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JEC Hearing on the Impact of Shareholder Primacy

Joint Economic Committee

Examining the Impact of Shareholder Primacy: What It Means to Put Stock Prices First

Wednesday, March 16, 2022

 

Topline

  • The hearing was lightly attended on both sides, especially by Democrats, with most questions being asked by Beyer.
  • Most of the hearing focused on stock buybacks, ESG, and shareholder primacy.

 

Witnesses

  • Lenore Palladino, Assistant Professor of Economics & Public Policy, University of Massachusetts Amherst, Amherst, MA
  • Judy Samuelson, Vice President of the Aspen Institute Founder, and Executive Director, Aspen Institute Business and Society Program, New York, NY
  • Frederick Alexander, CEO, The Shareholder Commons, Wilmington, DE
  • Joshua D. Rauh, Ormond Family Professor of Finance and Senior Fellow at the Hoover Institution, Stanford University, Stanford, CA

 

Testimony
Dr. Lenore Palladino, Assistant Professor of Economics & Public Policy, University of Massachusetts Amherst, Amherst, MA

In her testimony, Palladino described shareholder primacy as a flawed theory of the corporation because it makes incorrect assumptions about the role of both shareholders and other corporate stakeholders in the process of production. She then stated that the gains from spending corporate funds on financial practices like stock buybacks disproportionately benefit white, wealthy American households, because these are the households who hold the vast majority of corporate securities. The remainder of her testimony focused on three main points: defining the key components of economic innovation and resilience in the 21st century, where corporations and finance have gotten off track – what the harms have been of the prioritization of shareholder primacy and “putting stock prices first,” and what the opportunities are today to rewrite the rules to orient our economy towards innovation and shared prosperity.

 

Dr. Joshua D. Rauh, Ormond Family Professor of Finance and Senior Fellow at the Hoover Institution, Stanford University, Stanford, CA

In his testimony, Rauh discussed what shareholders want, including generally to make as much money as possible while conforming to law and ethical custom, which incentivizes not maximizing stock in all cases. He recommended structuring executive compensation to reward long term performance. He added that attention to environment, social, and governance (ESG) is related to lower rates of return and that public sentiment does not line up with ESG incentives. He concluded by stating that the goal should be to protect investors from arbitrary decisions made under the guise of ESG responsibility.

 

Question & Answer

Stock Buybacks

Chairman Don Beyer (D-Va.) asked about stock buybacks, and Palladino explained the arguments in favor of using stock buybacks and contradicted those arguments with examples from Amazon and Exxon showing the need for investment in a company’s workforce. She also said we need more information about private markets to understand the flow of funds from stock buybacks. Beyer also asked if the old Securities and Exchange Commission (SEC) regulation regarding corporate use of excess capital for buybacks should be reinstated. Alexander responded by discussing the importance of investing excess capital back into a company as opposed to buybacks. Beyer asked about Sen. Elizabeth Warren’s (D-Mass.) bill to postpone management from cashing out stock options and if that policy would be meaningful. Palladino said stock buybacks create a structural incentive for corporate insiders to personally profit and that this problem can be easily solved by rules, for instance, by changing Rule 10b-18.

 

Shareholder Primacy

Beyer asked Samuelson why we should not believe that shareholders, through their 401ks, own corporations in which they are invested. Samuelson said the corporation owns itself and that the shareholder only holds a certificate of stock that provides certain rights but does not add up to controlling the corporation. Sen. Ted Cruz (R-Texas) asked what Congress can do to ensure a robust system of shareholder capitalism in which shareholders can expect executives to focus on the bottom line. Rauh said the government should step back from mandating ESG regulations and consider actions to protect shareholders from their agents voting against shareholder maximization without the consent of shareholders.

 

Beyer asked what the tradeoff has been between research and development (R&D) and the rise of shareholder primacy. Palladino said there are opportunity costs when corporations focus on raising share prices and that CEOs feel hamstrung by activist investors pushing for the highest share price instead of R&D investment that would benefit the company. She added that lack of long-term focused investment is a significant opportunity cost.

 

Beyer asked why shareholder returns are not the sole measure of success for shareholders. Alexander said shareholders are not benefited when each company in the portfolio struggles to increase its own bottom line without regard to the effect of doing so, adding that multiple companies dragging down the economy hurts shareholders, for instance, by contributing to climate change that decreases Gross Domestic Product (GDP), hurting the gains of long-term investors.

 

Beyer asked how to change the incentive system for the largest index funds and if they are part of the solution. Samuelson said we should pull back from the emphasis on stock and that executives do not need to be loaded up with stock to be incentivized to manage their enterprise for the long haul.

 

ESG

Lee asked whether mandatory ESG reporting impacts ordinary Americans. Rauh said ESG actions have reduced energy production, which increases prices for ordinary Americans. Lee then asked how ESG focus hurts retail investors. Rauh said requiring companies to pursue ESG goals that reduce returns for individual investors is problematic and that ESG requirements come with tradeoffs. Rep. Ron Estes (R-Kans.) asked if stakeholder primacy would lead to companies assessing private customer ESG risk. Rauh said that would be a dangerous trend and imagined that happening with suppliers choosing to only buy from companies with specific ethical values. Cruz asked if woke corporations using their market power to enforce partisan political agendas is in shareholders’ best interest. Rauh said this is an example of the economic principal agent problem.

 

IPOs

Rep. David Schweikert (R-Ariz.) asked about the difficulty of going public for companies. Rauh said there has been a major trend of companies remaining private, adding that 401ks can only invest in public companies, so investors are experiencing more limited access.

 

Anti-Trust

Beyer asked about the interaction of shareholder primacy and the failure of anti-trust. Palladino said the rules that have enabled shareholder primacy also promote corporate concentration and that the same interest driving us away from innovation has incentivized companies to maintain market power.

 

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.