"Financialization," and the Exclusive Ostensible Focus on Shareholder Value
In the first post,(1) William Lazonick explained how corporations gave up their devotion to societal values to ostensibly focus only on the interests of shareholders:
What went wrong? A fundamental transformation in the investment strategies of major U.S. corporations is a big part of the story.
A generation or two ago, corporate leaders considered the interests of their companies to be aligned with those of the broader society. In 1953, at his congressional confirmation hearing to be Secretary of Defense, General Motors CEO Charles E. Wilson was asked whether he would be able to make a decision that conflicted with the interests of his company. His famous reply: 'For years I thought what was good for the country was good for General Motors and vice versa.'
the U.S. business corporation has become in a (rather ugly) word 'financialized.' It means that executives began to base all their decisions on increasing corporate earnings for the sake of jacking up corporate stock prices. Other concerns — economic, social and political — took a backseat. From the 1980s, the talk in boardrooms and business schools changed. Instead of running corporations to create wealth for all, leaders should think only of 'maximizing shareholder value.'
This was formalized in the the scholarly management literature,(1)
But in 1983, two financial economists, Eugene Fama of the University of Chicago and Michael Jensen of the University of Rochester, co-authored two articles in the Journal of Law and Economics which extolled corporate honchos who focused on 'maximizing shareholder value' — by which they meant using corporate resources to boost stock prices, however short the time-frame. In 1985 Jensen landed a higher profile pulpit at Harvard Business School. Soon, shareholder-value ideology became the mantra of thousands of MBA students who were unleashed in the corporate world.
Ignoring the Interests of Employees: Cost Cutting, Layoffs, Off-Shoring
Maximizing shareholder value only really seems to mean maximizing shareholder value in the short run, often by short-term cost-cutting that will reduce the ability to improve existing or develop new products and services. Hence, now(1)
When the shareholder-value mantra becomes the main focus, executives concentrate on avoiding taxes for the sake of higher profits, and they don’t think twice about permanently axing workers. They increase distributions of corporate cash to shareholders in the forms of dividends and, even more prominently, stock buybacks. When a corporation becomes financialized, the top executives no longer concern themselves with investing in the productive capabilities of employees, the foundation for rising living standards for all. They become focused instead on generating financial profits that can justify higher stock prices....
n the name of shareholder value, by the 1990s U.S. corporations seized on these changes in competition and technology to put an end to the norm of a career with one company, ridding themselves of more expensive older employees in the process. In the 2000s, American corporations found that low-wage nations like China and India possessed millions of qualified college graduates who were able and willing to do high-end work in place of U.S. workers. Offshoring put the nail in the coffin of employment security in corporate America.
Thus, "maximizing shareholder value" was the rationale for a variety of short-term cost-cutting approaches that turned employees (excepting, of course, the hired executives and their favorites) not merely into the makers of widgets, but into widgets themselves. By extension, this attitude that all employees (again, with the exception of top management and their cronies) are interchangeable applied even to highly skilled professional, technical and scientific employees, e.g., research scientists in a pharmaceutical company.
By further extension, as we have noted, health care organizations, including non-profit institutions like hospitals, insurance companies, and academic medical institutions, have been taken over by hired managers who are decreasingly health care professionals. Such hired generic managers have carried the latest fashionable management ideas into health care with them. Thus, in my experience, even experienced academic physicians began hearing that they had no individual value, were interchangeable and could easily be replaced starting in the 1990s.
For organizations that depend on highly trained, dedicated technical, scientific, and/or professional workers, devaluing and demoralizing such employees wold appear to be the height of foolishness.
As Lazonick pointed out in a later post(3), treating workers as interchangeable can be the death knell for innovation:
As is generally recognized by employers who declare that 'our most important assets are our human assets', the key to successful innovation is the extra time and effort, above and beyond the strict requirements of the job, that employees expend interacting with others to confront and solve problems in transforming technologies and accessing markets. Anyone who has spent time in a workplace knows the difference between workers who just punch the clock to collect their pay from day to day and workers who use their paid employment as a platform for the expenditure of creative and collective effort as part of a process of building their careers.
As members of the firm, these forward-looking workers bear the risk that their extra expenditures of time and effort will not yield the gains to innovative enterprise from which they can be rewarded. If, however, the innovation process does generate profits, workers, as risk-bearers, have a claim to a share in the forms of promotions, higher earnings and benefits. Instead, shareholder-value ideology is often used as a rationale for laying off workers whose hard and creative work has contributed to the company’s success. That’s grossly unfair.
A Fallacious Rationale: Only Stockholders at Risk
However, the reasoning, such as it was, behind the "maximizing shareholder value" mantra contained a rationale for so devaluing and demoralizing even the most dedicated and well-trained employees. As Prof Lazonick explained,(1)
Proponents of the Fama/Jenson view argue that for superior economic performance, corporate resources should be allocated to maximize returns to shareholders because they are the only economic actors who make investments without a guaranteed return. They say that shareholders are the only ones who bear risk in the corporate economy, and so they should also get the rewards.
He then went on to easily explain why this was complete rubbish(1):
But this argument could not be more false. In fact, lots of people bear risks of investing in the corporation without knowing if they will pay off for them. Governments in the U.S., funded by the body of taxpayers, are constantly making investments in physical infrastructures and human capabilities that provide benefits to businesses, but without a guaranteed return to taxpayers. An employer expects workers to give time and effort beyond that required by their current pay to make a better product and boost profits for the company in the future. Where’s the worker’s guaranteed return? In contrast, most public shareholders simply buy and sell shares of a corporation on the stock market, making no contribution whatsoever to investment in the company’s productive capabilities.
By Extension, In Health Care, Ignoring the Interests of Patients and the Values of Health Care Professionals
If one believes only stockholders are at risk and hence only stockholders deserve benefit from corporate activities, by extension this eliminates the interests of patients and the values of health care professionals from consideration by the leadership of health care corporations.
Of course, in health care, the patients may be the ones most at risk from corporate activities. For example, think of a patient who pays a large amount out of pocket for a drug that fails to benefit him or her. Worse, patients are not only at financial risk, but are at physical risk. For example, think of a patient who suffers an unusual, but severe adverse reaction to a drug.
In addition, in health care, health care professionals who do not work for a particular health care corporation may be at risk from its activities. For example, think of a physician who is fooled by a pharmaceutical company's manipulation of clinical research into believing a drug is effective and safe when it is actually useless and harmful. We have documented numerous instances of suppression of clinical research, manipulation of clinical research, ghost writing, deceptive stealth marketing, and other tactics used by pharmaceutical, biotechnology and device companies to deceive physicians about the effectiveness and safety of drugs and devices. Physicians who have been thus deceived are at risk of violating their fundamental responsibility to put individual patients' interests first.
Subverting the Mission of Non-Profit Health Care Organizations
As we mentioned earlier, there is ample evidence that non-profit organizations are now most often lead by hired managers who have brought the latest management with them, rather than health care professionals. It is therefore likely that the dominant notion of "maximizing shareholder value" has been operationalized even in non-profit organizations that do not have shareholders.
Most likely it has been transformed into simply maximizing short-term revenue. We have certainly seen many instances of leaders of such health care organizations who seem mainly preoccupied with short-term financial goals. Bad as this is for a public for-profit corporation, it is potentially disastrous for a non-profit organization which is supposed to put upholding its mission ahead of financial concerns (see examples of such mission-hostile management here).
Interests of Shareholders or Interests of Executives?
It is terribly ironic that in practice "maximizing shareholder value" turns out to mean maximizing executive compensation. In retrospect, this mantra looks entirely self-serving. As Prof Lazonick noted in a second post, executive compensation has soared in recent years(2)
When all the data from corporate proxy statements are in within the next month or so, they will show that 2011 was another banner year for top executive pay. Over the previous three years the average annual compensation of the top 500 executives named on corporate proxy statements was 'only' $17.8 million, compared with an annual average of $27.3 million for 2005 through 2007. Yet even in these recent 'down' years, the compensation of these named top executives was more than double in real terms their counterparts’ pay in the years 1992 through 1994.
It might surprise you to learn that in the early 1990s, executive pay was already widely viewed as out of line with what average workers got paid. In 1991 Graef Crystal, a prominent executive pay consultant, published a best-selling book, In Search of Excess: The Overcompensation of American Executives, in which he calculated that over the course of the 1970s and ’80s, the real after-tax earnings of the average manufacturing worker had declined by about 13 percent. During the same period, that of the average CEO of a major US corporation had quadrupled!
We have documented seemingly endless examples of bloated executive compensation in health care.
In fact, as Prof Lazonick noted in his first post(1), by increasing stock prices short-term, executives of for-profit corporations can markedly boost their own compensation,
When a corporation becomes financialized, the top executives no longer concern themselves with investing in the productive capabilities of employees, the foundation for rising living standards for all. They become focused instead on generating financial profits that can justify higher stock prices – in large part because, through their stock-based compensation, high stock prices translate into megabucks for these corporate executives themselves.
The Conspiracy to Increase CEO Compensation
As CEO compensation climbed, they and their supporters have invoked a market-based rationale, as Prof Lazonick described in his third post,(3):
You often hear that stratospheric executive pay is the result of some inexorable law of supply and demand. If we don’t give top executives their multimillion dollar compensation, they won’t be willing to come to work and do their jobs. They are supposedly the bearers of 'scarce talent' that demands a high price in the market place. Even Robert Reich, Secretary of Labor in the Clinton administration and a critic of U.S. income inequality, has justified the explosion in executive pay, arguing that intense competition makes it much more difficult than it used to be to find the talent who can manage a large corporation (Supercapitalism, 2008, pp 105-114).We have provided many examples of similar talking points used to support fat compensation for health care leaders (e.g., here. here, and here).
However, as we described here, the mechanism that executives have developed to set their own pay in line with the supposed market does nothing like that,(3)
That is not what determines executive pay. Here is how it works: Top executives select other top executives to sit on “their” boards of directors. These directors hire compensation consultants to recommend an executive pay package, which consists of salary, bonus, incentive pay, retirement benefits, and all manner of other perks. The consultants look at what top executives at other major corporations are getting, and say that, well, this executive should get more or less the same. Since the directors are mostly these very same “other executives”, they have no interest in objecting – and if any of them were to do so, they would find that they are no longer being invited to sit on corporate boards.We have discussed similar mechanisms at work in health care, for example, here.
Meanwhile, given the preponderance of stock-based compensation (especially stock options) in executive pay, whenever there is speculative boom in the stock market, top executives of the companies with most rapidly rising stock prices make out like bandits. The higher compensation levels then create a 'new normal' for executive pay that, via the compensation consultants and compliant directors, ratchets up the pay of all the top dogs. And, when the stock market is less speculative, these corporate executives do massive stock buybacks to push stock prices up.
What we have here is not 'market forces' at work but an exclusive club that promotes the interests of the 0.1%. All too often executives allocate corporate resources to benefit themselves rather than to invest in innovation and job creation.
In other words,
almost unanimously, corporate executives proclaim that they run their companies for the sake of shareholders. In fact, their personal coffers pumped up with stock-based compensation, our business 'leaders' have increasingly run the corporations for themselves.
Were contemporary management of health care be only based on maximizing shareholder value or short-term revenue, that would be bad enough. However, it appears that it is really based simply on maximizing executive compensation. Health care, and our society as a whole has been turned into something like a feudal state, in which hired managers have become the new aristocracy.
The Rise of the Generic Manager
The likelihood that "maximizing [supposed] shareholder value" would lead to bad ends is increased by the decreasing likelihood that the managers who set out in this direction would know anything about the specific context in which they were working or other goals they ought to attempt. As Prof Lazonick pointed out, even before the rise of the "maximizing shareholder value" mantra,(1)
The beginnings of financialization date back to the 1960s when conglomerate titans built empires by gobbling up scores and even hundreds of companies. Business schools justified this concentration of corporate power by teaching that a good manager could manage any type of business — the bigger the better.
This was the notion of the generic manager. In health care, generic managers who have little specific health care knowledge or experience, and little understanding of or sympathy for the values of health care professionals might be particularly ruthless about putting short-term financial goals ahead of everything else.
On Health Care Renewal, we have focused on problems with health care leadership and governance. We have discussed the rise of generic managers, a focus on short-term revenue sometimes leading to mission-hostile management, the perverse incentives generated by executive compensation that is unrelated to achievement of the health care mission's goals, lack of executive accountability, and sometimes executives' complete impunity. It now appears that health care's leadership and governance problems simply reflect larger problems in the society as a whole.
Maybe it should be a relief that we in health care are not uniquely cursed. However, the immensity of the problems faced by our society as a whole will not make it easier to solve the problem of health care dysfunction.
I do feel better that our focus has been correct. Furthermore, I feel more confident asserting once again that true health care reform would put in place leadership that understands the health care context, upholds health care professionals' values, and puts patients' and the public's health ahead of extraneous, particularly short-term financial concerns. We need health care governance that holds health care leaders accountable, and ensures their transparency, integrity and honesty.
Maybe realizing that health care's problems are a part of society's problems will lead to more support for their solutions.
1. Lazonick W. How American corporations transformed from producers to predators. Naked Capitalism, April 2, 2012. Link here.
2. Lazonick W. How high CEO pay hurts the 99 percent. Naked Capitalism, April 3, 2012. Link here.
3. Lazonick W. Three corporate myths that threaten the wealth of the nation. Naked Capitalism, April 6, 2012. Link here.
4. Parramore L. Capitalism's dirty secret: corporations don't create jobs, they destroy them. Naked Capitalism, April 5, 2012. Link here.