Is shareholder capitalism a suicide pact?
Jerry Davis, Professor of Business Administration and Sociology at the University of Michigan’s Ross School of Business and Department of Sociology
June 2023
Since the turn of the millennium, most American families have been invested in the stock market. Whether they came to be investors passively (by taking a job with a 401k) or actively (by buying Gamestop shares on Robinhood), the consequences for individuals can be profound. People who embrace their identity as an investor think differently, vote differently, and have different material interests from those who do not. “Investor” can even reframe an entire worldview: education becomes an investment in human capital, and is evaluated based on increases in future earnings potential; family and friends turn into investments in social capital, essentially call options on benefits to be harvested in the future. The capital metaphor becomes pervasive, like microplastics in our water and blood.
When most of the population is invested in the stock market, it creates formidable barriers to social change — even when we face existential threats. Imagine that you have socked away 20% of your annual salary in an S&P500 fund for your kids’ college tuition and for your retirement — the standard guidance of financial advisors. Now, imagine that one-quarter of that fund is made up of a half-dozen rapacious tech companies, and that nearly all its growth is dependent on their performance. How enthusiastic would you be about antitrust efforts aimed at cutting Big Tech down to size? How excited would you be about reining in Big Oil if it means working an extra year or two before retirement? The investor worldview is easy to fall into, and it is reinforced by seemingly objective numbers that blare at us every day.
I argue that shareholder capitalism is a suicide pact. As long as the (perceived) well-being of most American households is tied to the performance of the stock market, our willingness to veer from our current course is limited. Unfortunately, there is no obvious win-win solution, contrary to the claims of the most optimistic ESG enthusiasts: hard choices are inevitable.
How American families became hedge funds
Well, how did we get here? Americans had a fickle relationship with the stock market over the past century. During the 1920s boom the number of American shareholders quadrupled to 10 million, but the 1929 crash scared off all but the wealthiest households for generations. Even up until 1980, only about one in five households played the market. That began to change in 1981, when the IRS began allowing companies to offer 401k pension plans to rank-and-file employees, in addition to executives. 401k plans are owned by employees, typically invested in mutual funds, and follow the employee if they change jobs. Companies preferred these “defined contribution” plans to traditional “defined benefit” plans (which promised workers a lifetime of payments when they retired), and some workers preferred them for their portability.
Households also found that the returns available from mutual funds were higher than from savings accounts, and not as risky as investments in individual stocks. Thus, by 2001 most families owned shares, overwhelmingly through mutual funds and similar vehicles invested in the broad market.
Participation rates have stayed at roughly this level ever since. The 2008 financial crisis was not a replay of 1929 in terms of scaring families out of the stock market. Instead, investors migrated from actively-managed funds (such as Fidelity, where fund managers buy and sell shares based on research) to passive index funds (such as Vanguard, where funds are invested in a fixed set of companies according to predetermined allocation rules).
Within a few years three fund families–BlackRock (proprietor of iShares), Vanguard, and State Street (manager of the SPDR ETF)–came to own 22% of the S&P 1500, a figure that grows every year. If trends continue, we can expect to see these three entities owning an absolute majority of hundreds of American companies. (Those with a long memory may recall Brandeis and Lenin calling attention to something similar early in the last century.) Already Vanguard is the single largest owner of 15 of America’s 25 largest corporations. In short, about half of America is invested broadly across the market, largely through three giant institutions.
Of course, families are involved in financial markets in dozens of other ways: their mortgages and auto loans and student debt have been securitized and sold to investors around the world, their loan payments may be tied to occult financial metrics after LIBOR, and their employers or neighbors may own a stake in their life insurance payoffs. We’re all miniature hedge funds now.
Finance invades the mind
If people were only tied to the stock market financially, the consequences might be modest. The median investing household held only $40,000 worth of shares in 2019, which is notably lower than the average cost of a new car. For those shareholders in the lower half of the income distribution, the median value of shares held was just $10,000. Meanwhile, the median homeowner’s net housing value was $120,000, and nearly two-thirds of families owned their own home. Home ownership is vastly more important to an average family’s finances than the stock market is.
But the market also pervades American culture and bombards American minds. We are constantly exposed to its movements through media and phone apps, and any market anomalies become instant news. Today, it is standard journalistic practice to note how the market reacts to events, from macroeconomic trends to scandals to presidential speeches to natural disasters. The stock market behaves like a giant national mood ring that shows us how the economy is feeling today.
In the 1990s, Republican theorists took note of the rapid rise in the number of shareholders, cobbling together a “theory of the investor class” that sought to capitalize on this trend. They observed that investors tended to read different newspapers than non-investors — more Wall Street Journal, less New York Times — and were more sympathetic to economistic interpretations of the world. It was almost as if investors grew a new sensory organ that attuned them to the S&P 500 and made them more supportive of policies that appeased the market. George W. Bush sought to exploit this opportunity via his “ownership society” programs,including his ill-fated effort to privatize Social Security after the 2004 election, which, according to Grover Norquist, an American anti-tax activist, would have made Republicans a permanent majority party by universalizing investing.
Of course, one could imagine that the collapse of the market in the weeks leading up to the 2008 election might not have been good news for the party in power, and that a privatized Social Security system could have led to Republican blood in the streets. But the basic outline of the investor class theory was not wrong: investors really did identify as Republicans at much higher rates than non-investors, and they really did favor different policies (including the privatization of Social Security). Identifying as an “investor” is a much more powerful force than the invested dollars themselves.
Gramsci meets the S&P 500
Large-scale participation in the stock market has become the political equivalent of an invisible dog fence that gives your pet a mild electric shock if it tries to go outside a delimited boundary. Public policies that will lower the value of the S&P 500 are doomed in the court of public opinion, from winding down the petroleum industry to taxing Big Sugar to reining in Big Tech. All of us with a retirement fund are complicit — and, besides, impoverishing future retirees is not a great look for politicians.
Optimists brighten at the thought of ESG investments. We can do well by doing good, they say, and all it takes is a few obscure metrics and some judicious portfolio surgery, deleting sinners and adding saints. Some even argue that do-gooder mutual funds outperform their value-neutral competitors. ESG mutual funds are the frozen yogurt of the investment world, both satisfying and good for you (or, perhaps, not as bad as the alternatives).
But the American stock market has evolved an interlocking set of mechanisms that ensure listed companies pursue shareholder value, no matter what their stated aims, and much of ESG investment appears to be more marketing gimmick than transformative investment philosophy. All those with decision-making authority in the corporate world are compensated in shares, tying their pecuniary interests directly to share price, and those who fail to pursue the corporate North Star are quickly disciplined by activist hedge funds. For example, in September 2022 Salesforce was lauded as a global leader through its ESG-related activities; within weeks two funds took major positions and demanded substantial restructuring, and within months it was engaged in massive layoffs.
Evidence on the superior performance of ESG funds is highly, highly selective, and runs up against decades of research as well as common sense. Exxon’s shares have been listed for over a century; the idea that divesting from this extremely seasoned issuer will raise its cost of capital and perhaps drive it from the market is whimsical at best, as there are plenty of blackhearts out there happy to buy out your position at a fleetingly discounted price. As recovered BlackRock executive Tariq Fancy points out, teams win by scoring the most points, not by winning the most good sportsmanship medals.
Indeed, good sportsmanship has a cost: researchers at Dartmouth and elsewhere found that firms with higher CSR scores actually attracted activist investors seeking to change their strategies for the sake of shareholder value, which in turn reduced their subsequent CSR activities. And consider the purest example: the performance of the Certified B corporations and public benefit corporations that went public in the 2020–21 IPO blizzard. The stock market performance of these certified do-gooders has been an unmitigated disaster: if you had invested your pension fund in these companies on the day of their IPO, you would be a pauper today.
Can shareholder capitalism be fixed?
Shareholder capitalism has evolved into an exquisite predator, very good at doing one thing: compelling companies to create shareholder value, no matter what the consequence. We are living within the confines and with the consequences of this value system every day. Every experiment at social impact investing aimed at firms listed on US markets is doomed to fail — you don’t buy a Hummer for its great mileage, and you don’t list on a US market if you want to do good.
Thankfully, as I have documented elsewhere, public corporations are mostly doomed in the US: pressures from Wall Street compelled the American economy to vertically disintegrate, disassembling corporate giants into their component parts, which can now be snapped back together like a set of Legos at minimal expense. The capital needed to start a business has never been smaller — we don’t need a stock market to fund business anymore, with a few rare exceptions.
At the same time, potential sources of capital have multiplied at all scales, from vast private equity funds at the high end to neighborhood crowdfunding platforms at the low end. Restaurants and barber shops can now tap their customers and neighbors for funding online, and the promise of community capital is finally coming to fruition. Imagine a world where community members could invest in their neighborhood’s enterprises — small businesses, worker-owned cooperatives, perpetual purpose trusts, mutual companies — and where their economic, civic, and local interests aligned. Thanks to innovations in policy and technology, efforts are currently underway to create the locavore version of the S&P 500 in the form of Diversified Community Investment Funds, and more is soon to come.
In 20 years, we may look back at shareholder capitalism as a misguided 40-year experiment that was inevitably doomed to collapse, replaced (hopefully) by something more human-centric and less distorting of our common values. The tools to achieve this future are available now, if we can correct course and recover from the wrong turn we took around 1980. Perhaps we can even free ourselves from the idea that everything we encounter should be seen as some form of capital and reclaim this ideological space in service of the social world.
This essay is a part of a series. Read the overview “Imagining Equity: Explorations into the Future of Enterprise” here.
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