Mariana Mazzucato - The Value of Everything - Making and Taking in the Global Economy

However, Fink’s message has not been widely echoed by investors. The ratio of buy-backs and dividends to reported earnings has hardly declined. Having set a required return on reinvested funds that few managements feel able to meet, shareholders have grown accustomed to having a steady stream of funds paid out instead.

Figure 21.Top ten stock repurchasers in the US (2004–2012), ranked by the absolute amount of share buy-backs 8

MAXIMIZING SHAREHOLDER VALUE

Share buy-backs boost executive pay. To defend the idea that incentive pay realigns executive and shareholder interests, it is often claimed that share buy-backs maximize shareholder value (MSV) and thus improve the efficiency of companies. 9Financial techniques, it is argued, are a legitimate way for managers to improve productivity and therefore benefit workers and customers as well as shareholders. If a company can earn a higher return at any given time from putting capital to work financially rather than directly selling cars or software, it is behaving rationally and in the best interests of the business. Having a choice between a financial or a productive use for capital helps to keep the (supposedly) core business of cars or software on its toes because it has to produce returns which compete with financial alternatives. By extension, it is argued that making it easier for customers to obtain credit, especially to buy your own products, is a service to ordinary people. There is something to this – but not much. Where did these ideas come from? And do they have validity?

Back in the 1970s, as the economic crisis and stagnation of the decade impaired the performance and profitability of the corporate sector, shareholder dissatisfaction made shareholder returns the principal aim of the corporation. In 1970, Milton Friedman published in the New York Times Magazine an article which became the founding text of the shareholder value movement and, in many ways, of corporate management in general. Titled ‘The Social Responsibility of Business Is to Increase its Profits’, Friedman’s article advanced the idea that America’s economic performance was declining because a cardinal principle of mainstream economics – that firms maximize profits – was being violated. There was no longer any punishment for managers who failed to profit-maximize. Shareholders could not inflict such punishment because they were too dispersed and uncoordinated; and markets could not do so, because listed companies had monopoly power and would not be assailed by new competitors if their costs and prices drifted upwards. Some 1960s economists had viewed ‘managerialism’ as potentially good for society, if bosses allowed profit to be eroded by paying better wages to employees, meeting higher environmental or health and safety standards and investing more in new products. Friedman reset the debate by suggesting that bosses were more likely to be sacrificing profit to their own expense accounts and luxury lifestyles; and that even letting costs rise through ‘corporate social responsibility’ was fundamentally wrong. The piece spawned an academic literature that would become known as ‘agency theory’.

Friedman’s idea was developed further by the University of Chicago-trained Michael Jensen, who was steeped in its ‘free market’ ideas. In 1976 Jensen, now a professor at the University of Rochester, wrote a paper with the Dean of Rochester’s business school, William Meckling (who, like Jensen, was a student of Friedman at Chicago), on how to implement Friedman’s idea. It was called ‘Theory of the firm: Managerial behavior, agency costs, and ownership structure’. The key argument was that managers (the agents) were not being disciplined by competitive financial markets or product markets, since they could misallocate resources or run up unnecessary expenses without incurring losses or endangering their jobs, and so it was hard for investors (the principals) to keep them accountable. The only way to do so was through strengthening the ‘market’, which was neutral and objective enough to make sure the company thrived. The result was a body of theory that argued that the only way for companies to be well run was if they maximized their ‘shareholder value’. In this way, investors would indirectly keep company managers accountable.

In the decades that followed, an entire intellectual apparatus was created around ‘maximizing shareholder value’, with new developments in law, economics and business studies. It became the dominant perspective of leading business schools and economic departments. The overriding goal of the corporation became that of maximizing shareholder value, as captured in the corporation’s share price.

However, far from being a lodestar for corporate management, maximizing shareholder value turned into a catalyst for a set of mutually reinforcing trends, which played up short-termism while downplaying the long-term view and a broader interpretation of whom the corporation should benefit. In the name of MSV, managers sought profits anywhere they could, directly fuelling globalization and outsourcing production to locations from China to Mexico. Jobs were lost and communities wrecked. Meanwhile, the added external pressures on corporate management did little to enhance its quality. Rather than become properly trained managers with sectoral expertise, who could make decisions on what to produce and how to produce it, top graduates in business schools preferred to go to Wall Street. While in 1965 only 11 per cent of Harvard Business School MBAs went into the financial sector, by 1985 the figure had reached 41 per cent and has risen since then.

Figure 22 shows how the influence of PE, one of the most aggressive manifestations of MSV, grew in the US in the first decade and a half of the twenty-first century. The arguments of Friedman, Jensen and Meckling suggested that shareholder value was going to waste. So a new type of investor that could capture this leaking value would be instantly rewarded, through bigger dividends or share price gains. PE funds and acquisition vehicles led the pack of new, value-hungry investors that now assailed the world’s stock markets.

PE is MSV turbo-charged. Many of the companies in which PE firms invest are not financial ones; often, indeed, they can be found on the productive side of the production boundary. But whereas traditional institutional investors were often satisfied to ‘buy and hold’, and to await share price gains via profit being reinvested rather than paid out, PE seeks to buy and resell at a higher price within a few years. What this means is that many firms owned by PE funds are pushed into taking a significantly shorter-term view than they might have done otherwise – the exact reverse of ‘patient capital’ and raising productivity to benefit society in the long run. If the influence of PE on the productive economy seems exaggerated, consider this: Blackstone, one of the largest PE companies, has a portfolio of over seventy-seven companies, which together generate over $64 billion in combined annual revenues and employ more than 514,000 people globally. 11

Figure 22.PE-backed companies as a percentage of all US companies (by enterprise size) 10

The recent history of the care home and water industries in the UK shows how PE can change a business – and not necessarily for the better. Until the mid-1990s the country’s care homes were owned either by small family firms or by local authorities. 12Today, for a combination of political and financial reasons, many local authority homes have closed. A new breed of financial operator has moved into the market, largely following a PE model, often ‘selling’ many of its places to local authorities but also generating private profit. In 2015, the five biggest care home chains controlled about a fifth of the total number of care home beds in the UK. These operators were attracted by stable cash flows, part of which came from local authorities, and opportunities for financial engineering: cheap debt; property which could be sold and leased back; tax breaks on debt interest payments and carried interest; and – ultimately – frail and vulnerable residents whom the state would have to look after if the business failed. The corporate structures of some care home owners became exceedingly complex and often hidden in tax havens, while corporation tax payments were low or nil. Given that local authorities still funded many care home placements and that the nurses employed in the homes had been state-trained, opaque corporate structures and minimal tax payments are hardly the way to provide an essential public service.