Transactions: May 7, 2012

What are the politics of corporate governance? This has always baffled me. The notion of shareholders as ultimate owners of corporations only fully emerges in that decade of beginnings, the '70s. On one hand, it borrows from one of the New Deal's leading lights, Adolf Berle, who (with Gardiner Means) decried the separation of ownership and control characteristic of large, public companies. Although Berle himself eventually altered his views, a shareholder-centric governance model seemed one way to make management accountable. On the other, it rode a rising faith in stocks as measures of all things corporate. This was articulated by Michael Jensen and William Meckling, who in a 1976 paper linked Berle's separation problem with the theory of agency costs -- that is, managers able to play off stakeholders were bound to run amok, entrenched in self-interest. This theory, which featured rudimentary psychological models (align incentives as if you were squaring a board), merged with free market views from Hayek, Friedman and the Chicago financial economists. This was a remarkable conjunction. Liberals could stress democratic aspect of shareholder control. Conservatives could emphasize market efficiency and its ultimate embodiment, share prices.

This ability to bridge the political divide contributed to shareholder governance's ascendancy -- that, and the fact that most souls had no idea what corporate governance was. Today, few question the orthodoxy of shareholders as owners. Shareholders, even institutions, have become financial avatars for the demos (despite their chronic agency woes), a legacy of a lost time when individuals dominated stock trading. Moreover, the belief that corporations require ever-greater shareholder oversight, even as contradictions proliferated, remains unquestioned. And yet there's a lot here that doesn't jibe. Institutional shareholders drove '70s reforms that liberated Wall Street (it initially resisted) from its post-'30s backwater. The modern Wall Street -- big, global, rich, efficient, interconnected, risky -- was nurtured by institutions. Performance became a shared uber-value. Today's wisdom is that Wall Street, or finance, has been on a reckless campaign for size and leverage since the '70s. But, of course, institutions "owned" Wall Street and the banks; public ownership was a key reform, and they knew what they had. Institutions (in all their variety, from pensions to hedge funds) and Wall Street have long engaged in a complex, clear-eyed relationship of mutual exploitation and collaboration.

The same applies to the corporate sector, where Wall Street is popularly viewed as an exploiter of innocent M.B.A.s. In the Platonic grove of the real economy, the sun rises and sets on share prices. Boards and execs may resist novel varieties of shareholder influence, like say on pay, but share prices shape nearly every decision: capital expenditures (through the capital asset pricing model), corporate finance (dividends versus reinvestment), M&A, R&D, restructurings, compensation. This sub-rosa determinism outstrips anything in a shareholder proposal. Does any of this make sense? We know that more and more stocks fall into two enormous buckets: They're either indexed or traded speculatively at astonishingly high frequencies, mostly by algorithm. Tidal volumes of shares surge back and forth with little human intervention. Durations have shortened; volumes have mushroomed. In both buckets, it's difficult to tell what prices mean. The venerable theory that shares reflect dividends discounted into the glorious future grows dubious. Deviations from efficient markets crop up like crabgrass. It's no revelation to suggest that companies strain to satisfy investors -- payouts (dividends plus share buybacks) regularly exceed earnings. But are shareholders synonymous with the public good? Are shareholder needs chiropractically aligned with whatever definition of the corporate good you conjure up?

When you scan the current "literature" of corporate governance, you might think executives are constantly scheming to elude shareholder oversight. It's likelier that current executives only know a world framed and defined by stock prices. (Agency problems resemble original sin: There's no getting rid of them, no matter the alignment.) Theirs is a world of volatility and uncertainty; and psychologically it's no surprise that CEO pay has escalated as tenure has grown more tenuous. (That's particularly the case because shareholders are passively disinterested in pay, which rarely affects dividends or share appreciation.) The real problem is that we cannot easily return to an age when shareholders were balanced by other interests: employees, customers, suppliers, neighbors. That past has been expunged as error. Moreover, the '70s did offer a devastating critique of an economic system that was growing less efficient and uncompetitive. The question comes down to balance, which is devilishly difficult to get right. How speculative should the markets be? How much power should shareholders have? How important are attributes like liquidity and performance? Are shareholders always right?