Shareholder value is OK but cronyism is a problem

It’s an article of faith in some quarters that economic problems are generally caused by deficiencies of the private sector and can best be addressed by giving more power to government regulators.

Financial crises (e.g., bubble, mortgage/housing bubble, financial system chaos) and scandals (e.g., Enron, Madoff) fuel the narrative, as do purported threats like global warming.  A typical conclusion is that the government should fix matters.  The “failure” of capitalism, Nicholas Vardy,, 12/4/09.

Thus, former Senator Ted Kaufman has written column after column for the News Journal advocating SEC regulation of corporate stock buybacks (
9/7/14), supporting EPA restrictions on carbon emissions (6/29/14), demanding further financial reforms because the Dodd-Frank Bill didn’t fix the “too big to fail” (TBTF) problem (6/8/14), etc.

For the record, SAFE contacted the members of Congress from Delaware (including Senator Kaufman) in 2010, urging them to vote against Dodd-Frank because, among other things, it didn’t address TBTF.

Assuming that the financial crisis of 2008 resulted from private sector malfeasance, never mind government policies that enabled marginal borrowers to acquire houses they couldn’t afford and Federal Reserve monetary ease, this 2,300-page bill granted sweeping new powers to half a dozen regulatory agencies (including the newly created Consumer Financial Protection Bureau) without much guidance as to what Congress wanted done.  The regulators have been floundering ever since.  Four years of Dodd-Frank damage, Peter Wallison, Wall Street Journal, 7/21/14.

As of July 18, only 208 of the 398 regulations required by the act have been finalized, and more than 45 percent of congressional deadlines have been missed. *** Even after regulations have been finalized, interpreting them can be a trial. For example, the regulations implementing the inconsistent Volcker Rule, which prohibited banks and their affiliates from trading securities for their own account, took more than three years to write, but key provisions are still unclear.

A learned business critic concurs that ever more regulations won’t enhance the quality of corporate decision-making. His approach would be to change the nature of the corporation, thereby dethroning “shareholder value” as the primary criterion for business decisions.  Firm Commitment lecture, Professor Colin Mayer,, 2/6/13. (41 minute video)

We tend to disagree, but it may be instructive to consider the logic involved.

1. Has corporate behavior changed for the worse, and why? –
There is “nothing new under the sun,” as the saying goes, and it would be safe to say that fraud and chicanery have been around for a long time in the business and financial world. 

Thus, a federal statute providing for whistleblower suits (qui tam) against suppliers, etc. seeking to cheat the government was enacted during the Civil War.  Charles Ponzi’s investment pyramid schemes were perpetrated during the 1920s, as is mentioned in the lecture.  All manner of securities wheeling and dealing came to light as result of investigations of the stock market crash of 1929, etc., leading to creation of the Securities and Exchange Commission.  And so forth.     

While the scandals of recent years have been quite significant, it’s not clear that they represent a major change – as Professor Mayer seems to suggest - from the way things used to be.

Still, Mayer reels off one recent corporate disaster after another, including, since the 2008 financial crisis, the LIBO scandal (Barclay’s Bank and others were found to have systematically fudged quotations in the London Interbank loan market), the BP drilling platform disaster in the Gulf of Mexico (due to compromising safety standards), and the nuclear reactor meltdown at Fukushima (Tokyo Electric Power Co. failed to adequately anticipate and prepare for earthquake/tsunami risk). 

And he offers a cogent explanation, which is that corporate ownership has over time become increasingly dispersed and transient, with the legal duty of corporate managers to shareholders leading them to focus on wealth transfers (cutting corners, clever financial deals, quick payouts to shareholders) versus long-term value creation.  So long as the results don’t backfire, triggering public fury and political intervention, “the stock market rejoices” and corporate executives are rewarded with “outrageous pay.”    

In a somewhat similar vein, see: Sell your soul to Goldman or save the world at Google?  Vivek Wadhwa,, 11/5/13.

There has been an effort to resolve such problems via government regulation, which basically means substituting the morality of the state for the morality of corporations.  Public opinion polls show, however, that trust in politicians and regulators is in short supply.  Also, regulations often exacerbate the very problems they are supposed to solve by shifting the focus from doing the right thing to doing the minimum necessary to satisfy the government’s rules. So perhaps it’s time for a different approach.

2. Does the stress on shareholder value shortchange other stakeholders?
– We would agree that corporations should be run in a way that seeks to respect the interests of all of the parties concerned, e.g., suppliers, customers, employees, and the general public.  But the point should not be carried too far, for it will never be possible for a human organization to completely satisfy everyone. 

Furthermore, in our view, Mayer exaggerates the tension between maximizing shareholder value and serving other stakeholders.  If a corporation fails to produce products and services that satisfy customer needs and wants, it won’t be in business very long – no matter how clever its financial advisers may be.  Enlisting the willing support of suppliers and employees is obviously a good business practice.  And the penalties for being perceived to have acted irresponsibly can be catastrophic, including loss of business as a result of the bad publicity, enormous legal liabilities (just ask BP, Bank of American, JPMorgan Chase, et al.), and/or sweeping new regulations.

This is not to say “greed is good,” but it’s not clear greed can or should be eliminated.  Consider the analogy of an “invisible hand” that can produce constructive results when all the players in a free economy are focused on pursuing their individual interests.  An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith, 1776,,

Every individual necessarily labours to render the annual revenue of the society as great as he can. He generally neither intends to promote the public interest, nor knows how much he is promoting it ... He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

In any case, it would seem ill advised to ditch the shareholder value model without a clear understanding of what would replace it.

3.  Is there a practical way to create more moral corporations?
– Mayer’s suggestions along these lines were not covered in the lecture, but they may be found in his book. Firm commitment: Why the corporation is failing us and how to restore trust in it, Oxford University Press (2013).

Here are some of the suggestions (review by John Gibbs,, along with our reactions.

•Require shareholders to register for the period for which they intend to hold shares, with voting rights being awarded pro rata to the length of time remaining before the shareholder can dispose of the shares.
The paperwork costs could be substantial, and we wonder what would happen if a shareholder sold early.  Also, do investors necessarily know how long they plan to hold a stock when they buy it? 

•Corporations should become "trust firms," with boards of trustees who ensure that the firm has clearly articulated values and principles and abides by them, but who do not otherwise interfere in the day-to-day running of the firm. 
Eliminating the role of the board in overseeing major decisions would be a mistake; having two boards would be even worse.

•The tax system should be changed so “corporations that demonstrate a public purpose, and an effective governance mechanism for upholding it, would be recipients of subsidies funded from corporation tax levied on corporations that have no public purpose.”  We can hardly imagine the IRS administering such a scheme; it wouldn’t be pretty.

•Rather than being considered agents of the shareholders, “corporations should be seen as independent entities which make credible commitments to other parties.”  Would the directors and top corporate managers stop being selected by the shareholders?

Mayer’s specific suggestions aside, we’re not convinced that attempting to reinvent corporations as morally driven institutions is practical.  Perhaps capitalism (based on the profit motive) is the best system available, as economist Milton Friedman argued in this interview (date unknown) on “greed.”

. . . where in the world [do] you find these angels that are going to organize society for us?  I don’t even trust you [the interviewer] to do that.

That’s not to say SAFE is satisfied with the behavior of “big business.”  To the contrary, we are deeply disappointed by the rent seeking and jockeying for political favors that is in vogue.  Corporate welfare has nine lives,

At the risk of overgeneralization, many [business leaders] seem to have adopted a pattern of pushing for all the special favors they can get while doing less and less to support the free enterprise and political liberty that have enabled this country to prosper.  If so, the longer-term implications are disturbing.

But necessary adjustments can more readily be made by our political leaders than by business leaders who have grown accustomed to besieging the government for favors because that’s how one gets ahead in a government-led economy.  Note also that business leaders can’t make agreements in restraint of trade; government involvement is required to legalize the arrangement.  The rise and decline of nations, Mancur Olson, Yale University Press (1982).

. . . special interest groups (privileged classes, producer cartels, labor unions, etc.) rig prices and/or output so as to advance their own interests, typically with the approval or support of the government. This leads to misallocation of resources and lower economic output than would otherwise be realized, but people in the favored class or group will still be better off.

The crux of the needed changes is not to eliminate all government regulations, which in many cases are OK provided they aren’t carried too far, but to have the government refrain from dictating economic choices.  The kind of light bulbs people use in their homes, the fuel efficiency (versus size and performance) of vehicles on the road, the kinds of food served in school cafeterias and even what food can be brought from home, the accommodations required for supposedly endangered species, and so on.

Make no mistake, these and other unnecessary regulations have pernicious economic effects – and their elimination would be a big plus.  This is what crony capitalism [aka cronyism, state-directed corporatism, or fascism] looks like, Veronique de Rugy, Washington Examiner, 7/20/12.

In a new paper called "The Pathology of Privilege: The Economic Consequences of Government Favoritism," my colleague Matt Mitchell explains that "Whatever its guise, government-granted privilege [to private businesses] is an extraordinarily destructive force. It misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector."

One of the benefits would be to restore balanced public discussion of policy issues, which affected firms often fear to talk about if the government is calling the shots – as for example in the healthcare industry due to GovCare.  None dare call it fascism, John Goodman,, 1/16/13.

And just as some observers worry about the wasted human potential of having top graduates go to work for Goldman Sachs et al., there are plenty of arguably useless jobs in a government-dominated economy.  Check out the video (1:40) showing children saying what they would like to be when they grow up, it’s wickedly funny.  Cronyism: Crushing the free market and promoting rent-seeking, Romina Boccia, Daily Signal, 8/28/12.

Realistically, however, cutting back the government regulatory apparatus wouldn’t be an easy sell.  Politicians benefit greatly from the current system, and it won’t be changed without pressure from the general public.  Cronyism: By-product of big government, National Center for Policy Analysis, 11/1/12.

First, politicians can expand their own personal wealth by giving favors to wealthy businesses that need something accomplished in Washington. Second, politicians can rely on the large support that businesses provide in election campaigns. And because the public can be largely unaware of the nuances in regulations, politicians have an incentive to cater more toward businesses in a regulated industry rather than making tough decisions for the public good.


Didn’t have a link, but could it be the Phil Donahue interview?  Watch that one – it is pure gold!!! - Joe Hilliard, PA
Bingo!  The interview was in 1979 (Friedman was promoting his book “Free to Choose”), ran 46 minutes, and here is the link.
While lauding the corporation as “one of the most important institutions in the world” in his book review, Professor Mayer also calls it “the cause of immense problems and suffering” and “a source of poverty and pollution.” The failures of corporations “are increasing,” according to him, and “while governments are subject to repeated questioning and scrutiny” corporations receive “relatively little attention.”  I don’t believe government actions are monitored more rigorously than corporate actions, certainly that’s not evident from the generally accepted explanations for the 2008 financial crisis, but even if they were so what?     It would be a big mistake to abandon corporations to the whims of left wing academics. – SAFE director


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