Shareholder Primacy Hurts Universal Owners (and Everyone Else)

Rick Alexander

One objection to benefit corporation governance is that it is unnecessary, because shareholder primacy is not a real problem.  B Lab has prepared a “Myths and Truths” document to address this objection.  Below is an excerpt, which explains how, in particular,  diversified, long-term owners (“universal owners”) are susceptible to the corrosive effects of shareholder primacy.  I also analyze this question at length in an article that appeared in the Seattle University Law Review’s symposium issue on B Corps and benefit corporations.

     It is true that stakeholder governance, in order to have some meaning, necessarily implies that there will be situations in which a corporation must make a choice that provides less value to shareholders than another option, and that such a decision would represent a “trade-off.” But shareholders who make concessions need not be concessionary investors. Trade-offs necessarily harm shareholders only from a static, isolated perspective.

     In fact, many observers believe that corporations with stakeholder governance are able to make stronger commitments to important constituencies, including workers and communities, and that such commitments induce firm-specific commitments in return, creating value that would not be obtainable in a shareholder primacy setting. The advantage of being to build such reciprocal relationships has been described by Lynn Stout, a well-known law professor at Cornell, in her book, The Shareholder Value Myth, and by Colin Mayer, a leading finance professor at Oxford’s Said Business School, in his book, Firm Commitment.

     More importantly, shareholders do not own just one company: most investors are diversified, and have broad shareholdings across the entire market. (This is particularly true when one focuses on the ultimate beneficiaries of the institutional asset owners that dominate the market. These pensions, mutual funds, insurance companies, endowments and foundations all have as ultimate beneficiaries a broad swath of the population that is diversified through such asset owners.)

     These “universal owners” earn most of their return not by successfully picking stocks that “beat the market,” but by being invested in a healthy market: generally, about 80% of an investor’s return comes from the behavior of the market. Accordingly, investors are actually hurt when a company in which they are invested tries to improve the return to its shareholders by externalizing costs in a manner that hurts the market. For example, universal owners who owned shares in financial companies were hurt by the “value-maximizing” activities of those companies that created the market crash in 2008.

     Moreover, these investors have non-financial interests as well: they would prefer to live in a world that is peaceful, prosperous, and stable, and such a world is much more likely to exist if corporations are not externalizing costs and risks in order to increase the financial return of a single company.

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