Among the many myths of mainstream economics—that asset prices reflect all available information, that workers are paid their marginal contribution, or that markets will “clear”—there is one myth so pervasive that it has crept into the everyday speech of even those who work in critical finance and labor: the idea that shareholders are investors. The misidentification of buying and selling financial assets with productive investment in goods-and-services production is not only conceptually confused; it also has the pernicious effect of supporting shareholder primacy, the idea that the purpose of all corporate activity should be to the benefit of shareholders. It is time that our language adapts to reflect the economic realities of the 21st century: shareholders of corporations whose equity trades on the stock markets are no longer “investors,” and the financial assets that they hold are no longer “capital.”
Shareholders are not Investors
The idea that shareholder “investment” is necessary for corporations to produce stems from early industrialization and is, to some extent, still how companies without publicly-traded stock find financing (although bank and non-bank lending is how most small businesses finance themselves). In the 21st century, however, calling shareholders “investors” completely confuses the difference between real investment that companies do to improve their production process and the trading of stock on the financial markets. We must be clear that those of us holding financial assets intermediated by complex chains of financial institutions are not contributing anything that improves production to companies. Instead, we hold these assets to build our own wealth—usually, for the non-wealthy among us, for retirement.
Retirement funds held 9.6 trillion in financial assets as of the end of 2020. These are the funds that move from a person’s paycheck withdrawal or individual contribution to a fund manager into funds that hold portfolios of stock, bonds, and other financial assets. For most of us, we hope that, once we reach retirement age, the assets we parted with earlier in their life will be worth enough in the financial markets to sustain our well-being. What happens to that money before we use it again is largely a mystery.
Colloquially, we call this process “investment,” which suggests that the money that you and I are saving turns into resources that are useful in the production processes of goods and services-producing companies. Today, however, the shares of publicly-traded companies are traded on the financial markets, and the money that we use to buy shares from share-sellers does not reach the company—it goes to the person or institution from who we buy the shares. The only way money reaches the company is when they issue share directly, whether through an IPO or a secondary issuance. This means that the only Apple shareholders today who contributed funds to the company were the purchasers of Apple shares in its $97 million IPO in 1980. For the past two decades, companies on U.S. stock markets have been repurchasing their own shares at a higher volume than they have been issuing new shares—which means that funds are flowing from companies to share-sellers, not the other way around.
So where do large, publicly-traded corporations get the resources they need for investment? Institutional economists like Bill Lazonick have documented how much of the financing for improving productivity has come from retained earnings. Properly speaking, then, shareholders are not investors because they are not providing the assets used to improve the innovative potential of a business enterprise.
Although we have entered the age of asset manager capitalism, in which asset managers hold legal title to shares whose beneficiaries are many institutional steps away, the confusion over the role of shareholders in the corporation is not new. Even Adolf Berle, whose The Modern Corporation, published in 1932, is often misread as arguing for shareholder primacy, pointed out that in the 1950s, sixty percent of real investment had come from retained earnings, while just six percent came from new equity issuances. As William Bratton and Michael Wachter explain,
Stock exchanges no longer served primarily as places for new investment and capital allocation, traditional functions only implicated in the rare instance of a new issue of common stock. The markets instead served as mechanisms for investor liquidity, a service provided for the benefit of the original owners’ passive grandchildren or the transferees of their transferees. The connection to capital gathering and productive allocation was for the most part psychological (p. 32).
The Pernicious Effects of the Myth
While “shareholder” and “investor” are, of course, just words, there are real stakes to clarifying the nature of the relationship between shareholding and investment. The perspective of shareholders as the most important actor in corporate decision-making drives economic inequality and the racial wealth gap, as it perpetuates the myth of shareholder primacy—and along with it, the idea that corporations should prioritize spending billions on stock buybacks and dividends in order to reward this most deserving group of its stakeholders. To understand the link between this conceptual and normative mistake, it will be helpful to say a bit about the standard justification for shareholder primacy.
Shareholder primacy defines the purpose of corporations as maximizing shareholder wealth, rather than producing goods and services for the benefit of multiple stakeholders. Shareholders, according to this view, should be given both power over decision-making and distribution. Why might one think this? Within the perfectly-competitive markets-based view of corporations, shareholders are hypothesized to be the only stakeholder group contracting within the firm that takes a certain kind of variable risk. In this view, employees, management, and bondholders have a “fixed” contract with a corporation, while shareholders buy corporate equity with no security of returns. Therefore, they have the best incentive to hold management accountable, as they have the most to gain and the most to lose. I have written on this blog and elsewhere about the myriad flaws of shareholder primacy, both in theory and in practice, and how the theory of innovative enterprises is a much better framework for understanding the social conditions necessary for innovation and production.
My central point here, however, is how this framework is illicitly given support by the misidentification of shareholding with investment. Today’s shareholders do not “take a chance” based on knowledge of industry or business prospects—the dominance of index funds and theories of safety based on diversified portfolios mean that no one but the extremely wealthy, or those gambling on Game Stop, has any idea what publicly-traded corporate stock they own. Yet we—even those engaged in critiquing the financialization of the economy—too often still refer to shareholders as “investors,” and speak of corporations “returning” or “paying out” money to shareholders. By doing so, we adopt a framework in which companies can spend $6.3 trillion increasing their own share prices in the 2010s, receive government funds during the pandemic, and then brag about raising consumer prices in 2022—as long as we have collectively bought into the myth that shareholders are “investors,” these choices make sense, since shareholders are the deserving recipients of corporate profits.