Maximizing Shareholder Value’ is ill-Conceived Concept

Here is an article:’Maximizing shareholder value’ is ill-conceived concept’

It’s become clear that a relentless focus on share price can hurt not only employees, taxpayers and society, but shareholders too. 

as  Lynn Stout  , professor of corporate and business law at the Clarke Business Law Institute at Cornell Law School.  Her article is at the bottom of this page. Click the link to get to it

Meanwhile,Michael Poulin wrote the following on the article on Customer Capitalism from a previous week:

I like this topic and appreciate your post. While I agree with many statements and ideas you articulated, I have some ‘deviations’. In my last book (in publishing process now), I argue that the only adequate form of modern enterprise in contemporary market situation is the one that is based on principle of service orientation. 

In the service-oriented ecosystem, the consumer is the master, and if a service does not meet consumer’s needs, it dies. Let’s leave aside an issue of service/business creating its consumers for now.

Getting back to the purpose of an enterprise, I see a serious difference between P. Drucker’s “create a customer” and Roger Martin’s “companies should place customers at the centre of the firm and focus on delighting them”. Customers are needed to make a revenue for the enterprise.

However, customer’s demand also can cause creation of an enterprise, to satisfy customer’s needs.

An enterprise can “place customers at the centre of the firm and focus on delighting them” but what for? In a society, an enterprise exists to satisfy customer’s needs, but no for-profit business will appear if such satisfaction would not bring the profit. So, from the enterprise point of view, customers should be “at the centre of the firm” to increase the profit.

I think that the problem of shareholder capitalism is in that it is not really a capitalism but rather a robbery – “grab and run” using an enterprise form. Shareholders need an enterprise only until it can grab. A mechanism  for this is a short-term thinking and planning that frequently works against a well-being of the enterprise itself. Capitalism, I think, is a model where an enterprise can grow based on the capital, which is possible in the long-term thinking and planning only.

I am taking a position of a prosperity of enterprise vs. profit of shareholders. From this perspective, the customers must be created and customer’s needs must be preserved “at the centre of the firm” but for the sake of the enterprise, i.e. customer satisfaction is HOW the enterprise works, not WHAT FOR/WHY.

If an enterprise is structured, organised and operates as a composition of internal and external services combined for maximising long-term revenue, this meets both customer and enterprise needs.

What do you think?

Michael Poulin

Friends, we would love your remarks and comments

Maximizing Shareholder Value’ is ill-Conceived Concept

It’s become clear that a relentless focus on share price can hurt not only employees, taxpayers and society, but shareholders too.

By Lynn stout

September 2, 2012

Over the last three decades, public companies have shifted their focus from promoting long-term growth to maximizing “shareholder value” (a euphemism for share price) in the short term. And the federal government has embraced this religion.

In 1993, Congress changed the tax code to require companies to link executive pay to “performance” (typically stock price). The Securities and Exchange Commission over the last two decades has adopted rules to make corporate directors ever more “accountable” to shareholders. And hedge funds have used these rules to harass companies into selling assets, cutting expenses and paying out large dividends to “unlock shareholder value.”

How has this worked out for American investors and the American economy? Not well.

In the name of increasing shareholder value, public companies have sold key assets (Kodak’s patents), outsourced jobs (Apple), cut back on customer service (Sears) and research and development (Motorola), cut safety corners (BP), showered CEOs with stock options (Citibank), lobbied Congress for corporate tax loopholes (GE) and drained cash reserves to repurchase shares until companies teetered on the brink of insolvency (much of the financial industry). Some corporations even used accounting fraud to raise share price (Enron and WorldCom). Public companies employed these strategies even though many executives and directors felt uneasy about them, sensing that a single-minded pursuit of higher share prices did not serve the interests of society, the company or shareholders themselves.

It’s now become clear, however, that a relentless focus on share price can hurt not only employees, taxpayers and society, but shareholders too. Managers who are pressured to raise stock price quickly often resort to tricks — selling assets, cutting payroll and investment, draining cash through dividends and share repurchase programs — to bump up stock price for a year or two. But such strategies often hurt a company’s long-term ability to grow and prosper.

Economists sometimes argue that if this managerial short-termism were really a problem, then the stock market would punish the companies that engage in it with falling stock prices. But the old “efficient markets” theory that stock markets will always price shares appropriately has long been discredited. Shareholder value thinking means short-term thinking in today’s market of high-frequency trading, where the shares of public companies change hands, on average, every four months. This may explain why the approach has produced more than a decade of the worst investor returns since the Great Depression.

But if shareholder value thinking is counterproductive, how did it become so prevalent? Non-experts often assume the approach is rooted in law, and that public companies are legally required to maximize profits and shareholder returns. This is pure myth. Thanks to a legal doctrine called the business judgment rule, corporate directors who refrain from using corporate funds to line their own pockets remain legally free to pursue almost any other objective, including providing secure jobs to employees, quality products for consumers and research and tax revenues to benefit society. The idea that shareholders “own” corporations is another powerful but mistaken myth with no legal basis. Corporations are legal persons that own themselves. Stockholders own only a contract with the company, called a “share of stock,” giving them limited rights under limited circumstances.

In fact, shareholder value ideology is a relatively new concept, one traceable to the rise of the “Chicago School” of free-market economists. (Nobel Prize-winner Milton Friedman once famously claimed in the pages of the New York Times that shareholders “own” corporations and the only proper purpose of business was maximizing these “owners'” profits.) In the 1980s and 1990s, the Chicago School’s views were enthusiastically embraced by several influential interest groups, including academics who wanted to use share price to gauge corporate performance, economists seeking consulting opportunities as governance experts, and executives like GE’s Jack Welch, who recognized that whatever stock-based compensation might do for shareholder wealth, it clearly helped him maximize his own.

But for most of the 20th century, professional managers of public corporations did not view themselves as “agents” whose only purpose was to maximize shareholder wealth. Rather, they viewed themselves as stewards or trustees responsible for steering great social institutions — public corporations — for the benefit not only of shareholders but also employees, customers and the nation. This system of “managerial capitalism” was hardly perfect. But, ironically, it produced better results for investors than the “shareholder primacy” philosophy that dominates public corporations today.

John Maynard Keynes once famously said that “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually slaves of some defunct economist.”

It’s time to recognize that the philosophy of “maximize shareholder value” is just such a defunct economist’s idea. Let’s throw off our intellectual chains so our corporate sector can do a better job for shareholders — and the rest of us too.

Lynn Stout is a professor of corporate and business law at the Clarke Business Law Institute at Cornell Law School and the author of “The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.” Written in Los Angeles Times.
 
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