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

Another constituency shared the managers’ interest in rent-seeking: the asset managers, a driving force behind the fashion for breaking up conglomerates to extract greater shareholder value. Economically and socially, asset managers were closer to corporate managers than they were to their real customers, the remote and probably poorly informed members of pension funds or holders of life insurance policies. MSV offered asset managers the chance to get rich alongside the managers of the companies in which they invested their clients’ money. Asset managers became the major holders of public equities, the ‘residual’ shareholder acting at least nominally on behalf of others. Their demands on the public corporation and later – through PE – the private corporation would profoundly affect the behaviour of the productive economy.

As we saw in the previous chapter, fund managers have played a central role in the development of contemporary capitalism. In theory, equity shareholders – largely institutional shareholders – monitor corporate performance. They act as gatekeepers, resolving the agent– principal problem generally and in particular monitoring how corporations use and allocate their capital. Their role should lead to better distribution of productive resources and make better use of resources already employed: for example, drawing on agency theory, a positive link has been made between institutional ownership and innovation. 16But these assessments often seem to neglect the broader picture. It is no coincidence that the case for shareholder activism and supervision often accompanies palpable breakdown of corporate governance: witness the string of corporate scandals such as Enron and WorldCom in the US, Sports Direct in the UK and Volkswagen cheating on diesel engine emissions.

Shareholders are not the only gatekeepers. Others include auditors, rating agencies, government regulators, the media and equity analysts – specialists who assess companies for investors. The cause of many of the corporate scandals of recent years, the standard argument goes, is the failure of these gatekeepers to do their job. Rather than being critical observers of companies, equity analysts have become their cheerleaders, and largely failed to see that banks were heading for the rocks. Independent auditors and rating agencies became business partners of the companies they oversaw instead of guarding the interests of investors and the wider community. Governments moved to ‘light-touch’ regulation of finance, often under pressure from the industry lobby. The media were slow to spot the scandals and uncover them. Corporate directors – who, let’s not forget, in the UK have a legal responsibility to act in the best interests of shareholders – were only a limited counterweight to managerial over-reach. 17There is no doubt that the incentive to generate fees – from advising, analysing and auditing companies, for example – resulted in collusion and conflicts of interest between the gatekeepers and the public corporations that led to failures of governance.

But the failure of the gatekeepers to fulfil their responsibility also owed much to the MSV mindset with which they perceived the fundamental role of the public corporation. And the key actors in the economy whose interests were most closely aligned with MSV’s objective were the institutional investors. Principal and agent were meant to eye each other warily, but instead an unholy alliance developed between them to extract value from the company. Their relationship worked against other stakeholders, not least workers, whose pay lagged further and further behind that of CEOs and senior managers.

SHORT-TERMISM AND UNPRODUCTIVE INVESTMENT

In the Great Depression of the 1930s, long before financialization entered the modern lexicon, Keynes observed that:

[most] expert professionals, possessing judgment and knowledge beyond that of the average private investor … are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional valuation a short time ahead of the general public. 18

A successful speculator himself, Keynes knew what he was talking about. He warned that the stock market would become ‘a battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years’. 19He would be proved right. The time within which shareholders seek to make profit, through a flow of dividends or a share price movement, is determined by the time for which they hold a particular share. And the average holding time for equity investment, whether by individuals or institutions, has relentlessly fallen: from four years in 1945 to eight months in 2000, two months in 2008 and (with the rise of high-frequency trading) twenty-two seconds by 2011 in the US. 20Average PE holding times jumped to almost six years when stock markets froze in the wake of the 2008 global financial crash, but were on a firm downward course again by 2015. 21

The ‘short-termism’ which Keynes anticipated is encapsulated in index fund pioneer John Bogle’s concept that institutional investors rent the shares of the companies they invest in rather than take ownership for the long term. Consider the increased turnover of domestic shares: according to the World Federation of Exchanges, which represents the world’s publicly regulated stock exchanges, in the US turnover of domestic shares was around 20 per cent a year in the 1970s, rising steeply to consistently over 100 per cent a year in the 2000s. Turnover measures how often a share changes hands and is calculated by dividing the number of shares traded in a given period by the number of shares outstanding in the same period. Increasing turnover is a sign that institutional investors’ sights were trained on the short-term movement of stock prices rather the intrinsic, long-term value of the corporation. High turnover can be more profitable for institutional investors than passive, long-term holding of shares. It should also be said that the short-termist behaviour of institutional investors reflects mounting pressure over the last four decades from clients who, expecting quick results and with a dislike of surprises, quickly withdraw their funds when disappointed. The result has been a corporate fixation on quarterly performance, which encourages consistent earnings growth to generate acceptable share price performance.

In 2013 the management consultants McKinsey and Company and the Canadian Pension Plan Investment Board surveyed 1,000 board members and senior company executives around the world to assess how they ran their businesses. 22The majority of respondents said that the pressure to generate strong short-term results had increased during the past five years to a point where managers felt obliged to demonstrate strong financial performance. But while roughly half of the respondents claimed to be using a time horizon of less than three years in setting strategy, almost all of them said that taking a longer-term view would improve corporate performance, strengthen financial returns and increase innovation. 23

Another important trend that further demonstrates the scale of MSV’s impact on corporate behaviour is that of rising hurdle rates. A hurdle rate, as we saw in the previous chapter, is a return on investment below which a company will not pursue an investment opportunity or project. It could be that, over time, there are fewer suitable opportunities available because the most profitable projects have already been taken up. Excess capacity in car-manufacturing, for instance, would naturally suggest that building a new plant would not be logical (though investing in other technologies very well might be). Fundamental economic forces may also be at work. Yet what has been happening to the hurdle rate seems to suggest that something else is also going on.