Stockholder Syndrome

One of the longest standing debates at the heart of economics is whether to operate towards ethical results, or through profit-driven means. Throughout history we’ve tried to adopt policies for moral causes but they just don’t work economically–think rent control, central planning, or artificially lowering certain prices. On the other hand, there have been times where we’ve tried to prioritize wealth creation but instead have created humanitarian nightmares like with child labor in the industrial revolution. In the last 50 years, perhaps the biggest stage of this eternal debate has landed on shareholder philosophy–and whether or not companies have any moral obligation besides creating maximum profits for their investors.

In 1970, the New York Times published the infamous essay ‘The Social Responsibility of Business Is to Increase Its Profits’, written by none other than Milton Friedman. This was in response to a growing sentiment among business people that their companies had a social responsibility to give back to the public, and what you would actually see a lot of in the late 60’s were CEO’s donating large amounts of money to social programs. Though of course, Friedman being Friedman thought this was highly inefficient and after writing the paper he effectively changed widespread belief and to this day, most business executives are still convinced that the primary responsibility of corporations is to their shareholders and not the public. Guess it didn’t take that much convincing.

Now in actuality, Friedman’s essay is pretty intelligent and it makes some good points, we’ll look at them in a second. What I want to investigate further is the actual moral angle, and how that leads to real changes in business. More specifically: when we substitute a social goal with an economic one, how does that change incentives as to lead away from the common good?

Every company, major or minor, is funded by its stockholders. They range from large scale investors, to middle class dads with stock portfolios, and the position of a stockholder is to invest in the right companies as to get returns later when it grows. To clarify this now, there is no alien authority that determines the price of a stock–it’s instead subject to demand, so the more people are interested in a company, the higher its value will become. Investing is one of the most important faculties of our economy, it often gets a bad rap but in reality no company would be able to thrive without it. And being a conscientious stockholder can actually be a tough job–it takes a lot of research and knowledge to know what companies are headed somewhere and have integrity. And that delegation of funding is what decides who the main players of our economy will be.

This is where Friedman’s first argument comes in, and it’s reminiscent of something almost like social contract theory. He says that for stockholders to continue investing, there can be no ambiguity on what their returns will be like. If they’re not sure how much money will go into a charity instead of being returned to them, there’s really no point of investing in the first place. In fact, there are quite a lot of companies who forecast that a percentage of their earnings will go to charities up front. Or give their stockholders a preemptively high wage for their employees which might in turn take away from company profits. If stockholders desired moral outcomes, they have an expansively large range of companies to invest in–but if all investors are subjected to this, there will be a lot less investment going on from generalized uncertainty.

Another of his points was that entrusting the distribution of charity to business executives really isn’t the best way to go about it–they have no comparative advantage in the matter. Where the government has large overhead planning, and the market has its own forces, CEOs trained in business will almost certainly pick the wrong way to spend their newfound philanthropy money. A further progression of the idea is that they really don’t have a responsibility to minimize damages within their company at all, from environmental issues to unemployment. If it’s much more profitable to say, pollute a lake, they should do so and then a more informed body will decide the best place for those profits to go, because chances are those profits outbalance the economic losses from pollution.

Now, there are definitely some conceptual holes in these arguments. First, what about stakeholders? Different from shareholders, these are people ranging from trade partners, to employees, to buyers of the product. Yes you may inspire more investment by prioritizing shareholders, but doing so may deter high level employees looking for a company that will take care of them. And for the second, it’s quite a big assumption that the cost of polluting that lake will actually create profits larger than the cost that would take to create another net positive for the environment later. In essence, making a mess is a lot easier than cleaning it up. And this is all assuming that shareholders would have the mind to do good with their profits in the first place.

Buybacks and Backlash

These issues are open questions meant to be resolved in the future, but for now we can return to the topic of overall incentives. Hard core classical economists like Friedman will emphasize that going by profit-driven means usually ends up with ideal moral scenarios, but what about the times when that just isn’t true? When profits become a sort of dead end, leaving the assumed moral umbrella goal to the wayside? Well, one of the very worst examples of this is stock buybacks.

Thinking back to the supply and demand explanation of stock prices, there are essentially two ways to raise a price. Historically it has mainly been through the company making an actual improvement, whether it involves edging out competitors, finding a more efficient method of production, or even just making a new thing that lots of people like–essentially increasing demand. Though the second way is much more sinister, which is to constrict supply by buying up your own stock. The less of something there is, the higher the price will go, so through the use of buybacks companies can project success in the world of stockholders without actually furthering their company.

And they spend quite a lot of money doing so. 2023 is the first fiscal year to expect over one trillion dollars worth of buybacks, which accounted for 3.7% of the SMP 500’s growth rate in the last quarter of 2022. This was actually illegal until 1982, when Reagan passed a law in hopes to get companies putting more wealth into the hands of the economy and their employees. But the actual effect was quite opposite–for example, the ratio of CEO to worker pay jumped from 26:1 in 1980 to 51:1 in 1986, though still nothing compared to the 399:1 ratio of 2021. And while worker productivity in the last century has continued to steadily go up, the early 80’s is also when worker’s wages began to flatline.

Essentially, money that should be reinvested into the company for long term growth instead goes into the price of the stock, or the CEO, for short term appearances. Stock buybacks have done quite a lot to hurt the economy and its workers, and only finally in recent years has it seemed like the conversation to illegalise them has been picked up again in Washington.

A Step In The Wrong Direction

But in reality, stock buybacks are a small piece of a much greater issue, lately taking the name of Financialization. One of the more kafkaesque and weird concepts in economics, it basically relates to a phenomenon where business is getting focused more on the flow of money itself rather than capital goods in the real world. It might also refer to the size of the financial factor relative to the rest of the economy, and in 2019 it took up a massive 21% of GDP.

We’ve seen that investors do provide economic value, as well as bankers–they help people start businesses, and create growth. But in the context of stock buybacks, derivative markets, banking monopolies, and a million of other things, we can see how financialization has become a much bigger entity than it ever really should have. In the last few decades, any major crisis in our economy has been a result of the world of finance, from 2008 to Crypto to the Silicon Valley Bank ordeal. Even the historic fall of Enron or Tyco was specifically due to shareholder intricacies. Financializatoin is subject to bubbles, crashes, and an overall lack of long term planning. In 2013 A Mckinsey survey was conducted with over a thousand high-up board members, and found that 44% of major businesses operated on a timeframe of less than three years, while 73% of those businesses said that they should.

Capitalism as a system has greatly succeeded over the past several hundred years through the radical idea of individual prioritization. That is, the most common good will be created if everybody seeks their best interests–thus creating a naturalistic division of labor and competition. And even though it’s created some large scale problems like massive inequality or climate externalities, it still mostly works as a system since its fundamental axiom still is a theory about creating common good. Financialization, on the other hand, represents a dialectical step which prioritizes money making over the individual itself.

Whatever degree of autonomy we decide to give to stockholders, it’s absolutely imperative that the economy maintains a community dream of collective wellbeing. Often this may simply be in the form of companies reinvesting into themselves and their workers, but profits are the very tool that can enable us to transcend into a more impactful, safe, and flourishing society. Who we prioritize in businesses has to be a functioning metaphor for the prioritization of everybody.

Works Cited

Bivens, Josh, and Jori Kandra. "CEO pay has skyrocketed 1,460% since 1978." Economic Policy Institute, 4 Oct. 2022, www.epi.org/publication/ceo-pay-in-2021/#:~:text=CEO%20pay%20has%20skyrocketed%201%2C460,in%202021%20%7C%20Economic%20Policy%20Institute. Accessed 10 Sept. 2023.

Fischer, Amanda. "The rising financialization of the U.S. economy harms workers and their families, threatening a strong recovery." Washington Center for Equitable Growth, 11 May 2021, equitablegrowth.org/the-rising-financialization-of-the-u-s-economy-harms-workers-and-their-families-threatening-a-strong-recovery/. Accessed 10 Sept. 2023.

Friedman, Milton. "The Social Responsibility of Business is to Increase its Profits." The New York Times, websites.umich.edu/~thecore/doc/Friedman.pdf. Accessed 10 Sept. 2023. Excerpt originally published in The New York Times, 13 Sept. 1970.

"How American CEOs got so rich." Youtube, uploaded by Vox, 11 Oct. 2019, www.youtube.com/watch?v=ylLTMYt24lA&ab_channel=Vox.

"Maximising shareholder value: an ethical responsibility?" Knowledge, 26 Dec. 2008, knowledge.insead.edu/responsibility/maximising-shareholder-value-ethical-responsibility. Accessed 10 Sept. 2023.

"The Myth of Maximizing Shareholder Value." Youtube, uploaded by New Economic Thinking, 23 Jan. 2014, www.youtube.com/watch?v=VV5XaRco7ag&t=917s&ab_channel=NewEconomicThinking. Accessed 10 Sept. 2023.

Zingales, Luigi, and Oliver Hart. "Companies Should Maximize Shareholder Welfare Not Market Value." Journal of Law, Finance, and Accounting, 2017, scholar.harvard.edu/files/hart/files/108.00000022-hart-vol2no2-jlfa-0022_002.pdf. Accessed 10 Sept. 2023.