When we talk about capitalism, we tend to reduce it to one model that can be applied universally. More specifically, economists tend towards a pro-US bias in which they depict the American model of capitalism as the “ideal one” (unsurprising given that economic theory originated primarily in the UK and the US). While there is no doubt that all capitalistic societies share certain characteristics with American capitalism — an emphasis on private property and wage labor among others — they might differ in the extent to which governments redistribute wealth via welfare states, for example. Similarly, countries might differ in the extent to which their business structure depends on shareholders.
Let’s Get Down to Business…
Historically, shareholders come from the era of maritime exploration by the major European powers of the 15th and 16th centuries. The cost of naval expeditions could be astronomical — including the costs imposed by shipbuilding, cartography, recruiting sailors and so forth — all without mentioning the fact that there was no guarantee that expeditions would provide a financial return. Selling “parts” in the expedition as if it were a company became a way for these early “shareholders” to diversify risk, while ensuring long-term returns. Although a few expeditions would inevitably fail, it only took one or two “successes” for investors to receive a big payoff.
What about investment in the modern era? Well, new businesses clearly still need capital to get off the ground. (In the financial literature, this is referred to as “raising capital”). There are essentially two ways to go about raising capital, although there are many variations. A business can take on debt through a bank loan, for example, or it can issue what is known as equity, much like the historical model above. When a company finances itself through equity, it is essentially “selling off” a little piece of its ownership — known as a “share” — to shareholders, who are typically investors or financial firms. This allows the company to raise capital quickly, but it can change the operating model of the business as “outside investors” are now given more of a say on how the business is run.
Selling “parts” in the expedition as if it were a company became a way for these early “shareholders” to diversify risk.
Many businesses that fund themselves through bank loans, by contrast, do not face these same “outside expectations” (aside from repaying their loans of course). They may, however, have a more difficult time raising capital in the short-term than do companies that issue equity. For many small businesses, the owner of a company who is involved in the day-to-day operations will be the majority if not the only shareholder, although they may still hire managers and employees to complete most of the work on their behalf. In this sense, shareholders plural only really become relevant as a company attempts to “get off the ground” or expand its operations by issuing equity.
Private vs. Public Equity
In the case that a small to medium-sized enterprise (SME), whether new or established, does issue shares, these are often initially privately traded. This essentially means that there are certain restrictions on who can buy them. For example, private equity investment might be limited to more experienced investors or investment firms that meet minimum capital thresholds (think venture capitalist investments for the former and leveraged buyouts by private equity firms for the latter). While this topic deserves an article of its own, suffice it to say for now that private equity investment falls victim to many of the problems with shareholders, as I’ll detail below, in addition to being less transparent than public equity investment due to looser financial regulations.
Publicly traded companies, by contrast, are those whose shares are listed on public stock exchanges, such as the New York or London Stock Exchange, following what is known as an Initial Public Offering (IPO). These shares (remember: “pieces” of the company) can be bought and traded by a larger number of investors, so long as they have access to what is known as a brokerage account. In theory, this means that members of the “general public” can buy shares in a company that pays them a dividend (a kind of financial return), although whether they actually do is another story.
Shareholders As We Know Them
With publicly traded companies, shareholders — in most cases, majority shareholders — elect the board of directors who take decisions regarding the overall direction of a company (the appointment of managers, the issuing of dividends, etc.). This allows shareholders to quite literally choose executives that will prioritize their own interests at the expense of other stakeholders within the company. Taken to its extreme, managers might be pushed to pursue what is known as shareholder wealth maximization, which essentially “funnels” a company’s profits to those at the top.
Issuing equity can change the operating model of a business as “outside investors” are now given more of a say on how the business is run.
If we return to our historical example, the “original” shareholder structure might have made sense while sharing the financial burden of maritime exploration, clearly a very risky venture but one with potentially astronomical returns. And perhaps it would still make sense today if shares purchased in the stock market were actually used to fund risky yet innovative long-term projects that would benefit society as a whole (especially since the public tends to bear the costs through public subsidies, pollution, etc.).
But as companies grow in size and eventually tend towards monopoly status — like many of the biggest publicly traded companies in the US — they actually tend towards less innovation. In actuality, they focus more on defending their position in the market, which ensures shareholders a long-term financial return since said companies are less likely to go bankrupt. The increased financialization of the economy over the past four decades has meant that investment, through both private and public equity, generally has much less to do with innovation nowadays and more to do with what is known as rent-seeking. (I mean, come on, what incredible new invention has Apple or Netflix come up with recently that isn’t just a more expensive (and often crappier) repacking of their old products?)
As companies grow in size and eventually tend towards monopoly status, they actually tend towards less innovation.
Shouldn’t other actors in the economy — workers, consumers and citizens more generally — have more of a say in how their businesses are run? This is especially true when we consider not only the exclusivity of the stock market, which remains inaccessible and thus undemocratic to most people, but also the fact that outcomes in business have repercussions for all of society.
Stakeholder Model vs. Shareholder Model
The most common alternative to the shareholder model and the ideology of shareholder wealth maximization that it espouses is what is known as the stakeholder model. The stakeholder model or theory attempts to take into account the concerns of non-shareholder actors in a company, such as employees but also suppliers and sometimes consumers. Common in Northern European countries such as Germany and Sweden, it effectively offers a working alternative to the “ideal” American version of capitalism that is based on shareholder primacy. The stakeholder model does this by giving voice to union representatives by ensuring they have a permanent position on the board of directors, among other measures.
The stakeholder model effectively offers a working alternative to the “ideal” American version of capitalism that is based on shareholder primacy.
Although shareholders and their concerns still tend to take priority in the company, this at least helps to level the playing field between the interests of shareholders and those of the workers they employ. As compared to shareholder wealth maximization, it is also more likely to lead to long-term value creation by taking into account the perspective of workers, i.e. those who actually carry out the decisions of shareholders and managers. Nonetheless, it does not solve the underlying problem posed by the separation between a company’s ownership (shareholders) and its production (workers), which is why cooperatives effectively need to play a more important role in the economy of tomorrow.
Institutional Alternatives
In a business context, cooperatives are companies that are collectively owned by their workers, giving each worker a direct say on how the business is run through voting. In contrast to the shareholder model, cooperatives encourage a “funneling” of resources not to those at the top of the company (shareholders), but back into the company itself, in addition to the local community in most cases. Since the owners of a business are directly responsible for the actions they take, this tends to lead to more sustainable, long-term business practices, not to mention more small-scale innovation.
While the cooperative model is probably unlikely to completely overtake the shareholder model anytime soon, there are a few alternative ways of raising capital that would allow businesses in the meantime to avoid issuing equity (and thus relying on shareholders). For example, new SMEs can seek out bank loans from credit unions or public banks. They may also want to consider funding projects through crowdfunding initiatives, local government grant programs or even through friends and family if this is an option. While such financial alternatives remain largely fragmented, sharing knowledge about their existence is at least a start in challenging shareholders!
Photo made available to Unsplash for free commercial use curtesy of Mathieu Stern.