The rise of the shareholder oriented corporate governance in the US
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Course
International Corporate Governance
Institution
Loughborough University (LU)
This document will illustrate the origin of the shareholder system that took place in the US as long as other important historical events that created today's system of governance. Those notes are backed by the journal article written by Lazonick and O’Sullivan (2000) called "Maximizing sharehold...
Maximizing shareholder value: a new
ideology for corporate governance
(Lazonick and O’Sullivan, 2000)
The Origin of Shareholder Value
The arguments about creating value for shareholders came in the United States in
the late 1980s. While making tremendous profits, the large sized organisations
allocated the profits according to the governance principle of ‘retain and reinvest’.
The corporations both retained the money made and the human resources and
reinvested in physical capital and on the people employed.
In the late 60s and 70s, the principle of ‘retain and reinvest’ ran into some
impediments. Due to the large expansion of the corporations by developing plants
across different geographical areas, the central offices were too far from the
manufacturing sites that could develop an informed strategy to allocate the
resources according to the principle. The rapid growth of corporations in 60s turned
into a poor performance 70s, taking into account the unstable macroeconomic
environment and the rise of competition from Japan.
The competition from Japan came in the automobile, electronic, electronic in
machinery and consumer electronics industries. This competition arose from the
development and utilization of integrated skills that were broader than what US
corporation invested in (Lazonick,1998). Unlike Japan, US used its managerial
resources to place its focus on making the working production unable to control the
work and pay.
US companies also tended to favour suppliers and distributors who would provide
goods and services at the lowest price today, even if it meant that they were not
engaged in innovation for tomorrow (Lazonick and O’Sullivan 1997).
During the 1970s, the shareholder’s value found its new source of power – the
institutional investor. The transfer from stockholder to institution created mutual
funds, pension funds or life insurance funds that gave more power to the
shareholders to influence yields and market value by owning the corporate stock.
During the 50s and 60s there were legal limitation about what corporate equities can
be introduced in pension or life insurance funds, but in the late 70s major changes
took place and those promoted the presence of corporation in the mentioned
portfolios.
In 1970, because of the oil-induced inflation, the struggle of the US government to
manage its financial institution and their assets to generate adequate returns, turned
into a deregulation of the American economy. Moreover, in the same period, the
, banking sector experienced a deregulation as well, which was created by the money
market funds that were able to offer higher interest rates on the saving deposits that
the other regulated banks. In 1978 the government intended to help the bank by
deregulating interest rates that commercial and saving banks could afford to pay the
interest promised and charge loans.
From ‘retain and reinvest’ to ‘downsize and distribute’
junk bond – a corporate or government bond that the bond-rating agencies
considered to be below ‘investment grade’.
Michael Milken – the inventor of junk bonds who convinced financial institutions to
buy and sell them (Bruck 1989: ch. 1).
In the early 70s, only the mutual funds were willing to take part in the junk bonds
activity. But financial deregulation attracted over the next decade the pension fund
and insurance companies, and later the S&Ls (Savings and Loans Institutions) into
the junk bonds market.
Late 70s – it became possible to issue new junk bonds, finance management
buyouts of divisions of corporations, a way of correcting the mistakes created in the
late 60s by the conglomerate movement to reduce the burdens of the companies left
with too much debt.
Early 80s and even after – S&L enter the market and used junk bonds to launch
hostile takeover.
The result of the creation made by Michael Milken was a powerful market control.
Lay-Offs & Downsizing
The corporations become better and better at creating shareholder value, even after
the stock market crash that happen in 87’, there was an accelerated recovery and
the principle of ‘creating shareholder value‘ gained more appeal.
In the run of creating shareholder value, managers adopted a different approach to
‘retain and reinvest’ and considered reducing the labour force and make internal
restructures to increase the return on equity. This happened mostly to the blue-collar
works, people who used physical tools performing manual activities. During 79’ and
83’ the people employed in the whole economy of the US increased with 0.4%, while
the employment of the blue-collar workers decreased by 15.9% (U.S. Congress
1992: 344).
From the end of the period mentioned before until 87’ there were 4.6 million of
employees who lost their job, 40% of them were from manufacturing industries.
(Herz 1990: 23; more generally, see Staudohar and Brown 1987; Patch 1995)
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