Companies used to borrow in the markets as a last resort finance investment in their business. Now it’s a front for shareholder giveaways
“All these people have a sort of parlay mentality, and they need to get on the playing field before they can start running it up. I’m a trader. It all happens for me in the transition. The moment of liquidation is the essence of capitalism.”
“What about the man in Rigby?”
“He’s an end user. He wants to keep it.”
I reflected on the pathos of ownership, and the ways it could bog you down.
—Tom McGuane, Gallatin Canyon
In January 2010, Wall Street Journal columnist Brett Aronds wrote a peevish article about Apple. Instead of wasting its money on this stupid tablet thing, he said, the company should “hand it back to its rightful owners. … The money belongs to stockholders: Give. Indeed Jobs should go further. Apple should—gasp—start borrowing, and hand that money back, too … the biggest innovation we’d like to see from Apple this season isn’t the iPad or iSlate or iTablet. It’s the iGetsomemoneyback.”
Given the spectacular success of the iPad launch a few months later, Aronds’ complaint would seem singularly ill timed. But no: It was prescient. In 2012, under the prodding of activist investor Carl Icahn, Apple announced it would begin paying dividends for the first time in its history. And it began a share-repurchase program to “return capital to shareholders” (in the words of its press release) that rapidly expanded in size. By last year, Apple’s share repurchases had reached a pace of $30 billion per year, on top of $11 billion in dividends. This tribute to shareholders represents four-fifths of the company’s cash from operations and slightly exceeds its $37 billion reported net income for 2013, compared with just $8 billion spent on fixed investment and $4 billion on R&D.
If you read the business press, you’re used to these kinds of stories. A company whose mission is making something gets bought out or bullied into becoming a company whose mission is making payments to shareholders. Apple is only an especially dramatic example. But the familiarity of this kind of story is a sign of a different relationship between corporations and the financial system from what prevailed a generation ago.
Prior to the 1980s, share repurchases were tightly limited by law, and a firm that borrowed in order to pay higher dividends would have been regarded as engaging in a kind of fraud. Shareholders were entitled to their dividends and nothing more—neither a share in any exceptional profits, nor a say in the management of the firm. In the view of Owen Young, the long-serving chairman of General Electric in the early 20th century, “the stockholders are confined to a maximum return equivalent to a risk premium. The remaining profit stays in the enterprise, is paid out in higher wages, or is passed on to the customer.”
In the managerial corporation of the mid-20th century, firms did not go straight to the markets for investment funds. Money for investment came first from internal funds—profits in excess of the standard dividend—which were freely at the disposal of management. They represented the lowest-cost source of investment capital and were exhausted first before a firm turned to financial markets for additional funds. If the firm’s investment demand was strong enough, it turned next to credit markets, seeking bank loans or issuing bonds. Only those firms with the most ambitious investment projects and most limited internal resources—typically those just starting—would consider raising funds from the stock market. On the other side, the supply of funds from markets was limited by the existence of a partitioned, heavily regulated financial system, so that even the largest firms could find themselves credit-constrained, unable to borrow as much as they would have wanted at the prevailing interest rates.
This hierarchy of investment finance implied a clear relationship between corporate investment and cash flow from operations, and between investment and borrowing. In 1960, there was a strong link between borrowing and investment. A firm that was borrowing $1 million more than a typical firm of that size would usually be investing $750,000 more. This relationship is consistent with a world where autonomous managers made their own decisions about the use of the firm’s funds, and the power of financial markets came only from the terms on which they would make any additional funds available.
Much discussion of corporate finance, both mainstream and heterodox, takes it for granted that this is still the world we live in. But in fact, by the mid-2000s the relationship between investment and borrowing had practically vanished, and the correlation between investment and cashflow was less than half as strong as in 1960. Unusually heavy borrowing was no longer correlated to high levels of investment; investment decisions seem almost unrelated to the funds flowing into corporations from operations and from credit markets.
If borrowing no longer matters for investment, what is the purpose of it? As at Apple, it is financing payouts to shareholders.
Before 1980, there was no statistical relationship between borrowing and payouts in the form of dividends and share repurchases at the firm level. But since then, a clear positive relationship emerged, especially at business-cycle peaks. Firms that borrow more have significantly higher payouts to shareholders.
For example: In the period from 2002 to 2008, net corporate borrowing rose from 1 percent to 6 percent of GDP. But unlike in earlier episodes of rising corporate borrowing, payouts rose point for point with borrowing. By the end of the boom, corporations were paying out more than 100 percent of their cash flow to shareholders. So on net, corporations raised no net funds from financial markets. The money that flowed in the front door as new borrowing flowed right out the back as higher dividends and share repurchases.
It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancing to pay for extra consumption. What nobody mentioned was that the rentier class had been playing a similar game longer and on a much larger scale. At the top of every boom in the neoliberal era, there’s been a massive round of stock buybacks, which you could think of as shareholders cashing out their bubble wealth. It’s a bit like the homeowners “using their houses as ATMs” during the 2000s, except that the shareholders don’t get stuck with the mortgage payments. The businesses’ workers and customers get to share the pain.
The transformation in corporate investment financing went largely unnoticed by the economics profession, but it was widely noted in the financial press. In the Financial Times, you’d read regularly about how “Corporate treasurers are shoveling investment-grade bonds out the door to raise money to buy back shares,” or that “U.S. blue-chip companies from Philip Morris to AT&T are taking advantage of cheap debt to finance share buy-backs and mergers and acquisitions activity at an accelerated pace.”
The change in the use of corporate funds helps explain one of the outstanding puzzles of the Great Recession: the lack of any clear connection between the financial crisis and the steep contemporaneous fall in corporate investment. Even the most sophisticated research finds that access to bank credit helps explain the fall in investment spending only for small firms. But it’s the largest firms that are responsible for the large majority of borrowing and investment. In 2009-2010, investment fell by as much at the largest businesses, and at debt-free businesses, as at small bank-dependent businesses. If the financial crisis interrupted the flow of credit only to small, bank-dependent businesses, it can explain at best a small part of the collapse in business investment after 2008.
Paradoxically, outside finance matters less for corporate investment decisions even as firms rely on it more. If shareholders effectively exercise first claim on every dollar that comes into the firm, it doesn’t matter whether borrowing is cheap and easy or hard and expensive. All that changes is the amount flowing out the door. Firms’ investment decisions, then, don’t depend on current earnings or credit conditions; they depend on whether management can propose projects with high enough returns to convince shareholders to leave “their” money inside the firm. The challenge is keeping money from flowing out of the firm, not bringing it in.
Under these conditions, the idea that fixing the financial system will boost growth and employment in the rest of the economy amounts to pouring water into a bucket that is already overflowing, and is also shot through with holes.
The transformation of corporate finance since 1980 has been driven by changing relations between corporate managers and the owning class. When Marx published volume one of Capital, he could speak of the capitalist as simply “the personification of capital” without begging too many questions. But today it’s harder to ignore capital’s split personality. Capital, after all, is a process, not a concrete thing—it exists in the exchange of money for means of production, in the labor process that converts those means of production into finished commodities, in the moment when the value of those commodities are realized through sale, and in the moment where the resulting money-value begins the process again. And as enterprises get larger and more complex, those different moments in the circuit of capital become the provinces of different specialists—managers, investors, financial intermediaries—any of whom can legitimately claim to personify capital.
Already by the end of the 19th century, it was evident to observers like Veblen that the separation of ownership from management was creating a new kind of bourgeois class, less connected to particular enterprises. As Dumenil and Levy write in The Crisis of Neoliberalism (probably the best recent discussion of these issues), after the 1890s the “concentration of capitalist power within financial institutions and importance of securities in ownership of the means of production gave ... the capitalist class a strong financial character.” But asset owners are the capitalist class only in retrospect. Through much of the 20th century, the managers of the production process seemed to have the better claim to be capital’s human embodiments.
The decades around World War II were the heyday of the managerial capitalism described by writers from Berle and Means (The Modern Corporation and Private Property) to Alfred Chandler (The Visible Hand), from liberals like John Kenneth Galbraith to Marxists like Paul Baran and Paul Sweezy. In managerial capitalism, the executives responsible for production and marketing were the real decision makers in the economy, with shareholders reduced to a passive role as income recipients. Whether the managerial firm was the “soulful corporation” of Galbraith or the soul-crushing monopoly capital of Baran and Sweezy, it was run according to its own growth imperatives, not to maximize returns to shareholders. The strategic choices in the economy rested with those who actively controlled the production process, not those who merely exercised financial claims to it. As Peter Drucker wrote (in 1949, the noontide of managerialism), “Where only twenty years ago the bright graduate of the Harvard Business School aimed at a job with a New York Stock Exchange house, he now seeks employment with a steel, oil or automobile company.”
The story of how autonomous management gave way to today’s shareholder dominance has been told many times. The best account remains Doug Henwood’s Wall Street, which I draw on here. Initially, this transformation had a strong element of conflict, with organized shareholders coercively asserting their control over a distinct group of managers. Over time, the conflictual aspect receded—though it has never disappeared—and rentier control came to be asserted more through the adoption by managers themselves of “shareholder value” as their overriding goal.
The idea that corporations exist solely to maximize shareholder wealth is as old as the corporation itself, and in the early days of the corporation it was accepted legal and economic doctrine. But it largely receded from view during the middle of the century, until the work of Michael Jensen and his coauthors legitimized the idea of takeovers and restructurings as tools to put the interests of shareholders first. For Jensen, the central task for finance was “to motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies.”
A number of legislative and administrative reforms in the early 1980s made it more feasible for shareholders to assert power over management. The Supreme Court overturned state limits on hostile takeovers of corporations and the Reagan Justice Department revised antitrust rules, opening up new possibilities for intra-industry mergers and the breaking up of conglomerates. Financial market changes made takeovers more feasible by creating new sources of funds to finance changes in corporate control.
During the 1980s, the central front in the shareholder revolution was the hostile takeover. Takeovers, as Margaret Blair’s emphasizes, were “used to discipline corporate managers and pressure them to pay out more money to shareholders and other investors.” Over the course of the 1980s, nearly half of U.S. corporations received takeover offers, and in several years acquisition volume reached the historically high level of 10% of total stock market capitalization. Among Fortune 500 companies, 28 percent were the object of takeover attempts, the majority hostile and the majority successful.
The era of hostile takeovers did not extend past the 1980s; KKR’s takeover of RJR-Nabisco was the last major deal of its kind. After 1990, the disciplinary aspect of the rentier-management relationship was more likely to take the form of shareholder activism, with large outsider investors publicly pressuring management to increase payouts and adopt “value-enhancing” policies. As with the earlier takeover movement, the rhetoric of shareholder activism highlighted productive efficiency, but the real goal was to get management to disgorge funds to shareholders.
In the familiar Foucauldian story, a power that was initially exercised coercively from the outside came to be internalized by its objects. By 1997, the repudiation of managerialism was sufficiently thorough for the Business Roundtable—representing the CEOs of the 200 largest American companies, and initially a site of bitter criticism of the shareholder revolution—to change its position on business objectives to read “the paramount duty of management and the board is to the shareholder and not to ... other stakeholders.”
Today, thanks to new compensation practices, increased executive mobility between firms, and the fact that top managers can themselves expect to become members of the wealth-owning class, managers have become less concerned with the survival and growth of the firm as an institution and more concerned with maximizing the flow of money it generates for owners. Dumenil has put it well: After some stormy conflicts, finance and management have achieved a loving marriage.
It’s hard now to separate the hostile-takeover wave from the sticky cultural residue of the 1980s. Mention of hostile takeovers conjures images of Gordon Gekko, or Richard Gere in Pretty Woman. What was it really all about?
It’s tempting to see productive business and finance as separate social actors (and to choose sides between them). And it’s tempting to see what they’re fighting over as money—who gets it, what it is used for. In this story, the fall in the profit share and rising inflation of the 1970s created sufficient urgency for the asset-owning class that—catalyzed by ideological entrepreneurs—they overcame their coordination problems and asserted themselves politically.
I think this misses the real content of the shareholder revolution. A useful way to think management and finance is as the embodiment of two different moments in the circuit of capital. The conflict isn’t about who gets the money. It’s about the extent to which productive activity should take the form of money at all. It’s about how oriented business should be toward the moment of liquidation. If we want to understand the specific conflict between shareholders and management—a conflict between worldviews as much as between distinct groups of people —we need to turn to Keynes and “the fetish of liquidity.”
As Keynes understood, liquidity is what stock markets are for. What they’re not for is raising funds for investment. Consider a recent example: Groupon. Their IPO raised $700 million. So the people who bought shares are getting ownership of the company in return for providing it much needed funds for expansion, right?
Except that, as Reuters columnist Felix Salmon points out, “Groupon has been shouting until it’s blue in the face that it doesn’t need the IPO cash.” Its cash flow was more than enough to finance all foreseeable expansion plans. So why go public at all? Because existing investors want cash. Pre-IPO, Groupon was already notorious for using venture-capital funds to cash out earlier investors. But the venture capitalists need to be cashed out in their turn.
And that’s what Wall Street is for: to give capitalists their exit. The problem finance solves is not how to allocate society’s scarce savings between competing investment opportunities. The problem is how to separate the rents that come from control of a strategic social coordination problem from the social ties and obligations that go with it. True capitalists don’t want to make steel or restaurant deals or jumbo jets or search engines. They want to make money.
Historically, the publicly owned corporation came into being to allow owners (or more often, their heirs) to delink their fortunes from particular firms or industries. In her history of the mergers of the 1890s, Naomi Lamoreaux notes that raising funds for investment was not an important motivation for adopting the new corporate form. In contemporary accounts, she says, “Access to capital is not mentioned.” The same point is developed by historians Thomas Navin and Marian Sears, who note that owners of the first firms to go public were motivated by “an opportunity to liquidate part of their investment” and thus have access to “immediate liquidity.”
This preference for immediate liquidity goes back to the beginnings of capitalism. In the 16th and 17th centuries, Fernand Braudel writes, “it was in the sphere of circulation, trade and marketing that capitalism was most at home; even if it sometimes made fleeting incursions on to the territory of production.” Production was “foreign territory” for capitalists, which they only entered reluctantly, always taking the first chance to return to the familiar ground of finance and long-distance trade.
When Marx first introduces the circuit of capital, M-C-P-C’-M’, we’re encouraged to think of the whole thing taking place in a short period. The capitalist shows up at the beginning of the year with a bag of money, buys means of production and labor power, coerces productive labor out of the labor power; by the end of the year the means of production are all used up, the commodities are sold, and the capitalist walks away with a bigger bag of money. But it doesn’t really work that way. Efficient production requires some large part of the capital to remain in the C-P-C’ stage indefinitely, steadily throwing off money but never fully returning to M. This is the case as soon as you have long-lived capital goods; it’s even more so as production increasingly happens through large, complex organizations. You can’t have an ongoing business unless people are oriented toward doing their job for its own sake; the whole thing will break down if everyone, and not just the capitalist, is looking for the exit.
Production can only be carried out successfully by managers who want to make things, and not just to make money. But profits do still have to take the form of money. To reproduce itself, capital must alternately be fixed in productive activity (and its physical and social requirements), and liquidated as money. Maintaining this cycle requires that political agency be exercised sometimes at one point in the circuit, sometimes at another.
Keynes’s call for the “euthanasia of the rentier” toward the end of The General Theory is typically taken as a playful provocation. But as Jim Crotty has argued, this idea was one of Keynes’s main preoccupations in his political writings in the 1920s. In his 1926 essay “The End of Laissez Faire,” he observed that “one of the most interesting and unnoticed developments of recent decades has been the tendency of big enterprise to socialize itself.” As shareholders’ role in the enterprise diminishes, “the general stability and reputation of the institution are more considered by the management than the maximum of profit for the shareholders.” With enough time, the corporations may evolve into quasi-public institutions like universities, “bodies whose criterion of action within their own field is solely the public good as they understand it.” Veblen, observing the same developments but with a less sunny disposition, imagined that the managers of productive enterprises would eventually tire of “sabotage” by the notional owners and organize to overthrow them, seizing control of production as a “Soviet of engineers.”
The function of finance is to keep this from happening. For the individual capitalist, finance provides liquidity—it turns a concrete claim on a particular production process into an abstract claim on the social product in general. For capital as a whole, it does something analogous -- it ensures that concrete production remains oriented toward profits. The point isn’t to take money away from productive enterprises, but to ensure that productive activity eventually takes the form of money.
At the moment, finance seems to be doing its job well. The idea that corporations will spontaneously socialize themselves looks utopian and naïve. The evolution described by Keynes, Berle and Means, Galbraith, and other theorists of managerialism early in the 20th century had been halted or reversed by its end.
But that doesn’t mean it wasn’t real. Just look at the scale of the financial apparatus required to keep productive enterprises focused on profit maximization, and the fear capitalists have of allowing managers discretion over corporate resources, even when their incentives have been arduously “aligned.” Isn’t it testimony to how tenuous and unnatural production for profit is? In these far from revolutionary times, radicals often fret about the difficulty of transforming the existing organization of production into socialism. But this project is nothing compared with the Sisyphean task faced by the other side, of constantly transforming the existing organization of production into capitalism.