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Adam Leaver
© Adam Leaver 2007
Like globalization twenty years ago, the term financialization now increasingly supplies a need, as the concept for a process that concerns us all. But defining financialization has always been difficult because its contradictory manifestations shift every 5 or 7 years. Currently, private equity and hedge funds dominate the front pages of the financial press, and the public company is disparaged by those who boost a new and purer form of capitalism. Compare and contrast with the late 1990s when a public listing was seen as the next positive step for all kinds of privately backed dotcom ventures. The problem with defining the concept of financialization is that it is not clear what 'thing' has happened or will happen next because, whilst capitalism has always created new divides and inequalities, its mobility and resourcefulness means it does not stay the same long enough for us to generalize its habits or predict its outcomes.
The diverse academic discourses on financialization have a tendency to fixate on aspects or sub-periods, and to take the part for the whole. The largest of these literatures is probably in international political economy (IPE) and dates from the late 1990s and early 2000s, when financialization was identified as emblem and vehicle for unwelcome developments in the international regime. For these academics, US imperialism had ridden roughshod over the democratic (though still fundamentally liberal) gains of the Bretton Woods period, with the financial world increasingly pushed into a neo-liberal frame that resulted in a disembedding of global finance from national programmes of governance and accumulation. Financialization thus represented a threat to national sovereignty and political democracy, and the results were apparently palpable: an enhanced role for footloose capital market speculation, the reshaping of traditional national controls to meet the needs of global finance and finally (quite logically) the decline of national varieties of capitalism as we have known them.
Within radical political economy, the rather different and less apocalyptic line was that financialization represented a rebalancing of the stakeholder pecking order, as the interests of capital were served at the expense of labour in firms under pressure to deliver shareholder value. The creation of shareholder value was ostensibly the sole and legitimate object of management action in the US and UK after the mid 1990s. Here, some academics argued that the outcome was a mutation in governance principles, as managers increasingly selected a strategy of 'downsize and distribute' not 'retain and reinvest', resulting in shareholder gains from dividends and share buybacks, and worker losses through job or wage cuts. The question then was whether this short-termist strategy would lead to under-investment and a loss of competitive advantage for Anglo-Saxon capitalism, and how the pressures would spill over into other (less shareholder friendly) kinds of capitalism in France and Germany.
If we consider the arguments and observations of IPE and political economy, there is much that is plausible - because, for example, by the early 2000s the international derivatives markets were already valued at trillions of dollars, just as shareholder value rhetoric was everywhere, and some US blue chips like GE or IBM did downsize in the 1980s and 1990s. But now much else has happened in the economy to suggest that financialization is not a stable entity operating in simple cause and effect ways, exhibiting the predictable and generalisable outcomes implied in the literature of the late 1990s and early 2000s. So let's trace some of the paradoxical outcomes of shareholder value which are clear in retrospect, from a vantage point in mid 2007.
Consider the evidence on the sources of shareholder value for pension funds and mutuals, who bought the index of giant firms as long investors, so that share price increases were their only major sources of gain. To illustrate what happened, let us take the S&P500 as example. Investors who bought the index of giant S&P500 firms in the 1990s were effectively buying a chunk of advanced country GDP. Between 1983-2002 the average annual real change in sales per annum was 2.5% for S&P500 constituents and 3.7% for S&P500 survivors. The figures for pre-tax profit were likewise mediocre, averaging just 1.5% and 2.5% respectively. Return on sales margins did not improve and ROCE performance was also fitful and sporadic, with no step-like improvement over the period for S&P500 constituents. All of this implies that, whatever the pressure from the stock market for shareholder value, managers were unsuccessful at wringing higher profits from slow growing sales.
Managers of S&P500 companies at the aggregate level did not deliver improved performance by key earnings related measures. And yet, this was a golden age for shareholders because there is dramatic rise in share prices, so that over the whole period 1983-2002 the annual increase in market value from 1983-2002 averages 13.3% for S&P500 constituents and 11.2% for survivors.
This gives us an interesting insight into the fundaments of shareholder value creation, which are rather more post-modern than supposed in shareholder value ideology (or by its critics). During the bull markets of the 1990s in the US and UK, the main driver of Total Shareholder Return (TSR) was increases in share prices arising from a rising price earnings ratio as the stock market put a higher valuation on a given quantum of (future) earnings. Such increases in share price had nothing to do with management effort but were the conjunctural result of the flow of institutionalised middle class savings into the market and falling rates of interest, combined with the irrational exuberance of investors who believed the new economy spiel. Whatever the disciplinary threats from the capital market, US managers of giant firms did not improve the operating numbers; but instead the gains of the post 1995 years were the result of shareholders engaged in a kind of DIY value creation.
If we turn to consider what happened outside the US and UK, the story quickly becomes even more complex and interesting. The French case shows us that discretionary management strategies are alive and well after financialization, because the managers of relatively unprofitable French giant firms were able to use the stock market to fund international expansion. US and UK fund managers eagerly bought into French equity throughout the 1990s and 2000s, so that by 2004 around 45% of all CAC40 shares were held by foreign, largely British and American, institutional investors, compared with just 10% in 1985. The new fund managers had much to grumble about because French giant firms were by any measure consistently less profitable than their US or UK counterparts. Over the period 1987-2002 CAC40 constituents averaged a ROCE of 6.5 per cent and a ROS of 4.6 per cent compared with 15.6 per cent and 12.4 per cent for FTSE100 constituents and 10.6 per cent and 8.6 percent for S&P500 constituents respectively. And yet, French giant firms were, thanks to foreign acquisition, growing much more strongly than their UK or US counterparts: between 1987-2002, average annual real sales growth for CAC40 constituents was 20.3%.
If the US fund managers were grumbling about profits, the investment bankers were trying to make the figures work on overseas acquisitions which were the basis for rapid growth and internationalisation, so that by 2004, 60.6% of the 4.2m working for CAC40 companies were employed outside France, compared with 48% of 2.7m in 1997. The end result was a great success for shareholders in French companies who, as in the UK and US, were engaged in a kind of alchemy, despite management's inability to improve mediocre operating margins and their unwillingness to distribute earnings: between 1995 and 2000 more than 95 per cent of Total Shareholder Return on the CAC40 was accounted for by the rising P/E ratio, with dividend payouts accounting for just 4.66 per cent. Paradoxically, while students and unionists take to the streets in France to demonstrate against Sarkozy and the forces of globalisation, French giant firm CEOs may think silently that it was their strategic decisions to 'go global' which created the sales growth and new profit sources to avoid conflict and maintain numbers employed at home for the last 10 years at least.
Shareholder value suggests that it is not so much a meaningful concept or definite programme of action but a social rhetoric that puts management on an often quixotic quest for value, where narrative and performative elements are only loosely aligned with numbers, and the stock market runs on narratives as much as discounted future values. Shareholder expectations and measurements of success vary across company, industry, nation state and time period, meaning that corporate responses will always be diverse and often involve not just strategic interventions such as labour shedding, share buybacks, etc, but a discursive and performative element.1 Financialization, then, is not anchored in some behavioural fundamental; what we see instead is a set of open dynamics and variable results distinguished by instability, reversibility and unpredictability.
We are now living through such a moment of change, where many of the old doxas about improved efficiency from shareholder value and the discipline of the stock market are being reversed. Capitalism adjusts very quickly, but in ways that are difficult to predict and with uncertain outcomes. Activist hedge funds represent two adjustments, both demonstrated classically in the intervention of TCI to block the takeover of LSE by Deutsche Borse. First, the hedge fund can go short and therefore make money out of share price falls as well as rises. Second, this represents a change in the mechanics of value creation (or perhaps value realization or extraction) because activism is focused around one near term value creating move or event which will crystallise returns. Private equity represents another kind of adaptation. The purchase of companies with 70% debt and 30% equity caps returns to the majority of those who provide capital, to the benefit of the minority who hold equity; and operations are much less important because the aim is to realize profits from asset sales, above all from selling the company on within 3-5 years.
All this is wrapped in a new kind of rhetoric which criticizes the public company and its lack of dynamism, which is now attributed to unresolvable agency problems. Behind it all, we have the enrichment of private equity general partners as the new kings of capitalism, whose status is conjunctural because private equity has boomed since 2002 with debt cheap and the stock market rising. What is clear, as hedge fund managers and private equity partners elbow aside the old guard of fund managers, is that financialized capitalism has an endless supply of opportunist bodies who deploy differently in each period because they go to where the profitable deals are. The financial elites are not necessarily a coherent group but more a distributional coalition.
What we are learning about financialization, therefore, is that it is not an epochal shift from before to after but an ongoing process of remaking capitalism around financial priorities, which, confusingly, does not have one set of outcomes in terms of firm behaviour or broad social effects - beyond the increasing inequality driven by the efforts of the working rich. The challenge for researchers is to understand how financialization speeds up the inherent mobility and resourcefulness of capitalism, which sustains itself through processes of redistribution and relocation that are powerful, variably articulated and often misunderstood or undisclosed. The possibility of new instabilities remains real even if apocalyptic fears have not yet been confirmed. The low interest rates which underpin the debt bubble are already starting to rise, and it remains to be seen whether this ends in the next stage with a big bang or a small phut.
Adam Leaver is a researcher for the ESRC funded Centre for Research on Socio-Cultural Change and a full-time lecturer at Manchester Business School. He also currently organises the International Working Group on Financialization.
Footnote
1. Julie Froud, Sukhdev Johal, Adam Leaver, Karel Williams, Financialization
and Strategy: Narrative and Numbers, Routledge, 2006.
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