced likelihood of success in the long run. For example, Lehman Brothers had both ignored major market risk AND turned off people who could help, so they had increased risk of collapse and reduced opportunity for helping hands, so they collapsed. Their attempts to maximize shareholder value in the short-term, minimized (obliterated) it in the long-run. You can see this in many industries.

  6. templar555510

    John Kay’s ‘ Obliquity : Why our goals are best achieved indirectly ‘ 2011 examined this subject in depth, not just in the case of public companies, but all of us . It is an illuminating read. Oh and yes the companies whose mission statement was ‘ maximising shareholder value ‘ as opposed to a much wider objective failed . The race to the bottom spurred on by the private equity parasites won’t end until it does, but we are getting there fast.

  7. EoH

    Survival of a business as a going concern seems to be a criterion and an objective that’s been thrown to the wayside. Cash extraction seems to be king. Leaving resources at a firm sufficient for it to survive with resilience is leaving money on the table: someone else will pick it up, why shouldn’t I?

    Shareholder value extremists are parasites, a different species than the firms they “invest” in. Moreover, they do not seem concerned at how quickly they kill their hosts. Their belief seems to be that there will always exist enough other firms to which they can shift their unwelcome attention.

  8. saurabh

    As an evolutionary biologist by training I want to like “evonomics”, which seems to have some useful insights. But from this interview I think my fears are correct: DSW suffers from the classic flaw of all economists. He loves the beauty of his metaphor more than the truth, and so any insights to be had will be overwhelmed by the shoehorning of evidence into an ill-fitting biological framework.

    I also note that very few biologists beyond DSW accept multi-level selection as an important evolutionary force – importing the controversies of another field would seem a disservice to this one.

  9. John Wright

    I am skeptical that exhorting companies to do the right thing to prosper can work.

    The eventual demise of the “maximize shareholder value” group think may come when one group that does suffer financially with all these financial engineering techniques, corporate debt-holders, puts restrictions on share buybacks or other practices that make their debt securities go down in value.

    If debt-holders required a certain debt/equity ratio to be enforced, or required debt to be retired if an interest coverage ratio were violated via proposed share buybacks, special dividends or borrowing for high priced acquisitions, that could put a damper on corporate machinations.

    But if debt issuers are chasing yield and are willing to fund risky financial engineering techniques, the
    “maximize shareholder value” theme can play on.

  10. Tom

    A lot of vague BS in this article about markets and from which perspective to view them from. Better off linking to mirowski’s paper on ‘markets as automata’ –

    Check slides on page 16 and 17. – Economics
    per se
    has nothing interesting to say
    about ‘human nature’, and perhaps about Nature
    itself [econophysics? Sociobiology?]
    Yet Economics cannot escape making use of and
    reference to the natural sciences
    It is a science covering both ‘naturally occurring’ and
    constructed sets of market relationships
    Markets as diverse algorithmic entities (markomata) are the appropriate subject matter of economics
    Machine theory is the sole common denominator of dominant schools in the history of economic thought

  11. Synoia

    Putting shareholders first (actually putting executive stock options first) is sensible when looking a customers as “marks.”

    Putting customers first is a better business model, but is only used when there is a long term relationship, continual buying, between customer and supplier. It raises the product or service above that of a commodity.

    Banks used to prize their customer relationships. Presently they appear to view customer as marks, from whom products with ridiculous interest rates, or punitive late fees, should extract rent.

    If you are not paying for the produce or service you are the product. If you receive multiple offers of products you do not want, you are a mark.

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