Rights of Public Shareholders

Lawrence E. Mitchell just published a very thoughtful paper, The Legitimate Rights of Public Shareholders. He argues that shareholders don’t contribute capital to finance industrial production but are, instead, net consumers. Since their investment incentives "significantly distort the behavior of corporate managers," leading CEOs to value stock price at the expense of long-term business health, shareowner rights should be eliminated, instead of expanded or enhanced.

The article reminds me a of Marjorie Kelly’s The Divine Right of Capital, which argued that instead of maximizing the return to shareholders, corporations should maximize total return …a concept I have been advocating at CorpGov.Net since 1995. Total return implies the long term efficient use of all resources, both natural and human.

I agree with both Mitchell and Kelly that, generally, stockowners aren’t providing capital to a company. We are buying shares from another stockowner, gambling the price will rise. We aren’t really investing, in the traditional sense. We’re buying the right to extract wealth in the future. I liked Kelly’s argument that efficiency is best served when gains go to those who create wealth. That puts an emphasis on brain power and knowledge workers.

Of course, the revelation that shareholders don’t contribute much isn’t new. Back in the 1960s Louis Kelso asserted that 99.5% of corporate capital came through internal earnings and debt. This insight led him to advocate employee stock ownership plans (ESOPs). Norm Kurland took up the cause with a call for a Capital Homestead Act. Kelly endorsed a similar idea and a renewed look at charters and other stakeholder reforms. Making every citizen a shareowner, especially in a broad-based basket of stocks, has appeal. Everyone would benefit from the wealth corporations develop. Yet, if ownership were universal, there would be little incentive for owners to externalize costs onto society.

Mitchell is less imaginative in this paper. He’s not sure if the problems can be solved by electing directors for five-year terms, letting creditors also vote, or by eliminating shareowner votes on all but except directors. This contribution is worthy, not in recommendations, which he says are beyond its scope, but rather in documenting a dramatic increase in off-balance sheet debt, the rise of stock buybacks, the fall in dividends and retained earnings and, more generally, the shift from "achieving gains from production to using the corporate machinery to manipulate stock price."

Yes, the shift from dividends to capital gains has distorted incentives in a way that "encourages managers to harm the long-term health of their corporations’ businesses in order to satisfy current shareholder demands." Yes, many forces have moved investors to think of themselves as simple gamblers based on speculative future value, rather simply extracting dividends from actual earnings. Yes, interested parties pushed more churning because it meant more commissions and fees.

However, I don’t think it follows that we should now begin to rely more heavily on the market for corporate control, especially one where shareowners are given less power. As an article in the FT points out, in the US overall debt reached an all-time peak of just under 350% of GDP, 85% of it private, up from 160% in 1980. (Seeds of its own destruction, 3/9/09) Like global climate change, we need to develop more sustainable models, both for corporations and for a salubrious environment.

Doing away with shareowner proposals under Rule 14a-8 won’t make companies more responsible. Shareowners raising issues through such resolutions serve as a better proxy for the public than reinforced insulation of CEOs and boards. After all, if the market had listened to ICCR’s warnings over many years and 120 resolutions on subprime lending and securitization, we probably wouldn’t be in the current financial mess. The fact that only 5% of retail shareowners are now voting under e-proxy is a sign that proxy voting must be made more meaningful, not less meaningful.

We should be looking at how to address short-termism and conflicts of interest that lead to gaming of numbers and the entire system. Perhaps long-term shareowners should have more voting rights. Maybe if more employees were shareowners we’d have a few employees on boards who are more likely to take a longer term perspective than day trading investors. Additional fiduciary duties on boards for the welfare of employees, the economy in general or for a salubrious environment might add a bit of stability and long-term thinking.

Why not look at the increase in off-balance sheet debt, the rise of stock buybacks, the fall in dividends and retained earnings and other shifts to manipulate stock price and address them directly? Mitchell had a better idea in The Speculation Economy: How Finance Triumphed Over Industry. There, he proposed the terms of capital gains taxes be tied to industry. For the auto industry that might be a tax on 90% of gains if sold in the first month, tapering to tax-free after seven years. "Perhaps the right time period is two years in the software industry, or four years in computer hardware." At least that solution actually attempted to address fundamental problems. Disenfranchising shareowners does not.