Exit, Voice, and Loyalty

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This article is intended for the educated layman. It was written as part of a continuing series of articles on a variety of investment topics. To view all the articles in this series, click on “More by the same author” in the left margin.

God, grant me the serenity to accept the things I cannot change,

The courage to change the things I can,

And wisdom to know the difference!

Reinhold Niebuhr

Part 1: What is Social Responsibility, and Who Exercises It?

An apparent conundrum nestles at the core of the philosophy of investing.

For all the knotty difficulties of defining investment concepts and then drawing out their implications, nearly all systematic thinking about investing begins with just four basic and required elements: return, risk, the assemblage of interrelationships among different investments’ returns over time, and the investor’s ability to tolerate risk. The first three elements, however they are defined, are given to us by the market or, more broadly speaking, the economy. The fourth is a matter of individual circumstance and psychology. (The third may be hard to grasp and is often forgotten by the layman, but it’s why we hold a portfolio, not just a single investment; it gives rise to the potential benefit of diversification.) Whether one goes about investing as a sport or as a science, whether one plays with these four elements or assembles theoretical structures from them, one must either estimate or assume (consciously or not, explicitly or not) their future values, after which one buys, sells, or holds investments to make money or to preserve wealth.

But there are some activists who object that those who accept this philosophy of investing merely interpret the economy; the point is to change it.

The activists seem, at first glance, to have nothing in common with the traditional investors, and to inhabit a separate conceptual world.


A vocabulary for talking about these two ways of addressing investments, and a framework for organizing our thinking about both at the same time, was created by the late Albert O. Hirschman, in his book Exit, Voice and Loyalty (1970).

Hirschman was an economist who is much admired by intellectuals and seldom cited by other economists.[1] His death, at the age of 97 in 2012, brought his work back to public attention, which was sustained with the publication shortly thereafter of a great, thick biography.[2] More than the typical academic economist, he led, in his youth, a life of action, but he was no swashbuckler, and afterward, he refused to talk of his experiences in the resistance during the Second World War. He spent most of his professional career in the sub-discipline of development economics, which seldom graces the business pages, and his reputation outside this field depends mostly on a number of short books and essays that he produced later in middle age.

In Exit, Voice and Loyalty, he explained that the book was inspired by his initial puzzlement over the sorry state of the railway in Nigeria, where he was a consulting economist. Major producers of goods had abandoned the railroad and were moving their products by truck. Standard thinking about free markets suggested that the railroad should either have failed altogether, or that the competition ought to have motivated it to improve its service. Yet neither happened.

Hirschman intended his book not just as an explanation for observable economic phenomena like this, where he perceived a failure of economists’ traditional thinking about competitive market forces, but also as an attempt to establish common ground between economic theory and political science. He applied his ideas not just to corporations, but also to civic associations and political parties.

And, in passing, he added that his approach added richness to the “Wall Street Rule”: that one should ditch the stocks of companies with bad prospects.[3]

This is what Hirschman called exit. Voice, another of his terms, would be continuing to own the stocks while speaking up and becoming an activist to change the issuing companies for the better.

Exit and voice, while complementary, are not mutually exclusive. For example, voice without the threat of exit might lack force and influence.

When – to continue with the case of stocks – we invest in a stock, we do so because we fancy the investment prospects of the company that issued it. If we believe that the prospects for a company are poor, then we don’t buy the stock in the first place, or, if we already own it, we sell it. We might also short the stock. (Shorting is an ancient practice of profiting from the fall of a stock; the investor borrows the stock from another owner and sells it, with the expectation that the price will fall, so that he can buy it back at a lower price and return it to the original owner.) If that’s what we do, then we are exiting.

Alternatively, we may believe that when we buy a stock, we become partial owners of the company that issued it, and usually (though not always), as owners, we nominally have a voice in and a vote on how the company is managed. If we don’t like how the company is being managed, we ostensibly have some opportunity, however small, to ask or demand that management change its practices. To seize that opportunity, to exercise that option, is voice. And we can add force to that voice with the threat to sell the stock, and exit.

Loyalty, another concept developed by Hirschman, creates conditions for the exercise of voice. Loyalty to the spirit and ideas of capitalism can explain why even someone who believes that the stock market is rigged against the common man might nonetheless continue to invest in stocks, whereas a Communist or an unhypocritical socialist would likely not invest in stocks in the first place.

What does shareholding confer?

The idea that ownership of a stock confers the right to influence management was current long before 1970, and, indeed, it was and is something of a commonplace that when you own a stock, you are a part-owner of the issuing company. But like nearly all commonplaces, it’s not strictly true at all times and in all cases, and this one doesn’t hold up to close scrutiny. Both the shareholders and the managers of the first company to issue publicly traded stock, the Dutch East India Company (in the early 1600s) would have been dumbfounded at the suggestion that the outside shareholders were actually owners of the company and were entitled to a say in how its affairs were managed.[4]

Then again, and although there are some these days who work themselves into a lather at the suggestion that any voting system other than “one person, one vote” might be democratic and fair, there were, in the early years of the United States, some corporations set up in such a way that holders of fewer shares actually had greater per-share voting power than holders of more shares, because this seemed more just. [5] (The use of this structure gradually fell away during the nineteenth century.)

Even today, stockholders don’t have equal rights per share owned. Anyone who attends an annual meeting of the New York Times Company or Facebook or Ford with the expectation of voting for a change in corporate policy will meet with disappointment. Those are three examples of companies that issue two classes of shares. If your name isn’t Sulzberger or Zuckerberg or Ford, yours can never be more than a soft, muffled voice, no matter how many shares you own. Exit is the only option. This is because the controlling families don’t simply own more shares than anyone else; they own special shares that confer superior control over their companies. (These are usually called “Class A shares” and “Class B shares,” but there’s no rule that says which letter designates the class that has greater rights.)

What share-ownership confers is defined by law, not by a popular understanding of ownership. (Financial economists now regard a publicly-traded stock as more akin to a very long-term option than to a share of ownership of a company. If this doesn’t make sense to you, don’t worry; it’s of little practical importance.)

Perhaps the most important difference between an ordinary understanding of corporate ownership and what share ownership in a public company actually confers is the limiting of liability; so that, if a public company incurs massive financial losses and racks up huge debts, its shareholders merely lose all the value of their shares, and they aren’t on the hook for any of the debt, once all the assets of the company have been used to pay back the bondholders to the extent possible. The limitation of the liability of corporate shareholders required legislation in the developed countries of the nineteenth century, and it wasn’t uncontested, since this went against common notions of justice and personal accountability. [6]

This is not to say, however, that it is necessarily a mistake to want company management to think of the shareholders as owners. Warren Buffett (1930- ), for example, has famously said that he treats investors in his company, Berkshire Hathaway, as “partners,” and he prefers to invest in companies that treat their shareholders likewise:

[B]y far [the] most common…board situation is one in which a corporation has no controlling shareholder. In that case, I believe directors should behave as if there is a single absentee owner, whose long-term interest they should try to further in all proper ways. Unfortunately, “long-term” gives directors a lot of wiggle room. If they lack integrity or the ability to think independently, directors can do great violence to shareholders while still claiming to be acting in their long-term interest. But assume the board is functioning well and must deal with a management that is mediocre or worse. Directors then have the responsibility for changing that management, just as an intelligent owner would do if he were present.[7]

From what Buffett says, it follows that an investor who selects individual companies in which to invest should identify those whose boards of directors, as well as management, think of the shareholders as Buffett does, as partners. (Whether such selection would actually result in superior investment performance is another matter, which I’ve addressed elsewhere.[8])

The role of the directors is critical, because the interests of management are seldom perfectly aligned with those of the shareholders, and the directors, more than anyone else, are expected to represent the interests of the shareholders. For one thing, corporate executives want, above all, to keep their jobs. For another, they may enjoy the social and professional status that comes from building and presiding over a corporate empire, to say nothing of the merely venal interest in treating the company as if it were their own piggy bank. The executives’ first concern is shared with the stockholders, if, indeed, those executives are doing a good job at running their companies and causing the price of the companies’ stocks to rise at an appropriate rate. In contrast, building empires and drawing upon the companies’ financial resources are seldom, if ever, in the stockholders’ interest, and if so, only by accidental coincidence. Furthermore, even if a company’s directors and management choose to think of you, the shareholder, as a rightful owner of the company and as a business partner, this is not really the same as giving you an actual say in how the company is run.