However, as time wore on, a new class of professional managers emerged to replace these charismatic entrepreneurs. As companies grew in size, it became more and more difficult for anyone to own a significant share of them, although in some European countries, such as Sweden, the founding families (or foundations owned by them) hung on as the dominant shareholders, thanks to the legal allowance to issue new shares with smaller (typically 10 per cent, sometimes even 0.1 per cent) voting rights. With these changes, professional managers became the dominant players and the shareholders became increasingly passive in determining the way in which companies were run.
From the 1930s, the talk was increasingly of the birth of managerial capitalism, where capitalists in the traditional sense – the ‘captains of industry’, as the Victorians used to call them – had been replaced by career bureaucrats (private sector bureaucrats, but bureaucrats nonetheless). There was an increasing worry that these hired managers were running the enterprises in their own interests, rather than in the interests of their legal owners, that is, the shareholders. When they should be maximizing profits, it was argued, these managers were maximizing sales (to maximize the size of the company and thus their own prestige) and their own perks, or, worse, engaged directly in prestige projects that add hugely to their egos but little to company profits and thus its value (measured essentially by its stock market capitalization).
Some accepted the rise of the professional managers as an inevitable, if not totally welcome, phenomenon. Joseph Schumpeter, the Austrian-born American economist who is famous for his theory of entrepreneurship (see Thing 15), argued in the 1940s that, with the growing scale of companies and the introduction of scientific principles in corporate research and development, the heroic entrepreneurs of early capitalism would be replaced by bureaucratic professional managers. Schumpeter believed this would reduce the dynamism of capitalism, but thought it inevitable. Writing in the 1950s, John Kenneth Galbraith, the Canadian-born American economist, also argued that the rise of large corporations managed by professional managers was unavoidable and therefore that the only way to provide ‘countervailing forces’ to those enterprises was through increased government regulation and enhanced union power.
However, for decades after that, more pure-blooded advocates of private property have believed that managerial incentives need to be designed in such a way that the managers maximize profits. Many fine brains had worked on this ‘incentive design’ problem, but the ‘holy grail’ proved elusive. Managers could always find a way to observe the letter of the contract but not the spirit, especially when it is not easy for shareholders to verify whether poor profit performance by a manager was the result of his failure to pay enough attention to profit figures or due to forces beyond his control.
And then, in the 1980s, the holy grail was found. It was called the principle of shareholder value maximization. It was argued that professional managers should be rewarded according to the amount they can give to shareholders. In order to achieve this, it was argued, first profits need to be maximized by ruthlessly cutting costs – wage bills, investments, inventories, middle-level managers, and so on. Second, the highest possible share of these profits needs to be distributed to the shareholders – through dividends and share buybacks. In order to encourage managers to behave in this way, the proportion of their compensation packages that stock options account for needs to be increased, so that they identify more with the interests of the shareholders. The idea was advocated not just by shareholders, but also by many professional managers, most famously by Jack Welch, the long-time chairman of General Electric (GE), who is often credited with coining the term ‘shareholder value’ in a speech in 1981.
Soon after Welch’s speech, shareholder value maximization became the zeitgeist of the American corporate world. In the beginning, it seemed to work really well for both the managers and the shareholders. The share of profits in national income, which had shown a downward trend since the 1960s, sharply rose in the mid 1980s and has shown an upward trend since then.[3] And the shareholders got a higher share of that profit as dividends, while seeing the value of their shares rise. Distributed profits as a share of total US corporate profit stood at 35–45 per cent between the 1950s and the 1970s, but it has been on an upward trend since the late 70s and now stands at around 60 per cent.[4] The managers saw their compensation rising through the roof (see Thing 14), but shareholders stopped questioning their pay packages, as they were happy with ever-rising share prices and dividends. The practice soon spread to other countries – more easily to countries like Britain, which had a corporate power structure and managerial culture similar to those of the US, and less easily to other countries, as we shall see below.
Now, this unholy alliance between the professional managers and the shareholders was all financed by squeezing the other stakeholders in the company (which is why it has spread much more slowly to other rich countries where the other stakeholders have greater relative strength). Jobs were ruthlessly cut, many workers were fired and re-hired as non-unionized labour with lower wages and fewer benefits, and wage increases were suppressed (often by relocating to or outsourcing from low-wage countries, such as China and India – or the threat to do so). The suppliers, and their workers, were also squeezed by continued cuts in procurement prices, while the government was pressured into lowering corporate tax rates and/or providing more subsidies, with the help of the threat of relocating to countries with lower corporate tax rates and/or higher business subsidies. As a result, income inequality soared (see Thing 13) and in a seemingly endless corporate boom (ending, of course, in 2008), the vast majority of the American and the British populations could share in the (apparent) prosperity only through borrowing at unprecedented rates.
The immediate income redistribution into profits was bad enough, but the ever-increasing share of profit in national income since the 1980s has not been translated into higher investments either (see Thing 13). Investment as a share of US national output has actually fallen, rather than risen, from 20.5 per cent in the 1980s to 18.7 per cent since then (1990–2009). It may have been acceptable if this lower investment rate had been compensated for by a more efficient use of capital, generating higher growth. However, the growth rate of per capita income in the US fell from around 2.6 per cent per year in the 1960s and 70s to 1.6 per cent during 1990–2009, the heyday of shareholder capitalism. In Britain, where similar changes in corporate behaviour were happening, per capita income growth rates fell from 2.4 per cent in the 1960s–70s, when the country was allegedly suffering from the ‘British Disease’, to 1.7 per cent during 1990–2009. So running companies in the interest of the shareholders does not even benefit the economy in the average sense (that is, ignoring the upward income redistribution).
This is not all. The worst thing about shareholder value maximization is that it does not even do the company itself much good. The easiest way for a company to maximize profit is to reduce expenditure, as increasing revenues is more difficult – by cutting the wage bill through job cuts and by reducing capital expenditure by minimizing investment. Generating higher profit, however, is only the beginning of shareholder value maximization. The maximum proportion of the profit thus generated needs to be given to the shareholders in the form of higher dividends. Or the company uses part of the profits to buy back its own shares, thereby keeping the share prices up and thus indirectly redistributing even more profits to the shareholders (who can realize higher capital gains should they decide to sell some of their shares). Share buybacks used to be less than 5 per cent of US corporate profits for decades until the early 1980s, but have kept rising since then and reached an epic proportion of 90 per cent in 2007 and an absurd 280 per cent in 2008.[5] William Lazonick, the American business economist, estimates that, had GM not spent the $20.4 billion that it did in share buybacks between 1986 and 2002 and put it in the bank (with a 2.5 per cent after-tax annual return), it would have had no problem finding the $35 billion that it needed to stave off bankruptcy in 2009.[6] And in all this binge of profits, the professional managers benefit enormously too, as they own a lot of shares themselves through stock options.
3
A. Glyn,
4
J. G. Palma, ‘The revenge of the market on the rentiers – Why neo-liberal reports on the end of history turned out to be premature’,
5
See W. Lazonick and M. O’Sullivan, ‘Maximising shareholder value: A new ideology for corporate governance’,