ACSBlog: The Blog of the American Constitution Society

by Kent Greenfield, Professor of Law and Law Fund Research Scholar, Boston College Law School

Editor's Note: To read more of Professor Greenfield's progressive view of corporate law, see his book, The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities.

Last Tuesday, I returned from my 75-minute Corporations class to find that the stock market had plummeted by over 200 points while I was teaching.  Its loss for the day was over 400 points, 3% of the market’s value.  As of this writing two days later, the market seems to have stabilized a bit, but not before many on Wall Street refilled their prescriptions of anti-anxiety meds.

Market watchers rushed to explain the drop.  While some theories posit that it was caused by increasing fear of recession, most analysts seem to be saying that this drop was brought about more by the panic of the herd than by anything in the underlying economic fundamentals.  According to the Wall Street Journal, many investors have been putting their money in increasingly risky investments, with the concomitant increase in nervousness.  In such a situation, any sign of market retreat will cause a rush to sell, adding momentum to any panic.  That, at least in part, was what apparently happened on Tuesday.

Does such volatility really matter?  Most people in America make money through wages rather than stocks, of course, so the day-to-day market volatility is mostly a concern of the well-to-do. Over thirty percent of the stock market is owned by the richest one-half of one percent of Americans; the bottom 80% of us own less than 6% of the market, if you don’t count pensions.  Even those of us with pensions and 401(k) plans arguably aren’t hurt that much from the kind of blip that happened on Tuesday, since we are holding those investments for the long term.

But that of course is the problem.  For most Americans, the long-term health of the companies we work for and the fundamental strength of the economy are the most important things that determine our financial well-being.  But companies – and their management – are increasingly under pressure to focus primarily on the short term, and to measure that short term by stock price.  Shareholders are taught to expect high returns quarter to quarter, and if they don’t get them they get out.  (The average stock turnover for Fortune 500 companies is over 100% a year.)

This “short-termism” creates a gladiatorial culture among senior executives, reflected by a penchant for risky acquisitions and in grossly inflated pay.  I think it is fair to say that as senior management becomes more and more concerned with what Wall Street thinks, they care less and less about Main Street.  How could they not?  Ten years ago, a typical CEO worked half a week to earn what an average worker earned in 52 weeks.  Now, it takes a CEO less than a day.

This short-termism also makes it difficult to run a company with a long-term focus, paying attention to the company’s non-shareholder stakeholders.  If there are short-term costs to such a managerial style, as there often are, the company instantly becomes a target for takeover.  Companies with anything approaching a conscience are squeezed out of the market.

If I am right about all this, part of the problem is the underlying legal framework, which establishes the shareholders as the only stakeholder that matters, and which offers management incredible discretion in how to serve them.  Management is not required to listen to anyone other than their shareholders.  The other principal stakeholders – employees, creditors, and communities – are left to their own devices to protect themselves. 

I find it hard to believe that society as a whole benefits from this rule.  If we valued stability and long-term growth rather than volatility and short-termism, we could choose to have a different legal framework.  A legal framework, for example, that required management to owe enforceable fiduciary duties to employees would encourage companies to build human capital as well as financial capital.  A requirement, for example, that major companies include non-shareholder stakeholders on their boards of directors would help ensure the company is not producing earnings simply by externalizing costs onto workers or communities.  Such participation would also lengthen the relevant time horizon for decisions – most employees hope to be in their jobs longer than shareholders hope to own their shares.

In any event, it’s worth noting that the stock market tumble of last Tuesday was not a random occurrence.  It is a symptom of the kind of market we have chosen.  We could choose differently.