In our current system, most medium to large companies have a top-down business structure in which the owners of a company (shareholders) are different from those who control and operate the business (managers and workers). This is an example of what is referred to as the principal-agent problem, in which those who take decisions on others’ behalf (the agents) may pursue their own self-interest rather than those of the people they represent (the principal). More concretely, managers (agents) may adopt certain business strategies that benefit them at the expense of shareholders (the principal) or, in other words, they may try to “cut into” the revenue of shareholders. It is exactly this line of thinking that led many businesses in the 1980s to start tying managers’ salaries directly to a company’s share or stock price for shareholder wealth maximization.
Again, the line of thinking here (as it is, erroneously, in most economics teachings) is that a company’s share price directly reflects its value or competitiveness in the overall economy. However, a company’s share price can be related to extraneous factors that have little to do with its business operations or the economy more generally. Financial speculation or what British economist John Maynard Keynes called “animal spirits” — which I’ll define as “emotional whims” — can affect a company’s share price. Hell, even media coverage, both positive and negative, as well as trends on social media can affect a company’s share price (just look at Elon Musk and X or the GameStop short squeeze).
How Shareholder Wealth Maximization Works
When managers’ salaries and/or bonuses are tied to a company’s share price, they have every incentive to increase the part of the company’s profits that go to shareholders. Where are the workers in all this, you might ask? Well, assuming share prices do not increase due to external factors such as those mentioned above, the additional profit for those at the top needs to come from somewhere within the company. Conversely, managers can “call in” or borrow funds from a company’s shareholders that can be used to invest in new projects in order to maximize profits on the long-term (but again this somewhat defeats the purpose of shareholder wealth maximization, which tends to prioritize short-term returns).
Breaking this down in simple terms, a company’s profits are equal to sales revenue minus input costs (Profit = Revenue – Costs). So, managers can either attempt to increase revenue or lower costs, or, ideally, both. In terms of increasing revenue, they can allocate more of a company’s funds towards marketing through advertisements for example. They could also lower costs by allocating fewer funds towards research and development (R&D), switching to lower-cost (and lower quality) intermediate goods, investing less in infrastructure and safety, or — every CEO’s favorite — spending less on labor through layoffs and salary reductions.
A shareholder wealth maximization strategy encourages managers to cut corners on what is known as “long-term value creation”.
While trends in marketing and R&D spending appear to be inconsistent across time and space, wage stagnation and reduced investment in infrastructure and safety since the 1980s have been very well documented. The problem with this strategy is that it encourages managers to cut corners on what is known as “long-term value creation” by investing less in risk management or employee training for example. While shareholder wealth maximization might be beneficial on the short-term (at least for those at the top), it can lead to a company’s long-term financial ruin by essentially chipping away at what once gave that company value, i.e. the quality of its products or services.
What this Means for Workers
This seems like an unwise strategy (supported by “economic genius” Milton Friedman might I add), especially given that shareholders or investors can simply sell their shares as soon as a business begins to go under, while workers are left without any real company to work for. Beyond the future of individual businesses, however, shareholder wealth maximization also has wider implications for the economy. Namely, it shifts focus away from the production of goods and services (what I like to refer to as the “real economy”) towards investor interests in a process known as financialization.
And this is just about the time where I would like to reintroduce class conflict. Clearly, workers suffer under a strategy of shareholder wealth maximization as it encourages managers to financially reward shareholders at the expense of workers. Yet, at least workers can benefit from a dynamic stock market by investing in it themselves, right? Well, this argument assumes that the average worker actually has enough money to invest in the stock market, which — as the astronomical amount of private debt and declining real wages globally shows — seems unlikely. However, let’s assume that this is the case: investment also requires know-how, time and risk-taking (all three of which appear to be in short supply for the majority of workers), which poses a number of barriers to entry.
Furthermore, one only has to look at the rise in concentration of stock ownership globally by investors — as compared to “average people” — to see why this argument falls sort. Many of the corporations with the highest stock price also achieved such by pursuing policies that were actively harmful to worker interests (monopolization and loosening of labor rights for example). As the strategy of shareholder wealth maximization shows, it is illusory to think that the interests of shareholders align with those of workers, as they are effectively at odds. The best way for workers to amass wealth is still by increasing their share of profits through unionization and rallying together to increase taxes on the wealthy.