THE DIVINE RIGHT OF CAPITAL

Is Maximizing Returns to Shareholders a Legitimate Mandate?

By: Marjorie Kelly

Where does wealth come from? More precisely, where does the wealth of major public corporations come from? Who creates it?

To judge by the current arrangement in corporate America, one might suppose capital creates wealth―which is odd, because a pile of capital sitting there creates nothing. Yet capital-providers (stockholders) lay claim to most wealth that public corporations generate. They also claim the more fundamental right to have corporations managed on their behalf. Corporations are believed to exist for one purpose alone: to maximize returns to shareholders. This principle is reinforced by CEOs, The Wall Street Journal, business schools, and the courts. It is the law of the land―much as the divine right of kings was once the law of the land. Indeed, “maximizing returns to shareholders” is universally accepted as a kind of divine, unchallengeable mandate.

It is not in the least controversial. Though it should be. 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 a little quiz:

Stockholders fund major public corporations―True or False?

False. Or, actually, a tiny bit true―for the most part, massively false. What’s intriguing is that we speak as though it were entirely: “I have invested in AT&T,” we say―imagining AT&T as a steward of our money, with a fiduciary responsibility to take care of it. In fact, “investing” dollars don’t go to AT&T but to other speculators. Equity “investments” reach a public corporation only when new common stock is sold―which for major corporations is a rare event. Among the Dow Jones Industrials, only a handful have sold any new common stock in 30 years. Many have sold none in 50 years.

The stock market works like a used car market, as accounting professor Ralph Estes observes in Tyranny of the Bottom Line. When you buy a 1989 Ford Escort, the money doesn’t go to Ford. It goes to the previous owner. Ford gets the buyer’s money only when it sells a 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, about 99% of the stock out there is “used stock.” That is, 99 out of 100 “invested” dollars are trading in the purely speculative market, and never reach corporations.

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 $555 billion in capital. According to the Federal Reserves, sales of common stock contributed 4% of that. I used this fact in a full-quote for a magazine article once, and the designer changed it to 40%, assuming it was a typo. Of all capital public corporations needed in 1993, stockholders provided 4%.

Well, yes, critics will say―that’s recently. But stockholders did fund corporations in the past.

Again, only a tiny bit true. Take the steel industry. An accounting study by Eldon Hendriksen examined capital expenditures in that industry from 1900 to 1953, and found that issues of common stock provided only 5% of capital. That was over the entire first half of the 20th century, when industry was growing by leaps and bounds.

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 a company goes public, and in occasional secondary offerings later. But in the life of most major companies today, issuance of common stock represents a distant, long-ago source of funds, and a minor one at that. What’s odd is that it entitles holders to extract most of the corporation’s wealth, forever. Equity investors essentially install a 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 to be 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 1,000th hand, also take a risk―but it is a 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 a second oddity―that we believe stockholders are the corporation. When we say. “A corporation did well,” we mean it stockholders did well. The company’s local community might be devastated by plant having its groundwater contaminated with pollutants. Employees might be shouldering a 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 a 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 land could vote. Employees are disenfranchised.

We think of this as the natural law of the free market. It’s more accurately the result of the corporate governance structure, which violates free-market principles. In a free market 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 a single, magical word: “ownership.” Because we say stockholders “own” corporations, they are permitted to contribute very little, and take quite a lot.

What an extraordinary word. One is tempted to recall Lycophron’s comment, during an early Athenian slave uprising against the aristocracy, “The splendour of noble birth is imaginary,” he said, “and its prerogatives are based upon a mere word.”