Back when I was a law-school student in the early 1980s, my professors taught me that shareholders “own” corporations and that the purpose of corporations is to “maximize shareholder value.” I was just out of college at the time and not very familiar with the business world, so this made sense enough to me. When I first began lecturing and writing in business law myself, I incorporated the shareholder-value thinking that I had been taught into my own teaching and scholarship.
It soon became apparent to me that there was a problem with this approach. The more I read business-law cases, the more obvious it became that U.S. corporate law does not, in fact, require corporations to maximize either share price or shareholder wealth. My first reaction was puzzlement and frustration. Shareholder-value thinking was almost uniformly accepted by experts in law, finance and management. Why, then, I asked myself, wasn’t it required by the actual rules of corporate law?
My sense that something was wrong with shareholder-value thinking was only heightened when Enron, a firm obsessed with raising its share price and a supposed paragon of good corporate governance, collapsed in fraud and scandal in 2000.
Meanwhile, I was becoming involved in the business world myself as an advisor to and a director of for-profit and nonprofit organizations. I took every opportunity to ask the business executives, corporate lawyers and individual and institutional investors I dealt with how they thought corporations really worked. The more I listened to their answers, the more I grew to suspect that “maximize shareholder value” is an incoherent and counterproductive business objective.
According to the doctrine of shareholder value, public corporations “belong” to their shareholders, and they exist for one purpose only: to maximize shareholders’ wealth. Shareholder wealth, in turn, is typically measured by share price—meaning share price today, not share price next year or next decade.
Shareholder-value thinking is endemic in the business world today. Fifty years ago, if you had asked the directors or CEO of a large public company what the company’s purpose was, you might have been told the corporation had many purposes: to provide equity investors with solid returns, but also to build great products, to provide decent livelihoods for employees and to contribute to the community and the nation. Today, you are likely to hear about only the maximization of shareholders’ wealth. This sort of thinking 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; and drain cash reserves to pay large dividends and repurchase company shares, leveraging firms until they teeter on the brink of insolvency.
They do these things even though 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.
More recently, shareholder-value thinking has gained traction, and boards have become more attuned to shareholder demands. At the same time, investor returns have, if anything, declined instead of improving. Meanwhile, truly public companies are disappearing. Many firms are going private, fewer are going public and large numbers of the companies that do go public (Google, LinkedIn, Zynga) are adopting dual-class voting structures that disenfranchise public investors. This suggests that shareholder primacy may work fine as long as the shareholder in question is an individual or a small group, and the corporation essentially a closely held company. But the disappearance of the classic U.S. public corporation provides indirect evidence that shareholder primacy is not an attractive or effective business model for companies with dispersed public shareholders.
It’s time to rethink the wisdom of shareholder value.
Turning first to the managers who run corporations, the new work on corporate purpose teaches that directors and executives do a disservice to their firms and their investors if they use share price as their only guiding star. To build enduring value, managers must focus on the long term as well as tomorrow’s stock quotes, and must sometimes make credible if informal commitments to customers, suppliers, employees and other stakeholders whose specific investments contribute to the firm’s success.
Moreover, emphasizing share price can harm shareholders’ other economic and personal interests, including the prosocial interests of shareholders willing to sacrifice some profits in return for greater corporate social responsibility.
Second, if we want public corporations to remain a vibrant force in the economy, policymakers and would-be reformers need to stop reflexively responding to every business crisis or scandal du jour by trying to “improve” corporate governance by making boards and executives more “accountable” to certain shareholders’ demands.
Third, investors themselves—including individual retail investors, but especially institutional investors like mutual and pension funds, which are supposed to ultimately serve the interests of their individual beneficiaries—need to rethink the common assumption that anything that raises the share price of a particular company at a particular time necessarily serves investor welfare.
To help corporations do their best for investors and the rest of us as well, we need to abandon the simplistic mantra of “maximize shareholder value” and adopt new and better understandings of the legal structure and economic functions of public companies. It’s time to free ourselves from the myth of shareholder value.
This is an edited excerpt fromThe Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public
(Berrett-Koehler), by Lynn Stout.
