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Why the Shareholder Rescue Never Comes

The recent vote to keep Jamie Dimon as CEO and chairman of JPMorgan shows why the corporate governance movement won't work when it comes to Big Banking.

Shareholders can't be counted on.

That's the message from the dispiriting shareholder vote on whether to leave Jamie Dimon as both the chief executive and the chairman of JPMorgan Chase, or to split the roles. Even more shareholders backed him in his dual role this year than did last year.

For some time, reformers have hoped that shareholders might ride to the rescue to solve the problem of Bank Gigantism, otherwise known as Too Big to Fail.

Big-bank critics, like the freethinking analyst Mike Mayo, analysts at Wells Fargo, and Sheila Bair, the former head of the Federal Deposit Insurance Corporation — and others, including me — have raised the possibility that shareholders might revolt over banks' depressed stock valuations and seek breakups. Broken-up banks would be smaller and safer.

No, it's not going to happen. Shareholders are part of the problem, not the solution.

No group has skated free of severe (and deserved) criticism in the wake of the financial crisis: financial firms, regulators, credit rating agencies, borrowers and the news media. That is, except one, which happens to be among the most culpable: institutional investors. Yet today, the structure of institutional investing is the same. And so is shareholders' view of their responsibilities.

When applied to banks, corporate governance campaigns are wasted efforts.

"We need to recognize that corporate governance is not going to fix the financial sector," said Lynn A. Stout, a Cornell law professor, who is a critic of the notion that companies should be run primarily to maximize shareholder value. "We have to have effective government regulation."

By keeping Dimon in his two roles, shareholders indicated their belief that only a supposed superhuman executive could run such a banking monstrosity.

But he either failed to rein in his bank's reckless trading, or he failed to understand it. And he has failed in the most basic responsibility of any steward, to plan for his succession.

These transgressions may not have been worth ousting Dimon. But hardly anyone called for that. Instead, shareholders had an opportunity to reorganize the company to diffuse a little power and increase oversight.

They punted. So what explains this shareholder fecklessness?

In some sense this was an act of reflexive class fealty. In rejecting a split of the chief executive and chairman roles, institutional shareholders seemed to prefer spiting pension funds (for their perceived union bias) to rebuking a CEO whose actions last year actually put them at risk.

That's not the only reason shareholders are immobilized. Giant bank financial disclosures are too incomprehensible for even the most sophisticated and dedicated professional investors.

Shareholders suspect that management wouldn't break up the banks in a risk-reducing way. They would be separating whole businesses, not shrinking the size of any one division. Therefore spinoffs would mean that the unknowable supernova risks, like that of derivatives businesses, would be concentrated in smaller entities.

But the most important reason is that shareholders benefit from the big banks' structures. Stout points out that shareholders want companies to take high-risk, high-return bets. They capture the unlimited upside and their losses are capped.

This is true across sectors, which is what helps drive so much short-term corporate thinking. But with banks, things are even worse. Big banks benefit from government subsidies, both implicit and explicit. As the Federal Reserve moves interest rates down and engages in huge asset purchases, the holdings on bank balance sheets rise in value. Shareholders are the chief beneficiaries.

The economy? Not so much. Not when unemployment is at 7.5 percent and so many Americans have "jobs" that can't support anything close to a middle-class life.

Shareholders, a group that includes executives who were larded up with options, helped push banks into the financial crisis. And then, in one of the most damaging and least remembered episodes of the debacle, learned some valuable lessons about what a protected class they were.

When JPMorgan saved Bear Stearns in early 2008, Treasury Secretary Henry M. Paulson Jr. initially pushed for a symbolically low price for the stock — $2 a share. Such a low price would have sent a punitive message. Bear Stearns was going down; shareholders would have gotten absolutely nothing if JPMorgan hadn't saved them.

Yet instead of being grateful, they revolted. They threw tantrums and bluffed. And it worked. JPMorgan raised its offer to $10 a share.

Of course, shareholders did get wiped out in the Lehman Brothers bankruptcy.

But what was the lesson the government drew from that? To rush in to save every institution it can.

Today, the government says that it has ended Too Big to Fail. By the provisions in Dodd-Frank, the government plans to seize holding companies of failing financial companies, wiping out shareholders and even some debtholders. The government might be able to carry this through if just one giant bank fails on its own for an isolated reason, like the storied British bank Barings did in 1995.

But most of the time, if one giant bank is going down, they will all go down together. Inevitably, the Federal Reserve spigot will open and the Treasury and Congress will find a way to intervene, as the economist Simon Johnson recently pointed out.

If shareholders really believed that bailouts were a thing of the past, they would be acting responsibly. From the JPMorgan vote, we can see that they aren't.

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