CHAPTER-BY-CHAPTER CRITIQUE OF 23 THINGS THEY DON’T TELL YOU ABOUT CAPITALISM: Thing 2: Companies should not be run in the interest of their owners.

This is the second delivery in the series constituting a chapter by chapter refutation of Ha-Joon Chang’s book with the above title. In the introduction he stakes his claim:

What the free-marketers have promised is at best half true.

Free markets make economies worse off than the correct alternative policies.

Capitalism remains the answer, but government intervention is necessary to make it work.

The book is based on the formula that free-marketers are guilty of peddling myths, and the author’s business is to debunk those myths (“things” the reader presumably does not know) – one per chapter. For that reason it is convenient to follow the same formula to criticise the points the author makes.

Thing 2: Companies should not be run in the interest of their shareholders

The basic premise of this chapter at first seems seductive. The author points out that in the 18th and 19th centuries limited-liability companies were the exception rather than the rule. Governments granted a dispensation permitting limited liability by exception, and only late in the 19th and early in the 20th century was limited liability a common phenomenon. The suggestion is of course that it required the intervention of the state to bring about the undoubtedly beneficial phenomenon of limited-liability companies, which allowed shareholders to feel much freer to invest their capital, as they would not be open to claims instituted by creditors of the company. That set in motion the positive cycle of investments that aided the industrial revolution so much.

The basic fallacy underlying this argument is of course the assumption that it was government intervention that allowed limited-liability companies to come about. The truth is (and this is even apparent from the author’s own account) that for years the government prohibited limited-liability companies, except for certain state monopolies and so on. Far from being the facilitator of limited liability, the state for years prevented it.

Just think about it logically for a moment: In a truly free market surely nothing prevents a company from declaring itself a limited-liability company? Any party contracting with that company would then know that it is a condition of any deal with the company that shareholders may not be sued if there is a dispute. Contracting parties would then be free to choose whether to enter into a contract with the company on that basis or not.

A further fallacy in the author’s thinking is the idea that, because of the limited-liability status so graciously bestowed on companies (to benefit and protect their shareholders) the shareholders are protected and run no risk. It is of course true that they cannot be sued for damages and other claims from creditors, but surely it is they who risk their hard-earned capital by investing it in the company? If that bet fails, and the company is liquidated, they lose their investment. Why should they not be rewarded by the company managing itself to improve shareholder value? Take the owner of the corner shop, a sole proprietorship. He is presumably entitled, as the sole investor, to run the business in his own interest and that of his family? If that is so, then why may the company not be run in the interests of its owners?

From there the author then proceeds to demonstrate that in the US two historical developments occurred: the traditional family business of the late 19th and early 20th century disappeared, and in the eighties it became vogue to run a business in the interests of its shareholders, which in turn resulted in company buy-backs of their own shares, which reached a climax at the time of the 2008 crash.

He compares the periods of the seventies and eighties and the period of 1990 to 2009, to demonstrate that per capita income growth declined. The point of this is to demonstrate of course that the second was a period of shareholder maximisation, and see, it resulted in less growth. I tested this by comparing the per capita growth rates of the two periods:

1970-89: 54.5%

1990-2009: 31%

If we ignore for a moment that the second period is inclusive of the biggest post-depression financial crash in the history of the US, then the point seems to be made.

Growth rates slowed down in the era of shareholder maximisation, not so?

The author’s explanation for the slowdown seems to be that, contrary to free-market countries like the US and the UK, some countries in Europe and the East did not suffer in the same way due to the emphasis on shareholder value, and indeed because these countries had mechanisms preventing such buybacks and consequent large pay-outs to managers and shareholders, outsourcing and off-shoring of labour, dismissal of workers and suppression of wages. Such measures include “stabilizing” large shareholdings for the state (France), differential voting rights for founder families (Sweden), supervisory boards for workers (Germany), cross-shareholding among companies (Japan).

Well, then it is only fair that we subject these countries to the same growth comparison, not so? Here are the results (excluding Germany, as the unification of 1989 falls between the two periods, and bedevils any calculation):


1970-89: 58.54%

1990-2009: 23.07%


1970-89: 41.77%

1990-2009: 30.72%


1970-89: 95.4%

1990-2009: 12.7%

So it is clear that all the countries suffered downturns in their income in the second period. So whatever it was that caused the downturn, also did so in the non-Anglo-American countries. And equally importantly, the measures that were supposed to stop share buybacks, did not succeed in preventing the fallout in terms of growth.

One obvious candidate to explain the downturn in the wealthy countries, is the economic phenomenon of convergence. For example, here is Wikipedia[1]:

The idea of convergence in economics (also sometimes known as the catch-up effect) is the hypothesis that poorer economies‘ per capita incomes will tend to grow at faster rates than richer economies. As a result, all economies should eventually converge in terms of per capita income. Developing countries have the potential to grow at a faster rate than developed countries because diminishing returns (in particular, to capital) are not as strong as in capital-rich countries. Furthermore, poorer countries can replicate the production methods, technologies, and institutions of developed countries.”

In other words, over time, wealthy countries tend to grow more slowly.

Here is another candidate, namely economic freedom:

Country Ave free-market rating 1980-90 Ave free-market rating 2000-2010 Change in rating Change PC GDP first/second period
US 8.275 8.216 -0.59 -43.11%
France 6.545 7.4 +0.855 -60.59%
Sweden 6.31 7.583 +1.273 -26.45%
Japan 7.655 7.783 +0.128 -86.68%


France and Japan, for all their protective measures, fared far worse than the US. These countries at all relevant times had far lower levels of economic freedom than the US. The country that bucked the trend of a decline in growth best is Sweden. Sweden is also the country that underwent the biggest deregulation (ie became freer) between the two periods.

That of course still does not mean that the share buyback trend is a force for the good, or that it doesn’t matter. It is, on the face of it, worrying that companies do not invest in machines, technology and training of workers, instead choosing to cannibalise their own shares. This is bound to be less than optimally productive. But knowing that, still begs the question: was it free enterprise that caused it?

Why did this tendency increase so much during the period 1980 to date, as correctly pointed out by the author?

The answer lies in easy money. Here is a graph showing the federal Fund interest rates in the US from 1971 to date:

The declining interest rate trend since the early 1980s is notable. Equally obvious is that the interest rates imposed by the Fed trended downward over precisely the period that the share buyback trend grew in severity. It is also the time during which a decline in productivity has been noted, as well as a trend for businesses to buy shares in businesses (including their own shares) instead of investing in research and development, training, new technology and new plant. The culture that took hold since the seventies has been one where consumption has been fuelled by debt, not productivity. This is all no coincidence. It is a fundamental principle of economics that production has to precede consumption. Low interest rates effectively open the door to money creation out of nothing. That encourages malinvestment in the form of share buying instead of building factories (to simplify) and fuels consumption[2]. The Mises Institute explains:

“On account of loose monetary policy and the subsequent increase in the money supply, the process of wealth transferring from wealth generators to the holders of the newly created money is set in motion. Since this new money was generated out of “thin air,” nothing was exchanged for it hence we have here an exchange of nothing for something.

This means the holders of newly printed money have taken from the pool of real wealth without giving anything back in return. Consequently, this puts pressure on the pool of real wealth. Similarly to government, these holders of newly created money are engaged in non-wealth generating activities. (These activities sprang up on the back of money pumping. In the free unhampered environment these activities, which ranked as low priority would not be undertaken.)”[3]

It is no wonder the US economy has suffered.

For our purposes the important point is that the increasing (and damaging) trend of growing share buybacks is more than explained by the Fed artificially pushing interest rates down, in effect pumping money into the economy. Needless to say, this process of priming the economy by means of low interest rates, is government intervention in the economy. It is not the free market at work. In a free market money would simply be a liquid medium of exchange, and interest rates would reflect supply and demand of real credit. In a fast-growing economy interest rates would tend upward, because demand for credit would increase. That would encourage ordinary people and businesses to enter the loans market. Conversely, if for some reason the growth rate of the economy declines, so would interest rates.

Now we can return to the notion that companies should not be run in the interest of their shareholders. That is like saying people should not obey their survival instinct. In a properly functioning economy, businesses would operate like the corner café or the local tailor: They would aim to serve their customers by giving the best value for money, because they would be driven by the selfish and normal urge to better their own economic well-being. To the extent that companies hire professional managers, the latter would be rewarded on a fiduciary basis, namely that contractually they are obliged to serve the interests of the company first and foremost. That is economically to all intents and purposes indistinguishable from the interests of the shareholders. Employees should receive rewards and favourable terms and conditions of employment to the extent that they serve the interests of the company in that sense, and not as an aim in itself.

Any suggestion that any other outcome is possible, likely or desirable, is clearly nonsense.


[2] See



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