The modern corporation features a great deal of separation of ownership (shareholders) and control (executives), which is often thought to be a problem. Yet Colin Mayer writes that the United Kingdom is probably best-in-class in terms of “good” corporate governance where executives are sharply disciplined to run firms in the interests of shareholders and has a deeply mediocre economy as a result. Rather than allocating capital in a way that creates tons of highly productive firms, the U.K. model produced a hypertrophied financial sector and now post-crisis the entire country seems to be going through a massive negative productivity shock.
His account of what’s wrong is that shareholder sovereignty “systematically extinguishes any sense of commitment—of investors to companies, of executives to employees, of employees to firms, of firms to their investors, of firms to communities, or of this generation to any subsequent or past one.” He says that “what economics does not recognize is the fundamental role of commitment in all aspects of our commercial as well as social lives, and the way in which institutions contribute to the creation and preservation of commitment.”
This is actually one of the oldest and best critiques of the way the private equity industry works in practice. Lawrence Summers and Andrei Shleifer wrote in “Breach of Trust in Hostile Takeovers” that leveraged buyout firms essentially generate profits by violating informal understandings inside firms. The whole point of having firms is that it’s wildly impractival to try to conduct business arrangements through fully specified contracts, but then in hops the buyout firm to make money by backing out of informal arrangements. In other words, people get screwed over. And over time, the society-wide level of trust and commitment erodes.
It’s an important idea, and I’m glad to see it revived. But in some ways I think it’s even simpler than that. When what you’re interested in is innovation—new ideas—then efficient allocation of capital just doesn’t matter that much. What matters is ideas. And you tend to see new ideas championed by CEOs with some appropriate combination of megalomania, charisma, and vision to take people along for a ride. Ex post, the visionary megalomaniacs whose ideas pan out tend to make a lot of money for their investors. But it just doesn’t seem to be the case that backing visionary megalomaniacs is really a sound investment strategy. It’s almost certainly good for America that nobody can really stop Sergei Brin from investing search profits in heads-up displays and driverless cars, and nobody can stop Jeff Bezos from playing out his vision of a all-growth no-profits world-destroying retail monster. Any normal person would rather see Apple blow tens of billions of dollars on a crazy moonshot new product category than pay out a bunch of boring old dividends.
It’d be wrong to say that what economics doesn’t recognize is the importance of innovation and growth. But it doesn’t have a great deal to say on the subject. The economics conventional wisdom is instead full of good ideas about how to efficiently allocate a fixed pool of resources. And that’s what good corporate governance is all about—making sure that resources are employed in high-value ways rather than squandered. But fundamental innovation may simply require a certain amount of resource-squandering.