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Thursday, April 7, 2016

What's Good for General Motors isn't good enough any more. They think too small.

One of the biggest conclaves of dog whistle talk- not the usual Republican racial sort, but the high-powered sort that only the elite use to communicate- is the Davos Conference in Switzerland.

The Univerity of Chicago's Stigler Center- which recently launched a very good blog- has a long account of a debate over one of the benefits- or banes- or Reagan-era and post-Reagan corporate doctrine: Milton Friedman's Randian declaration that the only social obligation corporations have is to make as much money as is humanly possible.

Here's an exceprt. I was surprised to learn that Larry Fink, chair of Black Rock Partners, is now the nation's principle shareholder. With $4.5 trillion under management, Black Rock is the largest single shareholder in 20% of publicly traded American companies, and a major shareholder in 40%.

It's pretty clear, watching the radical Republicans in the North Carolina General Assembly over the last four years, that it's the Larry Fink philosophy that fuels their drive for near-zero business regulation, and their scorn for the corporate backlash to its gay-stomping, court-blocking, wage-strangling HB2:
Lambasting the Department of Labor’s so-called “fiduciary rule,” which applies new fiduciary standards on brokers who work with retirement accounts, Fink said, “We live in a world where the Department of Labor gave us this guidance about what is our fiduciary responsibility as investors. We only have one responsibility as investors: to maximize return. That’s it. So basically we can tell a company to fire five thousand employees tomorrow, and if that maximizes return for the company we did something well. We can tell that company to do something that maybe is bad for the environment. There is nothing right now that guides, other than a maximization of return behavior.”

“If you invested large sums of money right now for environmental good, and if you lost two percent versus what you should have earned, you could get sued by the Department of Labor,” claimed Fink, to which Zingales said: “I asked lawyers, and they basically told me it’s impossible to sue on that ground. We had a meeting of academics with the top lawyers, because I was concerned about the same thing. No chance in the world someone would win a case like this.” Zingales was referring to a conference that took place recently at Harvard Business School, about which you can read in ProMarket.

Rajan added historical perspective to the question of value maximization. “What is supposed to be maximized has changed tremendously over history. Over time we changed our interpretation of what firms are supposed to do. But the view that shareholders value maximization works under some fairly constrained assumptions.”

“Essentially it is that the entire value that the firm contributes to society is made up of contributions by commodity suppliers, such as labor and other things. All of them can be exactly priced. Under those circumstances, maximizing shareholder value makes absolute sense. However, supposing you have a bunch of employees who contribute tremendous value to the firm, over time they get a share of the rents the firm generates. But when you look at what the shareholders are getting, it’s not that much. In fact, you can sell the assets, sell down the firm, and make more. It’s value destruction for society, because you’re ridding these workers of their share of the rents, but you’re benefitting their shareholders. The point that was made earlier about the environment was similar: there is a value to society which is not being captured by shareholders. If you’re just maximizing shareholder value, you’re actually doing the wrong thing for society,” said Rajan.

And Friedman? “I think Milton Friedman and others who proposed shareholder value maximization were essentially targeting a different kind of behavior,” said Rajan. “When a company gave away millions to the New York Philharmonic so that they could sit on the board, it was personal aggrandizement on the part of the CEOs. They [Friedman et al.] were against that. There are situations in which shareholder value maximization doesn’t work, and typically we need to understand what those cases are. [But] I wouldn’t go immediately to stakeholder maximization, because we need to define what those stakeholders are.”

“There are a lot of deviations from the theory. Raghuram mentioned one, one that can be fixed by better accounting, because this means we are not properly accounting the capital of the firm, and that human capital is not really taken into consideration,” said Zingales.

“Especially in a service economy, like the US, that is absolutely critical”, said Engelbert.

Zingales continued, “Milton Friedman, when he wrote his famous piece about the only source of responsibility for business being to increase profits, was very careful in saying as long as  it operates in a competitive economy without fraud or deception. The part that is often ignored is ‘competitive economy,’ and the idea that the rules of the game are fixed. Companies are very good at changing the rules of the game in their favor.”

Then Zingales expressed concern about the excessive power of lobbying by big firms, and Fink insisted that it is well within the definition of maximizing shareholder value:

“If maximization to shareholders is the only priority we’re going to look [at], then lobbying is really good because it is maximizing shareholder value,” said Fink.

Zingales: “Do you think companies should not lobby?”

Fink: “I think everybody should have a voice, whether it’s conversation with regulators or public politicians. I don’t see a problem with that.”

Zingales: “Everybody has a voice, but someone has a voice with a $2 billion check, and someone has a voice but no check—it’s not exactly the same voice.”

Fink: “I don’t agree.”

Zingales: “Here’s an example: Disney makes a lot of profit by extending the copyright on Mickey Mouse every time it is due to expire. They exert a huge amount of lobby, and then they extend this copyright by twenty to thirty years.”

Fink: “As I said, if the sole purpose of a company is to maximize shareholder value, then Bob Iger has done a fantastic job achieving that.”

Zingales: “Maximize, as long as you don’t change the rules of the game.”

Fink: “Why are you making this limit? I agree that we need to raise the question of what is the definition of maximizing return.”

Zingales: “I am concerned that if you allow complete freedom to lobby, you have freedom in which one party has a billion dollar check.”

Before having to leave early, Fink acknowledged that firms’ behavior is a driving factor behind some recent political tumults. “I believe what is happening in Spain with Podemos and what’s happening in the United States with Trump is all reflective of society raising questions. I think this is real. That is why I am raising the question of what is our responsibility.”

“We are doing a lot of big data research to try and get better insight into how we invest, and what we found is that when companies are perceived to be good companies, especially by their employees, those shares do better than companies that are perceived to be bad employers. Better-run companies that employees like do better than companies employees don’t like working in, or that have a bad reputation,” he added.

When asked about lobbying and political balance, Rajan said: “Obviously if one party has excessive power, it creates a skewed structure that distorts decision and is bad for society in the long run. It does not necessarily follow that in every society the bar is skewed towards the corporations. Sometimes we have strong unions, sometimes we have other strong organizations. Societies that have skewed systems tend to exacerbate all the things that we worry about: inequality, unfair treatment, et cetera.”

Lévy added that “any rule which is taken to the extreme is a wrong rule. When you take a rule like maximizing shareholder value and consider it the only metric, I consider it a bad rule, because it’s not the only metric.”

Regarding firms growing out of their exclusive focus on shareholder value maximization, Engelbert referred to the influx of millennials into the job market as a potential reason why this shift might be inevitable. “They want purpose over profits. This whole ecosystem of value and purpose is going to be very important to retain this generation.”

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