Why 'Shareholder Primacy' Should Worry Us All
The belief that the primary purpose of a business is to maximize profits for its shareholders is widely held across the country, from the boardrooms of the Fortune 500 to the classrooms of the nation’s top business schools. But this idea, which emerged in the 1970s and is now virtually assumed to be economic law, came under attack this week from a surprising direction.
Pro-business Republican Sen. Marco Rubio released a study warning of threats to the economy posed by excessive financialization. The well-researched, persuasive report highlights that private sector investment – defined as businesses using capital to purchase or build assets – has been in decline for decades, while the profits accruing to shareholders have dramatically increased. The report paints a bleak picture of an economy becoming less innovative, less competitive, and less rewarding for most of its participants.
Rubio lays the blame for this situation squarely at the feet of a business sector captured by the “ideology of shareholder primacy.” The report briefly mentions the evolving career choices of graduates of Harvard Business School while discussing America’s manufacturing decline. As a recent HBS graduate, I know that shareholder primacy theory is rigorously debated on campus by students and professors. But less often discussed is how the career choices of the school’s graduates are evidence of the ideology’s pervasiveness. The result is a staggering misallocation of some of the country’s most valuable human capital.
Harvard's data shows that in the 1960s, 6% of HBS graduates pursued careers in finance; that figure is now over 30%, making finance the school’s most popular career field. Hedge funds, private equity firms, and investment banks are just the first order players. Over the last five years, 24% of the school’s graduates went to management consulting firms, whose rise parallels corporate America’s pursuance of shareholder primacy and its emphasis on financial initiatives like cost-cutting and merger diligence. The data shows 18% took jobs in technology, but it seems that Silicon Valley increasingly produces start-ups designed to maximize value for investors rather than pursue true innovation.
These career choices are not confined to Harvard. Data from Stanford and Wharton, two other top business schools, shows nearly identical trends. If you believe these findings, what they suggest is that many of this country’s future leaders work on behalf of an increasingly smaller group of shareholders rather than putting their talents and training to use in building, hiring, and inventing – the pursuits that result in economic development and shared prosperity.
The consequences are not just economic. The clustering of young talent in financial hubs has cultural and political implications. Over the last five years, an astounding 61% of U.S.-bound HBS graduates have landed in three cities: Boston, New York, and San Francisco. Those cities certainly have vibrant economies, but they generate just 15% of the country’s GDP and contain only 6% of America’s population.
Meanwhile, huge opportunities for leadership and wealth creation are being missed in other parts of the country and in other sectors of the economy. Texas, for example, is home to 9% of the country’s population and a dynamic economy that created one in seven new American jobs last year. Nearly 50 Fortune 500 companies are headquartered in the state, and several of its largest cities offer bustling start-up scenes. It is the epicenter of the shale revolution, arguably the most geopolitically important American innovation of the last two decades. Yet, over the same period, just 3% of HBS MBAs moved to Texas after graduation.
This is a complex issue, not easily distilled into a story of makers versus takers. And none of this is to say that finance or its practitioners are bad. On the contrary, financiers play a critical role in the economy. But, as Rubio’s report explains, in a healthy system they would take a back seat to industry, and industry would be allowed to reinvest its profits into less certain activities designed to yield greater amounts of long-term value.
The political and economic consequences of all of this should be the most worrisome. What happens to a country that sits by idly while a generation of its best minds congregate in a handful of cities, pursuing activities so out of sorts with the historic tenets of American capitalism? We are in the process of finding out. The political divides and the rise in income inequality that we see today are not random occurrences; they are at least in part caused by financialization and a fixation on the shareholder.
Our universities can and should play key roles in undoing these trends. It was the business schools and their faculties, after all, that helped normalize the theory of shareholder primacy. But it was not so long ago that they sought different, nobler ends. Donald David, the dean of HBS during the late 1940s, asserted that the ideal graduate would combine “competence in management” with the application of “social skill as to make his business a ‘good society,’” while demonstrating “the willingness to contribute constructively in the broader affairs of the community and nation.” The idea that managers have an obligation to do more than just return cash to shareholders – produce goods, create jobs, and lead their communities – is as relevant in an era of Sino-American economic confrontation as it was on the eve of the Cold War.