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The Dumbest Business Idea Ever. The Myth of Maximizing Shareholder Value

The dominant business philosophy debunked

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By Lynn Stout

By the end of the 20th century, a broad consensus had emerged in the Anglo-American business world that corporations should be governed according to the philosophy often called shareholder primacy. Shareholder primacy theory taught that corporations were owned by their shareholders; that directors and executives should do what the company’s owners/shareholders wanted them to do; and that what shareholders generally wanted managers to do was to maximize “shareholder value,” measured by share price.

Today this consensus is crumbling. As just one example, in the past year no fewer than three prominent New York Times columnists have published articles questioning shareholder value thinking.1 Shareholder primacy theory is suffering a crisis of confidence. This is happening in large part because it is becoming clear that shareholder value thinking doesn’t seem to work, even for most shareholders.

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Consider the example of the United States. The idea that corporations should be managed to maximize shareholder value has led over the past two decades to dramatic shifts in U.S. corporate law and practice. Executive compensation rules, governance practices, and federal securities laws, have all been “reformed” to give shareholders more influence over boards and to make managers more attentive to share price.2 The results are disappointing at best. Shareholders are suffering their worst investment returns since the Great Depression;3 the population of publicly-listed companies has declined by 40%;4 and the life expectancy of Fortune 500 firms has plunged from 75 years in the early 20th century to only 15 years today.5

Correlation does not prove causation, of course. But in my book The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public,6 I explore the logical connections between the rise of shareholder value thinking and subsequent declines in investor returns, numbers of public companies, and corporate life expectancy. I also show that shareholder primacy is an abstract economic theory that lacks support from history, law, or the empirical evidence. In fact, the idea of a single shareholder value is intellectually incoherent. No wonder the shift to shareholder value thinking doesn’t seem to be turning out well — especially for shareholders.

Debunking the Shareholder Value Myth: History

Although many contemporary business experts take shareholder primacy as a given, the rise of shareholder primacy as dominant business philosophy is a relatively recent phenomenon. For most of the twentieth century, large public companies followed a philosophy called managerial capitalism. Boards of directors in managerial companies operated largely as self-selecting and autonomous decision-making bodies, with dispersed shareholders playing a passive role. What’s more, directors viewed themselves not as shareholders’ servants, but as trustees for great institutions that should serve not only shareholders but other corporate stakeholders as well, including customers, creditors, employees, and the community. Equity investors were treated as an important corporate constituency, but not the only constituency that mattered. Nor was share price assumed to be the best proxy for corporate performance.7

Go back further, to the very beginnings of business corporations, and we see even greater deviations from shareholder primacy. Many corporations formed in the late eighteenth and early nineteenth centuries were created specifically to develop large commercial ventures like roads, canals, railroads, and banks. Investors in these early corporations were usually also customers. They structured their companies to make sure the business would provide good service at a reasonable price – not to maximize investment returns.8

So where did the idea that corporations exist only to maximize shareholder value come from? Originally, it seems, from free-market economists. In 1970, Nobel Prize winner Milton Friedman published a famous essay in the New York Times arguing that the only proper goal of business was to maximize profits for the company’s owners, whom Friedman assumed (incorrectly, we shall see) to be the company’s shareholders.9 Even more influential was a 1976 article by Michael Jensen and William Meckling titled the “Theory of the Firm.”10 This article, still the most frequently cited in the business literature,11 repeated Friedman’s mistake by assuming that shareholders owned corporations and were corporation’s residual claimants. From this assumption, Jensen and Meckling argued that a key problem in corporations was getting wayward directors and executives to focus on maximizing the wealth of the corporations’ shareholders.

Jensen and Meckling’s approach was eagerly embraced by a rising generation of scholars eager to bring the “science” of economics to the messy business of corporate law and practice. Shareholder primacy theory led many to conclude that managerialism must be inefficient and outmoded, and that corporations needed to be “reformed” from the outside. (There is great irony here: free-market economist Friedrich Hayak would have warned against such academic attempts at economic central planning.)12Shareholder primacy rhetoric also appealed to powerful interest groups. These included activist corporate raiders; institutional investors; and eventually, CEOs whose pay was tied to stock price performance. As a result, shareholder primacy rose from arcane academic theory in the 1970s to dominant business practice today.13

Debunking the Shareholder Value Myth: Law

Yet it is important to note that shareholder primacy theory was first advanced by economists, not lawyers. This may explain why the idea that corporations should be managed to maximize shareholder value is based on factually mistaken claims about the law.

Consider first Friedman’s erroneous belief that shareholders “own” corporations. Although laymen sometimes have difficulty understanding the point, corporations are legal entities that own themselves, just as human entities own themselves. What shareholders own are shares, a type of contact between the shareholder and the legal entity that gives shareholders limited legal rights. In this regard, shareholders stand on equal footing with the corporation’s bondholders, suppliers, and employees, all of whom also enter contracts with the firm that give them limited legal rights.14

A more sophisticated but equally mistaken claim is the residual claimants argument. According to this argument, shareholders are legally entitled to all corporate profits after the fixed contractual claims of creditors, employees, suppliers, etc., have been paid. If true, this would imply that maximizing the value of the shareholders’ residual interest in the company is the same thing as maximizing the value of the company itself, which usually benefits society. But the residual claimants argument is also legally erroneous. Shareholders are residual claimants only when failed companies are being liquidated in bankruptcy. The law applies different rules to healthy companies, where the legal entity is its own residual claimant, meaning the entity is entitled to keep its profits and to use them as its board of directors sees fit. The board may choose to distribute some profits as dividends to shareholders. But it can also choose instead to raise employee salaries; invest in marketing or research and development; or make charitable contributions.15

Which leads to the third legal error underlying shareholder primacy: the common but misleading claim that directors and executives are shareholders’ “agents.” At law, a fundamental characteristic of any principal/agent relationship is the principal’s right to control the agent’s behavior. But shareholders lack the legal authority to control directors or executives. Traditionally, shareholders’ governance rights in public companies are limited and indirect, including primarily their right to vote on who sits on the board, and their right to bring lawsuits for breach of fiduciary duty. As a practical matter, neither gives shareholders much leverage. Even today it remains very difficult for dispersed shareholders in a public corporation to remove an incumbent board.16 And shareholders are only likely to recover damages from directors in lawsuits involving breach of the duty of loyalty, meaning the directors were essentially stealing from the firm. Provided directors don’t use their corporate powers to enrich themselves, a key legal doctrine called the “business judgment rule” otherwise protects them from liability.17

The business judgment rule ensures that, contrary to popular belief, the managers of public companies have no enforceable legal duty to maximize shareholder value.18 Certainly they can choose to maximize profits; but they can also choose to pursue any other objective that is not unlawful, including taking care of employees and suppliers, pleasing customers, benefiting the community and the broader society, and preserving and protecting the corporate entity itself. Shareholder primacy is a managerial choice – not a legal requirement.

Debunking the Shareholder Value Myth: Evidence

Which leads to the question of the empirical evidence. As noted above, the law does not require corporate managers to maximize shareholder value. But this certainly is something managers can opt to do. And certain corporate governance strategies — putting more independent directors on boards, tying executive pay to share price, removing “staggered” board structures that make it harder to oust sitting directors — are widely recognized as effective means to make managers embrace raising share price as their primary objective. If shareholder primacy theory is correct, corporations that adopt such strategies should do better and produce higher investor returns than corporations that don’t. Does the evidence confirm this?

Surprisingly, the answer to this question is “no.” Researchers have spent decades and produced scores of studies seeking to prove that shareholder primacy generates superior business results. Yet there is a notable lack of replicated studies finding this.19 For example, one survey looked at more than a dozen studies of supposedly shareholder-hostile companies that used dual-class share structures to disenfranchise public investors. Some studies found dual-class structures had no effect on corporate performance; some found a mild negative effect; and some studies found a positive effect (in one case, a strongly positive effect), exactly the opposite of what shareholder primacy theory predicts.20

But more important, studies that examine whether supposedly shareholder value-maximizing strategies improve the performance of an individual company for a year or two are looking in the wrong place and at the wrong time period. Individual shareholders may perhaps care only about their own investing returns in the near future. But policymakers and governance experts should care about public equity returns to investors as a class, over longer periods. As already noted, if we look at returns to public equity investors as a class, over time, the shift to shareholder primacy as a business philosophy has been accompanied by dismal results.

Why? The answer may lie in recognizing that shareholder value-increasing strategies that are profitable for one shareholder in one period of time can be bad news for shareholders collectively over a longer period of time. The dynamic is much the same as that presented by fishing with dynamite. In the short term, the fisherman who switches from using baited lines to using dynamite sees an increase in the size of his catch. But when many fishermen in the village begin using dynamite, after an initial increase, the collective catch may diminish steadily. Shareholders may experience the same regrettable result when they push managers to “maximize shareholder value.”

There Is No Single Shareholder Value

To understand why shareholder primacy can be compared to fishing with dynamite, it is useful to start by recognizing an awkward reality: there is no single “shareholder value.” Shareholder primacy looks at the world from the perspective of a Platonic shareholder who only cares about one company’s share price, at one moment in time. Yet no such Platonic entity exists.

“Shareholders” actually are human beings who happen to own shares, and human beings have different interests and different values. Some shareholders plan to hold long-term, to save for retirement; others are speculators, eager to reap a quick profit and sell. Some shareholders want companies to make long-term commitments that earn the loyalty of customers, employees and suppliers; others may want to profit from opportunistically exploiting stakeholders’ commitments. Some investors are undiversified (think of the hedge fund manager whose human and financial capital are both tied up in the fate of one or two securities). Most are diversified, and worry about the performance of multiple companies as well as their own health, employment prospects, and tax burdens. Finally, some shareholders may not care if their companies earn profits by breaking the law, hurting employees and consumers, or damaging the environment. But others are “prosocial,” willing to sacrifice at least some investment returns to ensure the companies they invest in contribute to, rather than harming, society.

It is these divisions between shareholders’ interests that allow some shareholders to profit by pushing companies to adopt strategies that harm other shareholders. The divisions make it possible for shareholders to “invest with dynamite,” as it were.

Investing With Dynamite

As an example, consider the conflict between short-term and long-term investors. It was once believed (at least by academic economists) that the market price of a company’s stock perfectly captured the best estimate of its long-term value. Today this idea of a perfectly “efficient” stock market has been discredited, and it is widely recognized that some business strategies can raise share price temporarily while possibly harming the company’s long-term prospects. Examples include cutting expenses for marketing or research and development; siphoning off cash that might otherwise be invested for the future through massive dividends or share repurchase plans; taking on risky leverage; and selling off all or part of the company. Hedge funds and other activist investors are famous for pushing boards to adopt such strategies. (Consider Carl Icahn’s recent efforts to get Transocean to pay out dividends rather than reducing its debt.)21 This is profitable for the activists, who typically sell immediately after the share price rises. But over time, this kind of activism diminishes the size and health of the overall population of public companies, leaving investors as a class with fewer good investing options.

A similar dynamic exists when it comes to how companies treat stakeholders like employees and customers. Shareholders as a class want companies to be able to treat their stakeholders well, because this encourages employee and customer loyalty (“specific investment”).22 Yet individual shareholders can profit from pushing boards to exploit committed stakeholders — say, by threatening to outsource jobs unless employees agree to lower wages, or refusing to support products customers have come to rely on unless they buy expensive new products as well. In the long run, such corporate opportunism makes it difficult for companies to attract employee and customer loyalty in the first place. Some investors profit, but again, the size of the total investing “catch” declines.

Conflicts of interest between diversified and undiversified shareholders raise similar problems. For several years, BP paid large dividends and kept its share price high by cutting safety corners to keep expenses down. Undiversified investors who owned only BP common stock benefited, especially those lucky enough to sell before the Deepwater Horizon disaster. But when tragedy finally struck, the BP oil spill damaged not only of the price of BP shares, but also BP bonds, other oil companies operating in the Gulf, and the Gulf tourism and fishing industries. Diversified investors with interests in these other ventures would have preferred that BP focused a bit less on maximizing shareholder value. Similarly, consider the irony of a pension fund portfolio manager whose job is to invest on behalf of employees pushing companies to raise share prices – by firing employees. This harms not only investors who are also employees, but all investors, as rising unemployment hurts consumer demand and eventually corporate profits.

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Finally, consider the differing interests of asocial investors who do not care if companies earn profits from illegal or socially harmful behaviors, and prosocial investors who don’t want the companies they invest in to harm others or violate the law. The first group wants managers to “unlock shareholder value” at any cost, without regard to any damage done to other people or to the environment. The second group does not. Asocial investing – one might even call it sociopathic investing23 – may not harm corporate profits in the long run. Thus it presents a different problem from other shareholder value strategies, discussed above, that reduce long-run investing returns. But it presents ethical, moral, and economic efficiency problems of its own.

Which Shareholders and Whose Values?

Closer inspection thus reveals the idea of a single “shareholder value” to be a fiction. Different shareholders have different values. Many, and probably most, have concerns far beyond what happens to the share price of a single company in the next year or two.

Some shareholder primacy advocates might nevertheless argue that we need to embrace share price as the sole corporate objective, because if we judge corporate performance more subjectively or use more than one criterion, managers become unaccountable. This argument has at least two flaws. First, we routinely judge the success of endeavors by multiple, often subjective, criteria. (Even eating lunch in a restaurant requires balancing cost against taste against calories against nutrition.) Second, the philosophy of “maximize shareholder value” asks managers to focus only on the share price of their own company, in the relatively near term. In other words, it resolves conflicts among shareholders by privileging the small subset of shareholders who are most shortsighted, opportunistic, undiversified, and indifferent to ethics or others’ welfare — the lowest common human (perhaps subhuman) denominator. This seems a high price to pay for the convenience of having a single metric against which to measure managerial performance.

There may be a better alternative: replace corporate maximizing with corporate “satisficing.”

The Satisficing Alternative

Milton Friedman and other late twentieth-century academic economists were obsessed with optimizing: picking a single objective, then figuring out how to maximize it. This preference for analyzing problems from an optimizing perspective may reflect a taste for reductionism. It may also reflect a taste for mathematics. (Although math can help you figure out how to maximize a single variable, it is much less useful for telling you how to pick and choose among several.)

But optimization is rarely the best strategy for either organisms or institutions. For example, if biology favored optimizing a single objective, humans would not need to drag around the weight of an extra kidney. And if people made decisions by optimizing, we would not find ourselves debating between taste, calories, and nutrition in choosing what to eat for lunch. Similarly, Nobel Prize winning economist Herman Simon argued more than a half-century ago that corporations need not try to optimize a single objective. Rather, firms can pursue several objectives, and try to do decently well (or at least sufficiently well) at each rather than maximizing only one. Simon called this “satisficing,” a word that combines “satisfy” with “suffice.”24

Satisficing has many advantages as a corporate decision-making strategy. Most obviously, it does not try to resolve conflicts among different shareholders by maximizing only the interests of the small subset who are most short-term, opportunistic, undiversified, and asocial. It allows managers instead to try to decently (but not perfectly) serve the interests of many different shareholders – including long-term shareholders; shareholders who want the company to be able to keep commitments to customers and employees; diversified shareholders who want to avoid damaging their other interests as investors, employees, and consumers; and prosocial shareholders who want the company to earn profits in a socially and environmentally responsible fashion.

When managers are allowed to satisfice, they can retain earnings to invest in safety procedures, marketing, and research and development that contribute to future growth. They can eschew leverage that threatens the firm’s stability. They can keep commitments that build customer and employee loyalty. They can protect their shareholders’ interests as employees, taxpayers and consumers by declining to outsource jobs, lobby for tax loopholes, or produce dangerous products. Finally, they can respect the desires of their prosocial shareholders by trying to run the firm in a socially and environmentally responsible fashion.

Of course, if managers don’t also earn profits, they won’t be able to do these things for long. But the satisficing approach recognizes that while earning profits is necessary for the firm’s long-term survival, it is not the only corporate objective. Once profitability is achieved, the firm can focus on satisfying other goals, including future growth, controlling risk, and taking care of its investors, employees, customers, even society. Our recent experience with the disappointing results of shareholder primacy suggest this approach may be better not only for shareholders, but for the rest of us as well.

2016 March 15

The article was originally published in The European Financial Review April/May 2013 edition.

References

1. Jesse Eisinger, “Challenging The Long-Held Belief in ‘Shareholder Value’”, New York Times (June 27, 2012); Joe Nocera, “Down With Shareholder Value,” New York Times (August 10, 2012); Andrew Ross Sorkin, “Shareholder Democracy Can Mask Abuses,” New York Times(February 25, 2013).

2. Edward A. Rock, “Adapting to the New Shareholder-Centric Reality,”University of Pennsylvania Law Review (forthcoming 2013).

3. Lynn A. Stout, “Toxic Side Effects of Shareholder Primacy,” University Pennsylvania Law Review (forthcoming 2013).

4. The Economist, “The Endangered Public Company,” (May 19, 2012), available at ww.economist.com/node/21555562.

5. Steven Denning, “Why Did IBM Survive?,” Forbes.com (July 10, 2011), available at http://www.forbes.com/sites/stevedenning/2011/07/10/why-did-ibm-survive.

6. Stout, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public (2012).

7. Gerald F. Davis, Managed by the Markets: How Finance Reshaped America 59-101 (2009)

8. Henry Hansmann and Mariana Pargendler, “The Evolution of Shareholder Voting Rights: Separation of Ownership and Consumption” (February 15, 2013), available at http://ssrn.com/abstract=2219865.

9. Milton Friedman, “The Social Responsibility of Business is to Increase Its Profits,” New York Times Magazine 32 (September 13, 1970).

10. Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” 3 Journal of Financial Economics 305 (1976).

11. Roger Martin, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL 11 (2011).

12. Hayak, The Fatal Conceit: The Errors of Socialism (1991).

13. Rock, supra note 2 and Stout, supra note 3.

14. Stout, supra note 6, at 37-38.

15. Stout, supra note 6, at 38-41.

16. Bebchuk, “The Myth of the Shareholder Franchise,” 93 Virginia Law Review 675 (2005).

17. Stout, supra note 6, at 42-44.

18. The only context in which courts require directors to maximize shareholder value is when the directors of a public company determine to sell the company to a private owner, in essence deciding to force public shareholders out of the firm. At this point shareholders are uniquely vulnerable to exploitation, and perhaps need the legal protection of the so-called Revlon doctrine. However, directors have no obligation to sell a company to a private bidder, even at a premium price.  In other words, as long as a public company wants to stay public, directors have no legal obligation to maximize either profits or share value.

19. About the only empirical finding that has been reliably replicated is that when governance changes cause directors to sell a company, the buyer pays a premium over market price. This increases the wealth of shareholders in target companies. Unfortunately, it also often depresses the stock prices of bidding companies by an equal or greater amount, suggesting that mergers and acquisitions do not increase the wealth of shareholders as a class.  One study has concluded that the net result for all shareholders of all mergers and acquisitions done between 1980 and 2001 was to reduce aggregate market value by $78 billion. See Stout, supra note 6, at 88-89.

20. Valentin Dimitriv and Prem C. Jain, “Recapitalization of One Class of Stock into Dual-Class: Growth and Long-Run Stock Returns,” 12 Journal of Corporate Finance 342 (2006).

21. Will Kennedy and David Weth, “Transocean Restores Dividend After Investor Icahn Pressure,” Bloomberg News, March 4, 2013, available at  www.bloomberg.com/news/2013-03-04/transocean-restores-dividend-after-pressure-from-investor-icahn.html.

22. Margaret M. Blair and Lynn A. Stout, “A Team Production Theory of Corporate Law,” 85 Virginia Law Review 247 (1999).

23. Lynn Stout, “How Investing Turns Nice People Into Sociopaths,” The Atlantic.com (April 4, 2012), available at finance.yahoo.com/news/investing-turns-nice-people-sociopaths-134532618.html.

24. Herbert A. Simon, Administrative Behavior: A Study of Decision-Making in Administrative Organization (1947).


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  • For a subsection titled “Debunking the Shareholder Value Myth: Evidence” there is remarkably little actual evidence besides a few anecdotes. Perhaps the book referenced in note 6 has better evidence, but it is not on display here.

    The question here is what the default rules governing behavior by corporate managers should be. If investors prefer different rules, you would have expected to see more of those alternative rules enshrined in organizational documents. This suggests that people do not have a problem with the current rules or that the game is not worth the candle.

    • jayrayspicer

      DWAnderson, you realize this web site is aimed at popular, rather than scholarly audiences, right? And that it’s more a forum for debate than a refereed research journal, right? The citation bar is a little lower. Even so, perhaps you didn’t notice the 24 citations provided. You certainly didn’t seem to notice any of the persuasive arguments.

      And no, the question here is clearly whether “maximizing shareholder value” works, and the answer is obviously that it doesn’t. It’s a just-so story, a wishful-thinking, made-up oversimplification of what corporations are for, and it suits a particular ideological agenda which is bad for the country and bad for the world. And bad for corporations and bad for capitalism.

      The only reason that many investors and many people generally don’t have a problem with the current focus on maximizing shareholder value is that pied pipers like Milton Friedman and CNBC have been pushing this self-serving fairy tale for so long. This web site is an attempt to debunk the long-term propaganda dragging us down.

      • What was the best persuasive argument that you think I missed?

        • jayrayspicer

          For starters, that shareholder primacy theory was invented out of whole cloth by Friedman, et al, in the 1970s with zero empirical support. No research, just a raw assumption that seemed elegant to them.

          Then there are Friedman’s mistaken beliefs about shareholders owning firms, or having residual claims on operating firms as a justification for investors sucking all the value out of a company, as though there are no other stakeholders.

          But if you want the best argument, it’s that there is no generic single shareholder whose value can be maximized. You can’t simultaneously maximize for the corporate raider, the pension fund manager, the day trader, the long term shareholder, or the social value shareholder. Just assuming that targeting the maximum value for the short term shareholder will result in maximizing the value for other kinds of shareholders is another groundless assumption, made on the sole basis that it would make the arithmetic easier if it worked that way. Math and reality have a habit of disappointing us when we think like that.

          • Legally, maximizing shareholder value does *not* mean targeting the maximum value for the short term shareholder. Only in the context of evaluating acquisition bids do you find legal arguments for that and then because that context makes it necessary.

            However, assuming a more reasonable definition of maximizing shareholder value (e.g. NPV of expected payouts to shareholders) I think the response to the *best* argument you cite is that in my original post: if there were superior alternatives, you would expect to see them put into organizational documents. Then those that wanted companies to pursue different goals could invest in those companies.

            I think the main reason that you do not see that is that the publicly held corporation is not a great vehicle for pursuing those other goals.

          • jayrayspicer

            Um, maximizing the net present value of expected payouts to shareholders is exactly the same as short term maximization, because the “present” in “net present value” is *now*. It doesn’t get any more short term than now. But that won’t at all satisfy social value shareholders, and in any case, shareholders have no greater claim on a company’s value than any other stakeholder, except at liquidation. There is no legal, empirical, or moral justification for shareholder maximization. Just because that’s the way most firms currently operate doesn’t mean it’s any more than a cynical smokescreen for elevating the moral value of capital over that of labor, or customers, or the environment, or the community.

            But some corporations do, in fact, put an emphasis on other stakeholders in the organizational documents. The B corporation, for example. See https://en.wikipedia.org/wiki/Benefit_corporation. And as Stout’s article points out, this multiple stakeholder approach used to be quite common before the 1970s, when shareholder maximization began to be parroted as a panacea in the business press. But good luck convincing existing boards and management, raised on Friedman’s BS and mired in the shareholder maximization rat race to the bottom, that anything matters but the stock price.

          • Just two small points as I think my point stands: First, the present in NPV is a reference to discounting to present value a stream of all future payouts. Second the reason shareholder maximization became popular was as a means to combat agency problems where management enriched themselves and their cronies instead in lieu of shareholders, which is the likely reason why alternate standards of performance are not popular in the market.

          • jayrayspicer

            I know how net present value works. If the various NPVs are calculable, and you maximize them, you are maximizing the short-term shareholder value of the firm, pretty much by definition. And maximizing short-term shareholder value is only really useful to a corporate raider (or stock-compensated management, essentially internal corporate raiders). For the long-term viability of the firm, for its customers and employees, the community and environment, this is simply irrelevant. Sustainability and responsible behavior is more important.
            I’m sure combating agency problems was used as one of many sales pitches for shareholder maximization. How’d that work out? Stratospheric executive compensation and mutual board/management cronyism are rampant, despite the fact that studies show firms with the most highly compensated execs perform worse. Not surprising, since the overpaid execs are leeching money straight from the bottom line. So maximizing shareholder value doesn’t even work for that purpose.
            Alternate corporate standards are not popular because a simplistic, fallacious standard serves the interests of management (as a pleasant fairy tale to tell shareholders) or corporate raiders (as justification for suits, threats, and their destructive behavior in general). Shareholder maximization theory also persists because it’s in all the textbooks, as though it had any theoretical, empirical, or moral justification, which it does not.

          • Al Black

            You clearly don’t know how NPV works, or you wouldn’t equate it with the “short-term shareholder value”. It is by definition the long term value, discounted to today for investment comparison purposes only. Growing a Forest gets you a large return in 30 years, and its NPV is far greater than your investment, so you plant the forest. Nothing short-term there. As a shareholder I expect the people I am paying to maximise the return on my investment for the longer term, so that means I want my Company to make sustainable profits, attract good people to work there, and be highly thought of by the public in general and our customers in particular.

          • jayrayspicer

            Anybody considering purchasing a firm would take into account the calculable NPV of the firm’s endeavors. That’s what today’s stock price is supposed to reflect. The long term revenue stream is already factored in, if it’s possible to calculate it. NPV is just a mathematical reduction of the projected income stream to what it’s worth now.

            If I were going to sell land with young trees, I would expect to be paid for their NPV, today. If I were trying to maximize shareholder value, and wanted to decide whether to plant trees for eventual harvest, or start mountaintop-removal mining, I’d figure the NPV for both. If the mining NPV were higher, goodbye environment. Whether you calculate the NPV or add up the long term revenue stream, you get the same result. NPV just let’s you do the comparison with a single number for each choice, in today’s dollars.

            Again, NPV is just another way of figuring out today’s (the very short term) value of the firm. And maximizing that value in dollars for the benefit of some shareholders, without regard to the preferences of other stakeholders, or even the sustainability of the firm, ignores all things that humans value, apart from cash. That’s bad. There are some things you can’t buy with cash.

          • Al Black

            That is where ethics comes in. The highest NPV is the best investment, all else being equal. You posit a case where all things are not equal: where there are ethical, environmental and stakeholder issues to consider. NPV is not the tool to deal with those, but I’d argue that the long-term shareholder value is best served by ethical managers making ethical decisions. Where a company or a manager has no ethical compass, that is where regulation is a regrettable necessity to ensure that the needs of the community are addressed as well as those of the Shareholders. The rights of the Shareholders are paramount to the company, until they infringe on the rights of others. It is good business to be a good citizen and ensure that human values are adhered to, in the long term. Capitalism has been the greatest force for good in human history, lifting billions out of poverty: we should not focus on the individual failures to the exclusion of its overwhelming success.

          • jayrayspicer

            The point of the article is that managers and investors who insist on “maximizing shareholder value” consciously and explicitly reject any other kind of value. Managers are not allowed to have an ethical compass. The stock price is the only compass permitted. That’s bad. That’s one important reason why “maximizing shareholder value” is bogus.

            Another reason, as discussed in the article, is that the rights of the shareholders are not, in fact, paramount, legally or morally. The shareholder maximization propaganda has just convinced a lot of people that shareholders are the only people that matter to a company. This is also bogus, and we should stop giving deference to such a false and harmful view of corporate goals.

            Furthermore, capitalism gets an awful lot of credit for lifting people out of poverty, when in fact automation and specialization of labor are the factors that made consumer goods cheap and abundant. The Soviet Union created a middle class that was better off than the serfs under the tsars. Their system wasn’t as good or as free as ours, but they actually did make a lot of industrial progress. Before that, under mercantilism, the great powers of Europe greatly increased the standard of living of their citizens, but nobody would argue that mercantilism is awesome.

          • Al Black

            I distrust people who label things I know to be true as bogus, without giving any evidence to support their view. The Soviet Union collapsed because central planning does not work, and it has been shown that it never can. The Soviet middle class survived on black market capitalism, that was all that kept it going for so long. Central planning and bureaucracy lock in baseline poverty because it stifles entrepreneurialism, innovation and invention. I reject utterly the idea that “maximizing shareholder value” excuses management from having a moral compass. The rights of the shareholders are paramount, legally and morally with the Company they own, within the constraints of morality and the law. Most businesses are run that way: corruption and criminality are the exception rather than the rule. The worst excesses of “Robber Baron” Capitalism fade in comparison to the evil carried out by Socialist dictatorships run by Hitler, Stalin, Mao, Mugabe and the like. Socialists believe in Central planning, that they know better than we what is good for us, and that the end justifies the means: the people must suffer for the good of the people. Our children should be taught in school how much we owe to Capitalism, and how to deny the seductive lies of Socialism.

          • Firdaus Hamdan

            Totally agree with you and the writer. It’s about time for the shareholder primacy be consigned to the dustbin of the history.

      • Firdaus Hamdan

        Totally agree with you and the writer. It’s about time for the shareholder primacy be consigned to the dustbin of the history.

    • Larryeart

      the evidence was clearly up front of article: the life expectancy of Fortune 500 Companies has declined by 80%. Like skin-eating diseases, corporations have devoured themselves-despite no complaints from stockholders.

  • JeffMowatt

    Lynne Stout’s book validated an assertion made about doing business for social benefit . http://www.p-ced.com/1/node/112

  • Pavlos Papageorgiou

    I agree. The purpose of a firm is to produce goods and services that the world wants, as well making a surplus to secure its own future and pleasing the internal stakeholders. From my blog: http://pavlos.geekhost.org/2010/10/09/on-business/

  • jayrayspicer

    If you focus on winning, you’re going to lose. If you focus on the game, you’ve got a shot at winning. Maximizing shareholder value takes everybody’s eyes off the ball.
    If maximizing shareholder value is your focus, then you should just go ahead and liquidate the company and cash out the investors, because that’s the best you’re ever going to be as an investment.

  • Al Black

    What a bunch of rubbish! If Shareholders don’t own the Company, who does? Maximising the long-term value for the shareholders requires that the Company also be a good Corporate Citizen, A good place to work, and provide superior goods and services to its customers. There is no contradiction there, unless you are a hair-splitting Academic with no skin in the game!

    • Amanda

      Even in your statement you have already qualified that “long-term” shareholder value drives companies to be good corporate citizens. The article (and indeed the stock market, as well as the recent astronomical valuations of tech startups around the world) show you that many shareholders are Not worried and Not focused on the long-term. Thus companies are often rewarded for gimmicks, instead. Speaking as a close friend of someone who is struggling to make enough returns to satisfy his investors, I can assure you, even people with skin in the game don’t find our current ideology satisfying or sufficient.

    • John M Legge

      Who owns the Hudson River? The US Supreme Court has ruled that companies are people and can participate as donors in elections and have objections to certain contraceptive practices. Isn’t there something in the Constitution banning the ownership of people?

  • Al Black

    Is This the Dumbest Business Article Ever? The Myth of Demonising Shareholder Value

  • Firdaus Hamdan

    Totally agree the writer. It’s about time for the shareholder primacy theory be consigned to the dustbin of the history.

  • Jim Loving

    This is not the first article/book to discuss the fallacies, flaws and shortcomings in shareholder value model of corporate governance and practice. What is certainly true in business and the economy is that what “gets measured, gets managed and rewarded.” The skewing towards one class of stakeholder and one metric (shareholder price and financial incentives around this number for senior executives) are drivers to fuel the worst elements of globalization and de-industrialization. This article does do a good job of reviewing the history of the practice and the legal underpinning (or lack of legal underpinning) for the approach. New models for business and economics are continuing to be explored and flourishing as it continues to be clear that the existing models are not sustainable or advantageous for most participants in society and the economy. The “New Economy Movement” looks at both new forms of ownership and governance, along with different measures of macro-economic performance beyond GDP. In business, there are owners, managers, and workers – along with customers and other stakeholders. Moving towards greater worker ownership and participation and stake in business management and governance is one model that is working and worth exploring as a means to expand in building greater local, regional economic resilience.

  • Stout and I approach the considerations of corporate
    behavior from different angles (Stout on shareholder value, I on profit
    maximization), but the conclusions arrive at the same point….

    https://thesmallr.wordpress.com/2015/04/21/profit-maximization-is-self-annihilation/

  • Pezdrake

    “embraced by a rising generation of scholars eager to bring the “science” of economics to the messy business of corporate law and practice.”

    May i suggest that this was motivated reasoning by those who wanted their worldviews bolstered by a defense of “science and reason”?