Thursday, August 27, 2020

'Shareholders at the gates’: Economist Luigi Zingales urges greater investor control of corporations

By Lene Powell, J.D.

Should shareholders be allowed to vote on social issues via shareholder proposals? Some argue not, saying that shareholders do not have the proper incentives to control corporate decision-making on social issues. But according to economist Luigi Zingales, diversified individual shareholders, in fact, are in the best position to decide how corporations should act on social issues because they consider only the wider social costs of corporate actions, not their own personal cost.

Yet in the United States, there are huge regulatory barriers that make it difficult for shareholders to express their opinion, and the SEC is trying to make it even harder, said Zingales, a professor at the University of Chicago Booth School of Business. In a recent lecture, Zingales said he believes this is because "shareholders are at the gates."

"The numbers suggest that with a little bit more push, even in the United States, we are pretty close to actually changing the way companies are run. And many people don't want this to happen, and they resort to the very un-Republican way to introduce regulation to prevent owners from expressing what they want. This, to me, is the greatest contradiction in terms—that a Republican administration is using regulation to squash the voice of investors," said Zingales.

Zingales further explained that shareholders can have more impact on a corporation’s decisions by remaining invested and voting on shareholder proposals than they can by selling their shares and boycotting corporations. Zingales developed this idea in a new paper, "Exit vs. Voice."

Beyond shareholder value. Under the classic "shareholder value" model, corporations should conduct business in accordance with their stockholders’ desire, which generally will be to make as much money as possible, explained Zingales. In this model, developed most prominently by economist Milton Friedman, the only social responsibility of a business, beyond complying with the law and rules of society, is to increase its profits. While the model does not imply that corporations should ignore the desires of workers, shareholders should not be "taxed" without representation by paying for actions that do not maximize profit, said Zingales.

But Zingales argues that the classical model has lost some relevance because the model ignores that investors care about other values besides money, including social objectives. Zingales pointed to a study of Dutch pensioners that, when asked if they wanted their pension fund to engage more in socially responsible activity and sustainable investment, 67.9 percent of the participants said they did want more sustainable investment, even if this meant a lower return.

Social costs of corporate actions. Zingales examined the issue of corporate actions that have negative impacts on society. Generally, it is cheaper for a corporation to avoid taking actions that it must then spend money to undo. For example, it is often cheaper for a company to avoid polluting in the first place than to clean up pollution.

But sometimes the opposite is the case, said Zingales. For example, the DuPont chemical company did a cost-benefit study in 1984 that found it was cheaper for them to pollute the Ohio River with a chemical called PFOA, which led to fatal health effects. DuPont was able to block regulations that would have increased the cost of polluting, including by hiring environmental regulators as they stepped down, lobbying Congress, and manipulating evidence, said Zingales.

According to Zingales, while some economic activity causes deaths, we do not want to cause deaths that are completely unjustified just because people do not factor in the costs. This is possible to do, and shareholder voting is one way to do it.

"Saving lives costs money. And I'm saying we should pay for it. And ideally, we should pay for it through some form of regulation. However, regulation is far from perfect," said Zingales.

"Exit vs. voice." Zingales discussed whether it is more effective for shareholders to affect the behavior of corporations by divestment and boycotts, or by owning shares and voting on corporate decisions. According to Zingales, the latter is more effective.

Zingales offered the example of oil companies. If shareholders divest from oil companies and share prices drop as a result, that creates a "fantastic opportunity" for others to buy the shares at a lower price, including large investors like the Koch brothers.

"[By selling oil company shares] I had a teeny tiny effect on the environment. But the first order effect is that I make the Koch brothers rich," said Zingales.

In contrast, shareholder voting can have a profound impact on company decisions, said Zingales. Many decisions these days come close to being approved. For example, in the last proxy season, on average, shareholder proposals for companies to disclose their lobbying efforts reached 31 percent of the votes. For large asset managers like BlackRock and Vanguard, if they voted in favor of such proposals, the proposals would pass.

"So this can really change the world if shareholder voice is done in a very consistent way," said Zingales.

Social vs. personal costs. Zingales contends that for diversified individual shareholders who hold shares in many companies through mutual funds, the relatively small personal cost of the decisions of any one corporation allows them to consider the broader social costs of corporate actions, just as a "benevolent planner" would. This puts them in the best position to make decisions for the corporation on social issues.

One challenge, however, is how shareholders can know the best way to vote. Zingales suggested that owning mutual funds allows diversified individual shareholders to exercise voice in a very effective way, by relaxing the informational burden that the voice option imposes on investments.

Regulatory barriers. Zingales said that Europe is more advanced in empowering shareholders than the United States. Regulatory barriers in the U.S. constrains the ability of shareholders to express their opinion; in particular, the "ordinary business matter" exception that allows companies to exclude shareholder proposals that involve routine business matters of the company.

And, said Zingales, he is "sorry to report" that the SEC and Chairman Jay Clayton are trying to make shareholder voting even more difficult. Zingales believes this is because shareholders are on the cusp of having real impact over the way companies are run. This is unwanted, and so the current administration is using regulation to prevent owners from expressing what they want.

Zingales believes that because investors care about other objectives besides making money on their investments, including social objectives, they should be allowed to vote on social issues.

"It's about time that we realize that we need to address this growing demand for other objectives besides money. Which doesn't mean money is not an important check—it’s still very important. But there are other things on the margin," said Zingales. "And what we argue is that letting shareholders vote is the best way to achieve this new objective."

Check on corporate power. Asked why Friedman and others underestimated the amount of power and influence a corporation can exert on a society's social and political system, Zingales said that in the middle of the 20th century when Friedman developed his ideas, the power of corporations had waned significantly from previous decades.

At the beginning of the 20th century, some economists had ominous views about the outsized power of corporations in society. But by the middle of the century, due partly to very strong antitrust enforcement and environmental and workplace regulation, corporations had lost significant power. By the 1970s, the dire forecasts had disappeared from economics. But now the pendulum has swung back, said Zingales.

"Corporations were too weak at the time. But, you know, there’s too much of a good thing. Now we have overshot in the opposite direction, and corporations are too powerful. And once again, my view is, Chicago should come to the rescue," Zingales concluded, smiling.