Shareholder value: is it holding back growth?

Andy Haldane, chief economist at the Bank of England, has recently spoken out against ‘excessive’ shareholder power as being one factor holding back business investment and growth in the UK. The dominance of shareholder value is a characteristic of what is often referred to as the ‘Anglo-Saxon’ model of capitalism, as it is prevalent in the US as well as in other English-speaking nations. This is part of an old debate, discussed in yesterday’s Observer newspaper by Will Hutton, for many years an advocate of ‘stakeholder capitalism’, in which it is suggested that business should take account of a wider spectrum of interests in its operations, such as workers, customers and the environment. It is possible that by focussing on the interests of shareholders above all else, and paying out a high level of dividends, short-term profitability can take precedence over the long-run interests of investing in and growing the business, funding innovation, and taking care of the workforce.

70% of corporate profits in the UK are currently paid out in dividends, compared to 10% in the 1970s. This is a dramatic change. I suggested in a previous post that economies such as Japan and South Korea, in which large companies have accumulated enormous reserves of idle cash, could possibly do with a bit more focus on shareholders, in order to promote a more efficient allocation of investment. But it is certainly possible to have too much of a good thing, and investment levels in the UK have been weak compared to comparable economies for some time. If changes to corporate governance encouraged firms to pay out less in dividends, they could then invest more for the longer term, and also pay out higher levels of wages. If this were the outcome, both investment and consumption could be boosted, raising overall economic growth, employment and productivity.

However it is difficult to predict what would be the outcome of nudging companies to change their pattern of spending. From a free market perspective, one might say that the status quo is an efficient outcome and one should adopt the attitude of laissez-faire and leave companies alone. By contrast, one could also argue that company law was created by past governments and should not be sacrosanct. It encourages a particular pattern of behaviour, and this could be changed to bring benefits to the economy and society.

If current dividend payments are consumed rather than saved, one could make an argument that it would be fairer for some of these funds to go to the workforce in higher wages. This might make for a more egalitarian outcome, if wage earners are on average poorer than shareholders. Some dividend payments are likely to be saved rather than consumed, especially for higher income recipients, and in the absence of a saving constraint on investment in the economy as a whole, this would act as a drag on aggregate demand and growth. If savings are a constraint on investment and are therefore too low, this would help boost the latter.

But Haldane’s argument is that excessive dividends are holding back investment. As mentioned above, changes to company law could nudge firms towards spending larger proportions of profits on investment, which could raise growth and productivity, and hence wages and employment. But they could also be paid out partly as higher wages, which would boost consumption more directly, and spread the benefits of economic progress more widely. Higher wages and consumption, in the presence of excess capacity among firms, and unemployment, open or disguised, would stimulate employment, and as firms approach full capacity it could also raise investment.

One argument supporting dividend payouts is that they can be reinvested in the same company if future prospects are good, or in different companies with better prospects. This may already happen with the buying and selling of shares, and both are a way to potentially improve the allocation and productivity of investment spending. Thus an improved economic performance can be achieved with the same volume of investment.

Some economists such as Michael Roberts have argued that profits are the ultimate constraint on investment and it is the relatively low rate of profits that is holding back investment. But with a larger allocation of the income received in profits going towards investment and wages with a still significant proportion paid to shareholders, it is possible that higher growth, productivity, employment and wages could result from the same rate of profits. These outcomes would spread the benefits of economic progress more widely and would be welcome for many stakeholders.

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