Shareholder value theory was a response in the 1980s to the poor performance of company management in the 1970s (much more on this here).* Academic finance theorists, led by Michael Jensen and colleagues, theorized that the best way to improve that performance was by importing the alleged discipline of financial markets into the management process by making share price the most important performance metric for management. The key assumption here was that financial analysts were well informed and best positioned to impose a form of collective external control. It was elegant and completely wrong, as it turns out, but the theory was a perfect match for the dawn of the bull market in 1982.
The dominance of the theory led to an overwhelming pressure on corporate management to reduce cost wherever possible, a pattern economic historians Lazonick and O’Sullivan describe as a shift “from ‘retain and reinvest’ to ‘downsize and distribute’” profits to shareholders. In practice, this means that all of the unlocking and unleashing and other metaphors have generally meant breaking open companies, supply chains, union contracts and other forms of stored capital and distributing the profits to owners. And while that process continues unabated, we seem to be nearing the point of diminishing returns. The result is a form of cannibalization as finance (and industry in general) “unlocks” and feeds on itself.
What I know about Marx wouldn’t power a matchbox car, but this has me thinking about Marx, and the idea that capitalism will eat itself. As I understand it, Marx stipulated two kinds of capital – circulating capital and the fixed capital used in production. With an increasingly financialized economy, however, it seems to me that the production of shareholder value is increasingly driven by capital markets – no fixed capital required (at least not in the US). So to torture the Grundrisse, when circulating capital itself becomes the means of production of more capital, then it behaves like fixed capital in an industrial economy, which in Marx’s terms means it will consume itself.
Several examples seem to fit the pattern. The WSJ this week ran an article titled “GE Feels Its Own Cuts” about the firm’s decision to join its large corporate peers in downgrading its employee insurance plans to save money. The irony is that these high-deductible plans are much more stingy in compensating claims for medical imaging. By offering them, GE is participating in a trend toward lower demand for its own expensive medical imaging products.
The drive to lower compensation costs has hit even closer to home for the buy side of Wall Street, which has been undermined by the sell side. The passage of ERISA in 1974 (and particularly its Safe Harbor for outsourcing to “experts”) opened the door to widespread outsourcing of investment duties from pension funds to investment managers, making corporate pension funds one of the foundations of demand for the investment industry. But the sell side began to attack pensions as anachronistic, overly generous and uncompetitive burdens on shareholder value in the late 1980s and became even more strident in the 1990s. Their pressure on corporate management to eliminate or minimize these costs was successful – I’m not aware of a single corporate pension fund that is open to new employees. While it pales in comparison to the dire effects for employees, it’s worth noting that this shift removed a pillar of demand for the buy side.
In an even stranger example, some pension funds are participating directly in this process, effectively cannibalizing other pension funds. The hullaballoo over Romney’s latest gaffe this week brought out the story of one of his major funders, a private equity manager named Marc Leder. According to the Times, Leder’s firm bought the restaurant chain Friendly’s through his private equity firm in 2008. Three years later, he put Friendly’s into bankruptcy, a move that the Pension Benefit Guarantee Corp. claims was made to offload the pension liabilities onto the government. Leder took control of the company again once it emerged from bankruptcy without the burden of its “inefficient” pension costs. The kicker – the investors in the vehicle that funded and stand to profit from this behavior included several large state pension funds. As for why these funds (or any of the companies in these examples) would participate in this cannibalization:
Jeffrey States is the investment officer for the Nebraska Investment Council, another Sun Capital investor. He said some private equity firms do provide information about how their dealings might affect things like jobs. But not all investors ask for such details.
“The primary objective is returns,” Mr. States said.
What happens when there are no more sources of returns?
* This 2000 paper by Lazonick and O’Sullivan provides historical background, which is more interesting than I had expected.