• Stockmarkets are Capitalism’s accountability mechanism
  • But we’ve outsourced their crucial function to fund managers
  • Now we’re paying the price, literally

Yesterday we exposed how private equity and venture capital are front running you in the stockmarket. The 1% are using stockmarket listings as an exit strategy. They list their private companies to sell out of their exclusive gotten gains. This differs markedly from a stockmarket’s true purpose: to raise capital for companies trying to expand.

Tomorrow, I’ll show you how you can respond to this corruption of the stockmarket. How can you avoid throwing the baby out with the bath water? It’s still more than possible to profit from a corrupted stockmarket. Once you understand how it creates opportunities.

But first, there’s another type of corruption going on. It’s far more insidious and far reaching than undermining your stock returns…

Out sourcing Capitalism’s crucial accountability mechanism

Alongside raising capital, stockmarkets are designed to reveal which companies are being run well and which badly. Well-run companies rise in value. And these higher valuations communicate a lot of important information to the economy.

First of all, higher share prices allow companies to raise more money with less dilution of their existing shareholders. A company which doubles its share price only needs to issue half as many new shares to raise the same amount of new funds from the stockmarket, for example.

This is great news for the existing shareholders, because they lose a proportionally smaller share of ownership from the capital raised.

Companies with high share prices are much more likely to acquire companies with low share prices because of this. And so you have a positive feedback loop toward well-run companies.

The consequences and incentives of this system are very good for the economy overall. It rewards prudent investors and management teams who satisfy their customers with good products and services. It punishes companies who prioritise…other things. As a result, Capitalism is kept on the guardrails of serving people – the consumers.

It also means that the resources of the economy are guided towards those who will use them to serve their customers. And away from those who have other priorities.

Gordon Gekko’s famous “Greed is good” speech is all about that. Listen to it carefully and you’ll find yourself agreeing, especially these days. It’s just a shame he’s also a corrupt villain behind the scenes.

Good capital allocation is how a country’s productivity grows. And the stockmarket is the mechanism that determines what capital is well invested and what badly.

So, what happens if we undermine the stockmarket’s pricing mechanisms and incentives? We lose the feedback loops that make capitalism function well. Large companies can behave contrary to the market’s wishes and try to deny that their shareholders are the most important thing.

Who does the stockmarket work for?

You might’ve noticed that, these days, the list of so called “stakeholders” which a listed company must serve is getting extremely long. The environment, endangered species, carbon dioxide, the WHO, disadvantaged groups, foreign governments and countless others must all be considered, consulted and bought off.

This differs from the old Milton Friedman view that a company has no priority other than to maximise shareholder value: A goal that inherently includes acting in the way its customers would demand – ethically and legally.

But, despite constant reminders from the silent majority, companies have gone off the capitalist rails. No amount of boycotts, “go woke, go broke” incidents, market share losses, or any other feedback loop seems to prevent the next ideologically-driven blunder.

Yes, there has been some accountability. People leading misguided social engineering efforts have lost their corporate jobs on occasion. It’s just that the message doesn’t seem to penetrate into boardrooms with any sort of lasting effect.

You expect this sort of thing from politics. Delusions can be sustained far more easily in that arena. Elections only occur every few years, and it seems the greatest prize of all is more easily achievable between elections by backstabbing elected leaders from your own party.

Customers of listed companies make choices every single time they purchase, or don’t purchase, a company’s product. It’s accountability in real time.

How many times did the British electorate have to remind its government that, yes, we really do want Brexit?

Has the Irish establishment woken up at all to the resounding “no” votes their electorate gave them, despite mainstream political parties and activists backing yes? I doubt it…

When companies spurn their customers in this way, they don’t need to hold a referendum to discover the consequences. Rejection shows up in their sales figures by the hour. And few firms have the gumption to ignore that sort of feedback. Lest they face this sort of scandal at their annual general meeting.

So, why are companies suddenly able to dodge the accountability mechanism of Capitalism? Why don’t they fear stockmarket turbulence enough to avoid taking sides in political or ideological issues anymore? Why are companies trying to create and influence public opinion instead of serving it? Why are boardrooms behaving like politicians? Why are corporate leaders attending Davos and signing up to climate change pledges?

I suspect his reason why is fairly simple.

Rise of the Boardroom Soviets

Management teams misunderstand Milton Friedman’s advice. They view their responsibility as lying with stockmarkets, not their customers. And stockmarkets are now dominated by institutions, not individual investors.

This means, a bit like journalists, our business leaders care about their peers, not their customers. They want to be popular at the club, not the supermarket isle. They care about virtue signalling, not market share. Heck, losing sales for backing some social cause is probably seen as a laudable thing to do. Why else would debanking happen?

Thanks to the rise of pension funds and insurance companies, huge chunks of stockmarket ownership are held at arms-length by investors who don’t even know what they own. They leave it to their fund manager to decide what to invest in. And their fund manager moves in very different social circles.

Public companies are now controlled by large fund management firms that face the same ideologically- and politically-misguided incentives as corporate leaders do. The accountability mechanism of the stockmarket has been lost to a strange system of peer pressure.

Companies that reject causes like ESG and quotas are punished by fund managers, even if that rejection is more profitable.

How many of those boycotting Anheuser-Busch’s Bud Light beer over the Dylan Mulvaney advertising campaign own AB shares in their pension fund without knowing it?

How many raving climate change sceptics own green tech funds without realising, because their financial advisor wants to be invited to the right cocktail parties?

How many people protesting against the war in Gaza or Ukraine own weapons manufacturing companies in their pension pot?

We know a lot of ESG funds own a lot of rather questionable stocks, including oil and defence, for example. This is vaguely amusing, but consider the long-term implications.

It is the political coup of the century, if you ask me. Partly because of how well it is hidden. Nobody realises that boardroom politics are now the force behind investment decisions and thereby share prices. It’s a radical change from a world where customers ruled corporate with their buying decisions and companies feared them. They no longer worry about the reward or punishment bad commercial decisions face in the politically and ideologically neutral stockmarket. After all, those making the asset allocation decisions that actually determine stock prices sit opposite them at dinner parties.

Without fearing the stockmarket as a policing mechanism, our corporate leaders can behave like politicians that don’t need to seek re-election. Their peers will do it for them.

Don’t forget to tune in to tomorrow’s discussion on what you can do about all this.

Until next time,

Nick Hubble
Editor, Fortune & Freedom