Leo Strine’s Corporate Decline Problem

Leo E. Strine, Jr. has long had a bully pulpit in corporate law, first on Delaware’s Court of Chancery and then as chief justice of the Delaware Supreme Court.  Bully pulpits are good things for the occupants but can be a bit infuriating for those in the congregation. Such is the case with Chief Justice Strine’s recent article, “Toward Fair and Sustainable Capitalism.”[1]

Strine argues that companies are too beholden to stock markets, fail to make long-term investments, and fail to share gains between shareholders and workers. He provides a list of proposals that are fairly characterized as arguing for a shift of value from shareholders to workers, both in terms of job security and higher compensation. All of these proposals veer far from Delaware’s current directive that boards of directors must “maximize the corporation’s value over the long-term for its stockholders’ benefit.” But nothing that Strine suggests can overcome a cold reality: Looking to corporations and their investors to solve society’s problems is futile because corporations rarely live long enough or generate enough value to turn Strine’s dream into a reality.

Since even before E. Merrick Dodd was at Harvard Law School in the 1930s, there have been those who wanted more from corporations than the products and services they provide.  As Professor Dodd put it, “public opinion, which ultimately makes law, has made and is today making substantial strides in the direction of a view of the business corporation as an economic institution which has a social service as well as a profit-making function[.]”[2]

In 1991, Martin  Lipton, founder of law firm Wachtell, Lipton, Rosen & Katz,  wrote that “the legal rules, the system of corporate governance, should encourage the ordering of these relationships and interests around the long-term operating success of the corporation. For it is this goal that will ultimately be the most beneficial to the greatest number of corporate constituents, including stockholders, and to our economy and society as a whole.”[3]

Compare Strine: “The bottom line is that America’s corporations are not playthings. They create jobs, produce goods and services that consumers depend on, affect the environment we live in, and build wealth for human investors to save for retirement and their kids’ education. That is, corporations are societally chartered institutions of enormous importance and value. Those who govern them ought to be accountable for the generation of durable wealth for workers, consumers, and human investors.”[4]

The problem with this debate is that, even when they try to maximize shareholder value, most corporations – including successful ones – eventually go out of business. Sometimes they simply weaken and then merge into other companies; sometimes, though less frequently, they declare bankruptcy and liquidate.  This is nothing new. In 1948, U.S. Steel Corporation was the third largest U.S. industrial firm by total assets. In 2009, after many changes, U.S. Steel was still included in the S&P 500 Index, the most important index of large U.S.-traded firms.  In 2014, though, it was removed from the S&P 500 because its stock-market value had fallen too much. By year-end 2018, U.S. Steel barely managed to stay in the Top 1,000 U.S.-publicly-traded firms, coming in 976th.

Still, U.S. Steel was better off than Bethlehem Steel Corporation, the 12th largest U.S. industrial firm by total assets in 1948. Bethlehem Steel filed for bankruptcy in 2001 and liquidated its assets.  Many of us of a certain generation grew up with Radio Corporation of America (RCA) televisions. RCA was in the top 100 industrial firms by assets in 1948. In 1986, General Electric acquired RCA and soon liquidated its assets.  F.W. Woolworth Co. and Montgomery Ward & Co. were nationwide retailers in the top 100 industrial firms by assets in 1948. You likely could not find an adult American in the 1960s, 1970s, or 1980s who did not recognize both as the names of large U.S. retailers. Then Woolworth closed its stores in 1997. Montgomery Ward filed bankruptcy in 2000 and liquidated in 2001. If you were born after 1990, you may never have heard of either one.

Today’s winners are often tomorrow’s losers. In 2001, when retailer Montgomery Ward liquidated, Sears Roebuck & Co. was over a century old, with a stock-market value over $15 billion. Sears shareholders earned a whopping 40.1 percent, inclusive of dividends, that year.  Less than 20 years later, on October 15, 2018, Sears’s successor, Sears Holdings, filed for Chapter 11 bankruptcy protection, its equity and much of its debt wiped out, its retiree pensions left partly unpaid. In the end, a company that once paid out billions of dollars in excess cash to its shareholders could not even pay the full administrative expenses of its own bankruptcy proceedings. For U.S. firms listed on the New York Stock Exchange or the American Stock Exchange between January 1963 and December 1995, only about 6 percent of the firms traded for the entire 33-year period;  over 55 percent of the firms delisted.  A 2014 study from J.P. Morgan found that, between 1980 and 2014, 320 companies were taken out of the S&P 500 because of business distress. To take just one year, of the 500 firms represented in the year-end 2009 S&P 500, six filed for bankruptcy by late-2019. Many others were removed from the index because their stock-market capitalizations had declined too severely to warrant continued inclusion in the S&P 500.[5]

Recent empirical evidence has demonstrated just how rare long-term corporate success really is, even under current corporate law.  In 2018, financial economist Hendrik Bessembinder of Arizona State University published[6] a remarkable discovery: The majority of U.S. publicly listed common stocks since 1926 returned less than the one-month Treasury bill rate over their lives as listed companies, including dividends. But what about the great gains in the stock market? It turns out that just 4 percent of publicly listed U.S. companies accounted for all of the gains of the U.S. stock market from 1926 to 2016. As two economists put it in a colorfully titled article, Survivorship and the Economic Grim Reaper, “firm death is not an unusual or aberrant phenomenon, but a common feature of a capitalist economy.”[7]

The social utopia Chief Justice Strine longs for can never be built on such a shifting foundation. Every major corporation traces its existence to some initial effort to seize a specific, promising profit opportunity. Those early opportunities rarely last. Competitors emerge. Times change. New technologies replace old ones. It is hard to innovate and compete over and again for decades. Despite platitudes to the contrary from both sides of the political spectrum, capitalism presents a choice: (1) allow investors to move capital freely into and away from businesses as shareholder-value maximization dictates, but then bear consequences in the form of lost jobs, failed careers, and destroyed communities along with the starts of new businesses, or (2) restrict the ability of investors to reduce the scale of declining business entities, encourage reinvestment and research in unproductive and obsolete businesses to save jobs and preserve communities and tax bases, but suffer the consequences of stagnated growth, reduced competitiveness, and lower future prosperity for those who would have benefited from easier exit. There is no way between the horns of this dilemma.  And since every nation’s businesses competes with those from other nations, the second choice is viable only in the shortest of time frames.

The reality of corporate decline means that corporations are simply not good vehicles for implementing social policies like reducing deep poverty,  achieving income equality,  slowing climate change (unless customers are willing to pay for it), cutting the cost of medicines, or providing basic health care. Corporations will not voluntarily exit harmful industries like tobacco, alcohol, or casinos or stop providing bad financial advice and products, and if they do, others will simply take their places. Capitalism has done more to lift humans out of deep poverty than any other system by far. But that is not its purpose, and there will always be many problems left unsolved in a vibrant capitalist system unless government intervenes efficiently.

No doubt a vibrant capitalist system is cold comfort to a dislocated worker, an officer or director whose business judgment is no longer bearing fruit, or a community ravaged by the close of its largest employer.  Strine’s sympathy for those who do not share in capitalism’s benefits as much as others is clear, but his proposals are just the latest in the on-going – one might argue by this point, tiresome—debate over the proper objective of the business corporation. If we are to make headway on these problems, we must look elsewhere than Chief Justice Strine’s proposal, which takes the corporation as he wishes it could be, not the way it is in the dog-eat-dog world of competition outside judicial chambers.

ENDNOTES

[1] Leo E. Strine, Jr., Toward Fair and Sustainable Capitalism: A Comprehensive Proposal to Help American Workers, Restore Fair Gainsharing between Employees and Shareholders, and Increase American Competitiveness by Reorienting Our Corporate Governance System Toward Sustainable Long-Term Growth and Encouraging Investments in America’s Future, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3461924.

[2] E. Merrick Dodd, Jr., For Whom Are Corporate Managers Trustees?, 45 Harv. L. Rev. 1145, 1148 (1932).

[3]  Martin Lipton & Steven A. Rosenblum, A New System of Corporate Governance: The Quinquennial Election of Directors, 58 U. CHI. L. REV. 187, 189 (1991).

[4] At p. 4.

[5] Results for 2009 to 2018 calculated by the writer from data at Bloomberg.

[6] Hendrik Bessembinder, Do Stocks Outperform Treasury Bills? 129 J. Fin. Econ. 440 (2018).

[7] G.P. Baker and R.E. Kennedy, Survivorship and the Economic Grim Reaper, 18 J. L. Econ. & Org. 324, 324 (2002).

This post comes to us from J.B. Heaton, the president of legal and financial consultancy J.B. Heaton, P.C.

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