[Joint House and Senate Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 117-257
EXAMINING THE IMPACT OF
SHAREHOLDER PRIMACY: WHAT IT MEANS
TO PUT STOCK PRICES FIRST
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HEARING
BEFORE THE
JOINT ECONOMIC COMMITTEE
OF THE
CONGRESS OF THE UNITED STATES
ONE HUNDRED SEVENTEENTH CONGRESS
SECOND SESSION
__________
MARCH 16, 2022
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Printed for the use of the Joint Economic Committee
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available via the World Wide Web: http://www.govinfo.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
47-578 PDF WASHINGTON : 2022
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Donald S. Beyer Jr., Virginia, Martin Heinrich, New Mexico, Vice
Chairman Chairman
David Trone, Maryland Amy Klobuchar, Minnesota
Joyce Beatty, Ohio Margaret Wood Hassan, New
Mark Pocan, Wisconsin Hampshire
Scott Peters, California Mark Kelly, Arizona
Sharice L. Davids, Kansas Raphael G. Warnock, Georgia
David Schweikert, Arizona Mike Lee, Utah, Ranking Member
Jaime Herrera Beutler, Washington Tom Cotton, Arkansas
Jodey C. Arrington, Texas Rob Portman, Ohio
Ron Estes, Kansas Bill Cassidy, M.D., Louisiana
Ted Cruz, Texas
Tamara L. Fucile, Executive Director
Kevin Corinth, Republican Staff Director
C O N T E N T S
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Opening Statements of Members
Page
Hon. Donald Beyer Jr., Chairman, a U.S. Representative from the
Commonwealth of Virginia....................................... 1
Hon. Mike Lee, Ranking Member, a U.S. Senator from Utah.......... 3
Witnesses
Dr. Lenore Palladino, Assistant Professor of Economics & Public
Policy, University of Massachusetts Amherst, Amherst, MA....... 5
Ms. Judy Samuelson, Vice President of the Aspen Institute,
Founder and Executive Director, Aspen Institute Business and
Society Program, New York, NY.................................. 7
Mr. Frederick Alexander, CEO, The Shareholder Commons,
Wilmington, DE................................................. 9
Dr. Joshua D. Rauh, Ormond Family Professor of Finance and Senior
Fellow at the Hoover Institution, Stanford University,
Stanford, CA................................................... 11
Submissions for the Record
Prepared statement of Hon. Donald Beyer Jr., Chairman, a U.S.
Representative from the Commonwealth of Virginia............... 32
Prepared statement of Hon. Mike Lee, Ranking Member, a U.S.
Senator from Utah.............................................. 33
Prepared statement of Dr. Lenore Palladino, Assistant Professor
of Economics & Public Policy, University of Massachusetts
Amherst, Amherst, MA........................................... 35
Ms. Judy Samuelson, Vice President of the Aspen Institute,
Founder and Executive Director, Aspen Institute Business and
Society Program, New York, NY.................................. 48
Mr. Frederick Alexander, CEO, The Shareholder Commons,
Wilmington, DE................................................. 57
Dr. Joshua D. Rauh, Ormond Family Professor of Finance and Senior
Fellow at the Hoover Institution, Stanford University,
Stanford, CA................................................... 69
Response from Mr. Frederick Alexander to Question for the Record
submitted by Senator Klobuchar................................. 89
Response from Dr. Joshua D. Rauh to Questions for the Record
submitted by Senator Lee....................................... 89
Question for the Record for Dr. Lenore Palladino submitted by
Senator Klobuchar.............................................. 91
EXAMINING THE IMPACT OF
SHAREHOLDER PRIMACY: WHAT IT MEANS
TO PUT STOCK PRICES FIRST
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WEDNESDAY, MARCH 16, 2022
United States Congress,
Joint Economic Committee,
Washington, DC.
The hearing was convened, pursuant to notice, at 2:21 p.m.,
in Room 106, Dirksen Senate Office Building, before the Joint
Economic Committee, Hon. Donald S. Beyer Jr., Chairman,
presiding.
Representatives present: Beyer, Schweikert, Estes, and
Peters.
Senators present: Cruz, Lee, and Hassan.
Staff: Ismael Cid-Martinez, Chelsea Daley, Hugo Dante, Sebi
Devlin-Foltz, Ron Donado, Carly Eckstrom, Ryan Ethington,
Tamara Fucile, Devin Gould, Owen Haaga, Erica Handloff, Colleen
Healy, Jeremy Johnson, Adam Michel, Michael Pearson, Elisabeth
Raczek, Alexander Schunk, Nita Somasundaram, Sydney Thomas,
Ivan Torrez, Emily Volk, Brian Wemple, and Katie Winham.
OPENING STATEMENT OF HON. DONALD BEYER JR., CHAIRMAN, A U.S.
REPRESENTATIVE FROM THE COMMONWEALTH OF VIRGINIA
Chairman Beyer. Our hearing is titled ``Examining the
Impact of Shareholder Primacy: What it Means to Put Stock
Prices First.''
Thanks to all of our distinguished witnesses for sharing
their expertise today. It is an exceptional panel of experts,
and I am looking forward to hearing from you. And I want to
apologize from the start that the House and Senate leadership
seemed to have determined to augment our hearings with votes.
So we will do our best to manage that back and forth.
This hearing will examine how the shareholder primacy model
of corporate governance has impacted the economy and how
Congress can help address the problems it has created.
Shareholder primacy is a corporate model that focuses
mainly or exclusively on increasing stock prices to generate
value for its shareholders. This approach, which has gained a
lot of favor just in the last few decades, encourages
corporations and their executives to spend a larger share of
profits on stock buybacks to reward investors in the short
term.
Who are the winners when corporations put stock prices
first? In the United States, shareholders are a relatively
small group. The top one percent owns roughly 50 percent of all
corporate equities, and only about half of the U.S. households
own any stock at all. As a result, the singular focus on stock
prices concentrates wealth at the very top, while leaving less
for companies to reinvest in their workers and innovative
technologies and in long-term growth.
For example, the seven largest publicly traded oil
corporations recently announced a near-record $41 billion stock
buyback program, on top of $50 billion in shareholder
dividends. While everyday American workers and families bear
the burden of higher gas prices, big oil is raking in record
profits and prioritizing padding the pockets of the wealthy
shareholders. It has not always been this way, though.
From the 1930s to the mid-1970s, American corporations
largely followed a retain-and-reinvest strategy to focus on
long-term innovation and job security for workers. Workers were
seen as an asset and a long-term investment, not a liability.
Managers viewed well-paid cared-for workers as vital to their
success. They primarily used profits to pay workers, provide
benefits, and make productive investments. Shareholders
received the residual after companies paid workers, invested
for the future, and paid down debt. Not accidentally, American
productivity had unprecedented growth during this period.
During this time, economic growth was strong and broad-
based. As the economy grew, workers saw their wages rise and on
the whole were more financially secure. They had access to
pensions and pathways to the middle class.
Since the 1970s, however, as shareholder primacy has become
more dominant, boards have put shareholders at the front of the
line for corporate profits, leaving everyone else behind. While
CEOs and executives at the top have seen their incomes go up,
940 percent over the last four years, the bottom half of
earners have seen their wages virtually flatline. These are all
in constant dollars.
Across the board, the share of domestic product, gross
domestic product going to employee wages and benefits has been
declining for decades. The increased corporate focus on raising
stock prices has driven this trend which in turn has deprived
workers of the gains from economic growth.
Because the corporate executives and shareholders who
benefit from this model are overwhelmingly and
disproportionately wealthy and white, this further reinforces
the widening wealth disparities across income and racial
groups. For 2019, the top 10 percent of American households
held 70 percent of all U.S. wealth, and the total wealth owned
by the entire bottom half of America dropped to just 2 percent.
The impact of shareholder primacy goes beyond the widening
difference between winners and losers. It is impacting our
economy at almost every level. Short-sighted decisions to help
companies hit short-term earnings for products can explain the
just-in-time inventory and staffing approaches that left U.S.
supply chains vulnerable to pandemic-related disruptions.
Shareholder primacy also hinders investment and innovation
and sustainability, the driving crux of economic growth and are
necessary to address threats by climate change. For example,
despite growing risks from climate change, corporations have
continued to make decisions that prioritize short-run
profitability at the expense of broad sustainability and
climate resilience.
Surprisingly, investors themselves also lose under
shareholder primacy. Families investing money in diversified
stock portfolios for college or retirement suffer when
individual companies put their short-term profits over their
long-term investments. It is no coincidence that widening the
economic inequality in this country, which began in the 1970s,
coincides with the increased dominance of shareholder primacy.
It has helped to concentrate economic power among the
privileged few.
But this is not how we as a Nation have always done things.
There are other paths forward that maintain firm profitability
and promote economic growth that is stronger, stabler, and more
broadly shared.
For example, incentivizing business to invest in
innovation, sustainability, and enhanced productivity, would
boost competition, workers wages, and economy-wide returns.
Legislative proposals that place limits and tax share buybacks
would help realign corporate incentives away from short-term
stock prices and toward long-term pro-growth investments. And
legislation that strengthens collective bargaining and raises
wages, like the PRO Act and the Raise the Wage Act would ensure
workers take home a larger share of the gains that public
companies and their executives have been keeping for
themselves.
As we dive deeper and deeper into these issues, we look
forward to the testimonies of our expert witnesses, and I would
like to turn it over to Senator Lee. Thank you for your
flexibility and for your opening statement.
[The prepared statement of Chairman Beyer appears in the
Submissions for the Record on page 32.]
OPENING STATEMENT OF HON. MIKE LEE, RANKING MEMBER, A U.S.
SENATOR FROM UTAH
Senator Lee. Thanks so much, Mr. Chairman. Thanks to all of
you for joining us today. Last week we learned that inflation
has reached a new 40-year high, a new 40-year high of 7.9
percent. That means that inflation is costing the average
American family $435 a month more each month, every month, for
the things that they ordinarily buy.
Given this new economic reality, I hope we keep in mind the
severe price increases that are facing American families right
now, as we hear about foisting environmental and other
political goals onto private businesses.
Americans are hurting. Low and middle class Americans are
the ones who pay the price for uprooting our market economy in
favor of a political agenda. This agenda will not only compound
inflation making Americans poor, and our businesses less
dynamic, less capable of offering products that people need to
buy, less capable of offering jobs that people want to have.
But the American people have reached the benefits of free
markets and of robust competition.
This free market system that has lifted Americans to the
highest standard of living ever achieved by a major economy.
Yet today the free market system that enables American
prosperity is under attack by bureaucrats, politicians, and
regulators who seek to impose their personal political goals
onto private parties, on businesses, and consumers alike. They
seek to override the competitive forces that grow workers wages
and keep prices low. They seek to make private companies
beholden to politicians rather than to the shareholders who
invest in companies in the first place.
When we hear the word ``shareholder,'' we do not usually
think about the average American, but that is exactly who they
are. Shareholders are the more than 180 million Americans who
live in a household with a 401(k), a pension, or some other
form of stockholdings. Shareholders are an ever-growing
majority of households who invest in the economy. They use the
return on that investment to save for retirement, buy a home,
or send their kids to college.
When the government tells companies not to listen to
shareholders, it is really telling companies not to listen to
the American people. When the government tells companies to
divert their hard-earned resources into work policy goals like
environmental and social justice, the government is taking
power and taking wealth out of the hands of the American people
and consolidating it in Washington.
When the government interferes with the private sector,
businesses stop serving their workers and customers. They
instead serve the bureaucrats who set the rules. We already see
this happening.
President Biden recently directed his Administration to
assess companies' progress on environmental and social justice
goals. A step toward requiring them to abandon their core
responsibilities to the school teachers, the firefighters, and
other everyday Americans who invested in them, and who buy
their products.
These actions ignore centuries of evidence that the free
market system is the best way to create prosperity for workers
and families and communities. Now America has always been a
place where the most effective common action occurs in the
space between the individual and the State. A Federal
Government that attempts to replace free enterprise is a
Federal Government that has overstepped its bounds. It has
started to diminish the very interests it was designed to
protect.
We ought to ensure that businesses are free to serve their
communities by remaining at the forefront of innovation and
creating value for the American families who invest in them and
are served by them. In today's environment of surging
inflation, we can afford nothing less.
Thank you.
[The prepared statement of Senator Lee appears in the
Submissions for the Record on page 33.]
Chairman Beyer. Senator Lee, thank you very much. I would
like to introduce our four distinguished witnesses.
Dr. Lenore Palladino is an Assistant Professor of Economics
and Public Policy at the University of Massachusetts Amherst,
Research Associate at the Political Economy Research Institute,
and a Fellow at the Roosevelt Institute. Dr. Palladino
researches corporate power, corporate innovation, shareholder
primacy, and the relationship between corporate governance and
the labor market, with a specific focus on economic policies
for innovation and the cost of shareholder primacy and stock
buybacks. Dr. Palladino holds a Ph.D. in Economics from the New
School University, and received her J.D. from Fordham Law
School.
Ms. Judy Samuelson is the Founder and Executive Director of
the Aspen Institute and Business and Society Program, which
works to align business and their investments to the long-term
health of society. Her work is focused on redefining the
understanding of the purpose of corporations, and shifting the
focus away from short-termism toward practices that maintain
long-term economic and societal well-being. She is the author
of The Six New Rules of Business: Creating Real Value in A
Changing World. Ms. Samuelson holds a B.A. from the University
of California Los Angeles, and a Masters Degree from the Yale
School of Management.
Mr. Rick Alexander is the Founder and CEO of The
Shareholder Commons. He founded the organization and for four
years as the Head of Legal Policy at B Lab. Over three decades
he served as a corporate attorney and managing partner at a
leading Wilmington-based firm where he was selected as one of
the ten most highly regarded corporate governance lawyers
worldwide, and is one of the 500 leading lawyers in the
country. Mr. Alexander's work with the Shareholder Commons
examines the significant economic risk presented by the current
practice of shareholder primacy. Mr. Alexander holds a B.A.
from the University of Maryland, and a J.D. from Georgetown
University.
Dr. Joshua Rauh is a Finance Professor at Stanford
University's Graduate School of Business, and a Senior Fellow
at the Hoover Institution. His studies focus on government
pension liabilities, corporate investment, business taxation
and investment management. Dr. Rauh was formerly the principal
chief economist on the President's Council of Economic Advisors
under President Trump. He taught at the University of Chicago's
Booth School of Business and Kellogg's School of Management.
Dr. Rauh holds a B.A. in Economics from Yale University,
and a Ph.D. in Economics from the Massachusetts Institute of
Technology.
Welcome all of you, and, Dr. Palladino, let's begin with
your testimony and then we will continue in the order of
introductions. Dr. Palladino, the floor is yours.
STATEMENT OF DR. LENORE PALLADINO, ASSISTANT PROFESSOR OF
ECONOMICS & PUBLIC POLICY, UNIVERSITY OF MASSACHUSETTS AMHERST,
AMHERST, MA
Dr. Palladino. Chairman Beyer, Ranking Member Lee, Members
of the Committee, thank you for the invitation to be here
today.
Policymakers have a critical opportunity to strengthen
American innovation and resilience as we emerge from the
pandemic. The economic and geopolitical challenges that face us
are not going to stop. That is why it is time to strengthen our
commitment to American productivity by reorienting our
corporate governance policies toward innovation and away from
the single-minded focus on share prices.
To truly understand the harms of shareholder primacy, we
must start by understanding what makes the company an
innovative enterprise? What are the structures within the
company that enable innovation? And what are the social
conditions for innovation that policymakers can support?
Corporations are engines of production. It is inside
corporations that decisions are made about what gets produced,
by whom, and how companies can succeed in producing higher
quality socially beneficial products at lower unit costs over
time.
We know from history that innovation comes about from long-
term risk taking by businesses, enabled by collective and
cumulative learning. It requires complex organization,
investment in and retention of a committed workforce, and long-
term financial commitments based on retained earnings and
leveraged by debt.
This brings us to shareholder primacy and how its sole
focus on share prices hurts the production process, and by
extension our whole economy. When corporate leaders mainly
focus on raising share prices, there are lost opportunities to
invest in the tangible and intangible assets that power
innovation, including in the American workforce.
Shareholder primacy is a flawed theory of the corporation
because it makes three incorrect assumptions about the role of
shareholders and other corporate stakeholders in the process of
production.
First, shareholders are not the owners of corporations.
Shareholders own their shares. They own the corporate
securities that they have purchased and that they are free to
sell. In fact, what distinguishes a corporation from a
partnership or a small business is that shareholders do not own
the assets of the company, nor are they responsible for its
liabilities.
Second, shareholder primacy is usually framed as necessary
for corporate financing. Shareholders must have authority in
corporate decisionmaking and see their share prices increase in
order for operating companies to have financing available.
However, most shareholders are traders. When I purchase
financial assets to save for retirement, the funds that I spend
do not go to the operating company whose stock is now in my
portfolio. The money I spend goes to the entity that sells me
the shares.
Lastly, the theory of shareholder primacy fundamentally
misunderstands the role of other corporate stakeholders and the
risks that they take. Business success hinges not only on the
actions of management and holders of stock, but the hard work
of employees, customer interests, and public infrastructure
supported by long-term financial commitments.
In practice, the orientation of our corporate governance
system toward ever-increasing share prices has created constant
pressure to pay shareholders or face activist shareholder
wrath. We have to distinguish activist shareholders from
households holding stock as a financial asset for life cycle
needs, and remember that corporations that focus on innovation
are actually best for shareholders who depend on the stock
market for their retirement, because their retirement security
depends on the success of the entire economy.
A key component of shareholder primacy is stock buybacks.
They benefit those who sell their shares. They manipulate stock
prices and they benefit corporate insiders.
U.S. corporations spent $6.3 trillion dollars, with a
``t,'' on stock buybacks in the last decade, and are on track
to spend $1 trillion in 2022. We have to ask what is the
opportunity cost for this use of corporate funds?
There are countless examples where the focus on spending
corporate funds on shareholders has left companies ill-equipped
to face shocks, not focused enough on long-term investment, or
using shareholder payments as an excuse for holding down labor
costs. For example, oil companies announced nearly $40 billion
in stock buybacks this year.
Proponents of stock buybacks say that companies conduct
them when they have no other use for corporate funds, but this
is plainly not the case for so many companies spending billions
on buybacks today. There are signs of progress. Intel, for
example, use to spend tens of billions of dollars on stock
buybacks every year. However, Intel's new CEO, Pat Gelsinger,
recently stated publicly that Intel would reduce its stock
buyback activity drastically in order to engage in long-term
investment in innovation.
There are a range of policies that Congress should take up
to reorient corporate governance. I appreciate the committee's
attention to these issues and look forward to discussing the
policies in our discussion. Thank you.
[The prepared statement of Dr. Palladino appears in the
Submissions for the Record on page 35.]
Chairman Beyer. Thank you, Dr. Palladino, very much. Next
we will hear from Ms. Samuelson.
STATEMENT OF MS. JUDY SAMUELSON, VICE PRESIDENT OF THE ASPEN
INSTITUTE, FOUNDER AND EXECUTIVE DIRECTOR, ASPEN INSTITUTE
BUSINESS AND SOCIETY PROGRAM, NEW YORK, NY
Ms. Samuelson. Judy Samuelson with the Aspen Institute,
Business and Society Program. Mr. Chairman, thank you for
having us today, and Members of the Committee.
For close to 25 years the Business and Society Program has
been engaging business executives, directors, scholars, leaders
in labor and corporate governance in both critics and those who
advise business. In pursuit of our mission, which is about how
do we align business decisionmaking with the long-term health
of the economy?
We believe this probably animates our work the most, that
business today is simply among maybe the most important and
influential institution of our day. It has extraordinary
capacity, especially global, international, multi-national
corporations, remarkable capacity and talent and problem
solving skills to address the most important problem.
We the people of course grant the license to operate. I
think the question that is really behind this hearing today is:
Are we harnessing that capacity for the public good? Who does
that license actually benefit?
I want to clarify one point that I think that my colleague
made this point, but let me just say again, the point about
governance and share ownership, but when it comes to redressing
shareholder primacy, it is important to note that shareholders
do not own the corporation itself.
Shareholders own certificates of stock. And, yes, they come
with very discrete and important rights. But the assets and the
liabilities are not the property of the shareholders. The
corporation owns itself. Shareholders do not own corporations,
and we do not need to treat them as such.
One thing that is kind of curious, if you will, is that we
spend this much time talking about the stock market at all.
When General Motors was at the top of the league tables and was
the largest corporation in the country back in the 1950s and
1960s, it had maybe a million employees just in the United
States of America, and it was constantly accessing the capital
markets to raise capital for factories, and to hold the
employee base, and to fill the need and desire of consumers for
automobiles.
But if you look at the situation today, many companies when
they access the public markets, when they initially go for
their IPO, if they are actually going to raise any money in the
market. They raise the money privately, and the opportunity to
go public is really about just providing their early investors
an exit in the stock.
In essence, the company receives the money at the IPO. Why
do you spend so much time talking about the stock market? The
question was raised about who owns stock. The wealthiest 10
percent of Americans own between 84 and 89 percent of publicly
traded stock--10 percent. Seventy seven percent of all U.S.
stock is held by white college graduates, and we must remember
that only 33 percent of white Americans have a college degree.
Only 50 percent of U.S. households own any stock at all, and
only 30 percent of Black and Hispanic households own stock.
Stock ownership among Black and Hispanic elites is also
tiny. Shareholder primacy, putting the shareholders at the
center of the metrics and of the belief system of the
corporation, ensures that our economy places the elite and the
wealthiest first.
I would like to end with making three discrete points:
The first is the tremendous cost that shareholder primacy
brings to the system. We have already spoken about inequality
and I mentioned it as well. But we also have to look at the
cost of capital allocation, which the Chairman has already
raised. The pressure to divert earnings and profits to the
shareholders has tremendous consequences and places limits on
investment infrastructure, research and development,
innovation, and it explains a lot about our tepid response to
climate change.
The barriers to addressing climate change of course are
about the cost of operation. And the Chairman has already
spoken to the tremendous amount that the high avengers are
actually placing through share buybacks rather than investing.
The second point is that shareholder primacy is built not
just in law, it is built through a set of incentives, and
practices, and protocols. It is really not a law at all. It is
baked into assumptions that are not very easy to unwind. It is
the scaffolding that keeps their whole share of primacy in
place.
Finally, in spite of the ESG, environment, society,
governance, in spite of the ESG narrative and the promise about
doing well by doing good, this is no longer a win/win world.
There are real tradeoffs involved, and the solutions, if you
want to address the solutions, may take us into some
uncomfortable places. It requires us to think about innovation
in employees voice and in governance, and it requires us to
once again really reward long-term investing. Just the capital
gains tax, for example, to go way beyond one year as a
recognition of what constitutes long term.
And finally, we will take a closer look at private capital
markets. That is really where a lot of the action is today, and
is growing in importance. It is not all bad news out there.
There are any number of companies that we could talk about
today, but to put employees at the center of their market and
of their enterprise because of the belief that that is how they
will perform best over the long haul. That is where the
employees gain their most important income and revenue, and
that then works for the employees and it works for the
customers as well.
[The prepared statement of Ms. Samuelson appears in the
Submissions for the Record on page 48.]
Chairman Beyer. Ms. Samuelson, thank you very much. We will
now hear from Mr. Rick Alexander.
STATEMENT OF MR. FREDERICK ALEXANDER, CEO, THE SHAREHOLDER
COMMONS, WILMINGTON, DE
Mr. Alexander. Chairman Beyer, Ranking Member Lee, Members
of the Committee, thank you so much. It is truly an honor to be
here today.
My name is Rick Alexander and I serve as the CEO of The
Shareholder Commons, a nonprofit that focuses on the issues we
are discussing here today. But my views on this subject
developed over a 25-year career of private legal practice,
advising directors, executives, shareholders, and others on the
rights and responsibilities under corporate law. Essentially, I
practiced shareholder primacy for 25 years.
I was often the person in the room telling the directors
that, no, they could not take the bid that considered the
American workers at their company. They had to take the highest
bid that paid the most to shareholders. That was my job for 25
years.
Turning to the subject at hand, I want to say that I do not
believe that shareholder primacy is all bad. I just believe
that it is a good idea that has become perverted over the last
50 years.
Shareholder primacy is the idea that a company is run
primarily for the benefit of its shareholders. There are two
reasons that this idea has developed such a following and
really dominates our economic life.
The first goes all the way back to Adam Smith. When a
business maximizes profits, it is creating value. You know,
profits are just buying inputs at X and then through hard work
and innovation, and maybe a little luck, selling at X plus,
creating value. In an economy like ours, that is not controlled
from the top, this is not just a way of protecting
shareholders, it is the way we allocate scarce resources and
determine prices.
The second reason that shareholder primacy is important is
that it allows enterprises to raise the large amounts of
capital necessary to do the work of a modern economy. Think
about the billions raised by a startup EV or biotech company.
This risk capital--this is kind of like the magic of
capitalism--this risk capital receives no contractual rights to
any return. All they get is a promise that if there's value
left over after everyone is paid, they will get that value. It
would be extremely difficult to raise this capital if the
company did not have a loyalty to those investors, if they
could decide to shift that profit to someone else.
I believe these two reasons still hold and do not argue for
the abandonment of the principal of shareholder primacy.
However, what I want to suggest today is that we are doing
shareholder primacy all wrong. We are not protecting
shareholders, and we are not allocating resources well. In
short, the problem is that primacy is exercised today with an
expectation that all investors care about is the enterprise
value of the individual company at which a decision is being
made.
This is agnostic to the kind of sustainability issues that
we are concerned about sometimes. It might lead a company to
treat its workers very well in order to induce loyalty. On the
other hand, it might lead another company to outsource or
offshore work if that allows the company to increase its
profits after having thought about loyalty and reputation and
all those issues. Like I say, it is agnostic.
But here is the problem with that indifference to social,
environmental, and economic effects of the decision. Investors
do not just own one company. Modern portfolio theory teaches us
that to achieve the best return with the lowest risk, you have
to own lots of companies. In fact, fiduciaries like pension
fund managers are required by law to be diversified. And for a
diversified investor, 75 percent to 100 percent of return is
based not on returns of individual companies or what they
produce or on performance, but rather on the performance of the
market.
So this means that if you are a shareholder, what is most
important to you is how the economy does, how the market does.
So think about the example of the outsourcing company. The
first question from the perspective of a shareholder ought to
be not how this will affect the company, but how will the
outsourcing affect the economy overall, and thus my diversified
portfolio? I do not have the answer to that question, but a lot
of people believe that lower paying jobs lead to less social
stability, less resilience, poor public health. And if that is
true, a diversified holder is receiving a bad bargain when a
company in his or her portfolio increases its own return by
externalizing this cost onto the economy.
If that is true, we should make sure that the rules that
govern investing allow investors to take that broader
perspective and not just think about individual enterprise
value. How does that translate into policy? Well, currently
disclosure rules and fiduciary rules, are interpreted as
focusing on enterprise value. Congress and the Federal agencies
have the ability to influence the way shareholder primacy is
practiced, and change these rules, or clarify them to be clear
that shareholders are empowered to influence the companies in
their portfolio to be more responsible with respect to the
entire economy, even if that might cost the individual company
a little bit of profit.
Thank you. I look forward to talking more about these
questions today.
[The prepared statement of Mr. Alexander appears in the
Submissions for the Record on page 57.]
Chairman Beyer. Mr. Alexander, thank you very much. Now we
will hear from Dr. Rauh.
STATEMENT OF DR. JOSHUA D. RAUH, ORMOND FAMILY PROFESSOR OF
FINANCE AND SENIOR FELLOW AT THE HOOVER INSTITUTION, STANFORD
UNIVERSITY, STANFORD, CA
Dr. Rauh. Chairman Beyer, Ranking Member Lee, Members of
the Committee:
In a competitive market, companies must serve their
customers, employees, and communities well, otherwise they go
out of business. Companies cannot sell products to consumers
who do not trust them, and they cannot hire and retain
employees who prefer other jobs.
Yet, clearly the interests of shareholders are not always
aligned with those of other stakeholders. For example, cutting
prices to levels below cost would be well received by
consumers, but bad for shareholders who are, after all, the
owners of the corporation in the traditional sense that they
control the corporation.
The CEOs who have claimed corporate purpose in the Business
Roundtable statement are not the owners of the corporation,
they are employees appointed by shareholder-elected boards. A
CEO announcing that shareholders are no longer in charge is not
far from a government official telling the American people that
they are no longer in charge.
So who are the shareholders? Most of the benefits of strong
stock returns accrue to U.S. households. U.S. households own 38
percent of the U.S. stock market directly, and most of an
additional 28 percent of the market through mutual funds and
ETFs. And then you have pension funds that own another 11
percent of the stock market. The benefits there also accrue to
households. And equity ownership is broad-based. Fifty three
percent of all U.S. households own publicly traded stock. When
you add on households that do not and are relying on a pension,
or own a private business where your principles also would
apply, or nonresidential real estate, over 68 percent of
households are in some sense shareholders.
So what do shareholders want? While I sense that other
witnesses here want some authority to prescribe what firms
should do, I would contend that Milton Friedman in 1970
basically got it right. He said shareholders want ``generally
to make as much money as possible while conforming to the basic
rules of the society, both law and ethical customs.''
So under shareholder capitalism, executives have a strong
incentive to make ethical decisions and plenty of leeway under
the business judgment rule to do so even if it does not
maximize the returns on the company's stock in all cases.
Regarding conflicts between short-term and long-term value,
more than 80 percent of companies that do IPOs in the U.S. have
negative earnings, yet they raise hundreds of billions of
dollars a year for investors, plus the venture capital referred
to by Mr. Alexander. So it is hard to see excessive short-
termism here. Still, in case of conflicts, the solution is
simple. It is to structure executive compensation to reward
long-term performance. It is not to give managers free reign to
make decisions in the interest of any stakeholders they want.
Of course some shareholders may and do have a taste for
investments that achieve non-financial goals. Chairman Beyer,
your description of this hearing says this hearing is supposed
to, quote, ``Examine the Rise in the recent decade of
shareholder primacy,'' unquote, but the hearing really should
be examining the erosion of shareholder primacy. Over 33
percent of total managed financial assets in the U.S. as of
2020 are now in sustainable investments, broadly defined. This
is the new phenomenon of recent decades.
Now if shareholders want to achieve social goals, even at
the expense of financial ones, should companies act
accordingly? Yes. But the difficulty comes if there is lots of
passive capital such as in the massive market tracking index
funds that many Americans own in their 401(k) plans. Large
numbers of smaller investors just want a good return on their
investments.
Meanwhile, powerful managers of the index funds they hold
impose ESG on corporate America as they vote on behalf of
trillions of dollars of other people's money. And investors may
be at risk. The surveyed evidence in over a thousand papers in
the performance of ESG investments in public markets is quite
varied. In my own work on private markets, I find that
preferences for ESG are related to significantly lower rates of
return.
In 2020, the Department of Labor protected investors from
arbitrary actions in the name of social responsibility when it
limited the extent to which ESG funds can be offered in 401(k)s
and other plans. The Biden administration's lack of enforcement
of that rule, and the new proposed ESG rule of Fall 2021,
threatened to undermine that.
In many cases, the majority views of the American people do
not even line up with the received wisdom of the ESG. For
example, Gallup polls from last year showed that only 39
percent of Americans want less emphasis on producing energy
from oil, and only 19 percent want less emphasis on producing
energy from natural gas. That is not good support for shaming
companies into pursuing these actions.
Finally, it is misleading to focus on bad examples without
considering the good of the entire system. Over the past 50
years, real per capita GDP in the United States increased 132
percent to $64,000 per person, the highest among all countries
with a population of at least 10 million people. Since 1959,
incomes for the bottom fifth of the income distribution
increased by 262 percent, the highest of all income quintiles.
Those are the fruits of shareholder capital.
In conclusion, the focus now should be how to protect
regular investors from the potential financial harms of
arbitrary decisions under the guise of ESG and financial
responsibility. And for fund management, we should return to a
default of shareholder value maximization within the bounds of
law and ethics, unless an individual shareholder actively
specifies otherwise.
Thank you very much.
[The prepared statement of Dr. Rauh appears in the
Submissions for the Record on page 69.]
Chairman Beyer. Dr. Rauh, thank you very much. We will now
begin with questions for our witnesses. I will begin with Dr.
Palladino.
Proponents of stock buybacks have argued this practice
serves the stock market by moving capital from firms that have
no use for it into companies with a higher need for new funds.
Why doesn't this hold true, in your opinion?
Dr. Palladino. Thank you very much for the question. That
is a great question that I will break into two parts. The first
is what I mentioned in my testimony. The argument for stock
buybacks often is that it is a way to efficiently move
financial assets or capital from a company that no longer needs
it to other companies.
So when we look at examples like for example Amazon who
just announced $10 billion in stock buybacks this past week,
and we look at the fact that Amazon workers have been
protesting and organizing for decent living wages for years, we
see there is availability for investment in the workforce.
When we look at Exxon and we see that they have invested
very little in the low carbon transition, we see that there is
opportunity for investment. So I look at the opportunity costs
as critical.
The other answer to your question is that we actually need
more information about the private markets to understand the
flow of funds that go from an operating company that
repurchases stock to an asset manager, and then back out into
the market. We know that net equity issuance has been negative
for the last two decades, meaning that publicly traded
companies are issuing less stock than they are repurchasing. We
need more disclosure and data for the private markets to fully
understand the flow of funds, but I believe that these
arguments are mainly misguided. Thank you.
Chairman Beyer. Ms. Samuelson, proponents of shareholder
primacy contend that shareholders own the company. We just
heard this from Dr. Rauh. And yet you have argued that the
corporations are actually owned by the corporations themselves.
Can you expand on this, and why we should not think that the
shareholder through their 401(k) or whatever, own the
corporation?
Ms. Samuelson. Well, the corporation owns itself. When the
corporation legally incorporates, it becomes legally a, you
know, fictitious person. And a person owns its assets and
liabilities just like any of us do.
The shareholder has the certificate of stock, but what that
certificate of stock enables the shareholder to do is to vote
for the board of directors, a critically important right. It
gets to do things like weigh in on whether or not the executive
is appropriately paid. And then of course, you know, it can put
votes on the ballot. It can ask, you know, at the annual
meeting for certain things to be taken up and considered. But
it does not add up to controlling or running the corporation,
as might have been the case if we went back a hundred and some
odd years in terms of how it was structured then.
So the situation has changed a lot. And if we kind of look
at the results of the incredible dependence on the shareholder
as to the organizing principles of the corporation today, we
would wind up with things like, another example, she talked
about Amazon. I will tell you about Target. Target got a lot of
great press a couple of weeks ago because it announced that it
was going to be doing about $300 million of investment in its
employees, with some wage increases in Targets across the
country, greater access to health care.
We can debate whether or not those things add up to much,
but if you kind of roll back in time, six months ago, this is a
$300 million investment announced on their employees, six
months ago they announced $15 billion in share buybacks. If you
go back over the last 10 years, something like 93 percent of
profits have been returned or, I do not even like to use the
``return,'' because I am not so sure they were necessarily due
to begin with, but were paid out to shareholders, 93 percent.
The factor that is most important in this environment is
what we are doing to reward executives. And the executives
today are being paid in stock, as well. So all of this is
consistent with their worldview and what they are being paid to
do. But, no, the shareholders do not own the corporation. They
own shares of stock that give them some rights.
The last thing I would just say is that if you look at the
stay on pay votes, they correlate with the stock price. As long
as the stock price is going up, the stay on pay votes largely
go with saying the pay is fine. It is only when the stock price
is going down that someone may raise an objection, the
shareholders raise an objection to how the CEO is paid.
So the system is kind of reinforcing of where we are now.
Chairman Beyer. Thank you, Ms. Samuelson, very much. We
will now introduce Senator Lee for his questions.
Senator Lee. Thank you very much, Mr. Chairman.
Dr. Rauh, I would like to start with you. We have heard a
lot today about reform proposals, and critiques of the way the
market works. I am concerned that in many cases when the
Federal Government gets involved in order to make the world
appear to be a more equitable place, or to enhance the fairness
of the marketplace, which can end up not only not achieving
that but having the opposite effect. It is particularly
dangerous in an environment like this one in which you see that
inflation--what we are experiencing today relative to a year
ago, the average family in Utah is spending an additional $582
a month every single month, just on the things that they
already have to buy. It is just higher prices on the things
they have already got to buy, relative to a year ago.
This is about $7,000 a year that they are having to cough
up just to buy the same stuff that they bought a year ago. Gas
prices are striking well over $4 a gallon, and just in this
last week alone the prices at the pump in Utah reached their
highest levels ever on record.
And so if we do these things right now, when we try to do
something like pursue the SEC's current plan to mandate
climate-related ESG disclosures, I feel it would undercut the
very interests that that they are supposed to serve. These
sorts of things inevitably hurt the poor and middle class. They
do so in a few ways.
Number one, I think they tend to entrench market
incumbence, well-funded market incumbence, who are in a better
position to absorb the compliance costs that startups would not
have to deal with. They also have superior access. You can
further degrade the ability of a startup to gain access to
capital when you do this.
And then, but across the board you are increasing
compliance costs. And so the cost of goods is going to become
higher, and made higher still by the relative lack of
competition from new entrants into the marketplace.
So tell me what your perspective is on this, on whether
mandatory ESG reporting, how that might impact ordinary
Americans?
Dr. Rauh. Well thank you for the question, Senator. I think
there is little question that ESG action, including both
reporting and ESG activism, has reduced production of oil and
gas in ways that are impacting regular Americans.
You know, Exxon Mobile lost four board seats last year to
Engine Number One, an ESG activist fund, and Chevron's board
forced them to commit to reducing their indirect emissions,
meaning the emissions from people buying their products. And
there has been a litany of sustainability statements from many
of the energy companies they have released recently, I sense
under ESG duress.
Commitment to--BP's commitment to decarbonize, that
involved the premise for new exploration, a decline in
production of 40 percent by 2030. Other oil and gas companies
have made similar statements. And so this must be affecting
production.
And actually another point, which is the companies that are
not subject to as much ESG pressure because they are private as
opposed to publicly traded and may not be subject to as many
regulations, they are now the ones who are stating that they
are going to do the most, the majority or more, of more capital
expenditures this year, 2022, than publicly owned companies,
particularly in the shale sector.
There is no question in my mind: ESG pressure has been
substantial and has had effects on production, driving down
quantity, and driving up prices.
Senator Lee. Thank you. That is very helpful. It seems to
me the last thing we ought to be doing in the name of making a
more competitive environment, an environment in which poor
economic mobility remains part of the American dream, the last
thing we would want to do is adopt a series of policies that
will further entrench elites, those who are already wealthy and
well connected, making them wealthier and more well connected
altogether at the expense of poor and middle class Americans.
Tell us a little bit from the investor standpoint, a little
bit about how you might create risks that would go to poor and
middle class Americans, today's workers, tomorrow's retirees,
those saving for retirement, or saving to buy a home or what
have you. How might that be affected by any system that would
prioritize political, social, environmental goals above and
beyond those required by existing environmental laws, instead
of growing their company and answering directly to their
shareholders?
Dr. Rauh. Well, Senator, in order to implement those
requirements, the money has got to come from somewhere. And so
that means it either has to come from customers in the form of
higher prices the consumers are going to pay, or it would have
to come from workers in the form of lower wages that we pay to
workers, or it is going to come out from shareholder returns.
And, you know, while there has been a lot of talk of how
much the top one percent owns of the stock market, and so on,
the fact is that we have a society where there is broad
ownership, where many, many Americans, 53 percent of Americans
own some stock, and a lot of people are relying on the stock
market for their retirement.
And it seems rather problematic to require companies to do
things that would reduce the returns that individual investors
are expecting and are relying on in the interest of goals that
are not actually part of the law. And it is an interesting
question to wonder why are these requirements not part of the
law?
I think part of it is because these requirements are just
not very popular, according to polling data. So the bottom line
is that whenever you put these types of requirements on
companies, it has to come out of something. There are
tradeoffs. There are conflicts. There are conflicts and
tradeoffs. And the market system has done a good job with
managing these over many decades.
Senator Lee. Thank you.
Representative Peters [presiding]. Thank you, Senator. In
the absence of the Chair, I will recognize myself.
Mr. Alexander, you have noted how shareholder primacy is
not the only doctrine that companies have used in the past to
inform their operations because it has become more standard
recently.
Can you tell us how companies operated before shareholder
primacy became the dominant doctrine, and how model companies
might take a different approach that would better align their
incentives, in your view, with what is the common good?
Mr. Alexander. So I would say that--thanks for the
question. I would say that, you know, in some sense there has
been a pretty direct line of shareholder primacy throughout the
20th and 21st centuries. As shareholders became more diffuse,
as there was more separation of ownership from control, and the
real issue has been in sort of, you know, what does it mean to
sort of represent the residual risk there to the equity holder.
And I think an important thing to think about, as we talk
today, is that the question of shareholder primacy or not, or
how we practice it, it is not a question of whether we practice
ESG or not. ESG is practiced today. It actually buys into the
shareholder primacy thing.
If you think about the Exxon Mobil, the Engine Number One
campaign last year, that was a campaign based on sort of the
ESG principles, shareholders saying, you know, the company has
not done a good enough job addressing climate change issues.
But the point they made was that the company had misallocated
capital in anticipating the switch to more renewable, and that
therefore they had done poorly for their shareholders.
Engine Number One is a hedge fund that was concentrated in
company stock, and they just wanted the company to do better,
and that was their theme. They were not asking the company to
make sacrifices in order to benefit, you know, the greater
good. You know, the question I think we are wrestling with is
whether, when a management team says we are going to put the
shareholders first, are they doing so in a way that
externalizes costs that hurts society as a whole, that hurts
the market, and in my mind that is not a good practice of
shareholder primacy because it is very likely that your
shareholders are invested in other companies who are hurt when
the economy is hurting. Thank you.
Representative Peters. Yes. I was sort of asking about
whether the perspective of companies has changed with respect
to shareholder primacy over time. You said it has been
different?
Mr. Alexander. So I will confess not being enough of a
historian to really answer that question well. But I don't--you
know, in the New Deal era this question was really wrestled
with. There was the Berle-Dodd debate that asked are companies
run for the benefit of society, or are they run for the benefit
of their shareholders?
And I think what happened post-War was there was not a
conflict. Companies were able to pay their employees well, do
well by their shareholders, and they just were not thinking
about, I would say, some of the debts that they were incurring
to the future in terms of what was happening to the
environment, what was happening to society. And what happened I
think in the last 50 years was, as we approached certain
planetary and social boundaries, management had to begin
focusing on the real tradeoffs that existed. And that is what
sort of called the question.
Representative Peters. Ms. Samuelson, when we talk about
the role that shareholder primacy plays in global climate
change, how do you think that companies can move beyond paying
lip service to sustainability and commit real resources to help
fight that particular cause?
Ms. Samuelson. Well these are definitely creative, but can
I steal a little time to respond to your earlier question?
Representative Peters. You have 45 seconds.
Ms. Samuelson. When the shareholder primacy really took
off, it was in the early 1980s. And what happened is, you asked
if it was a masked idea that we needed to put shareholders. The
single objective function is we needed to wake up corporations,
and they will then listen, perhaps.
But what happened is, in the 1980s we started connecting
the CEO pay back, to start. So they could hire people cheap and
promise them stock, and things really then began to take off.
It also happened in 1993 when Clinton put a one million dollar
cap on what could be deducted of the CEO's pay. And that's when
it really took off, stock options really took off at that
point.
You have really got to go back to that point of when this
whole thing started to launch and really took on steam.
Representative Peters. Maybe we can explore that later. We
will turn now to Mr. Schweikert for five minutes.
Representative Schweikert. Thank you. Just for the fun of
it, what was the second half of Milton Friedman's sort of
treatise from, what was it, 1970? ``So as long as it stays
within the rules of the game, which is to say, engages in open
and free competition without deception or fraud,'' we always
seem to forget that second half of the 1970 treatise from
Milton Friedman.
I actually have a slightly different view. In many ways,
this hearing actually bothers me from the standpoint of we
should have done something much more global with what is going
on in the economy and our world, and right now, and then this
sort of soft, nationalization of corporate boards, which is
functionally what it is, let's be honest, and the last witness
just said something that actually I think rings quite true.
Much of what is going on that the left considers bad is our
fault. We have made it so expensive that many companies are
choosing to go private. You know, in many ways would you take a
company public in this environment right now, if there is
enough liquidity in the market to stay private and not have to
deal with this sort of stuff? Our tax policy. In many ways we
drove this by our own tax policy.
And for Mr. Rauh, I really want you to touch on two things.
Because there is one thing in your written testimony about
rates of return, how many companies really do not have rate of
return, but people are willing to invest in it because it is a
new drug, but we are not going to see it for 15 years, or sort
of that hope. And also touching on the fact of the incentives
as we have so screwed up the market. How few companies come
public today to be available for society to invest in, and we
are creating a world where the haves, through family offices,
through others, get to own shares. But the availability to the
public keeps shrinking in many ways because of what we in
Congress do, which is making it miserable, difficult, and
expensive to go public.
Dr. Rauh. Thank you. Thanks for the question, Congressman
Schweikert.
Yes, there has clearly been a major trend over the past
couple decades toward companies remaining private. And going
public introduces a number--has always introduced various
government requirements, disclosure requirements.
And now with the advent of the ESG requirements, and now
with the SEC potentially getting involved and potentially
regulating what those requirements would be, that adds another
layer on top of this that adds further disincentives to go
public.
And firms not going public have major consequences. You
know, in a 401(k) individual investors do not have access to
private companies. They have to invest in publicly traded
companies. And so it is incredibly important that we have a
robust setting where firms are going public, and where
individual investors have access to invest in them. And it is
also important to ensure that the individual investors know
that the mutual fund managers who are managing their money on
behalf of them in Index Funds--that is when you buy, when an
investor just, you know, checks the default option in their
401(k) invested in the stock market broadly--that those
investors are going to be concerned with maximizing the returns
that the investor can get, not with some considerations that
are non-financial, but that the individual investor may simply
not share.
Representative Schweikert. Doctor, if I came to you right
now and said we do not like some of the corporate governances.
Would a much more egalitarian solution be to create an
environment where you minimize these sort of oligopolies, which
are essentially what we have created in our corporate world,
whether it be airlines, and you know, banks, so regulatory
constructs: We have made monster companies. To actually create
an environment where lots of disruptors, whether it be their
business model, the business plan, the technology, but it is
time to actually have the disruptive business environment where
you, if you want to invest in social good, that is the model
you choose.
My fear is, we are trying to change our own sort of almost
oligopolic, if that is a word, model right now instead of doing
a much more egalitarian holistic solution of screw it, we want
lots of competition out there.
Dr. Rauh. Well, regulation creates, as you say, benefits
for incumbents are able to make investments necessary to
comply. And it harms competition. And more competition means
more price competition for consumers and the products that
consumers buy, and it is better for the end consumer at the end
of the day.
Representative Schweikert. Thank you for your tolerance,
Mr. Chairman.
Representative Peters. Thank you. I will go to Mr. Estes.
Representative Estes. Well thank you, Mr. Chairman. And
thank you to all the witnesses for joining us today. I think
many Americans are right to be alarmed at the rapid increase of
political activism and bullying among our Nation's top
corporations. Rather than focusing on the well-being of their
employees, customers, and shareholders, there have been a
notable number of examples of large companies using their
market power to push far left political causes at the expense
of everything else.
Predictably, this has led to discrimination against hard
working families who disagree with those causes being pushed.
And whatever your political views, I think we can all agree
that it is not good for American capitalism to have our most
known brands bullying certain Americans for holding mainstream
beliefs.
I believe many of the current proposals from the left
involving stakeholder primacy would make this problem even
worse, mandating that companies partake in these unfair
activities. When it comes to the different metrics being
proposed, like environmental impact, or some of the ESG scores,
I am concerned about how these will be implemented. And if 53
percent of the U.S. households that own publicly traded stock
are best served when companies focus on building good companies
that are profitable not by getting investments into profitable
companies through ambiguous ESG scores.
To recover from our current economic catastrophe that the
Democrats and President Biden have steered us into over the
last year, we need permanent policies that encourage active
participation by U.S. investors to drive economic progress
rather than divisive policies like stakeholder primacy that
would put American families last and special interest groups
first.
Dr. Rauh, do you think stakeholder primacy would lead to
companies implementing private ESG scores for customers,
similar to a credit score but instead of rating travel
worthiness, rating a person's, a customer's so-called ESG risk?
Dr. Rauh. Thank you very much for the question. That is an
interesting idea. Just so I understand, are you referring to
the idea that the companies would then rate their customers on
alignment with certain values, and then would potentially
exclude or discriminate against those customers.
Representative Estes [continuing]. or avoid doing business
with them at all if they did not match the score that may come
back to reflect on them?
Dr. Rauh. Well that is an interesting idea, and it would be
certainly a very, very dangerous trend if that were to happen.
The idea that a company would discriminate against an
individual because of the political beliefs that they hold
would be quite concerning.
One place where you could imagine that happening at another
level would be with suppliers. I am going to choose to buy only
from companies that sign on to a certain statement of ethical
values that I also agree with.
I think this is all very detrimental to the forces that
have made the United States' economy the strongest economy in
the world, and one that has also delivered extremely broad-
based growth to after-tax, after-transfer incomes for
individuals. And it also would be extremely disturbing.
Now I would wonder if such practices would actually be
thought of as being legal--is the company allowed to
discriminate against the customer? I do not know. I would have
to turn to legal experts on that. And at least one thing that
can potentially constrain companies is the law.
Representative Estes. Do you think that the U.S. companies
could use ESG to maybe discriminate against Americans in
general for lack of political belief, or their affiliations?
Dr. Rauh. It is not impossible. You know, certainly it
seems that one could have a situation where companies could
attempt to only work together with people who sign on to
certain values that they hold on the front of the ESG. And if
they did so, it would be quite a disturbing development.
I will say, one constraint would be do companies really
want to give up potential customers? Are they willing to hold
on to these beliefs so badly that they are willing to give up
potential customers? I do not know. One of the forces that has
produced good ethics from companies in many setting is actually
the force of knowing that they want their product to be bought
by as many people as possible, and they want to have a good
reputation among the American public in general. It is pretty
costly to shut off your potential customer base by some pretty
large percentage by shutting off people who do not agree with
some of these principles. Which as I mentioned in my testimony,
it seems to me that there are many of these inherited wisdom
ESG principles that are not actually well supported in polling
data.
Representative Estes. Yes, I mean we have had a lot of
discussion lately about banks and others that may not do
business with certain companies, or certain industries.
At the end of the day, stockholders own the company,
whether their moms and dads or retirees, or pensions, and they
deserve to be able to manage the productive use of their
property. So thank you, and I yield back, Mr. Chairman.
Representative Peters. Thank you. We will turn now to
Senator Cruz.
Senator Cruz. Thank you, Mr. Chairman. Welcome to each of
the witnesses.
Dr. Rauh, more and more we are seeing a dangerous shift in
America where woke corporations are acting as the political
enforcers for partisan Democrats. And we are seeing more and
more CEOs weigh in on political matters, and use their
corporate power to try to punish anyone who does not agree with
a radical policy agenda.
In your judgment, is it in the shareholders' interests for
woke corporations and their CEOs to use their market power not
to provide the goods and services the company is focused on,
but instead to enforce a partisan political agenda?
Dr. Rauh. Well I think this is a classic case of what we
call in economics a principal-agent problem. The shareholders
are the principals, and they hire the managers, CEOs, as their
agents to act on their behalf. This is no different in a
startup or a private company. People on the committee have
business experience, of starting their own businesses. If you
hire a manager, that manager is your agent and works on your
behalf. And so when you have a situation where the manager, the
CEO, the executive who does not own the company, who is an
agent of the owners of the company, is taking actions to impose
their own political agenda, then I think that is a major
failure of governance and a major failure of accountability.
And I think that that is actually quite a dangerous--quite a
dangerous thing.
Senator Cruz. Well I agree with you. And there is not only
a principal agent problem with the shareholders versus their
woke CEOs who are not actually focused on increasing
shareholder value. But there is a principal agent problem with
regard to the voters, because these CEOs are not accountable to
the voters. And in my experience, most of them are profoundly
ignorant about the topics they are trying to regulate, that
they do so as a mild virtue signal without even doing the
barest of due diligence.
I can tell you major banks that try to legislate gun
control by saying we are going to cut off financial services to
companies either that do not sell firearms to people unless
they are 21 and over--which is not the law--or that bans so-
called assault weapons. I can tell you I had the senior
leadership of a bank that insisted it was going to cut off
capital to anyone selling assault weapons, and I asked the
leadership, I actually asked the person who designed the
policy, a simple question. What is an assault weapon? She had
no idea. She told me it was a machine gun, which is not what an
assault weapon is. And pause for a second to think that she is
writing a policy without even knowing what the hell she is
talking about.
Likewise, there were numerous corporations that took
political positions about election integrity laws in Georgia
and Texas. The CEOs of one of those corporations sat in my
office and I asked a very simple question: Name one provision
in the bill that you denounce as racist, name one provision
that is problematic? The CEO could not name a single provision
and put out a public statement saying it was racist and had no
idea what was in the bill.
Dr. Rauh, do these CEOs, do these corporations have any
meaningful expertise in political matters? Is there anything
about the companies that actually reflect the Democratic wishes
of the electorate?
Dr. Rauh. Well on the first point, if I might say, at the
Stanford Graduate School of Business we do attempt to give them
a broad education.
Now on some of the specific matters at hand, and also what
Americans believe, I think you really there identified one of
the main problems, which is that I suspect that part of the
reason that gun laws in America are not different from what
they are now is that in the latest Gallup Poll from 2022, 41
percent of Americans were satisfied with U.S. gun policy, and
13 percent were dissatisfied but wanted less strict laws. So
that is 54 percent of people who want either the same degree of
strictness or less strict gun laws.
So, plus, you know, given the Second Amendment of the
United States Constitution----
Senator Cruz. So let me ask you briefly, just because time
is expiring, what can Congress do, or what can Federal
regulators do to ensure a robust system of shareholder
capitalism in which shareholders can expect executives to
actually focus on the bottom line, rather than engaging in
political adventurism and pursuing their own partisan agenda at
the expense of shareholder values?
Dr. Rauh. I would say two things. First of all, you know,
step back from mandating ESG type of regulations, or trying to
regulate that sector in a do-no-harm kind of way. But secondly,
the government should also be considering actions that could
protect shareholders from their agents, you know, owners of
index mutual funds, from their agents voting against
shareholder maximization without the explicit permission of the
shareholders.
And I will tell you, there are many shareholders out there,
or just regular owners of 401(k) funds, who are relying on
index funds, the performance of the U.S. stock market for their
retirement. They are not interested in CEOs pushing their
personal political agendas. They are interested in getting a
fair return on their investments.
Senator Cruz. Well thank you. And I think those are good
and helpful suggestions.
Chairman Beyer [presiding]. Senator, thank you very much.
Now we will begin a second round of questioning. Forgive my
absence, since I had to go vote for myself and four other
members by proxy, people affected by COVID.
Let me go to Mr. Alexander. You had written that the
assumption of the interest of shareholders in the economy are
best served by using the financial returns of the company as a
sole measure of success. Why is that not the sole measure of
success?
Mr. Alexander. Thanks for that question. The reason it is
not the sole--and again, I differ from some of the other
witnesses here today in that I actually do not have an issue
with running a company for the benefit of shareholders. I just
would say shareholders are not benefited--shareholders with a
broad portfolio are not benefited when each company within that
portfolio struggles to increase its own bottom line without
regard to the effect of doing so. It is just a category error.
If you want to have a portfolio that performs the best, you
do not want each individual company within that portfolio
trying to be the best because they will interfere with one
another.
There is an economist, Thomas Schelling, who won a Nobel
Prize for this idea--the ecology micromotives. It is just like
when you drive. If everybody in the city wants to get to their
destination as soon as possible, you do not just put them all
out in their cars on the street and say, ``go get there as soon
as possible.'' You establish rules of the road, and stop signs,
and stop lights, and all those sorts of things. And it is the
same thing.
If a company, attempts to maximize its value, by paying its
workers significantly less than a living wage, and that leads
to poverty and, poor social determinants of health and things
like that; it is going to drag the economy down and when you
drag down the economy, you drag down the performance of
portfolios because the performance of a diversified portfolio
relates directly to the performance of the economy.
And what I would also say is I have heard some questions
today that sort of talk about putting handcuffs on
corporations. Let me just say that what I would like to do is
remove the handcuffs from shareholders.
Currently, disclosure from the SEC is built around one
idea: let's look at the ESG matters, social and environmental
matters. Will social and environmental matters affect the
performance of the company? But how about the SEC giving
shareholders information about how a company's social and
environmental performance affects the economy, and thus the
other companies within that economy? Swiss Re estimates that if
we stay on the carbon trajectory we are on, rather than a
Paris-aligned trajectory, then global GDP will be 10 percent
less in 2050 than it would otherwise be.
Swiss Re. This is not a radical institution: It is one of
the largest reinsurers in the world. Well, if GDP is 10 percent
less in 2050, then all the young teachers today who are in
retirement plans that have diversified portfolios are going to
have 10 percent less for their retirement.
So that is what I am talking about when I say from the
shareholders' perspective you cannot just look at individual
company enterprise value. You have to ask the question how will
my company's performance affect the economy? And right now, and
it is not just disclosure rules by the way, it is fiduciary
duties-particularly at the company level but also at the
trustee level--that make trustees and directors feel as if all
they can focus on is enterprise value. And there is a lot of
work that could be done to clarify those rules to make it clear
that acting in the interest of shareholders, or acting in the
interest of pension fund beneficiaries, incorporates this
broader idea of what shareholder value is.
Chairman Beyer. Thank you. Dr. Palladino, I actually do not
remember ESG being in the title of the sharing, but certainly
shareholder primacy was.
What has been the tradeoff in terms of corporate investment
and research and development over the last 10 or 20 years with
the rise of shareholder primacy?
Dr. Palladino. It is a great question. We know overall that
there is opportunity cost when corporations are focusing their
financial assets and their energies on raising share prices. We
know that CEOs today, many of themselves say that they feel
hamstrung by the need to constantly appease outside activist
investors who are demanding constantly higher share prices.
They would rather be focusing on the types of innovations
that their companies are best able to achieve. So I will just
give you a quick example.
GE is a prismatic example from the 20th century of an
innovative company. It is personal to me because it is where my
grandfather worked. He was a prisoner of war who then returned
to work as a--in aviation at GE in Massachusetts. He never had
a chance to go to college but had a good job in which he was
part of the process of innovation at his firm.
GE turned toward Wall Street, turned toward maximizing
shareholder value, as its main focus in the 1980s. And I think
probably may people know the story from there. The focus on
share prices caused the innovative potential that was there
within the company to decline. Ultimately we know that GE lost
$400 billion in market value over the--over a decade, since
2000, leading to 2010, and we know that that focus on
shareholder value ultimately took them away from what they
should have been doing, because it focused on producing more
innovative products over time.
Chairman Beyer. Dr. Palladino, is it fair to link the
dismal productivity increase rate of the last 10 years, 2010 to
2020, with the share buyback and the supremacy of stockholder
value?
Dr. Palladino. Absolutely. I think that while there are of
course many factors because the economy is complicated, I think
that the fact that we have not seen investment in the
workforce, in the American people who actually produce the
goods and services that our leading companies make, that
investment is what will increase productivity over time. We
know that from history. We know that empirically. And that lack
of investment is, in my view, the most important opportunity
cost of shareholder primacy.
Chairman Beyer. Thank you very much. Ms. Samuelson, you
wrote that--and I think this is a really important point,
because I want to suggest that corporations are not inherently
evil. You know, it sounds like we are bashing them for rebuying
of stock, repurchases and the like, but let me say. You said
corporations are amoral. There are the rules and protocols in
the Senate that drive behavior, and we license corporations to
create goods and services.
Deeper than that, and I know you are a student of this, the
creation of the corporation was to limit the liability of the
people that were investing in it. There were all kinds of
benefits that flowed from the rule of law around the
corporation that implied a tradeoff between their special
status, their special protection, and their responsibility to
society at large.
Can you talk about those rules and protocols?
Ms. Samuelson. Well the most dominant one I spoke about a
little bit earlier, I cannot remember whether you were in the
room or out of the room when I did, but it is really about how
were tethered CEOs pay to the stock price. So the dominant
measure today that is used in the market is TSR, Total
Shareholder Return, and it is basically made up of two things,
dividends. And then these share buybacks. The repurchase of
shares, which means some shareholders exit, and the ones who
are left it pops up the stock price by reducing the number of
shares outstanding. The valuation is still the same, but the
ones who are still there glean a lot of the gain. And that is
what these investors want.
I think the tricky part about this is not--the public
company is in massive decline. I think we have 50 percent as
many public companies as we did, something like 10 or 15 years
ago. And they are in decline not because of kind of ESG
investors, so-called ESG investors, but it is really just this
heightened moment now where investors of all kinds are starting
to raise fundamental questions about risk and expressing, if
you will, their desire for kind of clarity about what they are
investing in. What is it actually realizing? And is it
addressing, are these companies addressing the kinds of
concerns that people have as investors, as well as citizens.
I just think this question takes us back to who will hold
the system accountable? Corporations, as you said, corporations
were created initially to do the kinds of things you cannot do
with just your family's resources, or those of your best
friend. It is essentially a way of kind of a bundle of
contracts, or it is a way to hold together relationships. And
yes, ultimately they were also given limited liability so that
they are not vulnerable to the same kinds of demands as
executives would have been otherwise.
And so we are back to the question of kind of really who
holds these powerful institutions accountable? I am a big
believer in business. I truly do not believe that we can solve
our most complex problems without business at the table.
I believe in what Mr. Alexander has been talking about in
terms of the need of a whole market to work well, not just
creating the space where individual companies excel. But I
think it gets back to the question of who is really holding the
system accountable. And frankly investors are not going to do
it. Investors are very, very inclined toward, you know, price
and convenience, just like, you know, just like the consumer
is. They want it both ways. And I think today what is
interesting, what is the most interesting thing on the kind of
horizon is the degree to which employees have become a force
here. Where they are actually raising their voice and asking
questions about what are we actually in the business to do? Are
we doing it well? What does it look like? And what is my piece
of this kind of puzzle?
An so I think it is an interesting time to be having this
conversation, and we are hopeful that some of these questions
that we are asking today will start to kind of align with the
questions that executives themselves are asking about what job
they have, you know, as well as the investors, the questions
the investors are asking and employees themselves are asking.
Chairman Beyer. Thank you. Dr. Rauh, in your testimony you
talked about the surge in average household income since 1950,
or whatever. And then you followed it up with the increase, the
percentage increase in the average income for the lowest
quintile or the lowest quartile. I am sort of impressed with
numbers.
How do you reconcile that with the alternative reality that
our income and wealth and inequality has not been this great in
100 years? And that many, many sociologists and others suggest
that the deep divides in our country, this country today is
driven more by income and wealth inequality than anything else?
Dr. Rauh. Thank you for the question. So I think that
income inequality is often overstated by academics. I trust
people who have direct access to all the data in government.
Auten and Splinter, Auten at the Office of OTA, U.S. Treasury,
and Splinter at the Joint Committee on Taxation, JCT, right
here. And so when you incorporate additional assumptions like
changing marriage rates, and also various alternative sources
of income, including transfers from the government, the top one
percent share of pre-tax income has only increased 3 percent
since 1962. So primarily I believe it is not an accurate
narrative, and these are also figures from the CBO. It is
actually interesting that most of the studies that show that
income inequality has not increased that much actually comes
from government sources, whereas the ones that say it has
increased by a lot more are coming from academics. So that is
how I would reconcile those things.
Chairman Beyer. Okay, thank you. It is certainly an
interesting lone voice, but thank you.
Mr. Alexander, having come out of corporate law and for all
that time, one of the things that we have talked about was the
notion that the SEC for years and years and years had regulated
whether a corporation could use its excess capital for stock
buybacks. And some years ago, my history is not good enough to
tell you, it was early 1990s, whenever, that rule was changed
and thrown out so that corporations were given essentially a
free decision to own buybacks.
Does it make any sense, would it help us at all to restate
that SEC regulation?
Mr. Alexander. Thanks for the question. I am not going to
guess at the year because there is a real expert on stock order
buybacks on the panel, so I do not want to be embarrassed. We
can yield to her. But I will say absolutely, you know, here is
the way I express the problem of the buyback, and again I will
put this in the terms of thinking about the shareholder as a
single company versus thinking about the fact that shareholders
are actually diversified and what they care about is how a
company's decisions affect the entire market.
And if you think about companies that value only the
enterprise it is easy to just return cash to your shareholders
because they get 100 percent of the cash, and they can do what
they want with it. Whereas, if you reinvest in your workforce,
in R&D, in new drugs, in electric vehicles, whatever, your
shareholders benefit from that, but so does the economy. It is
what economists call spillover effect, and some people say,
two-thirds of the benefit of reinvesting goes to spillover
effect.
So it is harder for a company to do that. And I think, as
regulators, as policymakers, you have to be cognizant of that
risk. For my part, I think a lot of this can be solved by
changing--and this is what I have been talking about today--
changing the rules to make investors and shareholders think
more broadly and not sort of allow them to just focus on single
companies, or at least to give them the tools to not just focus
on single companies, because that is kind of what they are
forced to do today. And that will help with the buyback issue.
But I would also just say, because of the natural tendency of a
company to do a buyback because 100 percent of the value flows
to that single company, it is important for all the policies,
be it tax, securities regulation, to be very cognizant of that
issue, as well as--and this is a different issue but also an
important issue, the potential for corporate insiders to
manipulate the market because they may know when the buyback is
coming and they have lots and lots of stock and they can sort
of play games.
Chairman Beyer. Great. Thank you. Dr. Palladino, among the
many things written about shareholder primacy is the idea that
CEOs and C-suite folks are rewarded in their pay plans. I think
you actually write that one of the ways that shareholder
primacy is maximized is to make sure that top management's pay
is driven by shareholder price.
And Elizabeth Warren has an interesting bill, one she
introduced it in this session, that would postpone the ability
of top management to cash out their options until they had left
the corporation by three years, five years, something like
that. So essentially they were not dependent on stock price
buyback today, a share price surge tomorrow, and divesting of
their stock the day after.
Is this meaningful? Is this fair? Is this good policy?
Dr. Palladino. Absolutely. Thank you for the question. So
just on the point of stock buybacks, you know, one of the harms
that they pose is that they do create disincentives
structurally for corporate insiders to personally profit, as
you have said and as Rick said.
And I think that the broader story that we have seen over
the last several decades of executives being rewarded by stock.
And then the stock sort of compensation becoming more and more
complex, and more and more able therefore to be manipulated by
different types of corporate financing the nippers. It is a
huge problem. And I do think that it is important to reiterate,
this is a type of problem that can be easily solved by rules.
Corporate executives are not, you know, this is not a story
of one single sort of greedy executive over here. This a
problem that we have created through, for example, Rule
10(b)(18), which is the Securities and Exchange Commission rule
that was passed in November 1982, that essentially allows stock
buybacks to happen at essentially an unlimited rate because the
SEC does not collect the type of data that would allow them to
actually know if companies are staying inside what they have
constructed as a safe harbor. And it does not presume any
liability for stock buybacks outside of that safe harbor, in
any case.
Before 1982, stock buybacks did not happen that much
because they were presumptively understood as manipulating the
stock price of the company, which we would see as reasonably
problematic in securities markets that we want to be operating
and efficient.
So I think this disincentives that stock buybacks have
created for corporate executives to be able to, and
incentivized to really use short-term choices, or directions of
corporate fund in order to reward themselves has turned us
again away from innovation, which I think should be our North
Star. And I also think that the rules that govern stock
buybacks, I am really happy to see the Securities and Exchange
Commission propose Rule SR, which will be a good first step
toward disclosure of stock buybacks. And I really encourage
them and the Congress deciding to go further and join other
advanced capital markets around the world, and have common
sense rules in place because of this fundamental risk of market
manipulation and incentives for management.
Chairman Beyer. Thank you very much. I think this question
is for Ms. Samuelson, but if you want to defer, we had a
hearing some time ago, or maybe it was a conversation with one
of our many, many terrific economists, that essentially the
seven people that ran the seven largest Index Funds--think
Fidelity, Vanguard, or the like--were running our country, that
they had an enormous number of the stocks under their direct
control.
Clearly they may be the people that have a responsibility
to maximize shareholder price, or not. How can we change the
incentive system for them? Or is the incentive system right for
them? Are they part of the solution?
Ms. Samuelson. I think I would address first the assumption
of what are they actually doing with this incredible market
power that they have. I think the number that is usually tossed
around that Black Rock, which is the largest of the large, they
own something like 7 or 8 percent of virtually every publicly
traded security. They are the ultimate universal investor. They
cannot exit. They have to own the market.
And so they have actually limited ability to influence
corporations directly because they have thousands--you know,
they have probably hundreds of annual meetings during the
season every day, and they have a limited number of staff who
are really detailed to kind of directly engage with
corporations. So I think in some respects they mostly--Black
Rock is one that would have been criticized. But it mostly just
dealt with management. They vote what whatever management wants
on proxy votes.
They have started to step back from that on some issues
that, you know, kind are critically important. Climate change
being one of them. But it is not obvious what they can do as an
indexer. And so I think it takes us back to kind of saying what
are the expectations of investors?
And it takes me back also to this other question about how
we pay executives, and what the expectations there are,
because, you know, Elizabeth Warren's proposal would suggest
that it is just a matter of timeframe, and that loading up
executives with stock, which in some respects the Black Rocks
of the world like, right? Because that means that their, in
theory that those CEOs are very, very attuned to pumping up the
stock price. And of course there is an awful lot of that going
on. But if you are a Black Rock or a Vanguard, you want the
whole portfolio to do well. It does not really do this good
just as Rick said, playing it out to kind of focus in on one
stock or the other.
If I were writing that law, I would be pulling back, not
that Congress necessarily has the power to do this, by the way,
there is more power that resides within executives to fix their
own stuff, maybe than Congress doing it directly. We have
learned this from past experience.
But I pulled back from the emphasis on stock. I do not
think it is doing us any good. When you hire these executives,
they are people that have to exercise extraordinary judgment.
They do not need incentives to take seriously the kind of risks
that they are facing in this remarkably complicated day, and
remarkably complicated market. And I do not know why we have to
kind of load them up with stock in order to head them in the
right direction. They care ultimately about the health of their
enterprise, as they should, and they should care about, if not
everything that one might call a stakeholder--I do not
particularly like that term. They have to get the formula
right. They have got to manage their enterprise to the long
haul, and that means being very attuned to what is the input
that matters the most if I am in Intel? Or what is the input
that matters the most if I am Chevron, or Exxon. Those are
going to come up with different answers, and what we want is
executives who actually are well compensated, that is fine, but
who have kind of the sense of where they fit into the larger
market, not doubling down, tripling down, quadrupling down, to
have them just focused on the stocks.
Chairman Beyer. Thank you. Let me ask one more question,
and I think it is for Mr. Alexander from your corporate legal
background. I am a big fan of Thomas Philippon who wrote The
Great Reversal, which is the best damning indictment I have
seen yet of the corporate concentration, which I think Ms.
Samuelson mentioned earlier. Hasn't the stock buybacks,
dampened corporate concentration? Would it not be worse if
corporations were forced to hold their capital and simply buy
other smaller companies with it? Or how do those interact? Or
is it too complicated to talk about?
Mr. Alexander. I think I am going to say that I am probably
not a good person to answer that question. I would love to talk
a little bit about Black Rock, but you are the Chair, so I----
Chairman Beyer. Dr. Palladino, any insight into the
interaction between shareholder primacy and the failure of
antitrust since Milton Friedman?
Dr. Palladino. Absolutely. I think, you know, we could have
a whole other hearing on this question and maybe we should. I
think that within the theory that says that we need competitive
markets, we have forgotten that--you know, I teach introductory
micro economics, probably Dr. Rauh does sometimes too--we have
to talk about questions of market power. We have to talk about
questions of externalities. These are the assumptions that we
wave our hands and say do not exist when we are coming to this
point of believing that perfect market clearing will simply
occur.
I think that the rules that have been set in place that
have enabled shareholder primacy are fundamentally related to
the same drivers that have increased corporate concentration,
the same interests that have driven us away from a focus on
innovation, and has made some of our largest companies focus as
well on maintaining market power through the exact types of
practices that our antitrust laws were first set up to take on.
So while there is a lot of difference in terms of the
regulatory structures that govern State corporate governance
law and Federal antitrust law, I believe it is really in the
interest of the American people for regulators and those of us,
scholars and others on the panel, to think more about the right
balance between innovation and really constrain the types of
anticompetitive behaviors that our largest corporations have
unfortunately too often been practicing.
Chairman Beyer. Thank you very much. They have called the
second vote over in the House. I want to thank you for letting
me ask rounds two, three, four and five. I sort of like this.
In any way case, thank you all very much for being here. And I
want to thank you for joining me in this vital conversation
about the economic cost of shareholder primacy.
As was discussed today, increased corporate focus on short-
term value prices is a recent development. Given the right
model of corporate governance to put shareholders before
workers and innovation in the climate. And this recent pursuit
of short-term gains has eroded the voice of the workers, many
of whom have seen their earnings as a share of GDP diminish
over the years, while also exacerbating income, wealth, racial
and geographic inequality at least with respect to Dr. Rauh,
and according to many economists. Focused on stock buybacks and
the executive compensation, companies are investing less per
dollar of profit in long-term growth and sustainability than
they did in the past. And this is along with the
competitiveness and overall productivity of our economy, even
the average investor is left worse off.
The good news is that this is not the only way to do
business. Hearing from these experts today, I am confident that
we can once again prioritize investment that drives inclusive
economic growth and address complex existential challenges like
the threat posed by climate change.
We can do this by strengthening the bargaining power of
workers, and realigning the incentives to reward long-term pro-
growth investments that generate society and economy-wide
returns. And we can do this together.
So thank you to each of our panelists for your
contributions in this timely ongoing discussion. As we do this
important work, we rely on your expertise and good faith. And
thank you to my colleagues who came and went about their
business for being part of this discussion and sharing their
wisdom.
The record will remain open for three days. The hearing is
now adjourned.
[Whereupon, at 4 p.m., Wednesday, March 16, 2022, the
hearing was adjourned.]
SUBMISSIONS FOR THE RECORD
Prepared statement of Hon. Donald Beyer Jr., Chairman,
Joint Economic Committee
recognitions
This hearing will come to order. I would like to welcome everyone
to the Joint Economic Committee's hearing ``Examining the Impact of
Shareholder Primacy: What it Means to Put Stock Prices First.''
I want to thank each of our distinguished witnesses for sharing
their expertise today. We have an exceptional panel of experts, and I'm
looking forward to hearing from them.
opening statement
This hearing will examine how the shareholder primacy model of
corporate governance has impacted the economy and how Congress can help
address the problems it has created.
Shareholder primacy is a corporate model that focuses mainly or
exclusively on increasing stock prices to generate value for its
shareholders.
This approach, which gained favor in just the last few decades,
encourages corporations and their executives to spend a larger share of
profits on stock buybacks to reward investors in the short-term.
Who are the winners when corporations put stock prices first?
In the United States, shareholders are a relatively small group:
The top 1 percent owns roughly 50 percent of all corporate equities,
and only about half of U.S. households own any stock at all.
As a result, the singular focus on stock prices concentrates wealth
at the very top, while leaving less for companies to re-invest in their
workers, in innovative technologies and in long-term growth.
For example, the seven largest publicly traded oil corporations
recently announced a near-record $41 billion dollar stock buyback
program on top of $50 billion dollars in shareholder dividends.
While everyday American workers and families bear the burden of
higher gas prices, Big Oil is raking in record profits and prioritizing
padding the pockets of their wealthy shareholders.
But it has not always been this way. From the 1930s to the mid-
1970s, American corporations largely followed a ``retain and reinvest''
strategy that focused on long-term innovation and job security for
workers.
Workers were seen as an asset and a long-term investment, not a
liability. Managers viewed well-paid, cared-for workers as vital to
their success and primarily used profits to pay workers, provide
benefits and make productive investments. Shareholders received the
residual after companies paid workers, invested for the future and paid
down debt.
During this time, economic growth was strong and broad-based: As
the economy grew, workers saw their wages rise and, on the whole, were
more financially secure. They had access to pensions and pathways to
the middle class.
Since the 1970s, however, as shareholder primacy has become more
dominant, boards have put shareholders at the front of the line for
corporate profits, leaving everyone else behind.
While CEOs and executives at the top have seen their incomes go up
940 percent over the last 40 years, the bottom half of earners have
seen their wages virtually flatline.
Across the board, the share of Gross Domestic Product going to
employee wages and benefits has been declining for decades. The
increased corporate focus on raising stock prices has driven this
trend, which in turn has deprived workers of the gains from economic
growth.
Because the corporate executives and shareholders who benefit from
this model are overwhelmingly and disproportionately wealthy and white,
this further reinforces the widening wealth disparities across income
and racial groups. By 2019, the top 10 percent of American households
held 70 percent of all U.S. wealth, and the total wealth owned by the
entire bottom half of Americans dropped to just 2 percent.
The impact of shareholder primacy goes beyond the widening
differences between winners and losers; it is impacting our economy at
almost every level.
Short-sighted decisions to help companies hit short-term earnings
targets can help explain the ``just-in-time'' inventory and staffing
approaches that left U.S. supply chains vulnerable to pandemic-related
disruptions.
Shareholder primacy also hinders investments in innovation and
sustainability that drive inclusive economic growth and are necessary
to address threats like climate change.
For example, despite growing risks from climate change,
corporations have continued to make decisions that prioritize short-run
profitability at the expense of broad sustainability and climate
resilience.
Surprisingly, investors themselves also lose under shareholder
primacy. Families investing money in diversified stock portfolios for
college or retirement suffer when individual companies put their short-
term profits over long-term investments.
It's no coincidence that widening economic inequality in this
country, which began in the 1970s, coincides with the increased
dominance of shareholder primacy.
It has helped concentrate economic power among a privileged few.
But this is not how we, as a Nation, have always done things. There
are other paths forward that maintain firm profitability and promote
economic growth that is stronger, stable and more broadly shared.
For example, incentivizing business to invest in innovation,
sustainability and enhanced productivity would boost competition,
workers' wages and economy-wide returns.
Legislative proposals that place limits and tax share buybacks
would help realign corporate incentives away from short-term stock
prices and toward long-term, pro-growth investments.
Legislation that strengthens collective bargaining and raises
wages, like the PRO Act and the Raise the Wage Act, would ensure
workers take home a larger share of the gains that public companies and
their executives have been keeping for themselves.
turn it over to senator lee
As we dive deeper into these issues, I look forward to the
testimonies of our expert witnesses. Now I would like to turn it over
to Senator Lee for his opening statement.
__________
Prepared statement of Hon. Mike Lee, Ranking Member,
Joint Economic Committee
Last week, we learned that inflation reached a new 40-year high of
7.9 percent. This means that inflation is costing the average American
household $435 more each month for the things they ordinarily buy.
Given this new economic reality, I hope we keep in mind the severe
price increases facing American families right now as we hear about
foisting environmental and other political goals onto private
businesses. Americans are hurting. Poor and middle-class Americans are
the ones who will pay the price for uprooting our market economy in
favor of a woke political agenda. This agenda will only compound
inflation--making Americans poorer and our businesses less dynamic.
For centuries, Americans have reaped the benefits of free markets
and competition. It is this free market system that has lifted
Americans to the highest standard of living ever achieved by a major
economy.
Yet today, the free market system that enables American prosperity
is under attack by bureaucrats, politicians, and regulators who seek to
impose their personal political goals on private businesses. They seek
to override the competitive forces that grow workers' wages and keep
prices low. They seek to make private companies beholden to
politicians, rather than to the shareholders who invest in companies in
the first place.
When we hear the word shareholder, we don't usually think of the
average American. But that's exactly who they are. Shareholders are the
more than 180 million Americans who live in a household with a 401(k),
pension, or other stock holdings. Shareholders are an ever-growing
majority of households who invest in the economy and use the return on
that investment to save for retirement, buy a home, or send their kids
to college.
When the government tells companies not to listen to shareholders,
it is really telling companies not to listen to the American people.
When the government tells companies to divert their hard-earned
resources into woke policy goals like environmental and social justice,
the government is taking power and wealth out of the hands of the
people and consolidating it in Washington.
When the government interferes with the private sector, businesses
stop serving their workers and customers, and instead serve the
bureaucrats who set the rules.
We already see this happening. President Biden recently directed
his administration to assess companies' progress on environmental and
social justice goals--a step toward requiring them to abandon their
core responsibilities to the school teachers, firefighters, and
everyday Americans who invest in them and buy their products. These
actions ignore centuries of evidence that the free market system is the
best way to create prosperity for workers, families, and communities.
America has always been a place where the most effective common
action occurs in the space between the individual and the State. A
Federal Government that attempts to replace free enterprise is a
Federal Government that has overstepped its bounds.
We ought to ensure that businesses are free to serve their
communities by remaining at the forefront of innovation and creating
value for the American families who invest in and are served by them.
In today's environment of surging inflation, we can afford nothing
less.
Thank you.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Response from Mr. Frederick Alexander to Question for the Record
submitted by Senator Klobuchar
Mr. Alexander, in your testimony you stated that ``the laws and
regulations that support shareholder primacy'' should encourage
companies to ``appropriately prioritize the impact they have on the
social and environmental systems that undergird the economy.''
How does this recommendation relate to actions the
Federal Government is currently taking to encourage investment in
domestic manufacturing and spur investments to mitigate climate change?
The laws and regulations referred to in the question include
current interpretations of (1) the fiduciary laws that govern
corporations and investment fiduciaries (such as pension trustees) and
(2) the laws that require companies to make certain disclosures to
investors. These interpretations focus on the enterprise value of each
individual company and assume that the primary role of fiduciaries is
to ensure that investors' capital is managed in a manner that optimizes
the value of each company.
My testimony details the good reasons to provide that that the
primary loyalty of corporate directors and investment fund trustees
runs to the investors who provide capital. However, it also points out
that most investors are broadly diversified, and that they are best
served when individual companies refrain from behavior that threatens
the long-term health of our economy. Thus, it is better for most
shareholders if individual companies make choices that preserve and
improve vital social and environmental systems, even if doing so does
not maximize financial return at the individual company.
Encouraging private industry and the financial industry to adopt
this broader notion of shareholder primacy--one that puts the
collective success of our economy at its center--is key to the success
of Federal policies encouraging investment in domestic industry and
climate change mitigation.
Both of these objectives have the potential to improve the
performance of the Nation's economy over long times frames, by creating
a resilient economy, reducing inequality, and preserving the value of
the ecosystem services that undergird the economy.
However, if companies' primary focus remains on increasing their
own future cash flows to shareholders, there will be a great temptation
to manipulate these programs in a manner that makes them profitable for
companies, while not addressing the underlying policy concern.
For example, a company operating under the current interpretation
of shareholder primacy might use tax credits to increase its domestic
manufacturing capability but nevertheless seek to increase margins by
outsourcing critical components, defeating the resiliency goals of the
program. If the company were operating under an expanded understanding
of shareholder primacy, it would be more likely to account for the fact
that using the credits to create a dependable, authentically domestic
supply chain would protect the economy, and thus the portfolios of its
diversified shareholders.
Similar concerns would apply to programs that encourage investment
in climate mitigation. The mitigation technologies that are most likely
to reduce overall carbon concentration may not be the technologies that
are most likely to increase cash flow at an individual corporation;
policies that encourage a more expansive view of shareholder primacy
would make it more likely for companies to adopt the former, because
their decision could account for the positive ``spillover'' effects of
adopting the technology that is best for the planet.
__________
Response from Dr. Joshua D. Rauh to Questions for the Record
submitted by Senator Lee
Q1: What effects do stock buybacks have on innovation and
other economic outcomes?
The purpose of a stock buyback is to take a company's cash on-hand,
which its management determines does not have a productive outlet
(otherwise it would be invested), and to put it in the hands of
shareholders, who will in turn invest the cash from the sale of shares
into other investments, including in more innovative companies with a
demand for investment capital. So, while it is certainly true that
repurchases have become more common in the last decade or so, with $4.2
trillion in stocks bought by S&P 500 corporations between 2007 and
2016, this ignores that much of the buyback is reinvested in the same
group of companies, with $3.1 trillion in new shares issued by S&P 500
companies in the same time period,\1\ and a further $250 billion
flowing into non-S&P 500 companies annually between 2009 and 2019.\2\
Other investor proceeds from buybacks likely flow into private equity
markets or venture capital, whose assets under management have grown
substantially. In short, investors are using their buybacks to finance
corporations that have legitimately productive ideas, which desperately
need new investors. If anything, advocates of innovation ought to be
encouraging buybacks as a means of getting cash in the hands of
innovative firms.
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\1\ Jesse Fried & Charles Wang, Are Buybacks Really Shortchanging
Investment?, Harv. L. Sch. Forum Corp. Gov. (Mar. 19, 2018), https://
corpgov.law.harvard.edu/2018/03/19/are-buybacks-really shortchanging-
investment/.
\2\ Greg Milano and Michael Chew, Save the Buyback, Save Jobs, 31
J. Applied Corp. Fin. 126, 127 (2019).
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This innovation has wide-reaching implications for the rest of the
economy, too. For one, it means that private enterprise invests more in
R&D. Since 2001, R&D investment has grown at an annual rate of nearly
4.9 percent every year,\3\ far outpacing annual GDP growth in the same
period. Given that businesses make over 70 percent of total R&D
expenditures in the United States,\4\ policies that incentivize this
sort of investment impact the rest of the country in a significant way.
When corporations increase their productivity through research
investment, their workers become now more valuable to the corporation
than they were previously. These firms must then compete in labor
markets for these more lucrative workers with other firms, raising
wages. Research has demonstrated that this is no different for the
investment that comes from buybacks. A 2022 study found that the 1983
rule change by the Reagan administration making buybacks easier to
execute directly led to a 5.9 percent increase in labor wages.\5\
Critics would like to argue that buybacks are a zero-sum game between
employees and shareholders, but this simply is not the case. When the
market directs investment toward opportunities which are legitimately
productive, it turns out that everyone can benefit.
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\3\ Business Enterprise Research Development Survey (BERD), U.S.
Census Bureau, 2000-2019.
\4\ John Sargent, U.S. Research and Development Funding and
Performance: Fact Sheet, CONG. RSCH. SERVICE, 2021.
\5\ Ricardo De La O, The Effect of Buybacks on Capital Allocation
34 (Mar. 3, 2022) (working paper) (on file with author)
Q2: What does academic research find about the effects of
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capitalism and shareholder activism on productivity and innovation?
A shareholder engages in activist behavior when they put pressure
on the officers of the firm to change their management practices, often
in the name of increasing returns. Despite the derision from critics of
shareholder capitalism, in reality, shareholder activism increases the
efficiency of a firm, and ultimately makes it more productive in the
long run. For example, although it is true that shareholder activism
can reduce investment in research, this is often a reduction
ineffective investment. Subsequent to a shareholder activist event, the
number of patents filed by a target firm increases by 15.1 percent, and
the citations those patents garnered increases by 15.5 percent.\6\ The
type of research investment encouraged by shareholder activism thus not
only increases volume of research, but also increases the usefulness of
research being produced. This has systemic effects on the rest of the
firm, too. The labor productivity of the firm's employees increases, on
average, by 8.4 percent to 9.2 percent.\7\ The evidence, therefore,
points toward shareholder capitalism encouraging firms to be more
productive in the deployment of their limited resources.
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\6\ Alon Brav et al., How Does Hedge Fund Activism Reshape
Corporate Innovation?, 130 J. Fin. Econ. 237, 244-245 (2018).
\7\ Alon Brav et al., The Real Effects of Hedge Fund Activism:
Productivity, Asset Allocation, and Labor Outcomes, 28 Rev. Fin. Stud.
2723, 2749 (2015).
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The link between shareholder capitalism, and the activism it
engenders by investors, is strongly linked to rising productivity and
innovation in the economy. In the last forty years of American history,
a period in which shareholder capitalism has been the guiding principle
of corporate governance, the economy has increased its productivity by
nearly 118 percent, meaning that the average worker today is more than
twice as productive as his or her counterpart in 1979. \8\ This
increased productivity, in turn, makes workers more competitive in
labor markets, raising wages. Since 1979, the Congressional Budget
Office estimates that the post-tax, post-transfer median income of the
average American has risen by nearly 91 percent,\9\ demonstrating that
the benefits of such increased productivity are not just felt by the
wealthiest Americans. Rather, by incentivizing the sort of investments
that increase long-term efficiency, shareholder capitalism creates a
more vibrant and productive economy, the rewards of which are felt by
investors and workers alike.
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\8\ Nonfarm Business Sector: Labor Productivity (Output per Hour)
for All Employed Persons, Fed. Res. Econ. Data (FRED), https://
fred.stlouisfed.org/series/OPHNFB (last visited Mar. 18, 2022).
\9\ The Distribution of Household Income, 2018, Cong. Budget Office
(CBO) (Aug. 2021), https://www.cbo.gov/publication/57404.
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__________
Question for the Record for Dr. Lenore Palladino
submitted by Senator Klobuchar
Dr. Palladino, you testified that innovation depends upon ``both
resource development and utilization'' and discussed the need to bridge
the divide between academic innovation and commercialization.
In your view, what is the proper role of academic
research in driving innovation?
[all]