How's That Shareholdery-Valuey Stuff Working Out for Ya?
The purpose of a corporation is to maximize shareholder wealth. And a corporation's board of directors' chief fiduciary responsibility is to shareholders.
These are plain and simple facts — and have been so forever. Right?
No, and no, actually. The idea that shareholder value should be the organizing principle of the corporation is of relatively recent vintage — it was only in the 1990s that it really became widely accepted — and as legal scholar Lynn Stout keeps explaining, corporate law has far from fully embraced it. Which makes the statements in the first sentence just arguments, not facts.
Now, as Joe Nocera wrote last week in The New York Times, there's a "movement" gaining strength to replace shareholder value with a broader definition of corporate purpose that includes satisfying customers, providing good jobs, even paying taxes. I am now a card-carrying member of this movement, thanks to my article with Jay Lorsch in the July/August HBR, "What Good Are Shareholders?"
There is, however, a big barrier standing in the way of the movement's triumph, Nocera writes:
Measuring chief executives on the basis of their companies' stock prices is easy to understand — that was always part of its appeal. Those who want to change that, including Lorsch and Fox, have struggled to come up with breakthrough ideas that would be similarly appealing.
He's right about that, of course. Shareholder value is pithy, and makes some intuitive sense. It's also not completely wrong. There are moments in a corporation's trajectory when it's an appropriate guiding principle. The idea began its rise to dominance, after all, in the 1970s — a time when many big U.S. corporations had become bloated and uncompetitive. The looking-out-for-multiple-stakeholders philosophy that many executives espoused in those days masked a dangerous complacency. Emphasizing shareholders' interests seemed to encourage more flexibility, risk-taking, and bottom-line discipline.
But as we've learned since, focusing on shareholder value can be an excuse for lots of short-sighted, destructive behavior. People who study successful corporations — I'm thinking of Jim Collins, Rosabeth Moss Kanter, Michael Beer, and many others — keep reporting that one important trait that most of them share is that they don't emphasize the maximization of shareholder value.
Somewhat ironically, most of these scholars still use long-term return to shareholders as their main measure of corporate success. That's because shareholder returns over the course of a couple of decades can be a passable proxy for the economic and social value that a company creates — and they're certainly easy to measure. Over shorter periods, though, stock price movements usually convey more noise than signal. And in either case, it's key to remember that equity returns are a proxy for something else. They're a metric, not a goal.
That's because there's little legal or historical justification for making shareholder wealth maximization the goal of the corporation (Stout's 2002 Southern California Law Review article, "Bad and Not-So-Bad Arguments for Shareholder Primacy," is the best summary of the evidence on this). There's just the economic argument that trying to maximize one thing (shareholder value or, better, enterprise value) is logically possible while trying to maximize lots of things (returns to various stakeholders) is not. But since managers of corporations can't get reliable short- or even medium-term feedback from markets on whether they really are maximizing shareholder wealth over time, this is a pretty meaningless distinction.
All of which means that I don't think the anti-shareholder-value movement really needs to offer up something as catchy as shareholder value to succeed. It just needs to make clear that shareholder value is an argument, a tool, a means to an end. It should be judged by how well it works. Or, as Sarah Palin might say, how's that shareholdery-valuey stuff working out for ya? Lately, not so well.