The Shareholder Value Myth

Posted by Lynn A. Stout, Cornell Law School, on Tuesday June 26, 2012 at 9:16 am
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Editor’s Note: Lynn Stout is the Distinguished Professor of Corporate and Business Law at Cornell Law School. This post discusses Professor Stout’s book The Shareholder Value Myth, available for purchase here and for preview here.

Shareholder-value thinking dominates the business world today. Professors, policymakers, and business leaders routinely chant the mantras that public companies “belong” to their shareholders; that the proper goal of corporate governance is to maximize shareholder wealth; and that shareholder wealth is best measured by share price (meaning share price today, not share price next year or next decade).

This dogma drives directors and executives to run public firms with a relentless focus on raising stock price. In the quest to “unlock shareholder value” they sell key assets, fire loyal employees, and ruthlessly squeeze the workforce that remains; cut back on product support, customer assistance, and research and development; delay replacing outworn, outmoded, and unsafe equipment; shower CEOs with stock options and expensive pay packages to “incentivize” them; drain cash reserves to pay large dividends and repurchase company shares, leveraging firms until they teeter on the brink of insolvency; and lobby regulators and Congress to change the law so they can chase short-term profits speculating in high-risk financial derivatives. Yet many individual directors and executives feel uneasy about such strategies, intuiting that a single-minded focus on share price may not serve the interests of society, the company, or shareholders themselves.

The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public (Berrett Keohler Publications, 2012) challenges the ideology of shareholder value. Part I, “Debunking the Shareholder Value Myth,” traces the intellectual origins of shareholder-primacy thinking. It shows how the ideology of shareholder value maximization lacks any solid foundation in corporate law, corporate economics, or the empirical evidence. Contrary to what many believe, U.S. corporate law does not impose any enforceable legal duty on corporate directors or executives of public corporations to maximize profits or share price. The economic case for shareholder-value maximization similarly rests on incorrect factual claims about the structure of corporations, including the mistaken claims that shareholders “own” corporations, that they have the only residual claim on the firm’s profits, and that they are principals who hire and control directors to act as their agents. Finally, there is a notable lack of persuasive empirical evidence demonstrating that individual corporations run according to the principles of shareholder value maximization perform better over time than those that are not. Worse, when we look at macroeconomic data—overall investment returns, numbers of firms choosing to go or remain public, relative economic performance of “shareholder-friendly” jurisdictions—it suggests shareholder value dogma may be economically counterproductive. Part I concludes shareholder-value ideology is based on wishful thinking, not reality. As a theory of corporate purpose, it is poised for intellectual collapse.

Part II, “What Do Shareholders Really Value?,” surveys promising new theories of corporate purpose being offered by today’s experts in law, business, and economics. These new theories have two interesting and important elements in common. First, where historical challenges to shareholder primacy have focused on the fear that what is good for shareholders might be bad for other corporate stakeholders (customers, employees, creditors) or for the larger society, the new theories focus on the possibility that shareholder-value thinking harms many shareholders themselves. Second, the new theories raise this counterintuitive possibility by pointing out that “shareholder” is an artificial and highly misleading construct. Shareholders are not homogeneous Platonic entities but diverse people who hold stock directly or through pension or mutual funds. Some plan to own their stock for short periods, and care only about today’s stock price. Others expect to hold their shares for decades, and worry about the company’s long-term future. Investors buying shares in new ventures want their companies to make ex ante commitments that attract the loyalty of customers and employees, but after those specific investments have been made, may hope to profit from exploiting those commitments ex post. Some investors are highly diversified, and worry how the company’s actions will affect the value of their other investments and interests. Others are undiversified and unconcerned. Finally, many people are “prosocial,” meaning they are willing to sacrifice at least some profits to allow the company to act in an ethical and socially responsible fashion. Others care only about their own material returns. Rather than recognize and account for differences in shareholders’ interests and values, shareholder value dogma simply privileges the interests of the most myopic, opportunistic, self-destructive, and psychopathically asocial subset of shareholders. This keeps public companies from doing well for either their investors or society as a whole.

The Shareholder Value Myth concludes that the new theories of shareholder interest promise to advance our understanding of corporate purpose beyond the old, stale “shareholders-versus-stakeholders” and “shareholders-versus-society” debates. By revealing how a singled-minded focus on share price endangers the interests of many shareholders themselves, it demonstrates how the perceived gap between the interests of shareholders as a class and those of stakeholders and the broader society may be far narrower than commonly understood. In the process, it offers a more sophisticated and more useful understandings of the role of the public corporations and of good corporate governance that can help business leaders, lawmakers, and investors alike ensure that public corporations reach their full economic potential.

The Shareholder Value Myth may be purchased in its entirety at Amazon.com and at Barnes & Noble. Copies of individual chapters may be accessed free of charge here.

  1. Most will take an hour or two to read this slim volume but will think about its implications for years to come. Like the design of Apple’s iproducts, Stout’s central argument is simple and compelling:

    - U.S. corporate law does not, and never has, required directors of public corporations to maximize shareholder value. Most are formed “to conduct or promote any lawful business or purposes.”

    - Shareholders are neither owners, nor principals, nor residual claimants. Directors have primacy. The “business judgement” rule gives them tremendous latitude with regard to claims on the corporation, including decisions that reduce share price.

    - Shareholder primacy rules do not produce superior results. They lead to short-termism, externalization of costs and a tragedy of the commons.

    Stout is right in her fundamental analysis that maximizing shareholder value is a mantra that has generally contributed to short-term thinking. However, the solution isn’t to terminate the move towards more democratic corporate governance and rely on the beneficence of directors.

    Wouldn’t it be better to enlarge the domain of mutual influence in corporate governance? Instead of aligning corporate governance theory to reflect the dismal reality that businesses involve an apathetic majority and rule by a self-selecting minority elite in the form of directors, wouldn’t it be better to increase the political efficacy of the majority?

    Read my review at http://corpgov.proxyexchange.org/2012/06/review-the-shareholder-value-myth/

    Comment by James McRitchie — June 26, 2012 @ 10:07 am

  2. [...] full article via The Shareholder Value Myth — The Harvard Law School Forum on Corporate Governance and Financial Re…. Share OptionsPrintEmailMoreFacebookLinkedInStumbleUponTwitterPinterestRedditDiggTumblrLike [...]

    Pingback by The Shareholder Value Myth — The Harvard Law School Forum on Corporate Governance | Accounting and Small Business /Beverly Shares — June 26, 2012 @ 1:35 pm

  3. The ultimate measure of corporate/organisational performance is the nett community value added per community input. We can estimate both using currency. Inputs are all of the time/labour, expertise, materials, use of existing assets and risk consumed by the organisation. Value added is the net value added to those inputs. The difference is the nett value added. We then divide by the community input to work out the ratio. This value is the performance of the organisation. This is not profit… it is nett community value added. There will be many highly profitable corporations that actually have negative nett community value added and there will be some non-profit and government organisations that will have very good ratios. When we define performance in this manner then we can begin to work out what governance structures produce the best organisational performance.

    Comment by Jeff Popova-Clark — July 3, 2012 @ 1:12 am

  4. […] example of the trouble that can occur from misunderstanding what a corporation is comes from the mistaken belief that the purpose of a corporation is to make money — and that there is a corresponding rule that they are required to "maximize shareholder value." […]

    Pingback by Perhaps We Need Corporate 'Loyalty Oaths' | Dave Johnson — August 6, 2014 @ 8:51 am

 

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