Why the “Maximize Shareholder Value” Theory Is Bogus

From the early days of this website, we’ve written from time to time about why the “shareholder value” theory of corporate governance was made up by economists and has no legal foundation. It has also proven to be destructive in practice, save for CEO and compensation consultants who have gotten rich from it.

Further confirmation comes from a must-read article in American Prospect by Steven Pearlstein, When Shareholder Capitalism Came to Town. It recounts how until the early 1990s, corporations had a much broader set of concerns, most importantly, taking care of customers, as well as having a sense of responsibility for their employees and the communities in which they operated. Equity is a residual economic claim. As we wrote in 2013:

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…..Equity holders are at the bottom of the obligation chain. Directors do not have a legal foundation for given them preference over other parties that legitimately have stronger economic interests in the company than shareholders do.

And even in the early 1980s, common shares were regarded as a speculative instrument. And rightly so, since shares are a weak and ambiguous legal promise: “You have a vote that we the company can dilute whenever we feel like it. And we might pay you dividends if we make enough money and are in the mood.”

However, 1900s raiders who got rich by targeting companies that had gotten fat, defended their storming of the corporate barricades by arguing that their success rested on giving CEOs incentives to operate in a more entrepreneurial manner. In reality, most of the 1980s deals depended on financial engineering rather than operating improvements. Ironically, it was a form of arbitrage that reversed an earlier arb play in the 1960s. Diversified corporations had become popular in the 1960s as a borderline stock market scam. Companies like Teledyne and ITT, that looked like high-fliers and commanded lofty PE multiples, would buy sleepy unrelated businesses with their highly-valued stock. Bizzarely, the stock market would value the earnings of the companies they acquired at the same elevated PE multiples. You can see how easy it would be to build an empire that way.

The 1970s stagflation hit these companies particularly hard, with the result that the whole was worth less than the sum of the parts. This made for an easy formula for takeover artists: buy a conglomerate with as much debt as possible, break it up and sell off the pieces.

But CEOs recognized how the newly-installed leaders of LBO acquisitions got rich through stock awards or option-type compensation. They wanted a piece of the action.

One of their big props to this campaign was the claim that companies existed to promote shareholder value. This had been a minority view in the academic literature in the 1940s and 1950s. Milton Friedman took it up an intellectually incoherent New York Times op-ed in 1970. Michael Jensen of Harvard Business School and William Meckling of the University of Rochester argued in 1976 that corporate managers needed to have their incentives better aligned with those of shareholders, and the way to do that was to have most of their pay be equity-linked. In the late 1980s, Jensen in a seminal Harvard Business Review article, claimed that executives needed to be paid like entrepreneurs. Jensen has since renounced that view.

Why The Shareholder Value Theory Has No Legal Foundation

Why do so many corporate boards treat the shareholder value theory as gospel? Aside from the power of ideology and constant repetition in the business press, Pearlstein, drawing on the research of Cornell law professor Lynn Stout, describes how a key decision has been widely misapplied:

Let’s start with the history. The earliest corporations, in fact, were generally chartered not for private but for public purposes, such as building canals or transit systems. Well into the 1960s, corporations were broadly viewed as owing something in return to the community that provided them with special legal protections and the economic ecosystem in which they could grow and thrive.

Legally, no statutes require that companies be run to maximize profits or share prices. In most states, corporations can be formed for any lawful purpose. Lynn Stout, a Cornell law professor, has been looking for years for a corporate charter that even mentions maximizing profits or share price. So far, she hasn’t found one. Companies that put shareholders at the top of their hierarchy do so by choice, Stout writes, not by law…

For many years, much of the jurisprudence coming out of the Delaware courts—where most big corporations have their legal home—was based around the “business judgment” rule, which held that corporate directors have wide discretion in determining a firm’s goals and strategies, even if their decisions reduce profits or share prices. But in 1986, the Delaware Court of Chancery ruled that directors of the cosmetics company Revlon had to put the interests of shareholders first and accept the highest price offered for the company. As Lynn Stout has written, and the Delaware courts subsequently confirmed, the decision was a narrowly drawn exception to the business–judgment rule that only applies once a company has decided to put itself up for sale. But it has been widely—and mistakenly—used ever since as a legal rationale for the primacy of shareholder interests and the legitimacy of share-price maximization.

How the Shareholder Value Theory Has Been Destructive

The shareholder value theory has proven to be a bust in practice. Here are some of the reasons:

It produces short-termism, underinvestment, and a preoccupation with image management. We wrote in 2005 for the Conference Board Review about how the preoccupation with quarterly earnings led companies to underinvest on a widespread basis. Richard Davies and Andrew Haldane of the Bank of England demonstrated that companies were using unduly high discount rates, which punished long-term investment. Pearlstein provides more confirmation:

A recent study by McKinsey & Company, the blue-chip consulting firm, and Canada’s public pension board found alarming levels of short-termism in the corporate executive suite. According
to the study, nearly 80 percent of top executives and directors reported feeling the most pressure to demonstrate a strong financial performance over a period of two years or less, with only 7 percent feeling considerable pressure to deliver strong performance over a period of five years or more. It also found that 55 percent of chief financial officers would forgo an attractive investment project today if it would cause the company to even marginally miss its quarterly-earnings target.

As we’ve stated before, we’ve been hearing this sort of thing from McKinsey contacts for more than a decade. And the “55 percent” figure likely understates the amount of short-termism. First, even in a presumably anonymous survey, some CFOs might be loath to admit that. Second, for any project big enough to impact quarterly earnings, the CFO is almost certain not to have the final say. So even if his team approves it, it could be nixed by the CEO out of concern for earnings impact.

It empirically produces worse results. We’ve written from time to time about the concept of obliquity, that in a complex system that is affected by interactions with it, it is impossible to map out a simple path to a goal. As a result, other approaches are typically more successful. From a 2007 Financial Times article by John Kay, who later wrote a book about the concept:

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.

Merck and Pfizer was one such comparison. Collins and Porras compared the philosophy of George Merck (“We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear. The better we have remembered it, the larger they have been”) with that of John McKeen of Pfizer (“So far as humanly possible, we aim to get profit out of everything we do”).

Collins and Porras also paired Hewlett Packard with Texas Instruments, Procter & Gamble with Colgate, Marriott with Howard Johnson, and found the same result in each case: the company that put more emphasis on profit in its declaration of objectives was the less profitable in its financial statements.

Some more commonly-cited reasons for why a focus on shareholder value hurts performance is that it dampens innovation. Pearlstein describes another, how it demotivates workers:

Perhaps the most ridiculous aspect of shareholder–über-alles is how at odds it is with every modern theory about managing people. David Langstaff, then–chief executive of TASC, a Virginia–based government-contracting firm, put it this way in a recent speech at a conference hosted by the Aspen Institute and the business school at Northwestern University: “If you are the sole proprietor of a business, do you think that you can motivate your employees for maximum performance by encouraging them simply to make more money for you?” Langstaff asked rhetorically. “That is effectively what an enterprise is saying when it states that its purpose is to maximize profit for its investors.”

And on a societal level, it erodes social capital and trust, which are the foundations for commerce:

It is our social capital that is now badly depleted. This erosion manifests in the weakened norms of behavior that once restrained the most selfish impulses of economic actors and provided an ethical basis for modern capitalism. A capitalism in which Wall Street bankers and traders think peddling dangerous loans or worthless securities to unsuspecting customers is just “part of the game,” a capitalism in which top executives believe it is economically necessary that they earn 350 times what their front-line workers do, a capitalism that thinks of employees as expendable inputs, a capitalism in which corporations perceive it as both their fiduciary duty to evade taxes and their constitutional right to use unlimited amounts of corporate funds to purchase control of the political system—that is a capitalism whose trust deficit is every bit as corrosive as budget and trade deficits.

As economist Luigi Zingales of the University of Chicago concludes in his recent book, A Capitalism for the People, American capitalism has become a victim of its own success. In the years after the demise of communism, “the intellectual hegemony of capitalism, however, led to complacency and extremism: complacency through the degeneration of the system, extremism in the application of its ideological premises,” he writes. “‘Greed is good’ became the norm rather than the frowned-upon exception. Capitalism lost its moral higher ground.”

Many elite professionals are deeply upset with Trump’s win. Yet the ideology that he represents is very much in line with the logic of corporate raiders, many of whom, like him, went to Wharton Business School. And many elite professionals, in particular lawyers and consultants, profited handsomely from the adoption of the buccaneer capitalist view of the world and actively enabled much of its questionable thinking and conduct. As CEO pay rose, so to did the pay of top advisers. They couldn’t be all that good, after all, if they were in a wildy different income strata.

So as Lambert has warned, unless we hear a different economic and social vision from The Resistance, which looks troubling to have more failed Democratic party influence behind it than either of us like, the best we are likely to get is a restoration. And if you remember the French Revolution, strongman Napoleon was succeeded by the Bourbon Restoration, which then led to the Second Empire under his nephew. So if we want better outcomes, status quo ante is not good enough.

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43 comments

  1. Josh Stern

    The theory should have been accompanied by systematization and legal standardization of corporate governance, elections for BOD, and their role in public companies.
    https://en.wikipedia.org/wiki/Board_of_directors

    In theory, stock exchanges could play a role in insisting on standardization. It didn’t happen in practice. Some investors claim they can beat by the market by focusing on companies with a track record of raising dividends.

    Reply
    1. Yves Smith Post author

      I beg to differ. First, you ignore the fact that equity is a residual claim. Everyone else comes first. Every party that holds more senior instruments than equity, along with other parties that have enforceable claims, like the IRS and those with solid contracts that would give them the rights to damages in certain circumstances, have rights that are more enforceable under the law. You can’t overturn that via exchange rules.

      Second, Amar Bhide explained in the Harvard Business Review in 1994 why public companies will always have deficient governance. My recap of his main points:

      Disenfranchised shareholders are an inherent feature of liquid stock markets. In 1994, Amar Bhide argued in a Harvard Business Review article that efficient equity markets inevitably led inevitably to deficient corporate governance. Bhide explained that an ambiguous promise like equity is not suitable to be traded on an arm’s length basis. Historically, equity investors typically acted like venture capitalists: they knew the owners personally and were involved in the company’s affairs. The securities laws of 1933 and 1934 tried to make it safe for distant, transient shareholders to invest by providing for timely, audited financial statements, disclosure of information about top executives and board members, and prohibiting insider trading and other forms of market manipulation.

      But that turns out to be inadequate. No outsider can be told enough to make an informed judement about a company’s prospects; critical information, like acquisition and plans for new products, must be kept secret until well advanced because they are competitively sensitive. Boards are protected from liability by directors’ and officers’ insurance (plus hardly anyone even bothers pursuing board members. For instance, have any Lehman board members been sued?). Moreover, only a comparatively small cohort of people are deemed public-company-board worthy. Their incentives are to make nice in their community and not rock the boat, which means not making life difficult for the CEOs, since a nominating committee (of the current board) is responsible for nominating directors, which means the entire process is incestuous.

      This system has been fairly impervious to outside challenge. Once in a while, a company is so abysmally run that an activist investor will take up a proxy fight. But that dog seldom catches the car; instead, they might get a bad CEO to exit or force a restructuring. The stock trades up and the rabble-rousers take their winnings and depart. More polite efforts, even by large, powerful shareholders, are much less effective. For instance, some major institutional investors met with Goldman to object to the idea that the firm would pay lavish bonuses for 2009. The session appears to have had no impact.

      http://www.nakedcapitalism.com/2013/10/why-the-maximizing-shareholder-value-theory-of-corporate-governance-is-bogus.html

      Reply
      1. Josh Stern

        Main categories of complain about “Maximize Shareholder Value”:

        Category 1 – Other things should get more weight alongside shareholder value – e.g. societal responsibility – this is valid, but not our current topic/issue.

        Category 2- Current practices aren’t leading to the election of smart, capable BOD members acting primarily for shareholder value in their decision-making including hiring/fire of executives and voting on their proposals. This shown by, among other things, the very high levels of executive compensation relative to profit, the lack of correlation between executive compensation and profit, and the huge severance packages for released executives. This is my topic – what would improve that.

        Your points don’t seem to fall in those categories. Seniority of debtto equity is a respected feature of the common business landscape, not normally thought of as a problem. Lack of complete information when voting on corporate actions is also a feature of the corporate setup – representational government. It doesn’t stand in the way of the possibility of smart, conscientious executives. Other issues like cronyism, bad BODs, etc. are in the way, poor rules, poor communication, lack of interest by short term stakeholders, etc. are viewed as much more problematic.

        Reply
        1. Yves Smith Post author

          You are omitting a key point in the post, which is that seeking to maximize shareholder value results in lower returns for shareholders. It is empirically a bad idea.

          There are many views as to why this is so, but the biggest are likely the short-termism and obliquity. Electing more outspoken board members won’t solve that.

          My narrower point was addressing why this notion had never been enshrined in any corporate charter: it would be seen as created undue conflicts regarding directors making sure clearly senior obligations are met. Again, under very well settled law, directors and officers have duties of loyalty and care to the corporation, and those take precedence to serving shareholders. Go read any law firm guide to director duties.

          Reply
      2. Carla

        Yves, I caught a few typos in your post above, all in one paragraph:

        “However, 1900s raiders who got rich by targeting companies that gotten fat,” should read “However, 1980s raiders who got rich by targeting companies that had gotten fat,”

        Same paragraph: “Diversified corporations had popular in the 1960s” — insert the word “become”… and later in that paragraph:
        “Bizarrely, the stock market would valve the earnings” Change valve to “value.”

        With great respect, I submit these corrections because I know your posts have lasting value.

        Reply
  2. aab

    One picky point: the analogy to Bonaparte really doesn’t hold up. We haven’t had our French Revolution yet. And I’m rusty on my nineteenth century French history, but I don’t think there’s much of a valid comparison between him and Trump anyway. “Strong man” is way too vague. Whatever is going on with Trump, he’s not a brilliant military tactician and strategist moving into a power vacuum from inside the existing government.

    Agree about the “Resistance.” But I don’t see how the corporate Democrats return to power at this point — I mean real, governing power. Whatever comes next, it won’t be that.

    I don’t know yet whether to hope for oaths on tennis courts or not. That’s a really, really last resort, obviously. These people running around punching alt-right Teen Beat cover boys and breaking windows are either fools or something worse.

    Also, it’s nice to have data to go with my loathing of this “theory.” I feel like we need a different word for this stuff, though. All these intersecting economic beliefs that are not based in facts and are easily repudiated by facts can’t really be called theories, can they? They’re more like belief systems. They were never really about figuring out something about reality. They were always about manipulating behavior through assertion to get desired outcomes, weren’t they?

    Reply
    1. readerOfTeaLeaves

      I think that you seriously underestimate Trump.
      Napoleon excelled in an environment where military success was primary; Trump excels in a mediated environment where PR and imagery are primary. IMVHO, there are some eerie parallels between the two men; whether you like them or not, both men could be characterized by: ambition, vision, vindictiveness, and a willingness obliterate traditional social and political boundaries.

      I thought this was particularly brilliant:

      Many elite professionals are deeply upset with Trump’s win. Yet the ideology that he represents is very much in line with the logic of corporate raiders, many of whom, like him, went to Wharton Business School. And many elite professionals, in particular lawyers and consultants, profited handsomely from the adoption of the buccaneer capitalist view of the world and actively enabled much of its questionable thinking and conduct.

      That Wharton Business School model is oblivious to the human needs for: fairness, reciprocity, culture, and the need to penalize duplicity. (I would argue that the Wharton model exalts duplicity, if only to pass it off as some kind of exceptional superpower wielded only by Business Elites.) When you corrode trust, you damage economies.

      Trump is the apotheosis of neoliberal economics + junk-bond fueled casino empires in a media environment that worships ‘shareholder value’ and has lost sight of what genuinely creates sustainable value over the long term.

      Reply
      1. Hans Gruber

        To readerOfTeaLeaves;

        I like Your conclusions, and the reasons for them. I am in agreement about Trump’s potential as a great president for other reasons also. For months I have been watching body language and other non-verbal experts access the non-word communications of influential people. Trump is rated by most of the experts as actually believing what he says, unlike Hillary Clinton, Kaine, Schumer, Paul Ryan, and John McCain; who have definite on-going tells for deception. While Trump may be incorrect about some of his beliefs, his non-verbal language isn’t lying about them to hundreds of millions of people. Another viewpoint about Trump, is that he did well in acquisition of wealth within a distorted economy that increasingly favored speculation instead of production. If he had been Chinese in China, he might well have acquired wealth by developing manufacturing and distribution of goods to the West. If in Russia, he might have made billions in petroleum production. I think he has the obsessive/compulsive nature of Vladimir Putin to advance and improve, and like that Russian, has had to engage in less than saintly endeavors to succeed in a hostile environment. Putin oversaw the restoration of 30,000 churches in Russia since he gained enough political muscle to push that through, and has seen the average Russian improve their life dramatically after he out-played the communists, western central bankers, and the Russian criminal psychopaths. Trump will have to play the long game too, and not be nice about it, to succeed. Our President will have to play off one group of criminals against another group of psychopaths against another group of neurotic narcissists, etc. Of course I’ve listened to his speeches & those of his opponents as well, looking for signs of intelligence, adaptability, and realism. I make mistakes, but for now, I see him as the best option we had.

        Reply
        1. Hans Gruber

          To readerOfTeaLeaves;
          Sorry, I’m not used to this forum yet, and didn’t get the above post edited correctly. Correction follows: “I am in agreement with You about not underestimating Trump, and also see him having great potential as a President.”

          Reply
  3. Disturbed Voter

    Isn’t this just a side effect of optimization for one variable? And which variable to optimize is a question of governance? Since the invention of quantifiable economy, and the move from haggling to fixed price, particularly since the invention of monetary valuation in place of barter … the mathematics becomes relentless … to get the last drop of blood out of whatever turnip you are squeezing. And the invention of spreadsheets makes it that much easier to lean toward the quantitative, over the qualitative. We saw a similar process in “value engineering” in automotive engineering … in that case to get the last ounce of weight out of the car, in order to optimize mileage, regardless of less quantifiable values.

    Reply
  4. Clearpoint

    Awesome article. Great explanation of how wall street orchestrated casino capitalism controls today’s economy, and in a manner that is detrimental to everyone but the casino operators. Milton Friedman’s perverse views on “free markets”, have turned the economy into a casino, first by destroying the controls on the money supply, and then by destroying corporate governance and responsibility. And we all know who makes all the money in any casino operation.

    Reply
    1. David Apgar

      Agree, awesome article. And interesting Clearpoint addition that the Street has every incentive to orchestrate volatility, to the detriment of many firms’ greatest stakeholders, the neglected employees.

      Reply
  5. hemeantwell

    This question is of central importance, I only wish you’d find reason to bring it up more often. It raises another important question, although one that cannot be addressed so neatly: why has the capitalist project tended to turn away from long term commitments to profit-seeking through the production of (material) commodities? Was Friedman’s short-termist view simply foolish, a mistake that has had very damaging impact but which can be reversed? Or, was it an idea that somehow picked up on declining opportunities for profit via sales of commodities, as writers like Amin and Harvey variously argue? Or — and the article skips over this — did Friedman capture the growing political aggressiveness of capital, as capital gradually overcame the Great Fear of the 30s and prepared to mount, as Streeck has argued, a counteroffensive against the constraints of welfare capitalism? Likely all of the above, but in what proportions?

    Reply
    1. readerOfTeaLeaves

      A lot of corporate governance is controlled by legal decisions.
      These legal decisions are rendered by judges.
      Future judges are well-socialized into free market views long before they ever hear cases or render judgments. We are seeing this trend continue with the current SCOTUS nomination in the hands of a GOP controlled Congress.

      Some of these people truly believe that ‘free markets’ can somehow ‘improve and perfect’ Human Nature. (See also: Ayn Rand, ‘John Galt’, Alan Greenspan) In other words, it’s has more than a whiff of Nietzsche’s ‘Uber-man’ ideology in the mix. It’s an ideal system for equating human worth with net worth, and justifying vast inequalities in money and power.

      Thus does the snake swallow its tail.
      These judges fail to notice there is a large bump somewhere in the snake’s body; at some point, it ate the Golden Goose, and is slowly digesting.

      Reply
  6. oho

    index investing/etfs have made things worse. with such a big pool of ownership in passive hands, lots of rubber stamping going on

    Reply
  7. John Wright

    This does not directly mention the “increase shareholder value” action of a company buying its own stock.

    That should be viewed as a red-flag admission from the senior executives that the company doing a share buyback does not see a way to grow its markets, does not see suitable investments for R&D. sees no pressing need to improve corporate infrastructure, sees no reason to train their workers, and can’t find suitable acquisitions that would enhance their business.

    Effectively, the management team has scoured the globe searching for the best use of their spare cash, and, surprisingly, determined that one financial security, THEIR own company’s stock, was the best use of the corporation’s cash.

    A share buyback plan could be viewed as a warning shot indicating that management lacks ideas and is poorly managing the corporation.

    Instead it falls under a “increase shareholder value” tactic.

    Reply
    1. flora

      +1. Used as an attempt to ward off a hostile takeover stock buybacks might be justifiable. Mostly, however, this usually looks like a simple attempt to prop up prices.

      Reply
    2. blert

      It is that acme of Liberalism, Warren Buffett that created this fad.

      At a time when corporate dividends were taxed as ordinary income, whereas a stock price bump would be tax deferred — and ultimately taxed at long term capital gains rates — the scheme was merely tax avoidance.

      Warren Buffett’s entire empire is based on this and other tax avoidence schemes.

      Then, coupled with stock options for corporate management, the path was set.

      Reply
  8. Josh Stern

    Common criticisms of “Maximize Shareholder Value: 1) Should give more weight to something else – e.g. societal concerns. 2) Execs – prioritize other things; 3) BOD’s prioritize other things, including their personal relationship to execs. Improving corporate governance can, in theory, setup procedures and rules to fix 2) and 3) by making sure BOD’s in publicly listed corporations really have the legal power, and by making elections more open, including the selection of the initial selection of BOD candidates. However, this still requires interest from a majority of voting shareholders – it would be better to ask people not interested to not vote at all. (I tried to thread this comment as a reply above but it repeatedly disappeared).

    Reply
    1. Richard Fleer

      “However, this still requires the interest from a majority of voting shareholders-it would be better to ask people not interested to not vote at all”.

      1st question: Which shareholders aren’t interested? All shareholders are interested in getting some degree of value.
      2nd question: Do you always think the degree of interest should be taken into account when a vote happens? The shareholders who don’t have much stake in the decision making process will always use a board member as a proxy vote to advance their ideas. Thus, there are sheeple in the room.
      3rd question? Do you always think it’s a good idea to measure the weight of shareholder interest by how much stock they purchase? The exec team doesn’t have the time to be bothered by the small time stock purchasers.

      Unfortunately, companies don’t want to improve their governance. Companies don’t think there’s anything wrong with the way they govern themselves.

      Reply
  9. caloba

    For a UK example of a company choosing not to maximise shareholder value, the disastrous acquisition of HBOS by Lloyds is instructive. Management claimed to be looking through the (ridiculously underestimated) short-term issues to the resulting long-term competitive advantages which the government assured them (falsely) wouldn’t subsequently be challenged. Of the c95% acceptances supporting this lunatic deal, some proportion of the institutional shareholders must have been idiots, a few must have feared for the stability of the banking system were the deal rejected, and a great many must also have been HBOS bondholders…

    Reply
  10. flora

    “But CEOs recognized how the newly-installed leaders of LBO acquisitions got rich through stock awards or option-type compensation. They wanted a piece of the action. ”

    The maximize shareholder value ideology in practice looks like maximize CEO compensation and to heck with the company’s long term prospects. imo.

    Great post. Thanks.

    Reply
  11. Vedant Desai

    I doubt that any of the CEOs which have said that they are being pressurized to short-termism are actually willing this stupid concept to be removed considering they are the prime benefactor of this.
    I believe that supermacy of shareholders interest was originally adopted because they were bearing risk. Shares being an illiquid asset were supposed to be a source of income not capital gain. Due to this shareholders were forced to ensure that short-termism is avoided and corporate governance is adequate. Things started to reverse slowly as liquidity of shares increased gradually. Presently, when shares can be sold in seconds of owning them , risk a share -holder bear is greatly lower than they beared a century ago. Also , shares are bought for capital gain not income. Considering relationship between share’s liquidity and short-termism , any measure which reduces share’s liquidity, for example a high tax on ahort term capital gain, will greatly reduce both short-termism and corporate governance issues as share holders will be forced to assume the risk they were supposed to bear in exchange of supermacy of their interest.

    Reply
  12. John Wright

    HP was mentioned in the above text.

    I found it interesting to view the old HP Corporate Objectives as published in the HP employee magazine “Measure” in July 1974

    See http://www.hp.com/hpinfo/abouthp/histnfacts/publications/measure/pdf/1974_07.pdf,

    pages 7, 8, 9, 10

    Hewlett-Packard objectives

    1. Profit – Objective: to achieve sufficient profit to finance our company growth and to provide the resources we need to achieve our other objectives

    2. Customers- Objective: To provide products and services of the greatest possible value to our customers, thereby gaining and holding their respect and loyalty.

    3. Fields of Interest- Objective: To enter new fields only when the ideas we have, together with our technical, manufacturing and marketing skills, assure that we can make a needed and profitable contribution to the field.

    4. Growth – Objective: To let our growth be limited only by our profits and our ability to develop and produce technical products that satisfy real customer needs.

    5. Our people: Objective: To help HP people share in the company’s success, which they make possible; to provide job security based on their performance; to recognize their individual achievements; and to insure the personal satisfaction that comes from a sense of accomplishment in their work

    6. Management- Objective:To foster initiative and creativity by allowing the individual great freedom of action in attaining well-defined objectives,

    7. Citizenship – Objective: To honor our obligations to society by being an economic, intellectual and social asset to each nation and each community in which we operate.

    *****
    Note, Hewett and Packard, themselves, may have owned 40-50% of the company stock at this time, so they had great control of the company’s direction at this time.

    No corporate objective about shareholder value even though they were very large shareholders.

    Reply
    1. mle detroit

      Yes, but. I remember someone from UMichigan business school (Gary Hamel, I think) speaking to a group of top 2% Ford Motor Co. execs in the late 1980s. He asked, “Come on, guys…how many of you were thinking about shareholder value in the shower this morning?” The room laughed, but one pudgy hand in the back went up. It belonged to Edsel Ford.

      Reply
    2. susan the other

      This takes us back, HP was so honest it almost sounds quaint. And 1974 was just before Reagan’s supply side economics stuff in the aftermath of the awful stagflation that hit us after Vietnam. According to Paul Craig Roberts, supply side was embraced because it was thought to prevent inflation (wage price spiral) and still provide sufficient jobs and products. He goes on to say that supply-side/trickle-down was a reasonable idea but it was hijacked by Wall Street who took it to heart and then used it to justify offshoring jobs to enhance corporate profits, and eventually shareholder value. Because, as PCR puts it, Wall Street forced companies to get lean and competitive and if they didn’t nobody invested in them: aka no shareholders if no timely shareholder value. So it was almost an extortion racket. This was accompanied by all the corporate raiders and the real prosperity of the country was quickly retarded and siphoned off. Great post, thanks Yves.

      Reply
  13. Expat

    I have a rather naive question which I should have asked long ago in my one and only finance class at college. Why does it matter if a share price drops all other things being equal? A company sells shares, effectively handing out “residual claims” against cold, hard cash. If the cash is invested in a business – and assuming the business is at least “break-even” plus the risk-free rate of return- other than investor panic and CEO’s getting “refreshed” stock options, why would this matter?

    Reply
    1. John Wright

      Some reasons are frequently given for preferring a high stock price.

      1. A low share price encourages others to acquire the company
      2. A high price is good when stock is used as currency to buy other companies.
      3. Executive compensation schemes are sometimes tied to stock price.

      But if a company is not selling stock to fund current operations, then the stock price could go to zero with no operational effect. The employees who own stock would not be pleased. However, an apparent artificially low price could help with hiring new employees who may be granted low priced options.

      Occasionally I see someone claiming a company is being killed by short sellers driving the stock price down. I don’t see how this could damage the ongoing operations or cash flow EXCEPT if the company is selling stock to fund operations or is trying to make a truly worthwhile acquisition with their stock.

      If a company is doing well and cash flow positive and short sellers drive the stock price down too low, the company should use their cash to buy their shares and squeeze the shorts.

      In the case of Hewlett-Packard there was no official stock price set by the investment community for years, as the company waited a few years before doing an IPO.

      The company was founded in 1939 and IPO’ed eighteen years later in 1957.

      Imagine, operating for 18 years without Wall Street supervision.

      Reply
    2. Yves Smith Post author

      Agreed with your point and John Wright’s explanation. The idea that a stock price must be high is dogma that is never questioned. The big reason is for concern re a low stock price is it is seen as the market voting against management and an invitation for raiders to take the company over.

      But otherwise, if a company can raise enough money to fund expansion through its own cash flow (which is the biggest source of investment fund) and debt (the next biggest source), there is no reason to issue more stock (save your point re employee/executive stock options) and hence no reason to care regarding the price.

      Reply
  14. skippy

    Equity is a form of HPM these days, for C-corps, which can be used as a tool of pleasure [c-suite bonuses et al] or a weapon of destruction [excuse for diminishing labour and the enviroment].

    disheveled…. the religion of free markets has become the dominate meme in society and those that benefit the most from it…. wellie see history….

    Reply
  15. Chuck

    I’m struggling with the short termism argument. The cash flows from equity don’t have a maturity. Bonds due. If a company sought to maximize bond holder value, they would minimize risk (and R&D) to make sure sufficient funds were available to pay the bond holders. Equity maximization should be longer term focused than the maximization of limited life securities.

    Reply
  16. Chauncey Gardiner

    While it has damaged corporate social responsibilities and banks’ and corporations’ long-term financial stability, actions taken pursuant to the Shareholder Value optimization model have served well many individuals on Wall Street, at private equity firms, CEOs of large publicly traded corporations, hedge funds, networked board members, their academic and professional servicers, and the political elite

    Reflecting back on developments like the dotcom bubble of 1999-2000; the underlying causes of the financial collapse of 2007-09; massive debt-leveraged corporate stock buybacks; socially damaging private equity LBOs; the current volumes of opaque OTC derivatives at large financial institutions; repeated episodes of environmental damage caused by firms in extractive industries seeking short-term financial returns; and the license it provides to exert power over legislation and regulation by those who own and control these corporations in a Citizens United legal framework; etc., it is difficult to see much in the way of redeeming social value in this corporate governance model.

    Reply
  17. craazyman

    Everything is Both Itself and Something Else at the Same Time

    This post is a variation on the theme Ezra Pound expounded upon in Canto XLV:

    came not by usura
    Duccio came not by usura
    nor Pier della Francesca; Zuan Bellin’ not by usura
    nor was ‘La Calunnia’ painted.
    Came not by usura Angelico; came not Ambrogio Praedis,
    Came no church of cut stone signed: Adamo me fecit.
    Not by usura St. Trophime
    Not by usura Saint Hilaire,
    Usura rusteth the chisel
    It rusteth the craft and the craftsman
    It gnaweth the thread in the loom
    None learneth to weave gold in her pattern;

    This is a Deep Thawts topic but it’s Spanish Wine time and Youtube calls,. Frank Sinatra’s Luck Be a Lady. Whoa! That dude channeled the Gods. You can see every tick and every jump of his body with the rhythm of the song — if you watch it on Youtube. They paid him for sure, but he would have done it anyway. QED.

    Reply
    1. Harold

      Not by usury maybe, but wealth came to Renaissance Italy through use of interest , hitherto prohibited. And advances in book keeping. This wealth financed the great artists mentioned by Pound.

      Reply
  18. b1daly

    Thanks for this post. I always found the notion of “maximizing shareholder value” to be very strange, and counter to common sense. The concept of “stakeholders” always made more sense. For a company to be managed with a focus on the wellbeing of workers, customers, and community, in addition to owners, struck me as being obviously the way it should work. (And sometimes does.)

    The idea that parties who happen to own a share of the company should have their interests served above all is counter intuitive, as employees will almost always have a greater stake in the company than any individual owner, if shares are widely distributed.

    If you think of an sole proprietor who ventures forth to do business who has made clear to all that his interests are paramount in any transaction, I do not envision customers flocking to such an individual.

    The apparent lack of basic decency in corporate/management decisions that we see so often is just hard to reconcile with how most of us intuitively feel about how we see ourselves in the context of our community: most people have a significant level of self interest, but we are always aware of the need to consider the interests of others when we act. Even for something as basic as waiting in line for something.

    Somehow people at the elite levels of, finance for example, feel quite OK about heavily prioritizing their own interest above all.

    As someone not privy to this social realm, I am just mystified about the social dynamics that, if not encourage this, at least consider it a fine way to do business.

    In a small example, from my personal experience, I am a professional user of audio software from Avid. Avid has been losing money year after year. Over the past five years the company as taken actions that have outraged the user base, far more than any other software company I know of. Their forum is over run with vitriolic ranting, from longtime customers. (In fairness, this has abated a bit, as the company has finally been making moves that are sensible, and that meet the needs of the users.)

    There have been several rounds of significant layoffs, and the frontline workers bear the brunt of the customers wrath. Morale has been low.

    In conversation, a previous employee told me he considered management to be white collar criminals, who were looting the company.

    This type of product has a unique feature of having very strong platform lock-in effects. In few other product categories would you see such angry customers continue to buy the products.

    Yet the board has been approving generous compensation increases for C level management, and for themselves for the past few years.

    I’m fascinated from an everyday, social point of view, how the board and management make these decisions. Do they really think they are doing a good job? From the outside, it appears to me that they do it simply because they can, and have little concern for the long term well being of any of the other stakeholdes.

    Does anyone here have insight about the social dynamics that enable this behavior?

    Reply
    1. broadsteve

      This is something I’d welcome some insights on too as I find certain behaviours and attitudes impossible to understand.

      Is it simple greed, stupidity, cynicism, groupthink, false consciousness, sociopathy, the ‘attractions’ of a certain lifestyle, daddy-didn’t-love-them-enough or what that leads certain types to behave the ways they do and seek to justify it? If they acted with a degree of shame or embarrassment, or even full on chutzpah, I’d understand them more, but it’s the ordinary types, those who outwardly seem to be of the same species as oneself and otherwise appear to be perfectly normal people that I just don’t understand. I can believe almost anything of them, except for the possibility that they actually, genuinely, believe that they are on the right side of things.

      I have similar brain fade when it comes to much of what politicians of the Right have to say on most things. So often, and try as I might, I just can’t understand how supposedly sentient beings can honestly believe the drivel they come out with, still less have the brass-neck to stand up in public and display just how effing stupid and cynical they are. Feel much the same about all shades of politician but it’s far worse on the Right.

      Reply
  19. blert

    At bottom, Control Fraud is the issue.

    Word games// rationalizations are used to numb the public — while the crooks loot the collective wealth of the corporation in a systematic way.

    It’s the ability of the corporate suite to grant itself stock options — in almost unlimited amounts — that’s causing the trouble. They are a looting.

    MUCH would be solved by just taking such grants in equity out of the equation: make them illegal. Period.

    Suddenly, the CEO’s desire to juice the price would fade.

    Reply
  20. readerOfTeaLeaves

    I was absolutely delighted to see this over at EVONOMICs.
    Really encouraging to see this conversation keep moving forward.

    Reply

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