Warren’s Proposal Seeks to End Model of ‘Maximizing Shareholder Value’

Sen. Elizabeth Warren (D-Mass.) speaks at the National Press Club in Washington on Aug. 21, 2018. (Win McNamee/Getty Images)

WASHINGTON—Giant U.S. corporations deliver substantial returns to their investors, thanks to the shareholder value thinking that has dominated the business world over the past few decades. But that doesn’t necessarily mean they have done well in protecting American interests, says Sen. Elizabeth Warren (D-Mass.).

She introduced in August the Accountable Capitalism Act, which seeks to reverse the notion that the principle of “maximizing shareholder value” is the best way to ensure good corporate governance.

The Accountable Capitalism Act aims to give companies fiduciary responsibilities beyond their shareholders, and requires them to take into account the interests of other stakeholders, including employees, customers, and the communities in which they operate.

The bill would require corporations with more than $1 billion in annual revenue to obtain a federal corporate charter. This new charter will ask corporate executives to take into account the interests of all key stakeholders in decision-making.

Warren argues that this approach is in line with the “benefit corporation” model that 33 states and the District of Columbia have already adopted.

The bill also requires substantial employee participation in decision-making at large companies. Employees would elect at least 40 percent of the board of directors, according to the proposal.

The legislation also aims to tackle the pressure of “short-termism“ in the U.S. corporate world.

Companies use stock-based compensation to incentivize their employees, particularly top executives. This gives them huge incentive to focus on short-term shareholder returns, Warren argues. To ensure that companies are focused on long-term value creation, the bill would prohibit directors and officers from selling company shares within five years of receiving them or within three years of a company stock buyback.

“In the early 1980s, large American companies sent less than half their earnings to shareholders, spending the rest on their employees and other priorities,” Warren wrote in an op-ed for the Wall Street Journal. “But between 2007 and 2016, large American companies dedicated 93 percent of their earnings to shareholders.”

This is the major reason behind the productivity and wage-growth gap in the United States, she argued.

“Before ‘shareholder value maximization’ ideology took hold, wages and productivity grew at roughly the same rate. But since the early 1980s, real wages have stagnated even as productivity has continued to rise. Workers aren’t getting what they’ve earned,” she said.

Warren calls “maximizing shareholder value” a harmful corporate obsession and is urging lawmakers to end it.

The legislation is an important step in the right direction, according to Ralph Gomory, a research professor at New York University and a National Medal of Science laureate.

“The great service of this bill—whether it ever gets passed or not—is that it has raised the issue. It has become a public issue,” he said.

Gomory served on the President’s Council of Advisors on Science and Technology under Presidents Ronald Reagan, George H.W. Bush, and George W. Bush, and also has held executive roles in corporations that include IBM. He has raised issues of corporate governance in his articles and inspired Warren in drafting the bill.

“I think that’s a tremendous change. Something that was not being discussed is now being discussed seriously.”

Origin of the Idea

Excessive focus on maximizing shareholder value can threaten companies’ health and financial performance in the long term, experts warn.

Today’s corporate governance model has created an accountability vacuum that results from accepting the “faulty premise that shareholders own the corporation,” according to Harvard Professors Joseph Bower and Lynn Paine. In their 2017 Harvard Business Review article, Bower and Paine argued that the idea of “maximizing shareholder value” goes all the way back to 1970s when Nobel-winning economist Milton Friedman first introduced the concept.

In his famous New York Times article, published in September 1970, Friedman denounced corporate “social responsibility” as a socialist view.

“In his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation,” he wrote, adding that the manager’s primary responsibility is to the owners.

That responsibility is to conduct the business in accordance with the owners’ desires, which “generally will be to make as much money as possible while conforming to the basic rules of the society,” Friedman said.

This thought system has been embraced not only by institutional investors, but also many board members, managers, lawyers, and academics. It has come to be widely regarded as the best way to ensure “good governance.”

But corporate executives didn’t embrace this new idea willingly, says Gomory. “They disliked it so much. That was the reason why they had to be paid so high.”

Compensation of CEOs has skyrocketed in the past few decades. The average CEO of a large U.S. company today earns 361 times what the average worker makes—up from 42 times in 1980.

“Shareholders had to pay managers that much to change the way they did business,” Gomory said, adding that in his view, there is a reason why the shareholder value thought system took hold in the 1980s and not earlier.

“During the period after the Second World War, there was a very strong threat from communism,” Gomory explained. “If our corporations had been acting towards our people as they do now, we would not have won the cold war.”

During that whole post-war period, from the end of the war to about the mid-1970s, the average wage went up together with the stock market, Gomory said.

Corporations had to recognize their obligations to employees, customers, and the community. But this trend ended when the threat of communism start to disappear in the 1970s, he explained.

Today, there are conflicting views on the corporate governance issue and Warren’s bill has drawn criticism from both academics and the business world.

“It’s not simple but when people say, ‘Well we can’t do this,’ I would say ‘Well, we did [in the past] and it worked well,’” Gomory said.

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