During the past 30 years, “maximizing shareholder value” has unquestionably become our dominant economic creed with a vast impact on management practice.

 

Michael Jensen and William Meckling, authors of the famous 1976 Journal of Financial Economics article “Theory of the Firm: Managerial Behavior, Agency Cost and Ownership Structure,” can rightly claim that their paper changed the way corporations have operated: how they’ve been governed, how their top executives have been compensated, what strategic priorities they’ve set, and how they’ve dealt with their human resources.

 

One might argue, in short, that the article has had a transformative effect on a broad scale—so much so that we should ask whether the recent worldwide economic crisis would have played out in the same fashion had “maximizing shareholder value” not become the largely undisputed rallying cry of the corporate elite and the financial markets.

 

This question, in fact, will lie at the heart of this year’s Global Peter Drucker Forum, which will be held on Nov. 15 and 16 in Vienna, under the title “Capitalism 2.0.”

 

What follows is a handful of specific lines of inquiry that I suggest for discussion in preparation for the Forum; feedback from readers will be most appreciated.

  • How sound is the claim that shareholders “own” the enterprise? Or is it something fundamentally different to own shares in a company as compared with owning a car or an appartment buidling?
  • What were the positive and the negative consequences of making managers the agents of shareholders?
  • What are some alternatives to the “shareholder value” model, and how well have they been elucidated by economists and business school research?
  • What factors led to Jensen and Meckling’s theory becoming so popular? What can we learn from their success if we want to change the model?
  • To what degree has a focus on creating “shareholder value” contributed to the still-unfolding global economic crisis?

As you can probably tell, I am part of today’s growing chorus of critics of “maximizing shareholder value.” However, I remember well that when Lou Gerstner announced in 1993 that “shareholder value” would become one of IBM’s core principles, it made a lot of sense to me as a way to bring the company back to life.

 

The problem is that many corporations have driven the concept to an extreme. They’ve engaged in knee-jerk cost cutting when all slack has already been removed from the system. Pursuing profit as the purpose of the business seems to have become the norm. Peter Drucker, of course, had a very different view: The purpose of a business is to create a customer.

 

We would be interested in your vote on whether “maximizing shareholder value” has had a positive impact, negative impact or been a neutral force, along with a couple of lines to substantiate your position.

 

 

Richard Straub
President Peter Drucker Society Europe

@rstraub46

 

8 thoughts on “Shareholder Value – a theory that changed the course of history – for the better or the worse?

  1. The purpose of an enterprize is to survive for ever and create value for all stakeholders in fair proportions. Fair is defined in different cultures and different times in different ways. In many modern wellfare societies we have reached high levels on Maslows hierarky of needs and we can afford to be fair.

  2. Pursuing profit as the purpose of the business seems to have become the norm. Peter Drucker, of course, had a very different view: The purpose of a business is to create a customer.

    • what is the difference? what ever way you put it, a company is a legal entity created to make profits. If it has total people oriented motives, its an NGO not a company then.

  3. I think Shanita has it very correctly.

    To go a little farther, one could observe that Peter Drucker’s strength was always in his ability to see a more complete picture than typical corporatists.

    I can hardly think what he would have had to say about current ‘starve any person or national economy you think to’ capitalists. Other than to observe that they are killing everything they wanted to hope for.

    In so many ways, we are running out of time for any ‘humans just go by simple rules and the magic hand makes it work’ approaches to livelihood, aren’t we?

  4. One of the interesting phenomena today is that discussions about blog post may occur in different places. I just add the comments to the subject of this post that were made at the IMD Alumni and Faculty Group on Linkedin http://linkd.in/OFRrkx

    12 comments

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    Kai Friskberg • Maximizing stakeholder value is the the right strategy if you want to survive in the long run.Corporate social responsibility will sell in the future.
    20 days ago • Like

    1
    John Kline

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    John Kline • Maximizing shareholder value without regard to ethics and / or social responsibility is not a sustainable long term strategy. I believe the new mantra will become sustainable development with a better balance between growth, profits and social responsibility.
    19 days ago • Like

    2
    Roth Christof

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    Roth Christof • @John Kline: I totally agree.
    16 days ago • Like

    Pascal Roth

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    Pascal Roth • Shareholder Value is an indicator of sustainable entrepreneurship; in that sense I am totally pro – stressing the “-holder”, as opposed to “sharetrader”.
    9 days ago • Like

    Hans-Henrik Skonning Hansen

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    Hans-Henrik Skonning Hansen • Have been debatting with myself how to comment since I believe ‘maximizing shareholder value’ is defined very differently by different people.

    As mentioned by John then shareholder value is not sustainable if you completely disregard softer values. Perhaps you can buy some extra time (& shareholder value) if you are big enough and can influence politics sufficiently and have money to buy out innovative competitive products.

    However, most companies today have a very short term focus on shareholder value and thus forget to keep the product pipeline filled to survive long term.
    7 days ago • Like

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    Barbara Martellini • I totally agree with John Kline that a sustainable shareholder value must go alongside with etichs and/or social responsibility. However I notice that several fundamental discussions normally do not take place with shareholders or are limited at a very superficial level. Many of the events that have negatively affected major or smaller companies (fines, collapses, reputation damage) must have taken place because the shareholders did not question matters any deeper than getting the right returns on their investment. Any type of growth must have a long-term vision and must consider several elements that moving in a certain direction will imply, including ethics, better internal controls, responsibility towards customers, suppliers, workers and the community. Putting these elements in place and giving them the appropriate weight implies a considerable effort and also requires a strong vision at the top and the ability to see that every opportunity also has related costs. The CEO must have the confidence that discussing these elements with the shareholders is not a threat to the short term return, but a sign that the company is firmly on the road to long-term sustainability.
    7 days ago • Like

    Elena Andreenkova

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    Elena Andreenkova • i think that “Shareholder value” as a company mission is a nonsense, as it is purely abstruct for customers and employees and it is valid for shareholders only who have no influence on the core company results.
    I think that this term makes more damage than help for a company, as 1. it demonstrate company’s focus on the stock market vs customer interest; 2. It makes employees even less comitted to the company mission and more skeptical about the purpose of the work for “what holder? Ones that bought their shares yesterday or the ones that will sell them tomorrow?”
    2 days ago • Like

    1
    CHAUMEIL Jean-Louis

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    CHAUMEIL Jean-Louis • Very well said. Thanks
    2 days ago • Like

    Richard Straub

    Richard Straub • Excellent comments – let me just add one aspect. In order to survive companies must be profitable. Drucker always argued that that managers are responsible for the economic success of the business, for making their employees effective and for providing value to society. Without a profitable and sustainable business the other two elements cannot be achieved. The issue with shareholder value is that it is placing the market value of the company as the top priority – with a very short term horizon. The German Mittelstand shows great examples how companies can create long term value without maximizing profits in the short term. However, once you are a listed company you are penalized immediately by “the markets” if your profitability does not reach the consensus level. Roger L. Martin has analysed this issue very well in his book “Fixing the Game”. Big question therefore is – is there and alternative to the current shareholder value creed? There is no example in recent business history where a theory (see Blog Post) had such a deep impact on business and management. However, it is a theory – it can be changed and adapted to a new eara where more needs to be achieved than financial value for thos owning shares (not owning the company as such). Yet – how can we achieve a change favouring the long term as opposed to the short term?
    23 hours ago

    Roth Christof

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    Roth Christof • @Richard Straub

    I do also believe that it is a short-term versus long-term question. And “no”, as a listed company you were not penalized immediately by the “markets” but by the stock market and it is indeed a very big question of how to overcome this phenomenon. As long as CEOs and other C-level guys are being rewarded for achieving short-term goals they obviously would not invest in the future of the company, in new products, in new markets etc. – – – why should they? After a few years they are no longer with the company anyway.
    21 hours ago • Like

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    Barbara Martellini • There are two aspects to take into consideration. One is how production / sales are carried out in order to minimize any negative impact on the environment and the scocial fabric. This is common sense and it has a long term effect on the bottom line since by improving the management of production and sales ends up in saving money. However some of these activities need investments in either equipment or systems also in terms of monitoring which may considered in the same way as CAPEX. The other aspect is how to deliver benefits for the community: this can also be linked to improving the company’s customer basis or supplier basis. The two aspects are separate and may be based on a different philiosophical approach and have different returns. But both can be seen as opportunities: and opportunities, if taken in the right way, are positive!
    21 hours ago • Like

    Richard Straub

    Richard Straub • @Christof Roth – I agree with you, but just for clarification – with markets I meant the financial markets. In the media they are frequently referred to as “the markets”
    @Barbara Martellini – I would even add an aspect: jobs and the lack of job creation is becoming the key issue in Europe and the US. It seems that under the pressure of the financial markets which provide disincentives for corporate executives to run risks investments in innovation are confined to incremental innovation. They even prefer returning money to sharholders. Major breakthrough projects might not be successful in the first round and this would mean that the CEO looses his/her job. US Corporations sit on 2-3 T of cash. How should job creation work in an environment where we try to show great financial results from quarter to quarter, cut cost beyond reason and avoid taking risks for innovation oriented investments. Hence – isn’t innovation a social responsibility?

  5. The responses almost require a series of blog entries to handle but I will be brief for each one.
    ====
    How sound is the claim that shareholders “own” the enterprise? Or is it something fundamentally different to own shares in a company as compared with owning a car or an appartment building?

    The use of juristic persons to permit ownership rather than natural persons presents a true threat to models of democracy that have developed over the past several centuries. Democracy could not take root until land ownership and control were widely shared among natural persons who had a voice and vote in democratic governance. If the exaggerated claims of shareholder value are allowed to continue we will have few, if any, democracies left in the world within the next two decades.

    ====
    What were the positive and the negative consequences of making managers the agents of shareholders?

    There is adequate evidence that agency theory is just a theory in the way in which corporations are managed today. Perhaps the concept worked in the 19th Century when there was some moral anchoring of managers to the ownership but not today.

    =====
    What are some alternatives to the “shareholder value” model, and how well have they been elucidated by economists and business school research?

    One area lacking is to look at capital accumulation methods that do not result in toxic concentration of wealth that we are seeing in almost all industrialized countries today. Gar Alperovitz has done a good job of setting the stage for worker and community ownership models that avoid the march toward undesirable societies represented by hyper concentration of wealth.

    =====
    What factors led to Jensen and Meckling’s theory becoming so popular? What can we learn from their success if we want to change the model?

    Business is pragmatic world. Jensen and Meckling’s theories of agency were appropriated as a basis to allow scaling of capital markets as as part of the last phases of American and European expansionism. By the time their theories were gaining traction the ability of western economies to expand geographically, the game of over 400 years, was over. Scaling of capital markets enabled trans-regional business leading eventually to the extremely large multi-nationals of today.

    Business will, by its pragmatic nature, expropriate any theory as justifying framework. The use of a part of Adam Smith’s concepts provides a historical case in point.

    ====
    To what degree has a focus on creating “shareholder value” contributed to the still-unfolding global economic crisis?

    The transition from a multitude of “market logics,” often embedded in local cultures to a mathematically based electronic herd of financial shareholder value provided the equivalent of a mono-culture in agriculture to the global economy. Just as happened in the Irish potato famine, reliance on a non-diverse model can lead to rapid and systematic collapse.

    When the use of inherently unstable derivatives is added to the mix, the whole situation becomes a witch’s brew. The system has collapsed and, unless reformed, will collapse again.

  6. The concept of maximizing shareholders value is very appealing to management today because a lot of them own huge amount of their company shares. Which makes them, at the same time, agents and owners of the company. This creates a conflict of intrest in management. Their decisions seems to be the net result of the gains as a employee against the gains as a owner, which ever is greatest. that is what makes bootstrapping and other tatics more attractive to increase stock price

  7. abhishek kumar

    I think, there is dire need to extend the definition of shareholders in relationship with business. Not only the investors who buy share of companies but also the buyer of companies products should also incorporate in shareholders definition.In this way businesses can stick with that principle.

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