Corporate governance – J. W. Mason

What Is the Stock Market For?

Elon Musk’s pending purchase of Twitter is an occasion for thinking, again, about what function stock markets perform in modern capitalism.

The original form of wealth in a capitalist society is control over some production process. If you become a wealthy capitalist, what this means at the outset is that you have authority over people engaged in some particular form of productive activity. Let’s say a group of people want to get together to make steel, or write some computer code, or serve a meal, or put on a play: The armed authority of the state says they cannot do it without your ok.

That property rights are fundamentally a legally enforceable veto over the activity of others is one of the first points you get from legal analysis of property. “The essence of private property is always the right to exclude.” What makes capitalist property distinct is that it is a right to exclude people specifically from carrying out some productive activity, and is linked in some way to the concrete means of production employed.

As a capitalist, you are attached to the production process you have property rights over.¹ Now, you may be happy with this situation. You are a human person as well as a holder of property rights, and you may feel various kinds of personal affinity with this particular process. You may have some knowledge, or social ties, or other property claims that make this process a particularly suitable form for your wealth; or you may simply regard this as a more promising source of money income than the alternatives.

Then again, you may not be happy; you may not want to be attached to this particular process. There are risks associated with both an enterprise as a social organism, and with the kind of activity it is engaged in. (The steel mill may burn down, or be taken over by the workers; steel may be replaced by alternative materials or cheaper imports.) Ensuring that the process remains oriented both to its own particular ends and to producing an income for you requires active engagement on your part; you may be unsuited to carry this out, or just get tired of it. And even if your ownership rights generate a steady flow of income for you, the rights themselves cannot be easily converted into claims on some other part of the social product or process. (You can’t eat steel.) So you may wish to convert your claim on this particular production process into a claim on social production in general.

In the US context, this is especially likely at the point where the owner dies or retires. For Schumpeter, the ultimate ambition of business owners was “the foundation of an industrial dynasty”, “the most glamorous of .. bourgeois aims”. But in the US, at least, the glamor seems to have faded.² Heirs may not be interested in running the business, or competent to do so. There may be several of them, or none. And a curiously persistent monarchical principle generally precludes looking outside the immediate family for a successor.

At some point, in any case, the holder of ownership rights over an enterprise will no longer be in a position to exercise them. At this point, the business might shut down. Before the modern corporation, this was the normal outcome: In early-modern England, “The death of the master baker … ordinarily meant the end of the bakery.” This will often still happen in the case of small businesses, where the value of the enterprise is tightly linked to the activity of the owner themself. This is fine when the productive capacity of the economy is widely dispersed in the brains of the individuals carrying out, and in tools that can be owned by them. But once production involves large organizations with an extensive division of labor, and means of production that are too lumpy for personal ownership, some means has to be found for the organization to continue existing when the individual who has held ownership rights over it is no longer willing or able to.

The stock market exists in order to allow ownership rights over particular production process to be converted into rights to the social product in general.

This is true historically. In the great wave of mergers in the 1890s that established the publicly-owned corporation as the dominant legal form for large industrial enterprises in the US, raising funds for investment was not a factor. As Naomi Lamoreaux notes, in a passage I’ve quoted before, “access to capital is not mentioned” in contemporary accounts of the merger wave. And in the hearings by the U.S. Industrial Commission on the mergers, “None of the manufacturers mentioned access to capital markets as a reason for consolidation.” The firms involved in the first mergers were normally ones where the founder had died or retired, leaving it to heirs “who often were interested only in receiving income.” The problem the creation of the publicly-traded corporation was meant to solve was not how to turn widely dispersed claims not he social product in general into claims on means of production to be used in this particular enterprise, but just the opposite: How to turn claims on these particular means of production into claims on the social product in general.

The same goes for today. We already have institutions that allow claims on the social product to be exercised by entrepreneurs on the basis of their plans for generating profits in the future. These include banks and, in favored sectors, venture capitalist funds, but not the stock market. The stock market isn’t there for the enterprise, but those with ownership claims on it.

The purpose of a stock offering is to allow those who already hold claims against the enterprise (early investors, and perhaps also favored employees) to swap them out for general financial wealth. This is why IPO “pops” — immediate price rises from the offering price — are considered a good thing, even though, logically, they mean the company raised less money than it could have. The pop makes the stock more attractive to the investors who will be buying out the insiders’ stakes down the road. The IPO is for the owners, not for the company. Or as Matt Levine puts it, “the price of the IPO is less important than the insiders’ ability to sell stock at good prices in the future.”

As I’ve argued before, converting the surplus generated within the firm into claims on the social product in general is fundamental to the capitalist process as production itself. It’s also an integral part of capitalist common sense. As any guide for budding entrepreneurs will remind you, “It’s not enough to build a business worth a fortune. You also need a way to get your money back.”

Now, in principle this goal could be achieved in other ways. Money itself is a claim on general social product — that is one definition of it. When Antonio’s ships are safely come to road, his venture is concluded and his whole estate is available to meet his obligations. This is sufficient for merchant capital in early-modern Venice – its self-liquidating character means that no additional mechanisms are needed to turn claims on concrete commodities back into money.

Ongoing enterprises cannot be liquidated so easily. And money is liable to delink from productive economy over longer periods – what one wants is something with the safety, liquidity and non-need for management of money, but which maintains a proportionate claim on the overall surplus. Government bonds are an obvious choice here. They offer a claim on productive activity in general, or at least that part of it which is subject to taxation.

This possibility is worth pausing over. Historically, this was one of the most important ways for holders of claims against particular production processes to turn them into claims against society in general. The “rent” in rentier refers originally to the interest on a government bond. Government bonds as alternative to stock ownership also calls attention to the fundamentally political character of this transaction. For the capitalist to be able to give up their direct control over a production process in return for a proportionate share of the overall social product, someone else needs to oversee the collection of the surplus. And that someone needs to be accountable to wealth owners in general. There is an important affinity between finance and the state here.

Alternatively, partnership structures allow for the human owners to turn over while ownership as such remains tied to the particular enterprise. ³ Universal owners are another route. If Morningstar or Blackstone owns all the corporations, it’s redundant for them to do so in the form of stock. They could just own them directly. Many startups today have their liquidity moment not by issuing stock but being bought by a larger competitor. One could imagine a world where a startup that is successful enough is bought up by a universal index-slash-private equity fund, without the intermediate step of issuing stock.

Another possibility, of course, would be for the founder to give up their ownership rights and the company then just not to have owners. Wikipedia is a thing that exists; Twitter could, in principle, have a similar structure. I admit, I can’t think of many similar examples. When Keynes talked about corporations “socializing themselves”, this didn’t entail a change in legal structure; the shareholders continued to exist, but just were increasingly irrelevant. Plenty of rich people do leave some fraction of their wealth to self-governing charities of one sort or another, but this is their financial wealth, not the businesses themselves. The closest one gets, I suppose, is when someone leaves real estate to a conservation or community land trust.

Back in the real world, these other models of transition out of personal ownership are either nonexistent, or else confined to narrow niches. What we have is the stock market. Fundamentally, this is a way for owners of claims against production processes to pool them — to trade in their full ownership of a particular enterprise for a proportionate share of ownership in a broad group of enterprises. This was more transparent in the trust structures that preceded the development of publicly traded corporations, which were explicitly structured as a trade of direct ownership of a business for a share in a trust that would own all the participating businesses.⁴ But the logic of the public corporation is the same.

This is why shareholder protections are so critical. They’re often framed as protections for small retail investors. But the real problem they are addressing is mutual trust among owners. The pooling of claims works only if their holders can be reasonably confident that they’ll continue receiving their income even as they surrender control over production.

You’ll have noted that I keep using obtuse terms like “holders of property claims against the corporation” instead of the more straightforward “owners”. This is necessary when we are discussing shareholders. It is not the case, as more familiar language might imply, that shareholders “own” the corporation. One of my favorite discussions of this is an article by David Ciepley, which observes that many of the features of the corporation are impossible to create on the basis of private contracts. Limited liability, for example — there is no private contract a group of property owners can sign among themselves that will eliminate their liability to third parties for misuse of their property.

If we take a step back, it is obvious that the relationship of shareholders to the corporation is something other than ownership. Just think about the familiar phrase, separation of ownership from control — it is an oxymoron. What, after all, is ownership? The old books will tell you that it is a set of control rights — jus utendi, jus disponendi, and so on. Ownership without control is ownership without ownership.

The vacuity of shareholder “ownership” can be glossed over most of the time, but becomes salient in takeovers and governance questions in general.⁵ Dividends and other payments can be subdivided arbitrarily, but decisions are discrete and control over them is unitary. Either Elon Musk buys Twitter, or he does not. Yes, there are votes, but someone still sets the terms of the vote, and 51% is as good as 100%.⁶ This is the contradiction that shareholder protections are meant to paper over. The publicly owned corporation allows business owners to pool their claims on the income of their respective companies. But it is not possible to share control over the businesses themselves. So the board – which actually does controls them — is instructed to act “as if” the shareholders did.

All of this is visible by contrast in Elon Musk’s purchase of Twitter, which reverses the usual logic of shareholding. He is trading in a claim on the general social product (or on Tesla, but it has to be cashed in first) into a claim on the specific activity organized via Twitter. He wants Twitter itself, not the stream of income it generates. He wants to turn his share of Twitter’s (so far nonexistent) profits into control over the substantive production process it is engaged in. Twitter for him is a source of use-value, not exchange-value. In this specific transaction, he is acting not as a capitalist but as a feudal lord. (Italics for a reason. One of the many mistakes we can make on these tricky questions is to treat terms like “capitalist” as if they described the essential nature of a person or organization, something that one either is or isn’t. Whereas they are ways of organizing human activity, which one can participate in in one context but not in another.)

The tension between the social production processes over which property claims are exercised, and the specific people who exercise them and the means by which they do so, is easy to lose sight of. It’s natural to abstract from these questions when you’re focused on other questions, like the conflict between capital — whoever exactly that may be — and the human beings who more directly embody labor. In Volume 1 of Capital, the capitalist is simply the personification of capital, and there are good exposition reasons for this.⁷

It’s in Volume 3 — truly the essential reading on this topic — that Marx directly takes on the conflation of social relations with concrete things. In a blistering passage in chapter 48 he attacks the identification of the real conditions of production with the incomes that are received from them, as if for example land — the natural world — existed only insofar as it is a source of rent for the landlord. This is “the complete mystification of the capitalist mode of production, the conversion of social relations into things, … It is an enchanted, perverted, topsy-turvy world, in which Monsieur le Capital and Madame la Terre do their ghost-walking as social characters and at the same time directly as mere things.” This mystification is alive and well in modern discussions of economics, where ownership of claims against a thing are constantly confused with being the thing. The ubiquitous language of payments to capital (or factor payments) is an obvious example, in which a payoffs to whatever private rights-holder you need permission from to use a machine, are imagined as payments to the machine itself.

This is not just a matter of verbal ambiguity. It leads to completely wrong conclusions when transactions involving ownership claims on something are confused with transactions involving the use of the thing. For example, you sometimes hear housing activists say that investor purchases will drive up the cost of housing. This sounds reasonable – but only because the word “housing” is being used in two different senses. Ownership of a house, and living in a house, are not competing uses, they exist on entirely separate levels. We may object for various reasons to ownership of homes by large investors rather than owner-occupiers or small landlords (or we may not). But this shift in ownership claims has no effect on the amount of space available for people to live in.

Coming back to the stock market, the confusion comes from mixing up transactions and institutions intended to shift ownership rights over the enterprise with solutions to the financing needs of the enterprise itself. The terms of the twitter deal seem to be: The bankers will get $2 billion per year, half from Musk, half from Twitter. Current Twitter shareholders get a one-time payment of $54 per share, which they may or may not be happy with.⁸ Twitter as an enterprise — and its employees and users — get nothing from the transaction at all. The company ends up owing $13 billion in additional debt, which finances nothing.

On one level, this is just what the stock market, and finance more generally, do: They change asset and liability positions around, without necessarily implying any changes in the substantive activities that those positions give rights over and which generate the incomes that go with them. As Perry Mehrling likes to point out, the biggest single transaction for most families is the purchase of a home, which doesn’t even show up in the national income and product accounts. But on another level, again, in the specific trade here — away from liquidity and general financial claims toward a more direct relationship with a particular production process — is the opposite of what the stock market usually facilities. Musks’s purchase of Twitter is, precisely, a form of de-financialization.

On some level I suppose all this is obvious. Everyone understands that this a transaction between various groups of holders of financial claims against Twitter — Musk, the board on behalf of the existing shareholders, the banks— to which Twitter-the-enterprise is not a party at all. But coverage tends to treat this as a problem only insofar as Twitter is special, the “digital town square”. In weighing the deal, the Times sniffs, the board “might as well have been talking about a tool-and-die manufacturer.” Any conflict between relations of production and relations of ownership is, evidently, only a problem when what is being produced are 280-character messages.

At this point, I suppose, I should denounce Elon Musk’s purchase of Twitter. But honestly, I’m not convinced it will make much difference one way or another.

For me personally, Twitter has been a good outlet. It connects me with journalists, political people, potential students, and other folks I want to communicate with more effectively than any other platform. It’s a gratifyingly horizontal — anyone who has something to say is on the same level. I’d be sorry if it no longer existed in its current form. But I’m not sure any of its good qualities come from who exactly exercises a claim on whatever profits it may generate.

Do you think that any of Twitter’s positive qualities emanate from the particular individuals who’ve owned it, or “owned” it? Jack Dorsey seems like kind of a nut; if the platform works, it’s in spite of him, not because of him. The current gaggle of suits on the board don’t see to have much hands-on involvement one way or another. The people who do the actual work of maintaining the platform obviously take their jobs seriously. I have no idea who exactly they are, but I have a lot of respect for them. I expect they’ll continue doing their job, whoever is appropriating the surplus.

To say that having Elon Musk own a company is a central, transformative fact about it – for good or for ill — is to buy into the narcissistic worldview of the masters of the universe. I would rather not do that. Indeed, the idea that who owns a business and how it operates are inseparable, is more or less exactly the position I’m arguing against in this post.

The question of who owns a company is a distinct question from what it does or how it is run. Not entirely unrelated, to be sure — but to think about how they are connected, we first have to recognize that they are not the same.

Marx on the Corporation

(I wrote this post back in 2015, and for some reason never posted it. The inspiration was a column by Matt Levine, where he wondered what Marx would think of the modern corporation.)

Let’s begin at the beginning.

Capital, for Marx, is not a thing, it’s a social relation, a way of organizing human activity. Or from another point of view, it’s a process. It’s the conversion of a sum of money into a mass of commodities, which are transformed through a production process into a different mass of commodities, which are converted back into a (hopefully greater) sum of money, allowing the process to start again. Capital is a sum of money yielding a return, and it is a mass of commodities used in production, and it is a form of authority over the production process, each in turn.

When we have a single representative enterprise, managed by its owner and financed out of its own retained profits, then there’s no need to worry about where the “capitalist” is in this process. They are the owner of the money, and they are the steward of the means of production, and they are master of the production process. Whatever happens in the circuit of capital, the capitalist is the one who makes it happen.

This is the framework of Volume 1 of Capital. There the capitalist is just the personification of capital. But once credit markets allow capitalists to use loaned funds rather than their own, and even more once we have joint-stock enterprises with salaried managers in charge of the production process, these roles are no longer played by the same individuals. And it is not at all obvious what the relationships are between them, or which of them should be considered the capitalist. This is the subject of part V of Volume 3 of Capital Vol. 3, which explores the relation of ownership of money as such (“interest-bearing capital”) with ownership of capitalist enterprises.

For present purposes, the interesting part begins in chapter 23. There Marx introduces the distinction between the money-capitalist who owns money but does not manage the production process, and the industrial, functioning or productive capitalist who controls the enterprise but depends on money acquired from elsewhere. “The productive capitalist who operates on borrowed funds,” he writes, “represents capital only as functioning capital,” that is, only in the production process itself. “He is the personification of capital as long as … it is profitably invested in industry or commerce, and such operations are undertaken with it … as are prescribed by the branch of industry concerned.”

The possibility of carrying out a capitalist enterprise with borrowed funds implies a division of the surplus into two parts — one attributable to management of the enterprise, the other to ownership as such. “The specific social attribute of capital under capitalist production — that of being property commanding the labour-power of another” now appears as interest, the return simply on owning money. So “the other part of surplus-value — profit of enterprise — must necessarily appear as coming not from capital as such, but from the process of production… Therefore, the industrial capitalist, as distinct from the owner of capital [appears] … as a functionary irrespective of capital,… indeed as a wage-labourer.”

So now we have one set of individuals personifying capital at the M moment, when capital is in its most abstract form as money, and a different set of individuals personifying it in the C and P moments, when capital is crystallized in a particular productive activity. One effect of this separation is to obscure the link between profit and the labor process: The money-owners who receive profit in the form of interest (or dividends) are different from the actual managers of the production process. Not only that, the two often experience themselves as opposed. In this sense, the division between the money-capitalist and the industrial capitalist blurs the lines of social conflict.

Marx continues:

Interest as such expresses … the ownership of capital as a means of appropriating the products of the labour of others. But it represents this characteristic of capital as something which belongs to it outside the production process… Interest represents this characteristic not as directly counterposed to labour, but rather as unrelated to labour, and simply as a relationship of one capitalist to another. … In interest, therefore, in that specific form of profit in which the antithetical character of capital assumes an independent form, this is done in such a way that the antithesis is completely obliterated and abstracted. Interest is a relationship between two capitalists, not between capitalist and labourer.

We might read Marx here as warning against an easy opposition between “productive” and “financial” capital, in which we can with good conscience take the side of the former. On the contrary, these are just shares of the same surplus extracted from us in the labor process. It’s important to note in this context that Marx speaks of a “productive capitalist,” not of productive capital. The productive capitalist and the money capitalist are, so to speak, two human bodies that the same capital occupies in turn.

Once the pirates have burned your fields, seized your possessions and carried off your daughters, it shouldn’t matter to you how they divide up the booty: I think this is a valid reading of Marx’s argument here. Or as he puts it: “If the capitalist is the owner of the capital on which he operates, he pockets the whole surplus-value. It is absolutely immaterial to the labourer whether the capitalist does this, or whether he has to pay a part of it to a third person as its legal proprietor.”

But while the development of interest-bearing capital obscures the true relations of production in one sense, it clarifies them in another. It separates the claims exercised by ownership as such, from the claims due to the specific labor performed by the capitalist within the enterprise. With the owner-manager, these two are mixed together. (This is still a big problem for the national accounts.) Now, the part of apparent profit that was really payment for the labor of the capitalist appears in a distinct form as “wages of superintendence.”

Marx’s analysis here seems like a good starting point for discussions of the position of managers in modern economies.

The specific functions which the capitalist as such has to perform, … [with the development of credit] are presented as mere functions of labour. He creates surplus-value not because he works as a capitalist, but because he also works, regardless of his capacity of capitalist. This portion of surplus-value is thus no longer surplus-value, but its opposite, an equivalent for labour performed. … the process of exploitation itself appears as a simple labour-process in which the functioning capitalist merely performs a different kind of labour than the labourer.

As Marx later emphasizes, one consequence of the development of management as a distinct category of labor is that the profits still received by owners can no longer be justified as the compensation for organizing the production process. But what about the managers themselves, how should we think about them? Are they really laborers, or capitalists? Well, both — their position is ambiguous. On the one hand, they are performing a social coordination function, that any extended division of labor will require. But on the other hand, they are the representatives of the capitalist class in the coercive, adversarial labor process that is specific to capitalism.

The discussion is worth quoting at length:

The labour of supervision and management is naturally required wherever the direct process of production assumes the form of a combined social process, and not of the isolated labour of independent producers. However, it has a double nature. On the one hand, all labour in which many individuals co-operate necessarily requires a commanding will to co-ordinate and unify the process … much like that of an orchestra conductor. This is a productive job, which must be performed in every combined mode of production.

On the other hand … supervision work necessarily arises in all modes of production based on the antithesis between the labourer, as the direct producer, and the owner of the means of production. The greater this antagonism, the greater the role played by supervision. Hence it reaches its peak in the slave system. But it is indispensable also in the capitalist mode of production, since the production process in it is simultaneously a process by which the capitalist consumes labour-power. Just as in despotic states, supervision and all-round interference by the government involves both the performance of common activities arising from the nature of all communities, and the specific functions arising from the antithesis between the government and the mass of the people.

In one of those acid asides that makes him so bracing to read, Marx quotes an American defender of slavery explaining that since slaves were unwilling to do plantation labor on their own, it was only right to compensate the masters for the effort required to compel them to work. In this sense it doesn’t matter that the Bosses are performing productive labor. Their claims are just a version of the German nihilists’: It’s only fair that you give me what I want, since I’ve gone to such effort to take it from you. Or Dinesh D’Souza’s argument that equality of opportunity would be unfair to him, since he’s gone to great effort to give his kids an advantage over others.

But again, the industrial capitalist is not only a slave-driver. They do have an essential coordinating function, even if it is performed by the same people, and in the same activities, as the coercive labor-discipline that extracts greater effort from workers and deprives them of their autonomy. The ways these two sides of the labor process develop together is one of the major contributions of Marxist and Marx-influenced work, I think — Braverman, Noble, Marglin, Barbara Garson. It seems to me that, paradoxical as it might sound, it’s this positive role of managers that is ultimately the stronger argument against capitalism. Because the development of professional management fatally undermines the supposed connection between the economic function performed by capitalists, and the economic form of property ownership.

Marx makes just this argument:

The capitalist mode of production has brought matters to a point where the work of supervision, entirely divorced from the ownership of capital, is always readily obtainable. It has, therefore, come to be useless for the capitalist to perform it himself. An orchestra conductor need not own the instruments of his orchestra, nor is it within the scope of his duties as conductor to have anything to do with the “wages” of the other musicians. Co-operative factories furnish proof that the capitalist has become no less redundant as a functionary in production… Inasmuch as the capitalist’s work does not … confine itself solely to the function of exploiting the labour of others; inasmuch as it therefore originates from the social form of the labour-process, from combination and co-operation of many in pursuance of a common result, it is … independent of capital.

The connection Marx makes between joint-stock companies (what we would today call corporations) and cooperative enterprises is to me one of the most interesting parts of this whole section. In both, the critical thing is that the work of management, or coordintion, is just one kind of labor among others, and has no neceessary connection to ownership claims.

The wages of management both for the commercial and industrial manager are completely isolated from the profits of enterprise in the co-operative factories of labourers, as well as in capitalist stock companies. … Stock companies in general — developed with the credit system — have an increasing tendency to separate this work of management as a function from the ownership of capital… just as the development of bourgeois society witnessed a separation of the functions of judges and administrators from land-ownership, whose attributes they were in feudal times. Since, on the one hand, … money-capital itself assumes a social character with the advance of credit, being concentrated in banks and loaned out by them instead of its original owners, and since, on the other hand, the mere manager who has no title whatever to the capital, … performs all the real functions pertaining to the functioning capitalist as such, only the functionary remains and the capitalist disappears as superfluous from the production process.

This, to me, is one of the central ways in which we can see capitalism as a necessary step on the way to socialism. Only under capitalism has large scale industry developed; only the acid of the market was able to break the bonds of small family productive units and free their constituent pieces for recombination on a much larger scale. So the only form in which the organization of large-scale enterprises is familiar to us is as capitalist enterprises. (At least, this is Marx’s argument. Arguably he understates the ability of states to organize production on a large scale.) But just because large industrial enterprises and capitalism have gone together historically, it doesn’t follow that that capitalism is the only institutional setting in which they can exist, or that the conditions required for their development are required for their continued existence.

In fact, as capitalist enterprises develop, their internal organization becomes progressively less market-like. Markets exist only at the surfaces, the external membranes, of enterprises, which internally are organized on quite different principles; and as the scale of enterprises grows, less and less economic life takes place on those surfaces. So while capital continues, nominally, to be privately owned, relations of ownership play less and less of a role in the concrete organization of production. The “mere manager” as Marx says, “has no title whatever to the capital”; nonetheless, he or she “performs all the real functions” of the capitalist.

When Marx was writing this in the 1870s, he thought the trend towards the separation of ownership from control was clearly established, even if most capitalist enterprises at the time were still directly managed by their owners.

With the development of co-operation on the part of the labourers, and of stock enterprises on the part of the bourgeoisie, even the last pretext for the confusion of profit of enterprise and wages of management was removed, and profit appeared also in practice as it undeniably appeared in theory, as mere surplus-value, a value for which no equivalent was paid.

That’s as far as the argument gets in chapter 23.

The next few chapters are focused on the other side of the question, interest-bearing capital — that is,capital that appears to its owners simply as money, without being embodied in any production process. Chapter 24 is an attack on writers who reduce both to money capital, and imagine that the accumulation of capital is just an example of the power of compound interest. (Among other things, this chapter anticipates the essential points of left critiques of Piketty by people like Galbraith and Varoufakis, and by me.) Chapter 26 attacks the opposite conflation — the treatment of money as just capital in general, and of interest as simply a reflection of the physical productivity of capital rather than a specifically monetary phenomenon. This is today’s orthodoxy, represented for Marx by Lord Overstone. Chapter 25 anticipates Minsky on the elasticity of finance, and takes the side of the credit-money theorists like Thornton and banking-school writers like Tooke and Fullarton, against quantity theorists and the currency school. Marx’s debt to Ricardo is well known, but it’s less recognized how much he learned from this group of writers — the best discussion I know is by Arie Arnon. When Tooke died, Marx wrote to Engels that he had been “the last English economist of any value.”

Marx returns to the industrial or functioning capitalist in chapter 27, which is focused on joint-stock companies. Marx credits stock companies with “an enormous expansion of the scale of production and of enterprises, that was impossible for individual capitals.” And critically these new enterprises are public in both name and substance (the “public” in “publicly-traded corporations” is significant.)

The development of joint stock companies continues the sociological transformation that begins with the development of interest-bearing capital and the ability to operate on borrowed funds — that is, the

transformation of the actually functioning capitalist into a mere manager, administrator of other people’s capital, and of the owner of capital into a mere owner, a mere money-capitalist. Even if the dividends which they receive include the interest and the profit of enterprise, … this total profit is henceforth received only in the form of interest, i.e., as mere compensation for owning capital that now is entirely divorced from the function in the actual process of reproduction, just as this function in the person of the manager is divorced from ownership of capital. … This result of the ultimate development of capitalist production is a necessary transitional phase towards the reconversion of capital into the property of producers, although no longer as the private property of the individual producers, but rather … as outright social property. … the stock company is a transition toward the conversion of all functions in the reproduction process which still remain linked with capitalist property, into mere functions of associated producers.

In short, the joint stock company “is the abolition of the capitalist mode of production within the capitalist mode of production itself.”

Acquisitions as Corporate Money Hose

Among the small group of heterodox economics people interested in corporate finance, it is common knowledge that the stock market is a tool for moving money out of the corporate sector, not into it. Textbooks may talk about stock markets as a tool for raising funds for investment, but this kind of financing is dwarfed by the payments each year from the corporations to shareholders.

The classic statement, as is often the case, is in Doug Henwood’s Wall Street:

Instead of promoting investment, the U.S. financial system seems to do quite the opposite… Take, for example, the stock market, which is probably the centerpiece of the whole enterprise. What does it do? Both civilians and professional apologists would probably answer by saying that it raises capital for investment. In fact it doesn’t. Between 1981 and 1997, U.S. nonfinancial corporations retired $813 billion more in stock than they issued, thanks to takeovers and buybacks. Of course, some individual firms did issue stock to raise money, but surprisingly little of that went to investment either. A Wall Street Journal article on 1996’s dizzying pace of stock issuance (McGeehan 1996) named overseas privatizations (some of which, like Deutsche Telekom, spilled into U.S. markets) “and the continuing restructuring of U.S. corporations” as the driving forces behind the torrent of new paper. In other words, even the new-issues market has more to do with the arrangement and rearrangement of ownership patterns than it does with raising fresh capital.

The pattern of negative net share issues has if anything only gotten stronger in the 20 years since then, with net equity issued by US corporations averaging around negative 2 percent of GDP. That’s the lower line in the figure below:

Note that in the passage I quote, Doug correctly writes “takeovers and buybacks.” But a lot of other people writing in this area — definitely including me — have focused on just the buyback part. We’ve focused on a story in which corporate managers choose — are compelled or pressured or incentivized — to deliver more of the firm’s surplus funds to shareholders, rather than retaining them for real investment. And these payouts have increasingly taken the form of share repurchases rather than dividends.

In telling this story, we’ve often used the negative net issue of equity as a measure of buybacks. At the level of the individual corporation, this is perfectly reasonable: A firm’s net issue of stocks is simply its new issues less repurchases. So the net issue is a measure of the total funds raised from shareholders — or if it is negative, as it generally is, of the payments made to them.

It’s natural to extend this to the aggregate level, and assume that the net change in equities outstanding similarly reflects the balance between new issues and repurchases. William Lazonick, for instance, states as a simple matter of fact that “buybacks are largely responsible for negative net equity issues.” ¹ But are they really?

If we are looking at a given corporation over time, the only way the shares outstanding can decline is via repurchases.² But at the aggregate level, lots of other things can be responsible — bankruptcies, other changes in legal organization, acquisitions. Quantitatively the last of these is especially important. Of course when acquisitions are paid in stock, the total volume of shares doesn’t change. But when they are paid in cash, it does. ³ In the aggregate, when publicly trade company A pays $1 billion to acquire publicly traded company B, that is just a payment from the corproate sector to the household sector of $1 billion, just as if the corporation were buying back its own stock. But if we want to situate the payment in any kind of behavioral or institutional or historical story, the two cases may be quite different.

Until recently, there was no way to tell how much of the aggregate share retirements were due to repurchases and how much were due to acquisitions or other causes.⁴ The financial accounts reported only a single number, net equity issues. (So even the figure above couldn’t be produced with aggregate data, only the lower line in it.) Under these circumstances the assumption that that buybacks were the main factor was reasonable, or at least as reasonable as any other.

Recently, though, the Fed has begun reporting more detailed equity-finance flows, which break out the net issue figure into gross issues, repurchases, and retirements by acquisition. And it turns out that while buybacks are substantial, acquisitions are actually a bigger factor in negative net stock issues. Over the past 20 years, gross equity issues have averaged 1.9 percent of GDP, repurchases have averaged 1.7 percent of GDP, and retirements via acquisitions just over 2 percent of GDP. So if we look only at corporations’ transactions in their own stock, it seems that that the stock market still is — barely — a net source of funds. For the corproate sector as a whole, of course, it is still the case that the stock market is, in Jeff Spross’ memorable phrase, a giant money hose to nowhere.

The figure below shows dividends, gross equity issues, repurchases and M&A retirements, all as a percent of GDP.

What do we see here? First, the volume of shares retired through acquisitions is consistently, and often substantially, greater than the volume retired through repurchases. If you look just at the aggregate net equity issue you would think that share repurchases were now comparable to dividends as a means of distributing profits to shareholders; but it’s clear here that that’s not the case. Share repurchases plus acquisitions are about equal to dividends, but repurchases by themselves are half the size of dividends — that is, they account for only around a third of shareholder payouts.

One particular period the new data changes the picture is the tech boom period around 2000. Net equity issues were significantly negative in that period, on the order of 1 percent of GDP. But as we can now see, that was entirely due to an increased volume of acquisitions. Repurchases were flat and, by the standard of more recent periods, relatively low. So the apparent paradox that even during an investment boom businesses were paying out far more to shareholders than they were taking in, is not quite such a puzzle. If you were writing a macroeconomic history of the 1990s-2000s, this would be something to know.

It’s important data. I think it clarifies a lot and I hope people will make more use of it in the future.

We do have to be careful here. Some fraction of the M&A retirements are stock transactions, where the acquiring company issues new stock as a kind of currency to pay for the stock of the company it is acquiring.⁵ In these cases, it’s misleading to treat the stock issuance and the stock retirement as two separate transactions — as independent sources and uses of funds. It would be better to net those transactions out earlier before reporting the gross figures here. Unfortunately, the Fed doesn’t give a historical series of cash vs. stock acquisition spending. But in recent years, at least, it seems that no more than a quarter or so of acquisitions are paid in stock, so the figure above is at least qualitatively correct. Removing the stock acquisitions — where there is arguably no meaningful issue or retirement of stock, jsut a swap of one company’s for another’s — would move the M&A Retirements and Gross Equity Issues lines down somewhat. But the basic picture would remain the same.

It’s also the case that a large fraction of equity issues are the result of exercise of employee stock options. I suspect — tho again I haven’t seen definite data — that stock options accout for a large fraction, maybe a majority, of stock issues in recent decades. But this doesn’t change the picture as far as sectoral flows goes — it just means that what is being financed is labor costs rather than investment.

The bottom line here is, I don’t think we heterodox corporate finance people have thought enough about acquisitions. A major part of payments from corporations to shareholders are not distribution of profits in the usual sense, but payments by managers for control rights over a production process that some other shareholders have claims on. I don’t think our current models handle this well — we either think implicitly of a single unitary corporate sector, or we follow the mainstream in imagining production as a bouillabaisse in where you just throw in a certain amount of labor and a certain amount of capital, so it doesn’t matter who is in charge.

Of course we know that the exit, the liquidity moment, for many tech startups today is not an IPO — let alone reaching profitability under the management of early investors — but acquisition by an established company. But this familiar fact hasn’t really made it into macro analysis.

I think we need to take more seriously the role of Wall Street in rearranging ownership claims. Both because who is in charge of particular production processes is important. And because we can’t understand the money flows between corporations and households without it.

OECD: Activist Shareholders Are Bad for Investment

The OECD has just released its new Business and Finance Outlook for 2015. A lot of interesting stuff there. We’ll want to take a closer look at the discussion of the problems that low interest rates pose for pension funds and insurance companies — I’ve thought for a while that this is the most convincing form of the “reaching for yield” argument. But what I want to talk about now is the OECD’s apparent endorsement of the “disgorge the cash” thesis.

Chapter 2, “Corporate Investment and the Stagnation Puzzle,” has a very interesting discussion of shareholder activism and its effects on investment. The starting point is the puzzle that while participants in financial markets are willing to accept unprecedentedly low returns, the minimum returns on new investment projects remain high, as evidenced by depressed real investment despite sustained low interest rates. I think this apparent puzzle is, precisely, a rediscovery of Keynes’ liquidity premium. (Perhaps I will return to this in a subsequent post.) There are a number of ways to think about this, but one dimension is the pressure corporate managers face to avoid investment projects unless the returns are rapid, large, and certain.

Stock markets currently reward companies that favour dividends and buybacks and punish those that undertake more investment … which creates higher hurdle rates for investment.

Here in one sentence is the disgorge the cash argument.

Private sector companies in market-based economies allocate capital spending according to shareholder value. Earnings may be retained for capital spending and growth, but only if the return on equity exceeds the cost of equity. If this is not the case then … they will choose to use their operating cash flow in other ways (by issuing dividends, carrying out cash buybacks…) … and in the limit may close plants and shed labor.

The bolded sentence is puzzling. Is it description or prescription? (Or description of a prescription?) The rest of the section makes no sense if you think either that this is how corporate investment decisions are made, or if you think it’s how they should be made. Among other reasons, once we have different, competing discount rates, the “return on equity” no longer has a well-defined value, even in principle. Throughout, there’s a tension between the language of economic theory and the language of concrete phenomena. Fortunately the latter mostly wins out.

The last decade has seen the rising importance of activist investors who gain the support of other investors and proxy advisors to remove management, to gain influential board seats and/or to make sure that company strategy is in the best interest of shareholders… The question arises as to whether the role of such investors is working to cause short-termism strategies [sic] at the expense of long-term investment, by effectively raising the hurdle rate… Activists… favour the short-term gratification of dividends and share buybacks versus longer-term investment. Incumbent managers will certainly prefer giving in to shareholders desire for more ‘yield’ in a low-interest world to taking on the risk of uncertain long-term investment that might cause them to be punished in the share market. …

To test this idea, an index of CAPEX/(CAPEX + Dividends & Buybacks) was created for each company, and the following investment strategy was measured: sell the highest quartile of the index (capital heavy firms) and buy the lowest quartile of the index (Dividend and Buyback heavy firms). … Selling high capital spending companies and buying low CAPEX and high buyback companies would have added 50% to portfolio values in the USA, 47% in Europe, 21% in emerging economies and even 12% in Japan (where activists play little role). On balance there is a clear investor preference against capital spending companies and in favor of short-termism. This adds to the hurdle rate faced by managers in attempting to undertake large capital spending programmes — stock market investors will likely punish them. … it would be fairly logical from a management point of view to return this cash to shareholders rather than undertake uncertain long-term investment projects… The risks instead would be born more by host-country investment in capacity and infrastructure.

This is a useful exercise. The idea is to look at the ratio of investment to shareholder payouts, and ask how the stock price of the high-investment firms performed compared to the high-payout firms, over the six years 2009 through 2014. What they find is that the shares of the high-payout firms performed considerably better. This is important because it undermines the version of the disgorge argument you get from people like Bill Lazonick, in which buybacks deliver a short-term boost the share price that benefits CEOs looking to cash in on their options, but does nothing for longer-term investors. In Lazonick’s version of the story, managers are on one side, shareholders, workers and the rest of society on the other. But if high-payout firms perform better for shareholders over a six-year horizon (which in financial-market terms is almost geologically long term) then we have to slice things differently. On one side are shareholders and CEOs, on the other are us regular people.

The other thing that is notable here is the aggregating of dividends and buybacks in a single “shareholder payout” term. This is what I do, I think it’s unambiguously the right thing to do, but in some quarters for some reason it’s controversial. So I’m always glad to find another authority to say, a buyback is a dividend, a dividend is a buyback, the end.

Another way to see these two points is to think about so-called dividend recapitalizations. These are when a private equity firm, having taken control of a business, has it issue new debt in order to fund a special dividend payment to themselves. (It’s the private equity firm that’s being recapitalized here, not the hapless target firm.) The idea of private equity is that the acquired firm will be resold at a premium because of the productive efficiencies brought about by new management. The more or less acknowledged point of a dividend recap is to allow the private equity partners to get their money back even when they have failed to deliver the improvements, and the firm cannot be sold at a price that would allow them to recoup their investment. Dividend recaps are a small though not trivial part of the flow of payments from productive enterprises to money-owners, in recent years totaling between 5 and 10 percent of total dividends. For present purposes, there are two especially noteworthy things about them. First, they are pure value extraction, but they take the form of a dividend rather than a share repurchase. This suggests that if the SEC were to crack down on buybacks, as people Lazonick suggest, it would be easy for special dividends to take their place. Second, they take place at closely held firms, where the managers have been personally chosen by the new owners. It’s the partners at Cerberus or Apollo who want the dividends, not their hired guns in the CEO suites. It’s an interesting question why the partners want to squeeze these immediate cash payments out of their prey when, you would think, they would just reduce the sale price of the carcass dollar for dollar. But the important point is that here we have a case where there’s no entrenched management, no coordination problems among shareholders — and Lazonick’s “downsize-and-distribute” approach to corporate finance is more pronounced than ever.

Back to the OECD report. The chapter has some useful descriptive material, comparing shareholder payouts in different countries.

[In the United States,] dividends and buybacks are running at a truly remarkable pace, even greater than capital expenditure itself in recent years. There has been plenty of scope to increase capital spending, but instead firms appear to be adjusting to the demands of investors for greater yield (dividends and buybacks). … [In Europe] dividends and buybacks are only half what United States companies pay … While there is no marked tendency for this component to rise in the aggregate in Europe, companies in the United Kingdom and Switzerland … do indeed look very similar to the United States, with very strong growth in buybacks. … [In Japan] dividends and buybacks are minuscule compared with companies in other countries. …

Here, for the US, are shareholder payouts (gray), investment (dark blue), and new borrowing (light blue, with negative values indicating an increase in debt; ignore the dotted “net borrowing” line), all given as a percent of total sales. We are interested in the lower panel.

OECD_fig — from OECD, Business and Finance Outlook 2015

As you can see, investment is quite stable as a fraction of sales. Shareholder payouts, by contrast, dropped sharply over 2007-2009, and have since recovered even more strongly. Since 2009, US corporations have increased their borrowing (“other financing”) by about 4 percent of sales; shareholder payouts have increased by an almost exactly equal amount. This is consistent with my argument that in the shareholder-dominated corporation, real activity is largely buffered from changes in financial conditions. Shifts in the availability of credit simply result in larger or smaller payments to shareholders. The OECD report takes a similar view, that access to credit is not an important factor in variation in corporate investment spending.

The bottom line, though the OECD report doesn’t quite put it this way, is that wealth-owners strongly prefer claims on future income that take money-like forms over claims on future incomes exercised through concrete productive activity. [1] This is, again, simply Keynes’ liquidity premium, which the OECD authors knowing or unknowingly (but without crediting him) summarize well:

It was noted earlier that capital expenditures appear to have a higher hurdle rate than for financial investors. There are two fundamental reasons for this. First, real investors have a longer time frame compared to financial investors who believe (perhaps wrongly at times) that their positions can be quickly unwound.

From a social standpoint, therefore, it matters how much authority is exercised by wealth-owners, who embody the “M” moment of capital, and how much is exercised by the managers or productive capitalists (the OECD’s “real investors”) who embody its “P” moment. [2] Insofar as the former dominate, fixed investment will be discouraged, especially when its returns are further off or less certain.

Second, managers … operate in a very uncertain world and the empirical evidence … suggests that equity investors punish companies that invest too much and reward those that return cash to investors. If managers make an error of judgement they will be punished by activist investors and/or stock market reactions … hence they prefer buybacks.

Finally, it’s interesting what the OECD says about claims that high payouts are simply a way for financial markets to reallocate investment spending in more productive directions.

It is arguable that if managers do not have profitable projects, it makes sense to give the money back to investors so that they can reallocate it to those with better ideas. However, the evidence … suggests that the buyback phenomenon is not associated with rising productivity and better returns on equity.

Of course this isn’t surprising. It’s consistent with the academic literature on shareholder activism, and on the earlier takeover wave, which finds success at increasing payments to shareholders but not at increasing earnings or productive efficiency. For example, this recent study concludes:

We did not see evidence that targets’ financials improved… The targets’ leverage and payout, however, did seem to increase, suggesting that the activists are unlocking value by prompting management to return additional cash to shareholders.

Still, it’s noteworthy to see a bastion of orthodoxy like the OECD flatly stating that shareholder activism is pure extraction and does nothing for productivity.

UPDATE: Here’s James Mackintosh discussing this same material on “The Short View”:

[1] It’s worth mentioning here this interesting recent Australian survey of corporate executives, which found that new investment projects are judged by a minimum expected return or hurdle rate that is quite high — usually in excess of 10 percent — and not unresponsive to changes in interest rates. Even more interesting for our purposes, many firms report that they evaluate projects not based on a rate of return but on a payback period, often as short as three years.

[2] The language of “M and “P” moments is of course taken from Marx’s vision of capital as a process of transformation, from money to commodities to authority over a production process, back to commodities and finally back to money. In Capital Vol. 1 and much of his other writing, Marx speaks of the capitalist as straightforwardly the embodiment of capital, a reasonable simplification given his focus there and the fact that in the 1860s absentee ownership was a rare exception. There is a much more complex discussion of the ways in which the different moments of capital can take the form of distinct and possibly conflicting social actors in Capital Vol. 3, Part 5, especially chapter 27.

Selfish Masters, Selfless Servants

Via Mike the Mad Biologist, a Confucian parable for the financial crisis:

Mencius replied, “Why must your Majesty use that word ‘profit?’ What I am provided with, are counsels to benevolence and righteousness, and these are my only topics.
“If your Majesty say, ‘What is to be done to profit my kingdom?’ the great officers will say, ‘What is to be done to profit our families?’ and the inferior officers and the common people will say, ‘What is to be done to profit our persons?’ Superiors and inferiors will try to snatch this profit the one from the other, and the kingdom will be endangered….

Indeed, there are deep contradictions hidden in that word “profit.” Reminds me of a classic article on corporate governance, Bruce Greenwood’s Enronitis: Why Good Corporations Go Bad.

The Enron problem is … the predictable result of too strong of a share-centered view of the public corporation… Corporate law demands that managers simultaneously be selfless servants and selfish masters. On the one hand, it directs managers to be faithful agents, setting aside their own interests entirely in order to act only on behalf of their principals, the shares. On the other hand, in the service of this extreme altruism, they must ruthlessly exploit everyone around them, projecting on to the shares an extreme selfishness that takes no account of any interests but the shares themselves. Having maximally exploited their fellow human corporate participants, managers are then expected to selflessly hand over their gains…

Altruism and rationally self-interested exploitation are extreme and radically opposed positions, psychologically and politically. … For managers, one easy resolution of these tensions is a simple, cynical selfishness in which managers see themselves as entitled, and perhaps even required, to exploit shareholders as ruthlessly as they understand the law to require them to exploit everyone else. …

Internally, the share-centered paradigm is just as self-destructive. Corporations succeed because they are not markets and do not follow market norms of behavior. Rather, they operate under fiduciary norms as a matter of law and team norms as a matter of sociology. However, the share-centered paradigm of corporate law teaches managers to treat employees as outsiders and tools to corporate ends with no intrinsic value. Just as managers are unlikely to learn simultaneously to be selfish maximizers and selfless altruists, they are unlikely to be simultaneously cooperative team players and self-interested defectors. Thus, the share-centered view undermines the prerequisite to operating the firm in the interests of shareholders. …

Managers constructing the firm as a tool to the end of share value maximization treat the people with whom they work as means, not ends. …they learn as part of their ordinary life to break ordinary social solidarity. Learning to exploit ruthlessly is surprisingly difficult. … But cynicism can be learned, and managers subjected to the powerful incentives of the share value maximization principle do eventually learn it. … This training, however, surely creates cynics, not faithful agents. … A manager whose lived experience is a pretense of selflessness (with respect to employees, customers and business partners) covering real disinterested exploitation (on behalf of shares) is unlikely to suddenly see himself as “in a position in which thought of self was to be renounced, however hard the abnegation” and voluntarily hand over these hard-won gains of competitive practice to his principal. If you can properly lie to your subordinates, why not lie to your superior as well? … In the end, the cynicism of the share value maximization view must eat itself alive.

Something like Enronitis was clearly involved in the financial crisis. Indeed, some of the most famous controversies around the crisis hinge precisely on disputes about whether a transaction was between the parties linked by a fiduciary duty, or was an arm’s-length one where predatory behavior was expected, and even a moral duty. You can get yourself out of legal trouble, as Goldman has in the case of the Paulson trade, by establishing that you were on the war-of-all-against-all side of the line; but obviously, a system where predatory and trust-based relationships are expected to exist side by side, or even to overlap, is not likely to be a sustainable one. (Of course if the goal of our rentier elite is simply to stripmine the postwar social compromise, then sustainability is moot.) Friedman’s idea that a corporation’s duty is “to make as much money as possible while conforming to the basic rules of the society” isn’t coherent psychologically or logically, since it demands that management regard certain norms as absolutely binding and others as absolutely non-binding, without any reliable way of saying which is which.

Greenwood is talking about the “corporation as polis.” But the same point applies to the polis as polis.

It may not be the benevolence that makes the butcher, baker or brewer hand over the beef, bread or beer. But it is benevolence– or at least something other than self-interest — that ensures that it’s not full of E. coli. And if you say, well, it’s just their self-interest in avoiding the penalties of the law, that begs the question of why the authorities enforce the law. Or as Hume famously observed,

as FORCE is always on the side of the governed, the governors have nothing to support them but opinion. It is therefore, on opinion only that government is founded; and this maxim extends to the most despotic and most military governments, as well as to the most free and most popular. The soldan of EGYPT, or the emperor of ROME, might drive his harmless subjects, like brute beasts, against their sentiments and inclination: But he must, at least, have led his mamalukes, or prætorian bands, like men, by their opinion.

Boris Groys develops a similar line of thought in The Communist Postscript:

The theory of Marxism-Lenisnism is ambivalent in its understanding of language, as it is in most matters. On the one hand, everyone who knows this theory has learnt that the dominant language is always the language of the dominant classes. On the other hand, they have learnt too that an idea that has gripped the masses becomes a material force, and that on this basis Marxism itself is (or will be) victorious because it is correct.

This is a particular instance of Groys’ broader argument about the inherent power of rational speech:

The listener or reader of an evident statement can of course willfully decide to contradict the compelling effect of this statement… But someone who adopts such a counter-evident position does not really believe it himself. Those who do not accept what is logically evident become internally divided, and this division weakens them in comparison to those who accept and affirm the evidence. The acceptance of logical evidence makes one stronger; to reject it, conversely, makes one weaker.

Similarly, the decisionmaker who acts on norms consistently is stronger, in the long run, than the Enronitic manager whose honest service to “shareholder value” requires dishonest, strictly instrumental treatment of workers, customers, regulators, and the rest of humanity.

All of which is another way of saying that, despite the fantasies of libertarians, and cynics, that it’s self-interest all the way down, we can’t dispense with intrinsic motivation, analytically or in practice.

UPDATE: Added Groys quote. Had intended to include it in the original post, but I’d lent the book to someone…