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Author: chris dillow   |   Latest post: Thu, 11 Jul 2019, 2:03 PM

 

Yes, ownership matters

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I welcome the creation of the Common Wealth think tank, which aims to promote "deep shifts in property relations and ownership." There's one possible preconception about this project which must be debunked, however. This is that it is hippy-dippy yogurt-weaving idealism. It's not. The question of who should own and control companies is bog-standard mainstream economics: at least three Nobel prizes - to Hart, Williamson and Coase - have gone to economists working on this and related issues.

And in fact, stock markets themselves are calling into question the feasibility of existing ownership structures. In the UK the number of companies listed on the main market has dropped from 1747 to 1156 since the start of the century, a trend which matches those in the US and Europe. And as Kathleen Kahle and Rene Stulz show, those that are listed are bigger and older than they were then and are less profitable and hold more cash.

One big reason for this is that dispersed share ownership does not adequately control management. This is partly because of a free-rider problem. With hundreds of outside shareholders each one has an incentive to piggy-back off of others' efforts to oversee management. Everybody therefore hopes that somebody else will be the active investor, with the result that nobody is.

As Michael Jensen pointed out in a famous paper in 1989 this is fine for companies with lots of potentially profitable projects who need to raise money to finance them: it's no disaster if poor oversight of managers causes them to select projects with a 20 rather than 30% return on capital. But, he said, it is a problem for companies facing slow growth or which have lots of cash and few good investment opportunities. And in a world of secular stagnation there are more of these. For them, dispersed ownership is inappropriate - which is why we see fewer companies listed on western stock markets.

This problem can often be solved by more concentrated ownership. But there's another issue here. To see it, ask: who should control an asset? In theory, it should be the one who stands to lose most if the asset falls in value and gain most if it increases. This person is the one who has the strongest incentive to maximize the asset's value. Traditionally, this person has been the owner - be it the shareholder or direct owner. This, it has been thought, is because other stakeholders such as workers, bond-holders, banks or suppliers are protected by contract, leaving the owner as the residual claimant.

This thinking, though, is wrong. As Colin Mayer says (pdf):

Contracts are very restricted...Shareholders are not therefore by any means the only party exposed to the misfortunes of corporations and the more that we strengthen the rights and powers of shareholders, the more we threaten the interests of others.

There are at least four other actors who are residual claimants:

- As we saw with the collapse of City Link or Carillion, subcontractors often get shafted when a firm fails whilst owners and directors can extract large "consultancy fees".

- Workers who have invested job-specific human capital in a company cannot get so good a job if the company fails. As Oliver Hart has written, "a party with an important investment or important human capital should have ownership rights." (Firms, Contracts and Financial Structure, p48)

- The failure of large firms, or those that are key hubs in a network, can cause deep recessions, as we saw in 2008. Pretty much all of us suffered from the collapse of the banks. And as Edward I - a man not noted for socialist sympathies - said "common dangers should be met by measures agreed upon in common.*"

- For companies that are contributing to climate change, future generations are in effect a residual claimant: they are at risk from the firms' actions.

All this raises some questions. Carillionpa1

First, could these parties exposed to corporate risks be protected by changes in regulation, contracts or carbon taxes? We know that they have not been so far. And I fear that the power of capital to block such changes means they won't be.

Secondly, shouldn't market forces select against bad companies? In part, they don't simply because the forces of competition don't grind so finely. The fact that there is a long tail (pdf) of inefficient companies in all countries shows that bad management isn't strongly selected against. And even when it is, the process is disruptive of people's lives so the residual claimancy problem remains.

Thirdly, can the market alone achieve efficient changes in ownership? The fact of de-equitization suggests that sometimes it does. There are, though, at least two issues here. One is simply that there are credit constraints: the best owner of a firm might not be able to raise finance the buy it. A second is that new forms of ownership might require legal change. The limited company was we know it was created by two acts of parliament in 1844 and 1855. (The notion that free market capitalism is somehow natural and emerged without state intervention is a fiction.) Other new forms might require such change, or at least government encouragement, perhaps through use of its procurement activities as is happening in Preston.

Fourthly, who should own companies? The answer, as in most economic questions, is: it depends. In some cases, it should be workers. Where these have serious investments in the firm, in the form of job-specific human capital or a lack of outside options, they have sufficient skin in the game to warrant ownership or control. They also often have dispersed fragmentary knowledge about corporate performance and how to improve it that managers cocooned in the C-suite lack: worker control can be a solution to Hayek's knowledge problem. This is especially the case if such firms don't need to raise lots of equity finance. For other firms, Mayer has suggested ownership by a public benefit company, which ensures that firms fulfill a stated public purpose beyond mere maximization of profits: as John Kay has shown, the latter is better done as a by-product of other aims, such as producing great goods.

Fifthly, if all this is the case, why has ownership been off the political agenda for so long? One reason is that since about the 1930s Labour thought that it could achieve social democratic objectives without challenging existing ownership structures - by using macro policy, taxation, regulation or strong unions. The collapse of post-war Keynesianism in the 70s, and weak growth in our neoliberal order since, however, suggests that this belief was wrong. Maybe, therefore, ownership does matter - and in some cases at least, it might be in the wrong hands. And this is to consider the question without even raising the matter of justice and equality.

* I suppose the mood of the times requires that I note that he was a vicious anti-Semite.

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