U.S.-style capitalism is at a major turning point. Last August, the Business Roundtable, an association of major companies in the United States, released the Statement on the Purpose of a Corporation, signed by 181 CEOs who committed to leading their firms for the benefit of all stakeholders: customers, employees, suppliers, communities and shareholders.
The statement represented a move away from “shareholder supremacy” and included a “commitment to all stakeholders.” It was akin to a collection of contracts signed by the top executives of U.S. firms such as JP Morgan Chase, Amazon, General Motors, etc., and its meaning was significant. In the U.S., which does not have a federal corporate law, Business Roundtable statements such as this are authoritative enough to have quasi-legal effects.
In 1997, the Business Roundtable issued a statement that corporations exist principally to serve shareholders. Therefore the significance and impact of last year’s statement to move away from shareholders is enormous. It supersedes the 1997 statement and outlines modern standards for corporate responsibility. It has the same purpose as recent amendments to corporate law in countries such as Britain and France, including “enlightened shareholder’s value” in Article 172 of the U.K. Companies Act 2006, the French PACTE Act in April 2019, and so on.
The new statement also reinforces the recognition that the assertion of shareholder supremacy and maximizing shareholder value in corporate law has been a mistake. This represents a shift from shareholder capitalism to public interest capitalism.
Last August’s Business Roundtable statement is fundamentally different from the anti-shareholder supremacy paradigm of temporary swing-back that was once observed in the U.S. In recent years, wealth has been unusually concentrated in shareholders because of the principle of maximizing shareholder value and, in particular, because of excessive demand for shareholder returns by investors and the practice of giving huge stock options to CEOs, etc., which focus on short-term profit by shareholders.
The theory that shareholders are the owners of a company — as a background to the belief in shareholder supremacy and the need to maximize shareholder value — has provided the reasoning for excessive demands for shareholder returns. It has also justified large-scale restructuring involving job cuts to raise stock prices of relevant companies. As a result, extreme disparities between the rich and poor have emerged around the world, as typified by the U.S., with the globalization of capital markets and corporate activities.
Such disparities are no longer an economic issue but are causing huge social problems with broad repercussions in international politics. This is a problem that cannot be resolved by the conventional adjustments of tax and redistribution policies of a single state. Recent statistics show that the combined assets of the top eight wealthiest people in the world are comparable to those of the bottom 3.6 billion and companies that are generating sales exceeding the revenue of major countries are appearing one after another.
Under these circumstances, the sense of crisis over the system, in which shareholder supremacy has spawned social imbalances, has become extremely high at the leader level of the U.S. corporate community, and the review of the Business Roundtable’s 1997 statement has reflected this situation. The structural crisis of the world economy and the significant paradigm shift behind this review of the statement must also not be overlooked.
There is criticism that the new position of the U.S. Business Roundtable seeks to protect the interests of stakeholders at the expense of long-term shareholder value, but that is a fundamental misunderstanding. The new statement clearly calls for generating long-term value for shareholders.
Recently it has been widely recognized among investment funds that too much emphasis on shareholder value has rather negative effects from the viewpoint of long-term investment returns. Therefore, leading U.S. investment funds (for example, Blackrock, the world’s largest investment fund, and leading private equity funds such as Vista Equity Partners) that have been the standard bearers of maximizing shareholder value also signed the new statement. More attention should be paid to the significance of the new statement and the background of the value transformation.
There is another view that Japanese companies — many of which had been heavily influenced by the earlier focus of the U.S. business community on shareholder values — should not lightly follow the new position of the Business Roundtable because the new emphasis on the broad interests of stakeholders other than shareholders could weaken their management discipline. By doing so, the view holds, Japanese businesses would lose the power to earn money and gain international competitiveness, since their capital efficiency (e.g., return on equity) and labor productivity are generally lower than in other major economies.
Such a view is based on the theory that a company will be managed properly through monitoring by shareholders. However, management and financial policies that focus on improving the return on equity, as emphasized by such advocates, among others, have not led to long-term growth and profitability of Japanese businesses.
In the past, typical financial indicators such as ROE were used with a focus on short-term profitability. A typical approach was to repurchase a company’s shares to raise the ROE for the current term and increase “investor reputation.” However, these technical approaches to raising the short-term financial performance do not lead to improving companies’ intrinsic earning power. Going forward, when evaluating companies, it is necessary to increase the weight of medium- to long-term evaluation, and to develop new practical indicators suited to long-term growth and profitability.
If Japan’s labor productivity is a problem, the recent decline in labor’s share of corporate earnings in this country should also be taken into consideration. Under the Abe administration, large Japanese companies have earned record profits. The net income of companies in the manufacturing and service sectors in fiscal 2017 was 3.3 times higher than in 2010. During the same period, dividends to shareholders increased by 2.3 times. However, employee compensation remained almost unchanged — rising by only 1.1 times.
Labor productivity is also closely related to industrial structural issues. For example, Japan is currently the base of raw materials and parts supply for American and European companies, so raising the prices of those products will increase labor productivity, but transformation of Japan’s industrial structure is needed. The problem is not that simple, and enhancing management discipline by shareholders alone will not increase labor productivity.
In the first place, it is important to think again about the beneficiaries of the company’s earning power. The ideology, or propaganda, that shareholders are the owners of the company (property) has been spread around the world, especially in the U.S., and has had a great influence on Japan and distorted the theory of corporate law. In recent years, such an ideology may be even more prevalent in Japan and that has resulted in too much activism by some shareholders.
However, legal provisions to that effect do not exist even in U.S. corporate law, and the idea cannot be established as a legal theory because company property belongs to a legal entity in the first place.
We must move away from the concept of earning power that is biased in favor of shareholders based on the incorrect idea that shareholders are the owners of company property. In essence, the long-term growth of a company and appropriate distribution to stakeholders will ultimately benefit the interests of shareholders.
Hiroyuki Watanabe is a professor at Waseda University’s Faculty of Law and specializes in corporate law, capital market law and finance law.