The debate about shareholder capitalism has an unfortunate habit of becoming a clash of absolutes. In the 1980s and 1990s Michael Jensen and his followers argued that shareholder value was the secret sauce of management. In the wake of the 2007-8 financial crisis many influential management theorists declared that the secret sauce was in fact a deadly poison. The search is now on for a better way of measuring success and motivating managers.
There is no doubt that the cult of shareholder value produced perverse results. The fashion for linking remuneration to share prices allowed bosses to manipulate their shareprices to boost their income. The emphasis on short-term results rather than long-term health tempted companies to skimp on research and innovation (‘long term results cannot be gained by piling short-term results on short-term results’ Peter Drucker once remarked). There have been so many examples of the destructive side of share-holder capitalism that many of its high-priests have turned against it: even Jack Welch has pronounced that it is ‘the dumbest idea on the planet’.
But there is a danger of going too far in the opposite direction. None of the alternative systems of measurement that people have come up with are very compelling. One idea is ‘customer satisfaction’. But isn’t the best way to please customers to give everything away for nothing? And how can customer satisfaction take into account the interests of the people who risk their capital by investing in the company? Another idea is to rely on the judgement of managers. But isn’t this tantamount to allowing children to mark their own homework? It is odd that people who worry that shareholder value has been manipulated by managers for their own benefit should argue that managers should be given more power rather than less.
Most critics of ‘shareholder capitalism’ embrace ‘stakeholder capitalism’-that is a variety of capitalism which gives equal say to all the various constituencies in the business world from employees to communities. But this can easily become a recipe for all sorts of problems-from dithering as different constituencies manoeuvre for advantage to gamesmanship as clever managers manipulate gridlock for their own advantage. The stakeholder idea might have had some merit in a world where technological change was slower than it is today. But it has little relevance to a world where innovation is frequently disruptive and managers have to make unpopular decisions or miss the next wave.
The best way to deal with the issue of shareholder value is to reject the absolutists of both sides-the Calvinists of shareholder value and the Jesuits of stakeholder value as it were-and take a much more pragmatic approach. Shareholder value is a valuable tool. It provides us with a way of measuring a company’s performance from the outside. But it is an equally bad master. The trick is to adjust the tool so that it does the job better rather than to caste it aside.
This can be done relatively easily-by making sure that we focus on long-term rather than short-term shareholder value. Bosses should be forced to hold their stock in companies for a few years before they can exercise their stock options. They should also be deprived of their freedom to exercise their stock options whenever they feel like it. This will give bosses a powerful incentive to boost the long-term health of the company (and hence the long-term health of their own portfolios) rather than a perverse incentive to game the system.
Adrian Wooldridge is The Economist‘s management editor and writes the Schumpeter column. He was previously based in Washington, DC, as the Washington bureau chief where he also wrote the Lexington column. Previously he has been The Economist‘s West Coast correspondent, management correspondent and Britain correspondent. He is the co-author of “The Company: A Short History of a Revolutionary Idea”, “A Future Perfect: The Challenge and Hidden Promise of Globalisation”, “Witch Doctors”, a critical examination of management theory, and “The Right Nation”, a study of conservatism in America. His most recent book is “Masters of Management: How the Business Gurus and their Ideas have Changed the World-for Better and for Worse”.