Five myths about shareholders

Christopher Marquis is the Samuel C. Johnson professor in sustainable global enterprise at the Johnson Graduate School of Management at Cornell University. He is the author of “Better Business: How the B Corp Movement Is Remaking Capitalism.”

Investing is a mystery to many. In theory, the stock market reflects rational calculations as shareholders seek financial returns in companies that perform well. But there are bubbles that overestimate firms' value and dramatic crashes that suddenly correct the situation. More puzzling, research has long established that many factors beyond economic fundamentals, like holidays and weekends, lunar phases, and weather, can affect stock market performance. And stocks can even surge while the economy tanks, as they have during periods of the pandemic. Here are some of the most commonly held myths.

Myth No. 1: Shareholders are focused only on returns.

“Greed is good,” says Michael Douglas’s Gordon Gekko in the movie “Wall Street,” characterizing investors' profit motive as beneficial to all. In a groundbreaking 1970 essay that established the idea of shareholder primacy, Nobel Laureate Milton Friedman famously declared that companies should focus only on profit, as it is the only thing shareholders care about, and such a focus is in their best interest. Since then, this point of view has become widely accepted among executives and investors, according to leading legal and management scholars.

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But issues beyond profitability are increasingly important to a wide range of investors. For instance, many now hold shares in corporations that align with their values and aim to improve society as a whole. Socially responsible investing has exploded around the globe, and in the United States, 25% of total assets under management are now in funds that screen out socially and environmentally harmful companies. “Impact investing,” meanwhile, is a practice in which private investors aim to better the world and make money - by taking into consideration how the company addresses the interests of communities, employees, suppliers, customers and other stakeholders in addition to financial interests. Investors like Larry Fink from BlackRock, for instance, now advocate that companies look out for all stakeholders, not just shareholders. Even mainstream economists are coming around: In a 2018 paper, Nobel laureate Oliver Hart suggested that it’s wrong to assume that shareholders care only about profits.

Myth No. 2: Companies must focus on increasing shareholder value.

Starting in the 1980s, a number of influential legal decisions found that companies have a fiduciary responsibly to put shareholder interests first; if they don’t, shareholders can sue directors and executives. The two most well-known rulings are a 1986 Delaware Supreme Court case, Revlon v. MacAndrews & Forbes Holdings, and the 2010 case eBay v. Craigslist, in which a judge held that any corporate mission that “seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders” is invalid because it doesn’t align with the director’s fiduciary duties.

But in the past 10 years, many alternative corporate forms have emerged that allow companies to maximize value for all stakeholders. The most popular of these, the benefit corporation, has been established in three dozen U.S. states and several nations. Instead of putting shareholders first, benefit corporations must explicitly state a purpose beyond making money for investors, be transparent about their social and environmental impacts, and have their performance assessed using a credible third-party standard. The Accountable Capitalism Act, introduced by Sen. Elizabeth Warren, D-Mass., would establish this corporate form nationally. Many leading companies, such as Patagonia and King Arthur Flour, along with start-ups like Kickstarter, have adopted this form.

Myth No. 3: Diffuse and widespread shareholding democratizes ownership.

One feature of stock ownership in the United States is that most publicly traded companies are owned by many, many people. A recent report shows that 52% of Americans own stock, usually through their retirement plans. That means they are entitled to a say in the direction of the company and voting rights on a wide range of issues from director compensation to reporting on gender and minority pay disparities.

But in truth, corporate control falls to a much smaller set of actors. Among individual Americans, ownership is concentrated in the wealthy: 84% of all stock is owned by the top 10% of income earners. Furthermore, voting on corporate decisions is done by a much smaller number of institutional investors, such as the mutual funds and pension funds that hold shares on behalf of individuals. What’s more, 97% of the proxy vote advising market is controlled by two firms - Institutional Shareholder Services (ISS) and Glass Lewis - with the former holding 61% of this business. Investment funds hire ISS and Glass Lewis to guide them in how to vote. These firms thus have significant power to shape corporations through share votes. Thus, the extent to which the actual shareholders positions are reflected in the voting is not clear.

Myth No. 4: Small shareholders can’t make big changes in companies.

Economic theory states that the stock market is an instance of the separation of ownership and control: Investors purchase shares and own the firm, while professional managers control the firm. If any shareholders can have an effect, it is the largest ones. The votes of small investors are frequently seen as “largely meaningless,” as the New York Times once put it.

Yet some shareholders use their ownership as a platform to agitate for change in corporate behavior, especially along environmental, social and governance lines. They are able to do so because all shareholders with holdings greater than $2,000 have the right to submit proposals for consideration at the annual shareholders meeting. Many times, nonprofits or religious orders invest in companies aiming to change their behavior. For example, an anti-plastics activist group, As You Sow, introduced a proposal at Starbucks’s 2019 meeting that the coffee chain make its cups more recyclable, which garnered 44% of the vote; an earlier As You Sow proposal led Starbucks to introduce plans to abandon plastic straws. Some of this work is also done collectively. Trillium Asset Management organizes shareholders with minority positions to press companies for socially responsible practices. Chipotle Mexican Grill responded to a Trillium proposal by setting emissions reduction targets for its carbon footprint and reaffirming existing eco-friendly initiatives it will impose on its agricultural suppliers.

Myth No. 5: When shareholders do well, the economy does well.

Many people link stock market performance and economic health implicitly and explicitly. For example, Economics Help explains, “Generally speaking, the stock market will reflect the economic conditions of an economy.” President Donald Trump frequently makes this connection, for instance tweeting on Sept. 14: “Stock Market up BIG today. Will I ever be given credit for the Markets and Economy?”

But the recent disconnect between soaring stock market performance and the pandemic recession shows that it is not a good indicator of economic health. One reason is that large companies, especially Big Tech firms like Google, Amazon, Facebook and Apple, have an oversize influence on stock market indexes. Unlike the “real” economy, such IT firms thrive in conditions that emphasize e-commerce and virtual interaction. Another reason is monetary policy. After trading halts (“circuit breakers”) took place an unprecedented four times in 10 days in March as the pandemic roiled markets, Trump pressured Federal Reserve Chair Jerome Powell to lower interest rates, boosting the stock market. Investors then found it more profitable to buy stocks rather than save or invest in other assets, such as bonds. But since many pension funds primarily hold bonds, these low interest rates represent a long-term economic risk for American pension holders.