Stock markets of the kind we recognise today owe their existence to the development of railways in the 19th century. Railways were large, capital intensive businesses, and their physical assets were specific to their particular purpose. There is little you can do with a railway except run trains on it. The funds required were raised from a wide group of relatively affluent private individuals. The stock market both provided a focus for the raising of funds for railway construction and allowed secondary trading so that savers could realise their investment without disturbing the train timetable.
This model was successfully extended to the large manufacturing corporations which were at the centre of the industrial landscape for much of the 20th century – breweries, automobile plants, petrochemical installations. The shareholders provided the plant, the workers operated it, the managers oversaw the process.
But this does not describe the typical corporation of the developed economy of the 21st century. Business is no longer capital intensive. Apple is today the largest corporation in the world with market capitalisation approaching $600bn, but owns operating assets valued at less than $20bn, and is typical of the ‘new’ companies that have come to dominate the global economy in the last two decades. Such capital as these businesses do use is largely fungible – it need not be owned by the business which operates from it, and typically is not. Apple’s flagship store in Regent Street is jointly owned by the Queen and Norway’s sovereign wealth fund: on behalf of the citizens of the UK and Norway respectively (the profits of the Crown Estate are ceded to the Treasury). Such is the nature of capital, and capital ownership, in the modern economy.
Modern businesses are typically cash generative at a much earlier stage of their lifetime. When they come to market – and some are querying the need to do so – it is to provide a liquidity event for early stage investors and for employees rather than to raise funds for new investment. And established companies, too, are increasingly “capital light”. Even large oil companies, with large exploration and development programmes, earn more than sufficient from their operations for their needs: the value of repurchased shares in ExxonMobil’s treasury exceeds the value of its operating assets. In both Britain and the United States, amounts taken out of the market through share buy-backs and acquisitions for cash have exceeded the amounts raised through new issues over the last two decades. The stock market is no longer a means of putting money into companies, but a means of taking it out. This is not an unworthy or economically undesirable function, but it is different from the market’s traditional role.
At the same time as business has changed, so has the nature of savings and the channels through which these funds are directed. Outside the United States (and to an increasing extent even in that country) household savings are institutionalised. Two decades ago, UK equity markets had become dominated by large insurance companies and pension funds. But events have moved on further. Insurance and pension funds have outsourced or divested much of their asset management, while equity investors worldwide have begun to discard their ‘home country bias’, a preference for securities registered in the investor’s domestic market. More British savings are invested outside British markets, and sovereign wealth funds and other foreign investors now account for a large share of UK companies. The dominant player in UK equity markets today is the large asset manager. Many of these are American headquartered firms – BlackRock, Fidelity, Capital, Vanguard – but all maintain substantial operations in London.
The simple, but not inaccurate, historical caricature of the large listed corporation – the shareholders finance and own the plant in which the workers are employed – no longer describes business. What the shareholders of Apple own is a claim against the future earnings of the company. These earnings will be the product of the company’s brand, the creative energy of the team’s work there, its iconic designs. The loyalty of Apple customers, on which these earnings depend, is in part the result of spontaneous affection for the product, in part enforced by Apple’s proprietary operating systems.
And so the boundary between the property of the stockholders and the property of the employees, once relatively clear, is blurred. It is a corporate cliché that ‘our people are our most valuable assets’, and, like many clichés, it is often true. But if your most valuable asset goes home every evening, and can terminate his or her contract with you at short notice, your claim to ownership of such assets is tenuous.
This change in the nature of the corporation necessitates a change in the relationship between the company and its shareholders. If I acquire a share of your future earnings, I cannot be an arm’s-length owner of the asset I have purchased. A people business is intrinsically a partnership between its employees and its investors. The alignment of interests that follows from employees maintaining a substantial equity stake is an essential part of such a structure. Indeed, the transaction could only sensibly occur in the first instance on the basis of a relationship of mutual trust and confidence. (Importantly, there is no equivalent necessity in the traditional corporation: in these the commitment to the company of a particular management team is typically a rather modest part of the overall value of the business.)
In some instances, partnership may be the appropriate organisational form: in retrospect, the easy presumption of the last two decades of the 20th century that the listed company should not only be the dominant form of economic organisation of medium and large enterprises but the only form of economic organisation appropriate for such enterprises was a mistake. Too often conversion to a listed public company was the result of a greedy generation’s anxiety to realise the goodwill created over a long history for the benefit of those who had the good fortune to be around at the time. Shareholders in financial businesses which became limited liability companies and floated on public markets did not do well: neither former building societies nor investment banks proved rewarding for their shareholders. They fell victim to two problems: the asymmetry of risk allocation, in which employees shared the profits but not the losses from highly leveraged equity: and a clash of organisational culture within the firms which was incapable of maintaining a relationship of trust and confidence with outside investors.
External ownership of people and knowledge businesses demands an understanding of the business, and a familiarity with the people and knowledge substantially greater than that required when the assets of the business take the form of tangible assets you can see and touch. That has implications for the portfolios of those who invest in them, inviting greater engagement of a substantive kind, not simply the box-ticking of proxy services and some corporate governance departments. For such companies, governance and investment management are, or should be, inseparable.
It may be time to rethink the general hostility to multiple share classes which is visceral in Britain. Historically, these structures were typically used to maintain family control of a business in which the primary economic interest had passed to outsiders. But for Sergey Brin, Larry Page, and Mark Zuckerberg and their senior colleagues, the businesses they control are in a real sense still their businesses even after a majority of the shares are held by others; they are dependent on the founders not just for the realisation of their ideas, but for the development of their long-term value. In a world of algorithmic trades and ‘activist’ investors, there is nothing improper – or against the properly understood interests of long-term investors – in entrenching the role of charismatic founders and their management teams: and doing so may be a necessary condition if these charismatic founders are to allow such companies to be brought to market at all when there is no need of external capital.
Our markets need to adapt to the changed nature of 21st century business if they are to remain relevant in a world in which capitalism has little need of capital.