A recent study by the Federal Reserve reveals the shocking extent of accelerating wealth inequality in America. Out of America’s total assets of $114 trillion owned by Americans in 2018, the wealthiest 10% of Americans owned 70% (up from 61% in 1989), while the bottom 50% of American households had virtually no net worth at all—down from 4% in 1989 to 1% in 2018.
J. Samuelson writing in the Washington Post,
The truth is that we still don’t fully understand the surge in economic inequality of the past three decades. The populist temptation is to blame greed, but this is not a satisfactory explanation because greed is hardly new.”
Like many macro-economists, Samuelson seems unaware that this massive surge in wealth inequality has been driven by the notion that the purpose of a corporation is to maximize shareholder value as reflected in the current stock price.
This idea, which got going in the 1980s and 1990s with the intellectual leadership of Milton Friedman and Michael Jensen, has led to a gargantuan extraction of wealth from public corporations for shareholders at the expense of investment and innovation. The negative impact of the idea, which even Jack Welch has called “the dumbest idea in the world,” has further been aggravated by the massive resort to share buybacks, fueled by the 2018 corporate tax cuts.
The Origins Of Worsening Wealth Inequality
Milton Friedman won the Nobel Prize for Economics in 1976 but his article in the New York Times on September 13, 1970, was not particularly scholarly. It was instead a ferocious tirade in defense of the idea that the purpose of a firm is to make money for itself. Any business executives who pursued a goal other than making money for their firm were, Friedman said, “unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.” And on the rant went.
Not everyone agreed. Joseph L. Bower, then a young associate professor at Harvard Business School, told a National Public Radio at the time that maximizing shareholder value as the sole goal of business was “pernicious nonsense.”
But the “pernicious nonsense” spread. In 1976, in one of the most-cited, but least-read, business articles of all time, finance professors William Meckling and Michael Jensen offered a quantitative economic rationale for maximizing shareholder value, along with generous stock-based compensation to executives who followed the theory.
In 1990, an article in HBR by Michael Jensen and Kevin Murphy gave shareholder value thinking a new push. The article, “CEO Incentives—It’s Not How Much You Pay, But How” suggested that CEOs were being paid like bureaucrats. Instead, they should be paid with significant amounts of stock so that their interests would be aligned with stockholders. Thereafter, the use of the phrase ‘maximize shareholder value’ exploded and CEOs became very entrepreneurial — but in their own cause, not necessarily their firm ’s cause.
By 2017, shareholder value thinking was pervasive. Joseph Bower and Lynn S. Paine reported in Harvard Business Review that shareholder value thinking “is now pervasive in the financial community and much of the business world.” It had led to a set of behaviors by many actors on a wide range of topics, “from performance measurement and executive compensation to shareholder rights, the role of directors, and corporate responsibility.”
In fact, shareholder value is now no longer just an idea, but an entire “thought system.” It has been embraced by hedge fund activists, institutional investors, boards, managers, lawyers, academics, and even some regulators and lawmakers.