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The Myth of Maximizing Shareholder Value

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Yves here. This is a subject near and dear to my heart. So many of the assertions made about “maximizing shareholder value” are false that they should be assumed to be a lie until proven otherwise. The first is that board and managements are somehow obligated to “maximize shareholder value” is patently false. Legally, shareholders’ equity is a residual claim, inferior to all other obligations. Boards and management are required to satisfy all of the company’s commitments, which include payments to vendors (including employees), satisfying product warranties, paying various creditors, paying taxes, and meeting various regulatory requirements (including workplace and product safety rules and environmental regulations). As we wrote last year:

If you review any of the numerous guides prepared for directors of corporations prepared by law firms and other experts, you won’t find a stipulation for them to maximize shareholder value on the list of things they are supposed to do. It’s not a legal requirement. And there is a good reason for that.

Directors and officers, broadly speaking, have a duty of care and duty of loyalty to the corporation. From that flow more specific obligations under Federal and state law. But notice: those responsibilities are to the corporation, not to shareholders in particular…Shareholders are at the very back of the line. They get their piece only after everyone else is satisfied. If you read between the lines of the duties of directors and officers, the implicit “don’t go bankrupt” duty clearly trumps concerns about shareholders…

So how did this “the last shall come first” thinking become established? You can blame it all on economists, specifically Harvard Business School’s Michael Jensen. In other words, this idea did not come out of legal analysis, changes in regulation, or court decisions. It was simply an academic theory that went mainstream. And to add insult to injury, the version of the Jensen formula that became popular was its worst possible embodiment.

And as John Kay has stressed, when companies try to “maximize shareholder value,” they don’t succeed:

Oblique approaches are most effective in difficult terrain, or where outcomes depend on interactions with other people. Obliquity is the idea that goals are often best achieved when pursued indirectly.

Obliquity is characteristic of systems that are complex, imperfectly understood, and change their nature as we engage with them…

Obliquity gives rise to the profit-seeking paradox: the most profitable companies are not the most profit-oriented. ICI and Boeing illustrate how a greater focus on shareholder returns was self-defeating in its own narrow terms. Comparisons of the same companies over time are mirrored in contrasts between different companies in the same industries. In their 2002 book, Built to Last: Successful Habits of Visionary Companies, Jim Collins and Jerry Porras compared outstanding companies with adequate but less remarkable companies with similar operations…in each case: the company that put more emphasis on profit in its declaration of objectives was the less profitable in its financial statements.

So what is this propagandizing really about? As this post from INET discusses, it’s a justification for extractive capitalism. I encourage you to make the time to watch the video, which is very accessible and lends itself to sharing with friends and colleagues.

Originally published at the Institute for New Economic Thinking blog

In 2010, the 500 largest companies in the United States, otherwise known as The Fortune 500, generated $10.7 trillion in sales, reaped a whopping $702 billion in profits, and employed 24.9 million people around the world.

Historically this has been good news. After all, when these corporations have invested in the productive capabilities of their U.S. employees, Americans have typically enjoyed plentiful well paying and stable jobs. That was the case a half century ago.

Unfortunately, as Bill Lazonick points out in the interview below, it’s not the case today.

For the past three decades, top executives have been rewarding themselves with mega-million dollar compensation packages while American workers have suffered an unrelenting disappearance of middle-class jobs. Since the 1990s, this hollowing out of the middle-class has even affected people with lots of education and work experience.

As the Occupy Wall Street movement correctly recognized, the concentration of income and wealth of the economic top “one percent” of society has left the rest of us largely high and dry. Corporate profits are increasingly going to share buybacks or dividend distribution, but very little is going back into research and development efforts, capital reinvestment, and employment.

Corporations, in other words, are devoting increasing amounts of their considerable and growing financial resources to redistribution rather than innovation. And they are doing so based on the justification of 
“increasing shareholder value.”

However, as Lazonick points out, when the shareholder-value mantra becomes the main focus for companies executives usually concentrate on avoiding taxes for the sake of higher profits and don’t think twice about permanently axing workers. They also increase distributions of corporate cash to shareholders in the form of dividends and, even more prominently, stock buybacks.

When a corporation becomes financialized in this way, the top executives no longer concern themselves with investing in the productive capabilities of employees, the foundation for rising living standards. Instead they become focused on generating financial profits that can justify ever higher stock prices – in large part because, through their stock-based compensation, high stock prices translate into megabucks for these corporate executives themselves.

It’s not a pretty state of affairs. Lazonick discusses how we evolved from a society in which corporate interests were largely aligned with those of broader public purpose into a state where crony capitalism, accounting fraud, and corporate predation are predominant characteristics.

Lazonick makes a very powerful case that the ideology of “maximizing shareholder value” primarily works to the benefit of the very corporate executives who make corporate resource allocation decisions, and who derive high levels of remuneration from munificent stock option awards. As for the rest of us, we’re left to fight over the crumbs.

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65 comments

  1. JohnB

    For those who can’t get the video working, I was able to find one (and only one) working download URL, of the WebM format of the video, by pasting the youtube video link into the JDownloader download manager.
    https://www.youtube.com/watch?v=VV5XaRco7ag

    I looked around, but can’t find a good way to grab the direct WebM URL off of YouTube itself – JDownloader however, will grab the WebM file direct for you.

  2. Peter L.

    Very interesting post. However, I am confused by a couple of things: (1) the fact that shareholders have a residual claim doesn’t seem to me to imply anything about whether managers and directors should or should not maximize shareholder value, or whether they are required to by law. (2) However ever hard it is in practice, can’t shareholders sue both the corporation and the directors if they make decisions that harm shareholders? I remember reading about suit in which the Dodge brothers (shareholders in Ford) successfully sued Ford because of management decisions that may have reduced the value of their shares.

    1. Yves Smith Post author

      All the other claimants have specific rights they can enforce. By contrast, a share is an extremely weak and ambiguous claim. It amount to: if your share is in a SEC registered company, you get to receive mandated disclosures and are protected against insider trading and front running. You get a vote that can be diluted at any time on annual proxies and special proxies. You’ll get a dividend if the company makes any money and the board is in the mood to declare a dividend.

      The fact that you argue that the board has some obligation despite that (go read any list of director duties, they are not hard to find) shows how deep and widespread the propaganda on this issue is.

      The Ford decision was a Michigan state court decision. Most corps are incorporated in Delaware or else the state in which they do business. The decision has no relevance save to Michigan corps. And it says only the directors have to try to make a profit, not “maximize”, so the assertions about it go beyond the language of the decision. The court said Ford could not run the business like a charity.

      Perhaps even more important in this 1919 decision was that Ford was private, so the Dodge brothers were hostages. By contrast, the overwhelming majority of shareholders in public companies can exit at any time without depressing the price if they don’t like the way the company is being run. Hence it’s hard to see it as germane.

      It might help if you read this article: Corporate Malfeasance and the Myth of Shareholder Value: http://scholar.harvard.edu/files/dobbin/files/2005_ppst_corpmal_zorn_0.pdf

      1. Peter L.

        Thanks much for the further clarification. I’m interested in understanding this, so I’ll take a look at the link. Also, thanks for the note about Dodge. I had thought it went to the Supreme Court. Looking forward to learning more about this, because I do believe the myth, though that could very well change!

        To be clear, I wasn’t arguing that the board does in fact have an obligation despite all the other things they may be legally required to do. I was just raising a logical point. Maybe another way to put it is as follows: the fact that “a share is an extremely weak and ambiguous claim” doesn’t prevent the board from maximizing the income or capital gains for that claim, and thus doesn’t provide us with convincing evidence for an argument that they are not under an obligation.

        The most interesting bit of the original post to me was the claim that the myth is “a justification for extractive capitalism.”

        I’d very much like to understand this better, but I simply don’t see a straightforward connection between some the facts discussed that the lack of the obligation.

        Also, I do believe that boards and managers do not in fact try to maximize shareholder value, because they have the power not to. Yet the truth of this doesn’t indicate whether they have some kind of legal obligation that they are ignoring because shareholders don’t have the ability or inclination to enforce their rights.

        Anyhow, as is frequently the case, glad to read something here that challenges what I think I know.

          1. Peter L.

            Yes, by “I thought it went to the Supreme Court,” I intended to mean “I mistakenly thought it went to the Supreme Court.”

            The Dobbin & Zorn paper, Corporate Malfeasance and the Myth of Shareholder Value, was excellent. Thanks for the link. After reading it, I am slightly embarrassed about making a comment in the first place. I did not realize how the term was being used.

            Here are a few of the things from the paper that I found useful in clarifying the issues of the myth of shareholder value:

            1. D&Z refer to “rhetoric of shareholder value,” “new corporate strategy,” “shareholder value of the model of the firm,” (pages 181, 182). In the video interview Lazonick refers to “ideology” of shareholder value.

            2. They discuss the replacing of “the myth of corporate ‘portfolio management’ that had supported the expansion-through-diversification as the guiding strategy of the large American firm” (page 181) with the new myth of shareholder value.

            Thus, as I understand it, “myth” is being used to mean “motivating ideology.”

            3. D&Z write that “shareholder value” was “defined eventually as the capacity to meet securities analysts’ profit projections.” (Page 181) So it is a little weird to talk about maximizing “capacity to meet securities analysts’ profit projects.” Thus what we are really talking about is earnings manipulations.

            4. This change to a shareholder value model was driven by groups—outside the traditional corporate structure: (a) hostile takeover specialists, (b) institutional investors, and (c) securities analysts.

            5. D&Z conclude that “Ownership of capital is no longer all that matters. Knowledge professionals in business specialties are ascendant, and the owners of capital are more likely to be workers themselves, investing through pension funds.” (Page 194) And that “one should be skeptical of claims that making the company’s focus the management of earnings is in the interest of shareholders.” (Page 195)

            This speaks to the other meaning of “myth,” namely that it is probably false that pension fund recipients (for instance) actually benefit from so-called shareholder value strategies, which are really earnings manipulation strategies in service of the business-knowledge elite.

            I had assumed “maximizing shareholder value” simply meant something like “maximizing profit.” So, in some sense my confusion is just terminological.

            Does anyone recommend Lynn Stout’s book about this topic?

            Thanks.

      2. Alex Tolley

        So what is this propagandizing really about? (…) it’s a justification for extractive capitalism.

        It seems to me that a lot of things are being conflated and targets being set using “guilt by association”.

        Maximizing shareholder (vs stakeholders) value is a reasonable, simple goal in principal, and certainly much easier than optimizing all stakeholders values. How to do this is basic textbook stuff.

        AFAICS, the video focused on share buybacks. The impact of this is well understood in terms of shareholder value. Conflating this with the dynamics of executive compensation is missing the real issues.

        If financialization was the culprit, then we wouldn’t see the same sorts of CEO pay problems in countries that use different goals. But of course we do, including crude theft and looting.

        Because the future is unknown, we cannot maximize shareholder wealth absolutely, it is just guessing which options make sense, and the shareholders have the same problems. If they didn’t, the stock market wouldn’t behave the way it does.

        What the referenced article shows is that “crooked” managers can be enabled by the rules (and lobbyists make that enabling easier by influencing legislation). This would happen regardless of the MSV goal.

        The problem we see in the US and elsewhere, is that MSV has been successful in separating the other stakeholders from a share of the firm’s wealth. Most importantly, the employees whose productivity gains have not been rewarded, but retained solely by the firm. A share of this has then been diverted to the executives. That this is not just some systemic side effect of MSV, was just shown to be collusion by a number of top tech firms, led by Steve Jobs at Apple.

    2. Sammy Maudlin

      Corporate directors and officers do not have a strict legal obligation to maximize profit. They have a fiduciary duty to act in the best interests of the company. Generally, the “business judgment rule” is applied in United States courts with minor differences across the states. It essentially provides that a court will not second-guess a business decision made by a director or officer when such decision is made on an informed basis, in good faith, and in the honest belief that the action taken is in the best interests of the company.

      So, let’s say X Company sells Widgets. Widgets are made solely of steel. CEO is presented with two options for purchasing steel: one costs 50% less, but is of low quality and will render 50% of the widgets useless in two weeks.

      Now, if the duty was simply to “maximize profit” he or she would be forced to purchase the lower-cost steel because there would be so much more profit (this example assumes it is still more profitable considering returns, warranty claims, and product-liability suit expenses). However, because the Widgets would be so poor that no one would buy them again, the company would go out of business in one year. He or she would be “maximizing profit” but not be acting in the “best interests of the company.”

      That’s an overly simplified example, of course. It’s only meant to highlight the difference between what the duty really is, and what too many people are saying it is these days.

  3. F. Beard

    Legally, shareholders’ equity is a residual claim, inferior to all other obligations. Boards and management are required to satisfy all of the company’s commitments, Yves Smith

    Because the shareholders own the company and Owner Equity = Assets – Liabilities. Assets are essential but note that Liabilities can be largely precluded:

    , which include payments to vendors (including employees), Yves Smith

    If payments are largely made with the company’s common stock since shares in Equity are (duh!) listed under Equity, not Liabilities.

    satisfying product warranties, Yves Smith

    But this is a liability in service and parts, ie. the products which the company produces anyway and could easily be mostly virtual if the product is very good.

    paying various creditors, Yves Smith

    If a company has enough Equity to borrow bank money (credit) then why not instead buy assets with its own common stock and avoid the interest? ans: Because bank money (credit) creation is hugely subsidized by the government so a company can borrow much more purchasing power than it could issue itself for a given amount of equity. So why share when one can legally steal instead?

    paying taxes, Yves Smith

    Fiat is needed for this so a company will have to require at least some fiat for its goods and services.

    and meeting various regulatory requirements (including workplace and product safety rules and environmental regulations). Yves Smith

    The workers doing this can be paid with common stock too.

    1. Pepe

      Shareholders do not own the corporation. They own security in the corporation. The corporation “owns” itself.

    2. j gibbs

      Directors have no significant enforceable legal obligations. State corporation laws have been constantly watered down to eliminate them, enhance management prerogatives and attract incorporation business and franchise fees. This process began at the turn of the Twentieth Century, when William Nelson Cromwell (I think) rewrote the New Jersey corporation law for the benefit of Standard Oil to facilitate its monopolization efforts. Historically, corporations were chartered individually by legislatures and their rights were restricted to accomplish some (allegedly) public purpose. As the corporations became more and more powerful, they demanded and received legislative carte blanche. Today, corporations have greater rights than individuals. You cannot jail a corporation for criminal misdeeds, and they now have unlimited rights to bribe public officials through campaign contributions, too.

      The directors are just overdressed dummies, peddling dubious achievement resumes and competing for the opportunity to collect cheap stock while fronting for management loot demands. Corporate governance is a complete charade. No reason to waste any time on it. You would have to overturn the political structure to change it in any significant way.

  4. Dikaios Logos

    Great post and great video. The “maximizing shareholder value” cantt is a way for corporate insiders to convince the “dumb money”, i.e. shareholders, that they are on the same page. One of my favorite finance reads online in recent times highlighted how equity returns are mostly a function of investors’ allocations to equities (as opposed to cash and bonds). This means that corporate insiders have a great incentive to limit the supply of equity in order to further juice their own share price driven pay packages. The idea that the executives are somehow serving the interests of shareholders, which extend well beyond price per share thinking, is a just a very convenient fiction:
    http://philosophicaleconomics.wordpress.com/2013/12/20/the-single-greatest-predictor-of-future-stock-market-returns/

  5. F. Beard

    Corporate profits are increasingly going to share buybacks or dividend distribution, Yves Smith

    Which is insane since the purpose of a common stock company is to consolidate capital for economies of scale, not dissipate it. Instead, the ONLY buying back of company shares should be with the goods and services the company produces leaving the productive assets alone.

    Stock buybacks with borrowed money as well as leveraged buyouts should be illegal. Heck, government-backed banks should be illegal since they violate Equal Protection under the Law.

  6. Anders

    Why did the mantra of shareholder value only take hold in the 1980s?

    I agree that the focus on SV seems like a bad thing, but wasn’t it always inevitable given human nature? Shouldn’t we be more surprised at how long corporations existed before they were turned into vehicles to enrich shareholders?

    1. F. Beard

      There’s nothing inherently wrong with the consolidation of the capital of many small owners into a democratically (per share anyway) controlled common stock company.

      Government-backed banks, otoh, are wrong every which way including Sunday.

      Ironically, common stock as private money is a major part of ethical money creation since common stock is an ethical, asset-backed, endogenous money form that shares wealth and power rather than concentrates them. But trust Progressives to think government backing for the banks is needed while the inherently innocent common stock company is viewed as evil, thereby elevating theft and usury over honest sharing.

      1. Anders

        “There’s nothing inherently wrong with the consolidation of the capital of many small owners”

        I think Yves’ point, to which many agree (I can’t tell if you are amongst them), is that the way corporations are run today, according to principles of MSV, is inherently both wrong and economically inefficient.

        “democratically (per share anyway)”

        That’s quite a subversion of the sense of democracy, originally intended as “power to the demos / people”.

        “common stock is an ethical, asset-backed, endogenous money form…”

        Er, ethical? Money? Since all money needs to be a unit of account plus a medium of exchange (before being possibly also a store of value), I don’t think common stock comes close to qualifying as money.

        “…that shares wealth and power rather than concentrates them”

        In the age of MSV, wealth and power have become much more concentrated. I see how you can believe that common stock _could_ share the wealth and power; I don’t see hw you can seriously believe that common stock _actually_ shares them in practice.

        “trust Progressives to think government backing for the banks is needed…”

        I think progressives regard banking as an inherently public/private endeavour. There should be mandatory depositor insurance, for which banks should be charged; the govt should nationalise only if the bank goes bust, flushing equityholders, and the govt should reprivatise as soon as the bank returns to profitability.

        “…while the inherently innocent common stock company is viewed as evil”

        I think Yves referred to corporates, managed according to MSV, as being “not pretty”; “evil” would be a bit strong.

        1. F. Beard

          Nothing new to refute here.

          Your position has been sliced to pieces in previous comments of mine, if you care to Google “F. Beard” but frankly, I’m tired of throwing pearls before arrogant swine.

          1. Skippy

            “arrogant swine” – Beardo

            At least that pejorative descriptive has contextual validity, but as usual, the Austrian[s just don’t get the delirious absurdity in their utility of it.

            skippy…Center of the Universe dilemma man-infests yet again, did you not watch the simplistic doco on cosmology I gave you beardo?

          2. ChrisCairns

            NC would be better without you, F Beard. Like a broken record and too quick to refute what others would like to say

  7. Christer Kamb

    I couldn´t agree more with Lazonick last sentences above where he states that “maximizing shareholder value” primarily works to the benefit of the very corporate executives who make corporate resource allocation decisions, and who derive high levels of remuneration from munificent stock option awards.

    So how was this possible? I would say it is about kidnapping companies and company-boards.
    And it was possible when private ownership(majority) where replaced by fund-ownership like pensionfunds and mutual funds etc (incl 401k´s).

  8. diptherio

    “It’s not a pretty state of affairs. Lazonick discusses how we evolved from a society in which corporate interests were largely aligned with those of broader public purpose into a state where crony capitalism, accounting fraud, and corporate predation are predominant characteristics.”

    I haven’t watched the video yet so this might be a little off base, but my take on things is that we haven’t really (d)evolved from a golden age of mostly public-oriented big business to the cesspool we have today–that makes it sound like a one-way process. Surveying history, I find more of a pendulum swing. Veblen obviously considered himself to be living in an age where the interests of big business were not aligned with the public purpose and the age of Robber Barons was also one of “crony capitalism, accounting fraud, and corporate predation”.

    I think we got a little reprieve after WWII, but it pretty quickly swung back towards the horror show it is today, and has been in the past. I don’t know that Lazonick or Yves really means to imply a unidirectional process of devolution from some Golden Age, but that is a rather common idea (“if only we could put Glass-Steagall back in place”, etc.), and one that, I think, needs questioning.

    1. Klassy

      Jefferson Cowie said as much in Stayin’ Alive: The 1970′s and the last days of the working class– described the mid 20th century as more an aberration or interregnum.

    2. Chauncey Gardiner

      Diptherio,
      Thanks for your comment and particularly for your observation concerning the belief of many, including myself, that reinstatement of the Glass-Steagall Act would be beneficial economically, politically and to society generally. I do not view such a measure as a universal panacea, but feel it needs to be part of a broader legislative and regulatory initiative. After all, there was criminal activity on Wall Street that resulted in the incarceration of some then prominent figures in the 1980s, long before Glass-Steagall was effectively repealed.

      I value your views and would like to see your further thinking about this if you have time to do so. Thanks again.

  9. Code Name D

    One might also question just what is meant my “shareholder value?” There was a wave of shareholder revolts as the people who supposedly owned the company tried to force the corporations that they own to embrace values other than just strictly finical. Issues such as sustainability, worker compensation and labor conditions, off shoring, and other social odious issues.

    To my knowledge, these revolts mostly failed, because they didn’t control enough shares to move the vote. The real control was still held by the CEO and his cronies on the board who directly profit from the results of their decisions.

    I also think that SV may be just another part of the notion manifest destiny of the investor class in general. Some how the man who makes millions sunning himself by the pool and sipping margaritas is celebrated as a job and wealth creator while the man who works ten hours a day doing back-braking work pulling down a five figured income a year is some how a leach on society, and needs to be paid as little as possible.

    I think that SV also needs to be challenged on a moral plain as well as a legal or economic one. Compensation should be based on what one actually contributes, labor or intellectual. The man lounging by the pool – doesn’t deserve squat. He certainly doesn’t have the right to cut workers compensation or raid the pension plan, in order to raise his own personal wealth.

  10. Garrett Pace

    Isn’t the crux of the issue one of control, not value?

    The goals and activities of enterprise are based on the desires of those that own and control it. They can decide how to seek a profit and what way to do it.

    With modern, publicly traded businesses we see the perplexing phenomenon where the people who “own” the thing have almost no control over it. Indeed, their only relevant privilege is divesting this very notional “stake” in the organization.

    No one would ever fuss over “maximizing shareholder value” if the shareholders were actually involved in the organization.

    1. Garrett Pace

      You know, I thought of a relevant analogy.

      Imagine a baseball player who decides his goal as a player is behaving so as to increase the value of his baseball cards for the kids who own them.

      Of course, there’s lots of ways of doing that, some fair and some foul…

  11. Adam

    For executives of public companies, a majority of their salary is typically common stock grants and bonuses (based on the performance of the company’s stock). The system is designed this way because people are inherently selfish and want to line their own pockets with money before anyone else’s, so if the #1-10 execs at the company’s compensations are dependent on the stock price, I would argue that incentives are aligned between shareholders and executives.

  12. ChrisCairns

    Thanks Yves, this deserves a wide audience, particularly for corporation board members.

    In my MBA, it was hammered out to us that boards had a duty of care to the shareholder and an absolute focus on profits, ie cost minimization and revenue maximization.

    Richard Branson is a very savvy guy as we all know and, love him or hate him, his employees by and large, idolize him. The usual focus of corporations is to focus on the needs of shareholders, customers and employees in that order. Branson tips this on its head and focuses on creating happy, motivated employees who, in turn, will deliver great service to customers, in turn maximizing returns to shareholders.

    He often achieves this despite paying his employees below that of his competitors.

    1. Curt

      You answered the question – maximizing shareholder value – is a business school construct, not a legal one.

      1. Android 16

        And, if I guess correctly, business school curriculums are written by pries … err … economists.

    2. bobh

      I have seen Jim Sinegal, Costco founder and CEO, quoted as saying that stockholders interests come in third at Costco, behind customers and employees. Makes me want to own his stock.

    3. Publius

      ChrisCairns,

      I believe that the original function of the board of directors was to represent the interests of the wider society as well as investors. The board was seen as society’s chance to influence the corproration to act on society’s behalf. My history of US legal thought on this is a little shaky, however. If that’s the case, how have we come to “maximizing shareholder value”?

      Back in the bad 1980s – viz. Michael Milken, et al – corporations were seen as bundles of value – i.e., money and the potential to make more. If one part didn’t perform, you sell that part, or the entire corporation, to someone else who could.

      Along in the 1980s came Michael Jensen who popularized the idea of maximizing shareholder value. Raiders who were eager to rip corporations apart seized the idea as righteous justification for their hunting and fishing. The courts surprisingly accepted this premise. Maximizing shareholder value became the test of whether you are a responsible board or CEO. It could cost you big time if a court said you weren’t.

      At this point, maximizing shareholder value – a ridiculous notion on the face of it – is Bible in most college finance classes and has spread to other business classes. Most MBA students will mouth the received wisdom of maximizing shareholder value. What about laws and regulations? Keeping a good corporate reputation? Keeping your non-employee neigbors happy – or at least not pissed off? Keeping customers happy? Etc. It’s going to take a lot to remove this mantra from the minds of many graduated MBAs. Simply changing course syllabi won’t do it. The alternative idea, the corporation as a balancing of constituencies, hasn’t caught on.

  13. Historicaecon

    Read “Liquidated” by Karen Ho. It’s the best existing discussion of the shareholder value issue, and a great takedown of Wall Street culture.

  14. ten gray

    This is a fascinating conversation. I’ve learned a lot! As a former series 7 & series 8 registered financial services professional, I too operated under the belief that a corporations primary responsibility was to maximize shareholder equity, and something about that always felt inherently self defeating. maximizing profits is not an operational model that can thrive in perpetuity, at some point the profit levy will have been breached, and then what? I understand that the intent behind paying your corporate officers in stock instead of cash was to make them fully vested in the company’s success, but that has obviously been the discarded cigarette butt turning into a raging brush fire. I’m not anti capitalism, but the extent of human avarice should not be underestimated.

  15. giangi75

    Yves hits the nail on straight on the head, again.

    Imho, the shareholder value myth has been popularized and propagated by the now infamous “Wall Street” movie by Oliver Stone, which was both a warning bell and a possibily a roadmap. If my memory serves, Gekko extolled the virtue of giving shareholders the best possible return on their investment. Yet Gekko’s rethoric, salted with some creative-destruction (or the more oxymoronic destructive-creation, with a wink to perpetual transformation) served primarily the purpose of enriching Gekko, who eventually is indicted.

    Greed and its rationalizations are fairly well represented in the movie, but the “art” of Gekko the Conman was probably underrepresented, for sharehold value _promise_ was the classic bait used by almost every conman since the dawn of time. Once control of the company has been seized (which does not necessarily require obtaining 51% of stocks) the company can be loaded with debt, its valuable assets stripped and sold to “friends” at firesale values, while the unwashed shareholder masses are daydreaming for their share of return.

    What Yves represents, that is that executives have an obligation toward the legal fiction / entity we call a corporation, is much closer to a notion of corporation in which the company is an actual entity that struggles, first and foremost, to remain alive, eventually yelding some fruits for the people who tend to it, including its workforce. Its financers are a class to which stock owners belong.Financers have indeed a residual claim, imho exactly because their only contribution to the survival of the company is a financial one, which of course implies taking a risk, but that also does not imply any additional effort from the financiers.

    This notion of company is an economic one in which the primary and only purpose of a company is NOT that of producing a positive cash flow at any cost, but rather is that of producing goods and services in order to survive and evolve.

    Maybe that’s a novel notion to many, but it’s hardly novel to most economists.

  16. Management Professor (emeritus)

    As a professor of management, I witnessed the emergence of this new paradigm during the Reagan era. Over time, financial economists have enshrined shareholder wealth maximization as the singular “goal of the firm”. Michael Jensen was an early advocate. Today, MBAs are taught that decision making should always be focused on that goal. Thus, management compensation should be closely linked to annual profit maximization.
    Many older management professors still discuss stakeholder theories, which depict the large corporation as a “nexus of contracts” whereby benefits are distributed to a wide variety of interested parties for their contributions to the firm’s long-term success and survival. Stakeholders include stockholders, creditors, managers, employees, suppliers, distributors, franchisees, customers, host communities, local governments, et al.
    Today’s MBAs usually don’t think decision makers should care much about stakeholders. Perhaps, they see no point in questioning the dominant ideology which will govern their careers (e.g. promotions, bonuses, stock options, perks). Shot-term opportunism and narrowminded financial greed seem to be normative and highly rewarded now.

    1. JTFaraday

      I worked in educational publishing in the early 90s and finance enrollments in business schools were tiny in comparison to management, marketing, and old fashioned accounting. I’m sure that’s not true today.

      Thanks for the Jensen reference point:

      “It was a 1990 Harvard Business Review article CEO Incentives: It’s Not How Much You Pay, But How” by Jensen and Kevin J. Murphy that prescribed executive stock options in order to maximize shareholder value. The justification they gave was that shareholders were the “residual claimants” of the corporation, meaning that they had the sole right to profits. This idea that shareholders are residual claimants was later rejected by legal scholars (e.g., Stout 2002).

      After Jensen and Murphy (1990), Congress passed a law, making it cost effective to pay executives in equity. As a result, executives focused their efforts on increasing stock price. In the short run, many executives manipulated accounting numbers (e.g., Enron, Global Crossing). In the long run, executives outsourced labor to reduce costs, then used the cost saving to repurchase stock; thus, increasing their own compensation.”

      http://en.wikipedia.org/wiki/Michael_Jensen#Research

      I wish someone would write about this transformation in business school culture.

      1. Management Professor (emeritus)

        Actually, the new ideology gradually began to be recognized in Business Schools a few years after Michael Jensen and William H. Meckling published “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure” in 1976.
        Engineering ideology dominated in the early years of the 20th century. Financial economics ideology dominated in the late year of the 20th century. Emphasis on the Human Side of Enterprise, initiated by Industrial Psychogists, intervened and peaked somewhere in between.

  17. Sir Flatulus

    At the risk of making myself a hate-sponge (there is no topic that elicits internet-based hate more quickly and more virulently than economics, strangely), I actually think maximizing shareholder value is the goal and that it is a good goal. If I go on a roller coaster I do it for the thrill, for a kind of adventure with no real risk. It is understood that this is the goal. I don’t go on the ride for the goal of avoiding risk. I go for the thrill. If I really want to avoid risk, I remain in my basement. Likewise, if I start a business I do so to make a lot of money, not to pay suppliers and to pay my employees and to give them a way to lead productive and fulfilling lives. I am glad that they do, and that helps me. But my goal is to make my business as successful as I can and to yank out of it as much money as I can. My goal is profit maximization.
    Mr. Lazonick’s point about share buybacks being sanctioned – as in authorized – fraud is spoken as one speaks to an adoring, fawning audience, knowing that he will not be challenged, knowing that what he is saying is not true in the way it will be taken to be true but instead true only in a very particular special way that he needn’t bother to explain. Is that a kind of fraud? He is referring to the SEC’s safe harbor Rule 10b-18, which says it isn’t fraud to do buybacks if you abide by specified safeguards. One of the safeguards is disclosing that you are about to engage in buybacks. So if I disclose to you in advance that this is what I am going to do, is it fraud if I then do it?
    Finally, I am made uneasy by the growing public outrage about executive compensation and the 1% and income inequality and about this and about that and about evil corporations and such. Where is this going to lead? What is our real goal? Who really is leading this charge? And why? And finally, if it is true that we fail to achieve a goal when we make it our obsession but we stand a chance of achieving the goal when instead we don’t really try to, when we go about it obliquely, that is, why would we be more likely to succeed when our goal, our obsession, is equality and fairness? Shouldn’t we go about that obliquely too, if we actually wish to achieve those results?
    Sir Flatulus, signing out for the weekend.

    1. mansoor h. khan

      SirFlatulus said:

      “I actually think maximizing shareholder value is the goal and that it is a good goal.”

      Fine. But what are the rules of the game? Stay legal? Do what you can get away with?

      Management can stay legal but still be extremely short term oriented or do downright immoral and unethical things with respect to employees, customers, suppliers, community, competitors and even shareholders.

      The problem is one of culture. Most people have to want to be just and fair and balanced for any civilization to work out. Rules and laws are only a supplement to keep people who are mostly good and honest to not be tempted too easily and for the small fraction that is bad to be punished appropriately.

      The great depression and world war II was a consequence of bad behavior (extreme usury/debt and nationalism gone nuts). There will be consequences to our recent bad behavior as well. The universe has been constructed to punish bad behavior and reward good behavior.

      Mansoor H. Khan

  18. Sir Flatulus

    made mistake: advance disclosure might not be (probably isn’t) a requirement for relying on Rule 10b-18. Mistakenly conflating practice with the rule. Practice is to disclose in advance. Rule 10b-18 technically might not require that. My mistake. Sorry.

  19. Hossein Kazemi

    This articles arguments are without merits and are actually rather silly. The fact that there is a separation of ownership and management does not change anything. The firm belongs to shareholders — whether they run it themselves or hire someone to do it on their behalf.

    The goal to maximize shareholder value is clear, precise, and founded on economics and property laws. First, if the goal is not to maximize shareholders’ value, then what should it be? Whatever makes the management happy? When shares are publicly traded, maximizing shareholders’ value is clear and precise. Second, there is a reason shareholders’ have residual claim. Because the have claim to all gains after all creditors are paid. They own the company, they elect the board members who in turn hire the management. It would be silly not to act on behalf of the person who has hired you to manage an asset that belongs to him/her.

    I have residual claim to my home, but this does not mean my house should not be modeled and furnished to my taste. As long as I am able to pay my mortgage and do not endanger my neighbors, I should manage my home. The fact that we have separation of ownership and management in modern economies doe not reduce the property rights of shareholders as owners.

    1. Carla

      If you are a shareholder who has hired the management of a company in which you simply hold shares (and not a controlling stake) please tell us exactly — precisely — how you did this. A lot of us other shareholders really want to know.

      1. Hossein Kazemi

        Shareholders as a whole hire and fire the board and they in turn hire and fire management. The fact that one single shareholder may not have enough power to affect management does not change anything. As citizens we hire and fire and the President. Even if my single vote may not matter, it does not mean the president should not run the country for the benefits of its shareholders (i.e., its citizens).

        1. casino implosion

          The shareholder-value meme under discussion depends on the intuitive, emotional valence of the community. Your analogy of shareholders to citizens is thus not random at all, but actually forced on you by the underlying structure of the meme.

          Of course in reality, the corporation is run by and for the benefit of the CEOs and interlocking boards of directors.

    2. JTFaraday

      if you have a large long standing legacy (near) monopoly like, say, AT&T and Verizon, that has been long term enabled across generations by the state, then if it belongs to any one entity, it’s probably the state.

      It is, therefore, actually quite nice of the state–which is capitalist, so this is not surprising– to allow “shareholders” to make claims on its own assets in form of AT&T and Verizon, and the state can also regulate those corporate entities and tax them.

      And unless we want to bring back some 21st century facsimile of our former slave state,** then that regulation includes reasonable compensation for its employees, and shareholders and executives who would like to rig compensation schemes to pay themselves first at the expense of employees, can take a back seat until that’s accomplished.

      It’s true this puts, say, a small competitor like Vodaphone at a competitive disadvantage. If the state decides to bust up AT&T and Verizon so lots of small companies can compete with each other, I’m still not sure that means shareholders “own” these new small companies any more than they did before. The state still has a prior claim on them. Therefore, the same rules with respect to employees are among those regulations that are still going to apply and that’s the regulated environment within which Vodaphone will have to compete.

      ** Needless to say, this is a low standard, but it demonstrates why the claims of employees are prior to those of shareholders in a civilized society with a free citizenry.

      Feel free to argue with that if you like. I’m not necessarily opposed to arguing about it. I think it’s entirely possible that a citizens dividend might better free the citizenry than scratching out an existence laboring under a purely capitalist state.

      1. Hossein Kazemi

        Regardless of the legacy and monopoly position of a firm, it belongs to shareholders. Shareholders can vote to break up the company and reduce its monopoly power should they choose. At the end of the day, the one group of stakeholder that can make life and death decisions for a firm are the shareholders. They may decide to put the firm up for sale or decide to put up more money to expand its reach. Again, these are all subjects to the legal framework set by the state.

        1. JTFaraday

          I clearly stated that the US is a capitalist enabling state. Nevertheless, that capitalist enabling state has life and death power over the corporations it charters, not “the shareholders,” as you concede yourself.

          In the case of the example I suggested, moreover, there is no more reasonable claim on those assets than the state, followed by the temporal claims of the employees who currently run it, provided they prove to be good stewards of those (state) assets.

          When is the last time AT&T or Verizon made a deal of any size without getting the permission of the state?

          1. Hossein Kazemi

            This makes no sense. Why would the shareholders put their capital to work if the state is going to run it? State sets the framework as it does for other civil activities (e.g., even free speech). Shareholders can withhold capital and if the firm is not profitable, it will die — even state would not be able to support it.

            No one argues that the state does not have enormous power over corporations. The point is what is the primary responsibility of management? I would say the goal should be to maximize the value of the firm. Since shareholders have residual claim, this in effect means maximizing shareholders’ wealth. This cannot be done in the long-run if other stakeholders are not taken care of — creditors are paid, state is paid, workers are paid, local community receives its benefits, etc.

  20. Android 16

    A good film related to this subject is Adam Curtis’ The Mayfair set. Talks about leveraged buyouts and hollowing out of domestic industry in the name of ‘responsibility to shareholders’.

    I am a layman but I can not help to think the only way the model where stakeholders’ interests are disregarded can function is when the corporations exports much of its output. If it relies on domestic sales it needs functioning domestic economy where demand from investment, government spending and sufficient wages of workers drive the profits. As pointed out above, the share maximization seems to incentivize the 3rd world/Asia labor arbitrage while exporting to the 1st world markets where the much of the consumption is then debt financed. Is this somewhat accurate? Thank you.

    1. Hossein Kazemi

      No body is talking about ignoring other stakeholders. In the long-run ignoring other stakeholders will cost the firm and shareholders.

      Everyone talks about the evils of maximizing firm value and because shareholders have residual claim, in effect, maximizing shareholders’ wealth. But nobody talks about other possible goals. What should guide the management? Increasing the welfare of the workers? If yes, does this mean the management should triple everyone’s wages? Reducing pollution? Paying maximum taxes? What benchmark should the poor manager use in deciding whether a decision is right or wrong? Just like democracy, no one has come up with a better system.

      1. Android 16

        Thank you. Perhaps a lack of universal education is at fault? A decent manager should use both mathematical and moral intelligence to optimize.

      2. Android 16

        Thank you for the response.
        Management should be guided by principles of universal education. That is, juggle the variables using not only mathematical but also moral intelligence. What seems to be institutionalized is the numerical optimization only. That is my notion. It can be wrong.

  21. Marc LeBlanc

    Very large helping of food for thought. I confess I thought that this is what corporations and their directors were supposed to do, an outsized comp doesn’t serve that.

    But I wonder, if you are an institutional investor, or an activist institutional investor in particular, can you accept the back seat?

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