By Sanjai Bhagat and Siri Terjesen | The Daily Signal
President Donald Trump’s America First Investment Policy touts that welcoming foreign investment and strengthening the United States’ “world-leading private and public capital markets will be a key part of America’s Golden Age.”
Of the $124 trillion market capitalization of the global stock market, U.S. stocks account for 49%, and international investors own 17% of those U.S. stocks. By comparison, Chinese stocks comprise 13% of the global stock market, and international equity ownership of Chinese stocks is just 3.4%.
Why does the U.S. stock market dominate internationally? Why are international investors attracted to the U.S. stock market? What can U.S. policymakers do to increase the attractiveness of U.S. stocks?
President Donald Trump’s America First Investment Policy touts that welcoming foreign investment and strengthening the United States’ “world-leading private and public capital markets will be a key part of America’s Golden Age.”
Of the $124 trillion market capitalization of the global stock market, U.S. stocks account for 49%, and international investors own 17% of those U.S. stocks. By comparison, Chinese stocks comprise 13% of the global stock market, and international equity ownership of Chinese stocks is just 3.4%.
Why does the U.S. stock market dominate internationally? Why are international investors attracted to the U.S. stock market? What can U.S. policymakers do to increase the attractiveness of U.S. stocks?
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Americans and foreigners invest in stocks to earn a return commensurate with their risks. What assurance do investors have of receiving a fair return on their investment or, indeed, any return? Corporate governance is the set of processes that assures all investors a fair return on their investment.
The rule of law—as embodied in the respect for private property rights and fair courts that enforce legal contracts—is a necessary precondition to the formation of corporations. For the past two centuries, the U.S. has enjoyed a stable rule of law.
This rule of law and the American focus on investing in human capital, especially in science and technology, provided the building blocks for the formation and growth of corporations. Equally important, this rule of law is critical to international investors, since it gives them the assurance that if they invest in U.S. capital markets, their investments will not be expropriated by the U.S. government or nongovernment entities.
Once a company has received investor/shareholder funds, what prevents managers from using these funds for their own pet projects or from extracting excessive compensation from the company? A multitude of corporate governance mechanisms do just that.
First, U.S. courts have consistently ruled that the purpose of the corporation is to maximize long-term shareholder value while abiding by the law. Corporate charters and board members of U.S. companies often highlight the importance of focusing on long-term shareholder value. Recently, some U.S. managers have publicly noted that their companies should prioritize environmental and social issues rather than just shareholder value. However, investors and courts pushed back strongly on this deviation. Currently, U.S. companies, in contrast to many companies in other parts of the world, have resumed their focus on creating long-term shareholder value.
Second, corporate board members, who are the manager’s bosses, can and do monitor the manager’s actions and company performance—out of a sense of fiduciary duty to the shareholders and a concern for their own compensation and reputation.
Third, an active market for corporate control, via takeovers and proxy fights, also provides effective discipline on management. Companies face takeovers and proxy fights when their financial performance has been poor. Subsequent to a takeover or proxy fight, the target company manager’s employment prospects are severely damaged.
Fourth, the incentive compensation structure for U.S. managers has perhaps been the most effective mechanism to encourage U.S. managers to have a laserlike focus in maximizing shareholder value. More than 60% of the average CEO pay in large U.S. corporations is directly linked to shareholder value, hence, that link provides strong incentives to enhance it.
READ THE FULL COMMENTARY AT THE DAILY SIGNAL
Sanjai Bhagat, Ph.D., is a professor at the University of Colorado, serves on corporate boards, and is the author of “Financial Crisis, Corporate Governance, and Bank Capital.”
Siri Terjesen is a professor and associate dean at Florida Atlantic University College of Business, serves on nonprofit boards, and advises think tanks on business policy issues.
Editor’s note: Opinions expressed in commentary pieces are those of the author and do not necessarily reflect the opinions of the management of the Rocky Mountain Voice, but even so we support the constitutional right of the author to express those opinions.