Despite the popular wisdom that shareholders of a firm are its true owners, there is no sense, legal or otherwise, to which this is true. This post will serve to survey some of the political science literature and the contemporary legal scholarship which I believe thoroughly debunks the shareholder value myth. Taken as a whole, I believe these perspectives puts to rest any notion that the corporation’s shareholders are its owners.
A Political Economy Perspective
In his contribution to the Law & Political Economy Blog, Professor David Ciepley shows in “Privatizing Sovereignty, Socializing Property,” that the corporation as a legal entity creates the board and holds all of the rights of legal ownership which derives from the corporate charter that creates them, which comes from the state (i.e. public authority). By delineating legal characteristics, assets, obligations, and liabilities of general partnerships vs. the corporation, Ciepley shows the importance of the legal language that defines these rights in an attempt counter the core ideas of the largely successful, right-wing Law & Economics movement. He mentions the contributions of two leading scholars in corporate law and in within the broader Law & Econ movement: Reiner Kraakman and Henry Hansmann.
Ciepley gets to the core of the legal entity of the corporation by detailing what shareholders can and cannot do with their share of the company. He shows, in essence, that this dynamic is why partnerships differ from the corporation, and proves that shareholders are not legally the owners of the corporation.
The Legal Literature
If you take cues from the historical record, you find that this practice of shareholder value primacy is relatively new. As Cornell University legal scholar, Lynn Stout, shows, “For most of the twentieth century, large public companies followed a philosophy called managerial capitalism.” This is also often referred to as “managerialism.” Stout explains, “Boards of directors in managerial companies operated largely as self-selecting and autonomous decision-making bodies, with dispersed shareholders playing a passive role.” It was not always the case that managers and business schools alike started to accept this false idea of shareholder primacy. In my own undergraduate experience, both finance classes I took, from two different professors (both of whom were business practitioners), using different teaching material, made shareholder primacy a point early on. I can’t imagine it isn’t widely taught.
In Capitalism and Freedom, the libertarian economist Milton Friedman, made it his personal duty to advance the shareholder primacy myth, where he stated “corporations have no higher purpose than maximizing profits for their shareholders.”
Friedman made it his personal mission to convince economists and libertarians everywhere that if corporations did not put shareholder profit-maximizing above all other goals, that it would “thoroughly undermine the very foundation of our free society.” In 1970 he published an article in the New York Times entitled “A Friedman Doctrine: The Social Responsibility of Business is to Increase Its Profits.” He writes:
“In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires…the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation…and his primary responsibility is to them.”credit: New York Times
Like so many popular myths that circulate in economics and finance and in the broad public, the idea that the goal of corporations is to maximize shareholder value because they are the true owners is rooted in a mistaken readings about the law. In Stout’s paper, “The Shareholder Value Myth,” she offers evidence and shares where the law itself delineates the rights of the corporation. She writes, “corporations are legal entities that
own themselves, just as human entities own themselves. What shareholders own are shares, a
type of contact between the shareholder and the legal entity that gives shareholders limited legal
She mentions that the law itself (which derives from the corporate charter, which comes from public sovereignty of the state) does not make such proclamations that shareholders are the true corporate owners. But if that was true, wouldn’t one expect that corporations that prioritize a shareholder’s wealth above all other pecuniary concerns perform better than those that don’t? Also no. Stout cites much evidence of this. She mentions the wealth of research and decades of studies and surveys that try to prove that practicing shareholder primacy generates better results for business and thus more profits for the shareholders. She mentions that the whole of this research has failed to produce those results after repeated testing. She writes “For example, one survey looked at more than a dozen studies of supposedly shareholder-hostile companies that used dual-class share structures to disenfranchise public investors. Some studies found dual-class structures had no effect on corporate performance; some found a mild negative effect; and some studies found a positive effect (in one case, a strongly positive effect), exactly the opposite of what shareholder primacy theory predicts.“
Taken together, it is blatantly obvious that shareholders are not the corporations true owners. It is a total myth that shareholders are the true owners of the corporate, that the shareholders somehow create the board. It is easy to believe in instinct and lean in to popular mythologies about the law and economics broadly. But on further inspection, if you squint just a little and spend more than five minutes researching, you can see that there is no truth to these beliefs.