Maximizing Shareholder Value: A New Ideology for Corporate Governance
January 2002
DOI:10.1057/9780230523739_2
In book: Corporate Governance and Sustainable Prosperity (pp.11-36)
By William Lazonick & Mary O’Sullivan
The article written by William Lazonick and Mary O’Sullivan focuses on the shift of the firm governance ideology from retain and reinvest to downsize and distribute in the corporate US between the 1950s and the 1990s. Even though the actual ideology change took place in the 1970s and 1980s, the authors take a look at the events that triggered this change and also at the events that happened before and after the change, in order to analyse the events that triggered the change and the events that happened as a result of the change
Regarding the article’s information, this is one of the strong points of this article. It brings up to the reader all the important events that happened in the US economic system during the years between 1950 and early 2000 which led to the actual shift in ideology of corporate governance. It analyses the economic context that led to the change, such as the 1970s oil inflation and the rise of international competition in the same period, and it also takes into account all the relevant changes in the economic system that made the shift in the corporate ideology (Lazonick and O’Sullivan, 1997). Such changes can be the ending of the fixed commissioning of the transactions on the stock market and the rise of dividend ratio to profits or any other measures taken to make the stock market more popular for investors (Koch and Bracker, 1999).
However, regarding the chronological flow of the events in the article, this one is totally inexistent.The information in the article is presented in a chaotic manner that confuses the readers by quickly jumping from an event to another without taking into consideration the chronological order of the events. As an example, the article starts by focusing on the stock market boom of the 1980s and on the focus of corporations on the maximisation of the shareholder value, instead of starting by focusing on the 1950s and the economic situation of that time.
To begin with, in the 1950s and 1960s, retain and reinvest strategies were at the base of governing principles of the companies. The work place tenure was also high and the jobs were very stable (blue and white collar jobs) (Herz, 1990). Regarding the company shares and stocks, at that time, the companies were releasing shares to the public only in order to pay off debts and to increase the corporate treasures (O’ Sullivan, 2000). The institutional investors, comprising of insurance companies, mutual funds and insurance companies, that were responsible with the mobilisation of the savings of the public, at that time had limited investment potential in the stock market.
After the 1960s, the situation started to change and in the 1970s, the American economic environment started being unstable (Lazonick, 1992). The oil-priced inflation, new international competition and the excessive centralization of the big companies as a result of the rapid and massive growth during the 60s and 50s, has made the US industry remain behind in front of other competitors such as Japan or Germany.
Even though the level of information provided in the article is a very high one, the article fails to make the readers understand the deeper meaning behind of all the events. In order for the readers to get a bigger picture of the change and all its’ implications, the readers need first to understand the reasons why some processes have taken place. As an example, the boost in popularity of the stock market investment in the 1970s and 1980s was due to the need of the US government to raise capital in a fast and safe manner for the big companies in order to keep themselves ahead of the international competition. In addition, the oil priced inflation of the 1970s made capital raising even more difficult due to the decreased investment confidence caused by the inflation.The investment in the stock market was the solution at that time because it was safe and fast for the companies to sell shares to the public to rise the required amount of capital to upgrade their capacity.
The stock market investment became more popular when the ratio of dividends offered to company profits grew to an average of 42.3% in the 1970s and kept growing in the 1980s and ultimately reaching the peak in the 1990s at an average of 49.6% without taking into account whether the company profits were declining or not (US Congres, 1999). Furthermore, the Wall Street companies convinced the Securities and Exchange Commission (SEC) of the US in the early 1970s to remove the fixed commission of every transaction on the stock market.In order to attract institutions also to invest in the stock market, the ERISA act in 1974 gave permission to the institutional investors to invest substantial sums of money in the stock market that were not possible before.
Fast capital raising is not enough and a way of cutting the production costs throughout all the industries was necessary. In order to achieve that, most companies were focused on reducing the number of employees in order to spend less money on paying the workers’ salaries.Starting with the 1970s, US companies were dispersing the shop-floor skills as much as possible and invest into technologies to replace the need of hiring unskilled workers. In the 1980s, (US Congress, 1992) tens of thousands of “White collar” and “Blue collar” job positions were eliminated from the economy at a 10% job loss rate and later on in the 1990s, the job loss rate has gone up to 14% and kept rising at a steady rate which ultimately finished growing in 1998 (Staudohar and Brown, 1987).
This article proves to be a very analytical one because it doesn’t only describe the actual change in the ideology but it also analyses the advantages and disadvantages of the change in the American economic system. It offers the readers the possibility to understand some implications of such a change some economic mechanisms of the US economy. An example of such a disadvantage would be the dependency of the institutional investors and the US enterprises on the stock market. Another disadvantage would be the exacerbation of the income inequality distribution throughout the US. The principles of downsize and distribute only made the income distribution of the Americans because the top 1% of the US households own nearly 37% of all the existing corporate equities and nearly 80% of the US households own less than 2% of the corporate equities (Poterba and Samwick, 1995).
On the other hand, some advantages of the ideology change would be the reallocation of labour hand and capital from the big companies to the new start-up companies and of course the dismantling of corporate control over the allocation of returns and resources in the economy (Dial and Murphy, 1995). Basically, the big companies no longer have the monopole over resource suppliers and more companies can enter the market and survive in front of the big companies. The competition grows and the new firms can bring innovative ideas and concepts in the US industries which are necessary for the growth of the economic system as a whole.
In order to evaluate the representation of the data in this article, it is compulsory to take a look at the graphics. Even though the existing graphics give the reader an idea of the magnitude of the ideology change on the economic system in terms such as stock buyback rate or the number of unemployed people, there are no graphics representing the full implications of the change on the economic system by providing figures of the affected economic areas before and after the actual change. As an example, the graphic at the page 26 representing the CEO change in payment only displays it for three years. If that graphic would have provided the data of the CEO payment throughout the 1950s and 1990s, the readers could get a better understanding of the magnitude of the CEO payment change. In addition, the graphic at the page 24 shows the percentage of the stock buybacks as part of the corporate profits. If the graphic would have had a longer year range, such as 1950s and 1990s, the readers would have been able to understand better how the stock buyback process affected company profits before and after the change took place.
To sum up, by taking into account all the pros and cons of this article, my overall conclusion is that it is a good article but I really do not think that this article has other that informative purposes. The author tries to raise awareness of the mistakes of such a change in ideology, not to be repeated again because of the negative effects on the economy, mission in which he succeeded by presenting more economists’ views on the change. Even though the article has insufficient graphics in terms of the scope and the chronological order of events is totally missing, based on the level of information provided and the multiple layer analysis of the change and its contexts, with a little bit of work and time spent reading and critically thinking the article, the reader is capable of deducting the deeper implications of the changes in order to understand the bigger picture of the change and what triggered more exactly the change.
References
1) O’Sullivan, M. (1997) ‘Investment in innovation, corporate governance, and corporate employment’, Jerome Levy Economics Institute Policy Brief No. 37
2) Poterba, J. and Samwick, A. (1995) ‘Stock ownership patterns, stock market fl uctuations, and consumption’, Brookings Papers on Economic Activity 2: 295’372
3) Mary O’Sullivan ‘ (2000) Contests for Corporate Control: Corporate Governance and Economic Performance in the United States and Germany, Oxford: Oxford University Press, forthcoming.
4) US Congress (1999) Economic Report of the President, Washington, DC: US Government Printing Office. US Department of Commerce
5) Staudohar, P. and Brown, H. (1987) Deindustrialization and Plant Closure, Lexington, MA: Lexington Books.
6) Lazonick, W. (1992) ‘Controlling the market for corporate control’, Industrial and Corporate Change
7) K. Bracker, D. S. Docking, D. Koch (1999) “Economic determinants of evolution in international stock market integration” , Journal of Empirical Finance, Volume 6, Issue 1
8) Herz, D. (1990) ‘Worker displacement in a period of rapid job expansion, 1983’1987’, Monthly Labor Review May.
9) Jay Dial, Kevin Murphy (1995) “Incentives, downsizing and value creation at general dynamics” , Journal of Financial Economics, Volume 377, Issue 3