The question is no longer: are dispersed outside shareholders a bad way of organizing firm ownership? That’s clear. Instead, it’s: if publicly quoted firms are in theory so inefficient, why have so many thrived for so long?
This paper (pdf) by Raghuram Rajan and colleagues (via Brad DeLong) gives an answer: it’s because control over chief executives is exercised bottom-up, by key workers, rather than top-down, from shareholders.
Imagine a selfish CEO approaching retirement. He wants to get as much cash out of the firm as he can, and shareholders provide no discipline over him. Sounds like a recipe for catastrophe?
Not necessarily. In order to maximize revenues, and hence his own opportunities for rent extraction, the CEO needs his subordinates to work hard. But they won’t do this if they think the CEO is out only to maximize his own short-term rewards at the expense of the health of the company, because they‘ll believe the firm has no future.
In order to motivate them, he’ll have to invest in growing the firm, to give key employees the hope of big rewards in the future. In this way, even a selfish, short-termist CEO can be coerced into acting in the long-term interests of the firm.
And efforts to increase shareholders rights - say by paying big dividends or by getting more activist owners - might be counter-productive. Subordinates’ might reduce their effort if they think shareholders are depressing growth prospects. And shareholder control over a CEO might be a poor substitute for de facto workers’ control, as the latter know more about the firm.
(...)
There is, though, an obvious question here. If quoted firms thrive to the extent that they act a little like co-ops - by giving (some) employees (some) de facto control, why shouldn’t this arrangement be extend and formalized?
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