A controversial new book will be published in the US this month debunking “shareholder dictatorship”. Author Marjorie Kelly argues that the “relentless drive to make profits” has turned corporations into feudal estates leaving managers to do the bidding of powerful but tiny minority. We excerpt the introduction to her book, The Divine Right of Capital.
In an era when stock market wealth has seemed to grow on trees – and trillions have vanished as quickly as falling leaves – it’s an apt time to ask ourselves: Where does wealth come from? More precisely, where does the wealth of public corporations come from? Who creates it?
To judge by the current arrangement in corporate America, one might suppose capital creates wealth – which is strange because pile of capital sitting there creates nothing. Yet capital providers (stockholders) lay claim to most wealth that public corporations generate. Corporations are believed to exist to maximise returns to shareholders. This is the law of the land – much as the divine right of kings was once the law of the land.
In the dominant paradigm of business, it is not in the least controversial.
What do shareholders contribute, to justify the extraordinary allegiance they receive? They take risk, we’re told. They put their money on the line, so corporations might grow and prosper. Let’s test the truth of this with little quiz:
Stockholders fund major public corporations – true or false?
False. Or, actually, tiny bit true – but for the most part, massively false. What’s intriguing is that we speak as though it were entirely true: “I have invested in AT&T,” we say – imagining AT&T as steward of our money, with fiduciary responsibility to take care of it. In fact, “investing” dollars don’t go to AT&T but to other speculators. Equity investments reach public corporation only when new common stock is sold – which for major corporations is rare event. Among the Dow Jones Industrials, only handful have sold any new common stock in 30 years. Many have sold none in 50 years.
The stock market works like used car market, as former accounting professor Ralph Estes observes in Tyranny of the Bottom Line. When you buy 1997 Ford Escort, the money doesn’t go to Ford. It goes to the previous owner of the car. Ford gets the buyer’s money only when it sells new car. Similarly, companies get stockholders’ money only when they sell new common stock – which mature companies rarely do. According to figures from the Federal Reserve and the Securities and Exchange Commission, in any given year about one in one hundred dollars trading on public markets actually reaches corporation. That is, 99 out of 100 “invested” dollars are purely speculative.
Public corporations do have the ability to sell new stock. And they do need capital (funds beyond revenue) to operate – for inventory, expansion, and so forth. But they get very little of this capital from stockholders. In 1993, for example, corporations needed $698 billion in capital. According to the Federal Reserve, net sales of new equity contributed three percent of that.
If one wonders why I choose 1993 for illustration, it’s because this was the last year in which net new stockholder equity was actually positive number. The surge in stock buybacks has made “equity funding” misnomer, since for the last 20 years there’s been more going out to stockholders than is coming in from them. To put that more clearly: The stock market is not funding corporations. Corporations are funding the stock market.
Now, this is hard to grasp. One’s tendency is to shake it off and say, yes, well – that’s recently. But stockholders are reaping the rewards because they funded corporations in the past.
Again, only tiny bit true. Take the steel industry. An academic accounting study I discovered, by someone named Eldon Hendriksen, examined capital expenditures in that industry from 1900 to 1953, and found that issues of common stock provided only five percent of capital. That was over the entire first half of the 20th century, when industry was growing by leaps and bounds. Stockholders were not funding that growth.
So, what do stockholders contribute, to justify the extraordinary allegiance they receive? Very little. And that’s my point.
Equity capital is provided by stockholders when company goes public, and in occasional secondary offerings later. But in the life of most major companies today, sales of new common stock represent distant, long-ago source of funds, and minor one at that. What’s bizarre is that it entitles holders to extract most of the corporation’s increasing value, forever. Equity investors essentially install pipeline, and dictate that the corporation’s sole purpose is to funnel wealth into it. The pipeline is never to be tampered with – and no one else is granted significant access (except executives, whose function is to keep it flowing).
The truth is, the commotion on Wall Street is not about funding corporations. It’s about extracting from them.
The productive risk in building businesses is borne by entrepreneurs and their initial venture investors, who do contribute real investing dollars, to create real wealth. Those who buy stock at sixth or seventh hand, or 1000th hand, also take risk – but it is risk speculators take among themselves, trying to outwit one another like gamblers. It has little to do with corporations, except this: public companies are required to provide new chips for the gaming table, into infinity.
It’s odd. And it’s connected to second oddity – that we believe stockholders are the corporation. When we say “a corporation did well”, we mean its shareholders did well. The company’s local community might be devastated by plant closings, its groundwater contaminated with pollutants. Employees might be shouldering crushing workload, doing without raises for years on end. Still we will say, “the corporation did well”.
One does not see rising employee income as measure of corporate success. Indeed, gains to employees are losses to the corporation. And this betrays an unconscious bias: that employees are not really part of the corporation. They have no claim on wealth they create, no say in governance, and no vote for the board of directors. They’re not citizens of corporate society, but subjects.
Investors, on the other hand, may never set foot inside “their” companies, may not know where they’re located or what they produce. Yet corporations exist to enrich investors alone. In the corporate society, only those who own stock can vote – like America until the mid-1800s, when only those who owned land could vote. Employees are disenfranchised.
We think of this as the natural law of the market. It’s more accurately the result of the corporate governance structure, which violates market principles. In real markets, everyone scrambles to get what they can, and they keep what they earn. In the construct of the corporation, one group gets what another earns.
The oddity of it all is veiled by the incantation of single, magical word: ownership. Because we say stockholders “own” corporations, they are permitted to contribute very little, and take quite lot.
What an extraordinary word. One is tempted to recall the comment that Lycophron, an ancient Greek philosopher, made during an early Athenian slave uprising against the aristocracy. “The splendour of noble birth is imaginary,” he said, “and its prerogatives are based upon mere word.”
A mere word. And yet the source of untold trouble. Why have the rich gotten richer while employee income has stagnated? Because that’s the way the corporation is designed. It is designed to pay stockholders as much as possible, and to pay employees as little as possible. Why are companies demanding exemption from property taxes and cutting down 300-year-old forests? Because that’s the way the corporation is designed. It is designed to internalise all possible gains from the community, and to externalise all possible costs onto t