http://www.washingtonpost.com/blogs/wonkblog/wp/2013/09/09/how-the-cult-of-shareholder-value-wrecked-american-business/?wprss=rss_national&clsrd
I recommend a full read or at least a skim. High points are that the focus on share holder value is a result of the corporate raiding of the 80s, and encourages cutting wages, firing employees and general bad management all in the name of short term share value.
In the recent history of management ideas, few have had a more profound — or pernicious — effect than the one that says corporations should be run in a manner that “maximizes shareholder value.”
Indeed, you could argue that much of what Americans perceive to be wrong with the economy these days — the slow growth and rising inequality; the recurring scandals; the wild swings from boom to bust; the inadequate investment in R&D, worker training and public goods — has its roots in this ideology.
The funny thing is that this supposed imperative to “maximize” a company’s share price has no foundation in history or in law. Nor is there any empirical evidence that it makes the economy or the society better off. What began in the 1970s and ’80s as a useful corrective to self-satisfied managerial mediocrity has become a corrupting, self-interested dogma peddled by finance professors, money managers and over-compensated corporate executives.
Let’s start with some history.
The earliest American corporations were generally chartered for public purposes, such as building canals or transit systems, and well into the 1960s were widely viewed as owing something in return to a society that provided them with legal protections and an economic ecosystem in which to grow and thrive. In 1953, carmaker Charlie Wilson famously spoke for a generation of chief executives about the link between business and the larger society when he told a Senate committee that “what is good for the country is good for General Motors, and vice versa.”
There are no statutes that put the shareholder at the top of the corporate priority list. In most states, corporations can be formed for any lawful purpose. Cornell University law professor Lynn Stout has been looking for years for a corporate charter that even mentions maximizing profits or share price. She hasn’t found one.
Nor does the law require, as many believe, that executives and directors owe a special fiduciary duty to shareholders. The fiduciary duty, in fact, is owed simply to the corporation, which is owned by no one, just as you and I are owned by no one — we are all “persons” in the eyes of the law. Shareholders, however, have a contractual claim to the “residual value” of the corporation once all its other obligations have been satisfied — and even then directors are given wide latitude to make whatever use of that residual value they choose, as long they’re not stealing it for themselves.
It is true that only shareholders have the power to select a corporation’s directors. But it requires the peculiar imagination of a corporate lawyer to leap from that to a broad mandate that those directors have a duty to put the interests of shareholders above all others.
Becoming the norm
How then did “maximizing shareholder value” evolve into such a widely accepted norm of corporate behavior?
The most likely explanations for this transformation are two broad structural changes — globalization and deregulation — which together conspired to rob many major American corporations of the outsize profits they had earned during the “golden” decades after World War II. Those profits were so generous that there was enough to satisfy nearly all the corporate stakeholders. But in the 1970s, when increased competition started to squeeze out profits, it was easier for executives to disappoint shareholders than their workers or communities. The result was a lost decade for investors.
No surprise, then, that by the mid-1980s, companies with lagging stock prices found themselves targets for hostile takeovers by rivals or corporate raiders using newfangled “junk” bonds to finance their purchases. Disgruntled shareholders were only too willing to sell. And so it developed that the mere threat of a possible takeover imbued corporate executives and directors with a new focus on profits and share prices, tossing aside old inhibitions against laying off workers, cutting wages, closing plants, spinning off divisions and outsourcing production overseas. Today’s “activist investor” hedge funds, which have amassed war chests of tens of billions of dollars to take on the likes of Microsoft, Procter & Gamble, PepsiCo and Apple, are the direct descendants of these 1980s corporate raiders.
While it was this new “market for corporate control,” as economists like to call it, that created the imperative to boost near-term profits and share prices, an elaborate institutional infrastructure has grown up to reinforce it.
This infrastructure includes business schools that indoctrinate students with the shareholder-first ideology and equip them with tools to manipulate quarterly earnings and short-term share prices.
It includes corporate lawyers who reflexively advise against any action that might lower the share price and invite shareholder lawsuits, however frivolous.
It includes a Wall Street establishment that is thoroughly fixated on quarterly earnings, quarterly investment returns and short-term trading.
And most of all, it is reinforced by gluttonous pay packages for top executives that are tied to the short-term performance of the company stock.
The result is a self-reinforcing cycle in which corporate time horizons have become shorter and shorter. The average holding periods for corporate stocks, which for decades was six years, is now down to less than six months. The average tenure of a public company chief executive is down to less than four years. And the willingness of executives to sacrifice short-term profits to make long-term investments is rapidly disappearing.
A recent study by the consultants at McKinsey & Co. and Canada’s public pension board found alarming levels of short-termism in the corporate executive suite. They reported that nearly 80 percent of top executives and directors reported feeling most pressured to demonstrate a strong financial performance over a period of two years or less, with only 7 percent feeling pressure to deliver a strong performance over a period of five years or more. They 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.
The real irony surrounding this focus on maximizing shareholder value is that it hasn’t, in fact, done much for shareholders.
Roger Martin, the outgoing dean of the Rotman School of Management at the University of Toronto, calculates that from 1932 until 1976 — roughly speaking, the era of “managerial capitalism” in which managers sought to balance the interest of shareholders with those of employees, customers and the society at large — the total real compound annual return on the stocks of the S&P 500 was 7.6 percent. From 1976 until the present — roughly the period of “shareholder capitalism” — the comparable return has been 6.4 percent.
Obviously, a lot of other things happened during those two periods that could have affected returns to shareholders. One thing we know is that less and less of the wealth generated by the corporate sector was going to frontline workers. Another is that more and more of it was going to top executives. According to Martin, the ratio of chief executive compensation to corporate profits increased eight-fold between 1980 and 2000. Almost all of that increase came from stock-based compensation.
I recommend a full read or at least a skim. High points are that the focus on share holder value is a result of the corporate raiding of the 80s, and encourages cutting wages, firing employees and general bad management all in the name of short term share value.
In the recent history of management ideas, few have had a more profound — or pernicious — effect than the one that says corporations should be run in a manner that “maximizes shareholder value.”
Indeed, you could argue that much of what Americans perceive to be wrong with the economy these days — the slow growth and rising inequality; the recurring scandals; the wild swings from boom to bust; the inadequate investment in R&D, worker training and public goods — has its roots in this ideology.
The funny thing is that this supposed imperative to “maximize” a company’s share price has no foundation in history or in law. Nor is there any empirical evidence that it makes the economy or the society better off. What began in the 1970s and ’80s as a useful corrective to self-satisfied managerial mediocrity has become a corrupting, self-interested dogma peddled by finance professors, money managers and over-compensated corporate executives.
Let’s start with some history.
The earliest American corporations were generally chartered for public purposes, such as building canals or transit systems, and well into the 1960s were widely viewed as owing something in return to a society that provided them with legal protections and an economic ecosystem in which to grow and thrive. In 1953, carmaker Charlie Wilson famously spoke for a generation of chief executives about the link between business and the larger society when he told a Senate committee that “what is good for the country is good for General Motors, and vice versa.”
There are no statutes that put the shareholder at the top of the corporate priority list. In most states, corporations can be formed for any lawful purpose. Cornell University law professor Lynn Stout has been looking for years for a corporate charter that even mentions maximizing profits or share price. She hasn’t found one.
Nor does the law require, as many believe, that executives and directors owe a special fiduciary duty to shareholders. The fiduciary duty, in fact, is owed simply to the corporation, which is owned by no one, just as you and I are owned by no one — we are all “persons” in the eyes of the law. Shareholders, however, have a contractual claim to the “residual value” of the corporation once all its other obligations have been satisfied — and even then directors are given wide latitude to make whatever use of that residual value they choose, as long they’re not stealing it for themselves.
It is true that only shareholders have the power to select a corporation’s directors. But it requires the peculiar imagination of a corporate lawyer to leap from that to a broad mandate that those directors have a duty to put the interests of shareholders above all others.
Becoming the norm
How then did “maximizing shareholder value” evolve into such a widely accepted norm of corporate behavior?
The most likely explanations for this transformation are two broad structural changes — globalization and deregulation — which together conspired to rob many major American corporations of the outsize profits they had earned during the “golden” decades after World War II. Those profits were so generous that there was enough to satisfy nearly all the corporate stakeholders. But in the 1970s, when increased competition started to squeeze out profits, it was easier for executives to disappoint shareholders than their workers or communities. The result was a lost decade for investors.
No surprise, then, that by the mid-1980s, companies with lagging stock prices found themselves targets for hostile takeovers by rivals or corporate raiders using newfangled “junk” bonds to finance their purchases. Disgruntled shareholders were only too willing to sell. And so it developed that the mere threat of a possible takeover imbued corporate executives and directors with a new focus on profits and share prices, tossing aside old inhibitions against laying off workers, cutting wages, closing plants, spinning off divisions and outsourcing production overseas. Today’s “activist investor” hedge funds, which have amassed war chests of tens of billions of dollars to take on the likes of Microsoft, Procter & Gamble, PepsiCo and Apple, are the direct descendants of these 1980s corporate raiders.
While it was this new “market for corporate control,” as economists like to call it, that created the imperative to boost near-term profits and share prices, an elaborate institutional infrastructure has grown up to reinforce it.
This infrastructure includes business schools that indoctrinate students with the shareholder-first ideology and equip them with tools to manipulate quarterly earnings and short-term share prices.
It includes corporate lawyers who reflexively advise against any action that might lower the share price and invite shareholder lawsuits, however frivolous.
It includes a Wall Street establishment that is thoroughly fixated on quarterly earnings, quarterly investment returns and short-term trading.
And most of all, it is reinforced by gluttonous pay packages for top executives that are tied to the short-term performance of the company stock.
The result is a self-reinforcing cycle in which corporate time horizons have become shorter and shorter. The average holding periods for corporate stocks, which for decades was six years, is now down to less than six months. The average tenure of a public company chief executive is down to less than four years. And the willingness of executives to sacrifice short-term profits to make long-term investments is rapidly disappearing.
A recent study by the consultants at McKinsey & Co. and Canada’s public pension board found alarming levels of short-termism in the corporate executive suite. They reported that nearly 80 percent of top executives and directors reported feeling most pressured to demonstrate a strong financial performance over a period of two years or less, with only 7 percent feeling pressure to deliver a strong performance over a period of five years or more. They 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.
The real irony surrounding this focus on maximizing shareholder value is that it hasn’t, in fact, done much for shareholders.
Roger Martin, the outgoing dean of the Rotman School of Management at the University of Toronto, calculates that from 1932 until 1976 — roughly speaking, the era of “managerial capitalism” in which managers sought to balance the interest of shareholders with those of employees, customers and the society at large — the total real compound annual return on the stocks of the S&P 500 was 7.6 percent. From 1976 until the present — roughly the period of “shareholder capitalism” — the comparable return has been 6.4 percent.
Obviously, a lot of other things happened during those two periods that could have affected returns to shareholders. One thing we know is that less and less of the wealth generated by the corporate sector was going to frontline workers. Another is that more and more of it was going to top executives. According to Martin, the ratio of chief executive compensation to corporate profits increased eight-fold between 1980 and 2000. Almost all of that increase came from stock-based compensation.