‘Dark Towers’, a book on Deutsche Bank, throws light on a long running economic dispute.

In 1959, William Baumol, perhaps the most innovative modern economist who was never a Nobel laureate, published Business Behavior, Value and Growth, which argued that firms did not maximise shareholder value but maximised their own growth, subject to meeting a shareholder target return. Managers of larger firms get higher salaries and status.

Five years later, the very respected economist Robin Marris extended the analysis in The Economic Theory of Managerial Capitalism, which focused on the separation of ownership from management in large firms and on the resulting weakness of shareholder control, which allowed managers considerable discretion. Managers used their discretion primarily to make their firms grow faster than shareholders would choose.

JK Galbraith used the theory in The New Industrial State to argue that the ‘industrial system’ – the large companies which controlled around two-thirds of the output in key sectors of the economy – is controlled by a ‘technostructure’ of accountants, engineers, lawyers, managers and scientists rather than by shareholders. They did not aim to maximise profit but to maintain the organisation in their interests, which were remuneration, status and technological innovation. Again the target was growth over profits.

This approach was not popular in much of the economics profession which had built a comprehensive theory based upon profit-maximising firms. Drawing attention to less-than-pure competition did not go down well with its right-wing, progenitor of the neoliberals. Monopolies suggest government intervention to increase market competition. (We can’t have that can we?)

Their resolution was that the sharemarket provided the market for management competition. If a firm was not maximising shareholder value, it would be taken over by someone who would. As a result managers were under pressure to generate high profits because they would be taken over and sacked.

When the theory reared its head in the 1980s, a review of the literature did not find the evidence for it. It was not just that senior managers were paid on the basis of a firm’s size, not of its profitability. Studies of mergers and acquisitions suggested that about two-thirds of them reduced shareholder value. An M&A adviser who said ‘this acquisition will probably make your shareholders worse off but your remuneration will rise’ would not get very many jobs. (The practical import to a shareholder is that after an M&A, contemplate quickly selling out.)

Despite its lack of evidence the theory was used to justify the privatisation of state-owned enterprises because a business not on the sharemarket was not under the same pressure to perform well. Again the evidence is not compelling. Both Air New Zealand and KiwiRail were so badly managed in the private sector that they had to be taken back into public ownership. (Nowadays, one does not see as many references to the sharemarket as a market for management; opportunities for privatisation are not as common.)

I was reminded of this debate when reading Dark Towers by David Enrich, finance editor of the New York Times, which is a detailed examination of Deutsche Bank in the US up to 2019. He describes it as ‘an epic tale of destruction’. (The title alludes to its headquarters – the Twin Towers in Frankfurt.)

Deutsche Bank was founded in Berlin in 1870 and became Germany’s leading bank, which means it has a murky history, including in the 1930s with the persecution of Jews. Enrich’s story really picks up in 1989, when Deutsche Bank became more aggressively international, acquiring London-based Morgan, Grenfell & Co and then in 1999 adding the US firm Bankers Trust. In the interim it had hired some extremely aggressive American bankers. Further acquisitions made it one of the biggest banks in the world.

It also expanded into other domains including Russia – especially as the oligarch’s money conduit to the West – and there is a sad cameo of its expansion into Italy. Regrettably, there is little on the Bank’s involvement with Greece. You will recall that there was much relief when an international consortium, including the IMF and the European Central Bank with strong German involvement, bailed Greece out after the GFC. It turns out that they were not so much helping an imprudent borrower – as the subsequent austerity Greece faced demonstrates – but bailing out imprudent lenders such as Deutsche Bank.

The book’s focus is on the New York activities of Deutsche Bank told through a myriad of personal stories. Few of these characters appear attractive but they were extremely rich; one got a bonus of $US100m in one year. The book’s person-focus makes it difficult to see the overall picture. It is of an institution which was near dysfunctional although generating huge remuneration for its staff. The various acquisitions resulted in a plethora of unintegrated IT systems. Deutsche Bank itself often did not know what it was doing. When one division turned down an approach by Donald Trump for finance because the business looked shonky, he went to another which backed him (and still funds him). One gets the impression that there was a disjunction between its Frankfurt headquarters and its New York offices; between a European continental culture and an Anglo-American more aggressive one.

The personal stories illustrate the Baumol-Marris-Galbraith thesis. The banking staff – the technostructure – were operating in their narrow self-interests with little loyalty to the firm. They were cognisant that they had to make a satisfactory return for shareholders, but they were certainly not maximising it; they were maximising their bonuses.

It is a short-term strategy. The book finishes before the disorganisation goes through a ‘near-death experience’ as one senior manager recalls it. In the past ten years, its share price has fallen 65 per cent; its total assets have shrunk by a third; revenues are down 25 per cent; staff numbers have fallen 16 per cent; its dividend – suspended for several years – is now 73 per cent below the 2012 level. It has been subject to numerous fines by financial authorities; the biggest seems to be $US7b by the US Department of Justice in 2016. Among its misdemeanours were activities for which that staff member was given a $US100m bonus. There are ongoing investigations.

Despite two former bankers serving jail sentences for involvement in various scandals, and others, including former board members, being under criminal investigation, the general impression is that most of the bankers got away with their fabulous gains at little cost (although Enrich records that some committed suicide). It has been shareholders who paid for the hi-jinks.

The purpose of this column is not to discourage share investors, but to remind them that whatever the rhetoric in the corporate reports and at the AGM, they are not the priority which standard economic theory says they are. Each business has numerous stakeholders; shareholders are but one group of them. On average they get rewarded for their investment but management does very well out of the investors’ funds too. Shareholders appear to suffer more when things go wrong.

Yet managerial capitalism needs share investors to provide risk capital even if it does not always treat then well.