When shareholders join the populist revolt
Shareholder value maximization (SVM) has been a bonanza for executives, who’ve been showered with ever richer rewards
Apr 4, 2017
A trader wears a Donald Trump hat while working on the floor of the New York Stock Exchange (NYSE) on March 16. REUTERS/Lucas Jackson
By James Saft
(Reuters) — Some day, perhaps soon, the populist revolt will spread to another group badly served in recent decades: Shareholders.
Workers are not the only ones to have done poorly in the last 30 years; shareholders too have suffered, especially those who buy their shares rather than have them granted as executive compensation.
The upswell in populism that swept Donald Trump to power has thus far been good news for entrenched corporate interests, proposing only tax cuts and foreign cash repatriation holidays kindly to those, such as company executives, who’ve been the high priests of the cult of shareholder value maximization (SVM).
The irony is that SVM, the credo that a company’s sole objective is to maximize profits — an idea it then conflates with a rising stock price, has been a raw deal for the average investor saving for the future.
That’s in no small part because it has been a bonanza for executives, who’ve been showered with ever richer rewards at the expense of the rest of the shareholder base, in a doomed attempt to align their incentives with those of their supposed masters.
SVM, according to James Montier of fund manager GMO, has ill served non-executive shareholders, driven down wages and investment and set the stage for our current low levels of innovation and growth.
“SVM is not the result of a policy choice. It is the result of a shift in how corporations govern themselves — a corporate choice, not a government one, if you will. It can easily be stopped if corporations take it upon themselves to stop engaging in it,” Montier write in a note to investors on populism.
“Doing so will probably render them more profitable and more competitive. If they value their independence they might heed this warning now before it is too late. Populists have policies too, you know.”
Montier envisages a future in which government leans on, or compels, companies to manage themselves differently. But seeing as how shareholders, at least those of us who aren’t in the executive suite, likely would do better if they did, perhaps the revolt of the masses can spread to shareholders.
There are several salient points here, but uppermost is the track record of equity returns during the post-1990 period when SVM has been dominant, contrasted with the earlier era of managerial capitalism, when executives were paid far less and tended to invest more, both in their franchises and their employees.
NICE THEORY, PITY ABOUT THE RESULTS
Total inflation-adjusted returns in the SVM era have been slightly lower than during the 1940-1990 heyday of managerial capitalism. What’s more, when adjusted for changes in how the stock market values earnings, they are much worse; a bit over 5 percent annualized as against almost 7 percent. That’s a large performance gap, especially when compounded down the decades.
SVM has also coincided, and very likely driven, the trend towards companies taking on more debt to buy in shares, a tactic which helps to flatter earnings per share as companies shower executives with share-based compensation. Company payouts, dividends and buybacks have doubled as a share of GDP since 1990, to over 5 percent, while net investment has slid.
CEOs now make 276 times the pay of an average worker, according to the Economic Policy Institute, up from 58 times in 1990.
All of this has created a set of perverse incentives for insiders, who manage companies quarter to quarter with an eye on increasing the stock price during their short time at the top but with less regard for long-term growth.
If companies could be induced not to scrimp on investment, and not to wring every last penny from their employees, they might, as in the post-World-War-2 period, find their long-term returns better and that they could sell into a healthier, faster-growing economy with more middle-class people with cash to spend.
To be sure, a populist shareholder revolt would be difficult to pull off, despite being in the best interests of those the current system claims to serve.
Executives and boards are entrenched by decades of custom and of corporate voting rules which makes it difficult for shareholders to exert their rightful power.
Another problem is that most fund managers, though charged with acting to get the best returns for their investors, are actually evaluated based on performance against a benchmark, either a market benchmark or peer performance. That makes them, like company executives, overly focused on the short term.
Many executives may look at the Trump agenda and decide they like this populism stuff.
As the past year has shown, the populism ball can bounce in some funny ways and it is better to reform before you are forced.
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