In an interview with ProMarket, Nobel laureate Oliver Hart explains why broadening our perspective on fiduciary duty beyond maximizing shareholder wealth could empower individual investors to vote for their preferred social outcomes.
Will society be better or worse if Elon Musk is permitted to purchase Twitter and take it private? Some think Musk will find a way to abolish the trolls and bots, others think the result will be widespread misinformation that further deepens political divides.
In all likelihood, it doesn’t matter. The takeover will be approved because of the obligation to maximize profit, and Musk has offered to pay a healthy premium for the platform.
A new paper by Oliver Hart and Luigi Zingales explains why the laws, norms, and economic models that insist companies should maximize shareholders’ pocketbooks are not necessarily compatible with investors’ desires. Investors should be given the option to pursue slightly less profit when the tradeoff is better social outcomes, but fiduciary duty often prevents this choice.
The paper follows prior work by Zingales, Hart, and Eleonora Broccardo that looked at ways shareholders may choose to engage or divest from companies in order to attain the social outcomes they want. The pair also wrote that the purpose of a company needn’t only be to make money.
[The following interview has been edited and condensed for length and clarity]
Q: What is the shareholder welfare maximization model that you propose with Luigi Zingales in your newest paper?
Well, the basic idea is to recognize that shareholders are ordinary people who care about money, but also about other things, as we all do. So when it comes to what they would like their firms to do, it’s just a mistake to think that they always want the highest amount of profit or the highest stock price. That would be true if they only cared about money, but to the extent they care about other things, and to the extent that the firms they own can actually achieve some of the things they care about, then their perspective is going to be broader.
So shareholder welfare is just saying, in loose terms, let’s maximize the utility of their shareholders. The firm can’t maximize each person’s utility, but it can maximize the sum of their utilities and sort of aggregate their preferences. That’s what shareholder welfare maximization means. It means aggregating the preferences of shareholders taking into account that it’s not just about money.
Q: How does this apply to the case of Elon Musk buying Twitter?
The current situation is that the board, after being sort of resistant, accepted the bid. And so this looks like an agreed-on sale, but it’s going to have to go to the shareholders for final approval. It seems to be taken for granted that because the bid is attractive financially, obviously it’s going to go through because everyone’s going to vote for it. That’s sort of the implicit assumption: that it’s now a done deal.
There doesn’t seem to be any notion that maybe the deal could fail at this final stage. For most individual shareholders of Twitter, their shareholding is going to be really, really small. Because of index funds, their wealth is spread very thin, over many companies, so their actual shareholding in Twitter is going to be negligible.
But if they’re going to vote, they may as well vote for the outcome they want. So they should be thinking to themselves: do I want Elon Musk to own Twitter or don’t I? Now the benefit is that he’s offering significantly more than the shares were worth before. So there’s a healthy premium. But because I have such an incredibly small shareholding, the amount I will get from that premium is, well, we’re talking about cents. So, from my point of view, if he wins, I made a few cents.
But on the other hand, maybe I think that Musk owning Twitter is going to be bad for the world. Or I might think it’s good for the world. Depending on the kind of person I am, when I put aside the financial side, I might think this is a great loss for humanity or a great gain for humanity or anything in between. If I could really determine the outcome, the social side of whether it’s good or bad for the world for Musk to own Twitter, that’s going to dominate over the financial impact for me, which again, is just a few cents.
So that’s an example of shareholder welfare. In this case, I guess what we’re saying is the best way for the shareholders to make their utilities felt, or their total feelings about the bid felt, a pretty good way is through a vote. You could imagine that they might vote against Musk, just because the social side would be a negative for them and would dominate the financial side for each individual shareholder.
Q: When you describe it in this way, it makes one wonder how we got to a place where we thought everyone would only choose to make decisions that increase their financial outcomes. I wonder if you could talk a little bit about the context and why economists haven’t always taken these welfare decisions into account?
That’s a great question. Luigi and I, in our paper, talked about how jurisprudence has pushed us in the direction of only looking at the financial side. But I can speak for myself: my views have changed.
A few years ago, I would have accepted the Milton Friedman view, which is that people care about more than just money but the way to get these other things, the social things into the picture, should happen either by individuals doing good works or by the government, choosing the appropriate tax policy, let’s say. But the view was that for-profit companies, that’s not their business. Their business is just to make as much money as possible and then their shareholders, who are now wealthier, can use that wealth to do good things, if that’s what they want to do.
That logic seemed to make a lot of sense to a lot of people including myself. It’s also an attractive position, because it means that you keep politics out of corporate life because corporate life is just about making money.
The issue that economists and lawyers and people in finance have been concerned about for decades now is the principal-agent problem: shareholders want to be as wealthy as possible, but managers may have their own goals, and how do we align the preferences of managers with shareholders?
The only problem is, maybe because it was so attractive, people didn’t really think about it deeply enough. That’s the only explanation I can come up with. As I say, I myself did not think deeply enough about it.
At some point Luigi and I realized there are just some obvious cases where companies have a comparative advantage in making the world a better place. We’re not the only people who’ve realized this. Although the other people who have also realized it have been pretty quiet about it so the message has not been loud and clear and has not been received.
One of our favorite examples, which we have in our exit-versus-voice paper is DuPont, which had the choice of polluting the Ohio River, or using an incinerator to avoid the pollution, and incineration was more costly. This was back in 1984. So you could look at the cost of incineration, which was I think $19 million in 1984 dollars. The cost of the pollution in terms of illness and death was, I think, $350 million. So, this is a case where a profit maximizing company would just choose to pollute, because they don’t want to spend that 19 million. And that’s in fact what DuPont did.
But it seems obvious that a socially responsible owner of DuPont might say: wait a minute, I’m not comfortable making that extra $19 million at the cost of $350 million to society, I don’t think it’s worth it. And in fact, what becomes particularly compelling is if you think about a diversified shareholder who has half a million dollars invested in the stock market today. They would own a hundred-millionth of DuPont. So if they’d been asked about this decision, they would be looking at a cost of about 19 cents. So such a shareholder would be saying to herself: if the company incinerates, I lose 19 cents, but society gains $350 million in terms of the reduced deaths and illness. Now, how many people wouldn’t be willing to make that trade off? That’s our argument.
This seems a very clear example where the company is in a unique position to do the right thing. It’s not something that the government is probably going to get right because they probably weren’t even thinking about this issue. It’s also not something that shareholders can undo with their increased wealth: they can’t use that extra $19 million that they’ve got now because the cost of cleaning up the mess would far exceed the $19 million. So the thing is, DuPont is in a unique position to do the right thing: it has a comparative advantage in avoiding the pollution.
Once you start recognizing that there are tons of cases like that, you realize this separation idea, where companies can just make money and then the rest of society can do good things, it just breaks down. I don’t know why people haven’t seen that. I think it’s just because it was so convenient, this separation, that they just didn’t really look hard enough.
Q: Can you go into the particulars of how this works in reality?
Right. That’s important, because in fact, I think that also explains why the situation persisted and also why the scenario I described where the Twitter shareholders actually vote against the bid is unlikely to happen: most of the voting will be done by institutions. And institutions have taken the view that they have a fiduciary duty to their investors to act in a way that maximizes financial return. This has been the mental approach they’ve all had, and it’s been backed up by the law.
If you look at it that way, then the vote on Musk is a no brainer: he’s offering more money. Vanguard’s fiduciary duty, or State Street or BlackRock’s, is to vote for the bid. That’s their straight jacket, and I think we should take the straight jacket off. Institutions should realize that their fiduciary duty should be interpreted to mean acting in the interest of investors. So if our own investors don’t just care about financial return, then we’re actually being disloyal to focus entirely on it. But that’s a hard sell.
Q: If you could implement anything you want on this front, what would you change and what result would you expect to see?
I would like to see fiduciary duty rethought: I would like it to be thought in a broader way to be about more than financial return. Institutions could behave more flexibly, they can delegate voting to their own investors: instead of saying, you hold your shares with us but we’re going to vote them for you, institutions should ask shareholders to vote, or to tell them what principles they would like the institutions to use when voting.
One of the problems with relying on individual shareholders to vote is they may just not bother. There are a lot of votes that come up and individuals may end up being completely overwhelmed with all this voting they’re meant to be doing and may just ignore things, which is what I think typically people have done. But that’s also partly because a lot of the things they were being asked to vote on were very boring things. Some of these environmental things I think are much more interesting, like the Musk bid.
One way you can relieve the burden on individual small shareholders is to ask them to select one of these guidelines, that Institutional Shareholder Services (ISS) has come up with. It could be a faith-based thing, or a pro-labor thing, or pro-environmental thing. You could say in advance: these are the things I care about and so I would like you to vote my shares taking those things into account.
Another way to go is for new funds which announce their voting intentions. So you would have a Vanguard fund which indicates the kind of trade-offs they’re willing to make in their voting. If you like that idea, then you would put your money with that fund that in other respects would be like any index fund. It could hold the S&P 500, let’s say, but it would have announced its voting intentions.
A lot of investment is through retirement funds and there are special restrictions which are enshrined in the ERISA laws. The effect of those is that it’s very difficult for an institution like Harvard, say, to select an engagement fund for Harvard faculty. Even if we decided we want to invest in a fund that may vote to reduce financial return when there’s enough of a social benefit, that falls foul of the ERISA laws. The ERISA law says that when it comes to retirement, you have to be attempting to maximize financial return and the people who organize Harvard retirement plans could be in trouble if they offer this as part of the menu.
That’s the way the law is structured, which seems crazy, because surely Harvard faculty, or staff, are smart enough to make these decisions themselves. Surely you should have the right to put your money where you want to. But the current law, as I understand it, makes that impossible.
Think of companies that spend money on lobbying or political contributions to make regulation of themselves less likely. Let’s say they’re lobbying against regulations about climate change and meanwhile, their shareholders might care a lot about mitigating climate change. This is actually directly going against what their shareholders want and who, if they were asked, they would say no to it.
If shareholders could express their opinion about non-financial things and about how important those things are to them, the result of that could be, and this may sound optimistic, but it could be a better world.