It is unclear exactly how the court will rule, but there are indications that the d. C. Circuit is skeptical of the ftc s authority. A look at a Major Telecommunications issues of 2013 and the reporters to cover them. At 8 eastern on cspan2. Cornell University Law prof. Lynn stout has written a book about shareholder value. A recent lecture in arkansas, a professor said a focus on shareholder value has prevented corporations from making a full contribution to solving the problems of the world. This is about 45 minutes. [applause] good evening, everyone, and welcome. Professor lynn stout is a distinguished professor at the cornell University Law school. Her work focuses on the intersection of law, business, and morality. She has worked with Many Organizations around the world, including the clinton global initiative. In 2012, she was named top on the economy. Her new book is the shareholder values myth. Please welcome professor lynn stout. [applause] thank you, charles, for that kind introduction. I want to start by saying what an honor it is for me to speak in front of this audience in particular, especially the students in the clinton school. I, myself, have a masters from the Princeton School of public policy, and i have always found it amazing that i have been able to carve a career for myself, as you are doing, not thinking about how the world could be made a better place. For those of you at the clinton school, i think there is no more rewarding thing that you can do. So my appreciation for you, and thank you for inviting me. I have read enough history to know that we have come a long way and i really glad i am leaving today and not in the 16th century. But we have our problems, and these include environmental degradation, we dont have enough clean water, we dont have an of clean energy to support a growing population. We have not develop the technologies to solve those problems. Here at home we have a very high unemployment rate. And of course, we have a generation of aging baby boomers, like myself, who are wondering how we are going to support ourselves and our retirement. These are all big problems. My thesis is that we will get much further toward solving them if we can engage the power of the private sector to contribute to peace and prosperity. I tell people, i love corporations. I study them the way jane goodall studies chimpanzees. And i appreciate their potential to help solve those problems, to provide jobs to people who need to make a living, and provide decent investment returns. To come up with the technologies that can help us have a more Sustainable Future where we are in harmony with the environment and the planet. A lot of corporations are doing those things, but not as well as corporations could. Corporations could contribute still more toward Human Welfare and avoid doing damage in some areas where they do, if only we can correct what i have come to view as a very mistaken and ultimately counterproductive idea that has captured the Business World. This is the idea that corporations are run well, when they are run to maximize shareholder value, specifically measured by share price. Many people in the room may have the reaction, but isnt that something that has been accepted forever . Dont we all know that the purpose of the corporation is to maximize profits for shareholders . I would say no, actually, that is not an idea that has been around forever. That is a pretty new idea. If you were to get in a time machine and go back and study the first eight decades of the 20th century, and it is at the beginning of the 20th century were refer start to see the great publiC Corporations that we think of today when we think of corporations. For most of the 20thcentury, they were run according to a philosophy called managerialism. They were paid very modestly by todays standards. They viewed themselves as trustees for great and institutions that should be run for the benefit of many different groups, including customers, their employees, their communities, the nation, and last but not least, their shareholders. And what is most interesting to me is that during the decades of managerialism, shareholders got higher returns from earning public stock in companies than they are getting today. I want to start off immediately by saying sometimes when i talk about operation serving nine shareholder groups, people immediately assume that i am a communist. Nothing is further from the truth. I am 100 on the side of the shareholder. What is upsetting to me is that i look at what our publiC Corporations have done for the past 15 years, and they are not doing well for shareholders, along with much of anybody else. So what happened to the managerialist philosophy . First, we had the great bear market of 19731974, when the dow jones lost almost half its value in two years. I think the quadrupling of oil prices during the oil embargo might have had something to do with that. Just imagine what would it would do to stop prices today if oil went from 100 a barrel to 400 a barrel. The group that began criticizing were people like me, academics. What we see in the 1970s is the rise of a new idea about what corporations are about. In some ways, i trace this to an article that Milton Friedman published in 1970 in the new york times. He argues that shareholders own corporations. The idea comes out of academia. This idea comes out of academia, and because of the poor stockmarket performance in 1973 and 1974, it becomes appealing to a number of Interest Groups. I will talk about those in a moment. First i want to talk about why, oddly enough, this idea which came out of academia is just wrong. It is just empirically incorrect. If you look at the foundation it is built on, it crumbles when you look at it closely. As the Supreme Court has recently reminded us, corporations are illegal persons. They on themselves. What shareholders own is a contract called a share of stock. But bond holders also have a contract with the corporation, and employees have a contract with the corporation. Theres no reason to treat shareholders as different from any of these other contrasting parties on the basis of some ideal of ownership. Another idea that is often thrown around, not only by economists but legal experts, if shareholders are what we call the principles and directors or their agents. In law, principals control their agents. The directors are protected by something called business judgment rule, that says as long as they are not taking the corporation does the money for themselves, they can make any decision they think is in the best interest of that legal entity, the corporation. The third idea, and i apologize to those who do not find economics at least fascinating at this point. There is a notion that academic economists everybody else just gets what their contract entitles them to, and shareholders get everything that is left over. So if you can maximize shareholders interest, that will maximize the value of the corporation. That turns out to be non likely correct. It is correct when the corporation is bankrupt, but not in a living corporation. The profits belong not to the shareholders but to the corporate entity, and the board of directors decides whether any of those profits will be paid out to employees in the form of higher wages or maybe a dental plan, to executive that want to fly firstclass instead of coach. Maybe some of it goes back into the firm in research and development investment. Finally, there is the fourth mistaken idea floating around their that the law somehow requires directors and executives to maximize profits to shareholders. If directors do not do this, they can be sued. The business judgment rule makes clear that as long as directors and executives are not taking the money for themselves, they have complete discretion over how to spend the Corporation Goes the profits. They want to put more money into r and d are take better care of their employees, or maybe not spend money on lobbying to reduce their tax bill, those decisions are legally protected. So we have this idea that came out of academia, especially from finance economist, that turns out to be built on several mistaken assumptions about the law and the nature of the corporate entity. By the way, who is a lawyer here in the room . I think we need to reclaim our expertise. Who is an economist . We need to look the economist in the eye and say, you know what, guys, sitdown. The people who really understand them are lawyers, not economists. This idea became embraced partly because it appealed to some very high individuals first of all was academics themselves. If you are teaching a class in Corporate Law in a Business School or a law school, or discussing corporations in an economics class, it is much easier to say these are things that are on by shareholders, than to describe what are very complex Political Institutions that are legal entities in their own right. A concept that many have a hard time grasping. It also suggests that if you are an academic who likes to run empirical test, you have a perfect proxy for sheer performance in the form of share price. You can measure whether governance is good or bad by simply looking at whether the stock prices went up or down. But academics are not that powerful and Interest Group, right . To others weighed in. One was the socalled corporate raiders of the 1980s who eventually became the head funds of the 1990s. They loved shareholder value ideology. It allows them to go take stakes in companies, harassed the boards into doing things that would raise the share price in the short term, although probably hurt the companies longterm profitability and even survival ability, then sell their shares and get out with a tidy profit. That found it incredibly personally profitable. The other group, very sadly, was many executives. Executives became an Interest Group that adopted shareholder value ideology. The date of demarcation was sometime in 1993. What happened when congress amended the tax code to require executive compensation to be tied to some objective performance metric in order for to be a taxdeductible business expense. Share price was the magic that was picked. We went from a world in which executives typically receive less than a Million Dollars to world in which 80 of their compensation was based on share price performance, and they started making hundreds of millions of dollars. I view 1993 as the watershed point. Shareholder value ideology gets embraced by the Business World that sell. What have the results been . Focusing on nine shareholder groups, i think it is pretty evident that our American Public corporations are not doing as good a job for employees as they once did. There are not providing secure jobs. They are outsourcing, cutting back on salaries whenever they can. There is some evidence that our corporations are not as innovative as they used to be. There are cases like ibm, kodak, xerox, procter and gamble, all of which used to run Pure Research centers, which now have been either eliminated or reduced to a shadow of their former selves. Of more concern to me, it is apparent that our Public Companies are no longer doing the job they should do for the average investor. Three years ago we talked about the lost decade for shareholder returns. I think we are now looking at the lost decade and have. That is very troubling to me, because i am keenly aware of the vital Public Interest function that corporations have performed in the past and that we see expect them to perform. So we have an ideology that is not low grounded. Our practical experience with that ideology for the past 15 20 years has not been a good one. Where is the problem . I think the problem lies in the mistake that people often make. People think that corporations are fiction and that shareholders are real. I would say it is the other way around. Corporations are very real. Exxonmobil is a very real institution. Is the shareholders that are fictional. We are really thinking of human beings who happen to own shares. There is no platonic shareholder out there, no loading entity that only cares about the share price of one company. What we have our human beings who own stocks, may be in many companies, and have other interests as organisms who breathe it the air and drink the water. We are talking about human beings who began to realize that often, the interest of our socalled shareholders are in conflict. My book talks a lot about various kinds of conflicts. I would just discussed one in the time that is left to me. I enjoyed the discussion part of these events. That is the fun part for me, because people often have very interesting insights. One of the biggest conflicts is a direct conflict of interest between longterm shareholders, people saving for retirement, and shortterm shareholders like those raiders in hedge funds that are only planning on opening their shares for two years. This is a problem because it turns out there are a lot of wellestablished ways that you can do things to make the stop price of a Public Company go up in the short term, without improving longterm performance or even harming longterm performance. What are the things you can do . You can ask the company to do a massive Share Repurchase to drain cash out of the firm. That will leverage the permanent it more likely to fail, but it will bump up the share price. You can cut down on expenses like Research Development and customer salaries. Until the inevitable consequences, you lose your good employees, you have no new products in the pipeline. Another fairly reliable way to bump up share price is to sell off parts of the firm. There are some theories why, but we do know that when you put a company on the auction block, generally you can get a premium price for it, and the person who buys it will not do any better with it than the original owner. Still you get an increase in share value without an actual increase in performance. It turns out those are exactly the things that shortterm investors like hedge funds typically agitate the board to do. Here is the problem. What if you are a longterm shareholder, and i do get comments like that. My answer is, it doesnt matter if you are not pushing for them, as long as you share the market with shortterm investors who are pushing for them, you will be at a disadvantage. You can make careful investments in companies that you think are doing the right thing and you never know when a carl icahn is going to show up and upset the apple cart and cause a corporation to get that one time share price bump up. But in the long run, it is hard to make your longterm returns. If you have an questions about whether that is happening, i have a new piece of Macro Economic evidence for you. Number one, our publiC Corporations are disappearing. The number of Public Companies listed on the u. S. Exchanges has declined by more than 40 in the last 15 years. If it were a species, we would call it in danger. Number two, the life span of a fortune 500 company was about 75 years in the 1920s. It is down to 15 years today. So if you have any doubt that shorttermism is harming our corporations, that should be some evidence you think about. You might wonder if there is more going on than you have realized. What are we to do . The good news is, i do see this problem is very fixable, or at least improveable. In 1960, the Holding Period for a share of stocks was eight years. Today is down to around four months. What can we do to change that . There are a million things you could do. You could change the Capital Gains holding time from one year to threefive years. You could put in place a Stock Transfer tax such as we had before 1960. I am a big fan of transfer taxes. Corporations can do things on their own. They could use time waited in dividends. You could change the voting rules the that shareholders who have been there a long time get more votes than shareholders who are short termers. The next thing we have to do is revisit our assumptions about what is good executive compensation. It is fair to say that the emphasis on paper performance has not lived up to its promise. I would like seeks the federal government get out of the business of telling corporations how to compensate their executives and employees. I am not against regulation, but i am against dahmer regulation. The provision of the tax code has produced only disastrous results. Those left to their own devices got better results. It would create a situation where boards have to own the compensation the gate to executives. Today we have created an ironic situation where the board can say, we did not plan to see the executives and the ceo 40 million, but congress made us take a formula last year. Turns out that the formula says that zero us 40 million. Finally, we have to recognize that ideas matter, and the shareholder value idea that has become so powerful in the Business World today is, indeed, a dangerous and potentially destructive idea, and we should be very careful about not teaching it as perceived wisdom to at least our next generation of Business School graduates, policy and Public Service school graduates, an economics graduate. I just want to close with a quote from john maynard keynes. The ideas of economists and political philosophers, but when they are right and when they are wrong, as more powerful than commonly understood. Indeed, the world is ruled by little else. They are usually the slaves of some defunct economist. So i am arguing that the idea that corporations are run well when we run them to maximize shareholder value as measured by share price, should at least become a defunct economic idea. Talks like this, i hope, will move us a little further in that direction. Thank you. [applause] we