by Lynn Stout
Still, there is reason to suspect the American corporate sector is no longer quite as positive an influence on our lives. Over the past decade, public shareholder returns have stagnated; innovation may be declining; corporate employees are increasingly stressed and insecure, or are no longer corporate employees at all. Meanwhile, many of our largest public companies have cast themselves in the role of corporate villain by perpetrating massive frauds (Worldcom, HealthSouth, and Adelphia), spearheading deregulatory lobbying campaigns that brought us to the brink of financial disaster (Enron, Citibank), preying on their customers (Countrywide), creating risks that nearly toppled the financial system (AIG and Goldman Sachs), and damaging the environment (Exxon and BP).
The Role of Shareholder Value Thinking
This book has argued that many of the problems we see in the corporate sector today are the unintended consequences not of corporations as such, but of a mistaken idea about corporations: the idea that they ought to be run to maximize shareholder value as measured by share price. Experts increasingly recognize that the conventional shareholder-oriented model of the public corporation isn’t the only intellectual game in town. Indeed, the model doesn’t fit reality. Shareholder primacy is not required by the law; the theory underpinning it mischaracterizes the corporation’s true economic structure; it is not supported by the empirical evidence on corporate performance. Perhaps most disturbing, far from having proven itself a governance cure, the increasing influence of shareholder value thinking on business law and practice has been accompanied by, if anything, a decline in American corporate and economic performance.
Nevertheless, shareholder value thinking continues to wield enormous influence in the business world and in the popular press. Worse, it still dominates instruction in law and business classes. A recent Brookings study of the curricula of top law and business schools concluded that “many professional school courses emphasize maximizing corporate profits and shareholder value” and that “the emphasis on shareholder value is especially prevalent in law schools.” As a result, “students believe the primary purpose of the corporation is to maximize shareholder value, and they believe this is how current corporate leaders behave when they are making decisions.”146
Why does shareholder value thinking have such staying power? As already noted, the shareholder primacy approach appeals to some influential interests. These include educators and journalists looking for a sound-bite explanation of corporations to offer their students and readers; researchers seeking an easy way to measure corporate performance; activist hedge fund managers hoping for intellectual cover as they agitate for personally profitable but socially costly business strategies; and CEOs delighted to discover that the mantra of “increase shareholder wealth” gives them room to increase their own wealth through stock options and other pay-for-performance schemes.
But the needs of interest groups only partly explain how, after decades of managerialist thinking, shareholder primacy came to dominate modern discussions of corporate purpose. After all, as we saw in Part II, shareholder value ideology often harms the interests of another powerful interest group: investors themselves. Nevertheless, many investors—including not only mom-and-pop individual investors, but also institutions like pension and mutual funds, not to mention activist hedge funds—were at the front of the line in demanding that corporations de-stagger their boards, use stock options and other share-price-based schemes to compensate executives, and adopt majority rather than plurality voting rules to make it harder for incumbent directors to seek reelection. Similarly, investors have supported SEC initiatives to promote “shareholder democracy” by eliminating broker voting, giving shareholders access to corporate funds to mount proxy battles, and adopting other rule changes intellectually grounded in shareholder value thinking. Shareholders are among the most ardent supporters of shareholder primacy, even as they are its victims.
The Lure of Mythology
In his 2007 bestseller The Black Swan, author and former hedge fund manager Nassim Taleb offers an explanation for why shareholder value mythology has proven so powerful. According to Taleb, “A novel, a story, a myth, or a tale, all have the same function: they spare us from the complexity of the world and shield us from its randomness.”147 The greatest appeal of the shareholder value myth may lie in how it seems to tame and simplify an unruly and complex reality: the natures of shareholders themselves.
This book has shown that the idea of maximizing shareholder value rests on an impossible abstraction of “the shareholder” as a Platonic entity that cares only about the market price of a single corporation’s equity. This means that shareholder value is an inherently flawed concept, because in reality different shareholders have different values. Contemporary experts in corporate law and economics increasingly recognize that shareholders are human beings with differing investment time frames, different interests ex ante and ex post, different degrees of diversification, and different attitudes toward sacrificing personal wealth to follow ethical rules and avoid harming others. Conventional shareholder value thinking reconciles different shareholders’ conflicting desires by simply assuming the conflicts away.
In the process, shareholder value ideology reduces investors to their lowest possible common human denominator. It favors the desires of the pathologically impatient investor over the long-sighted; favors the opportunistic and untrustworthy over those who want to be able to keep ex ante commitments to stakeholders and each other; favors the irrationally self-destructive over those more sensitive to their own interests as diversified universal owners; and favors the psychopathically selfish over the prosocial concerned about other people, future generations, and the planet. This single-dimensioned conception of shareholder interest is not only unrealistic, but dysfunctional.
We Don’t Need a Single Metric
Some experts might argue we have no alternative. One common defense of using shareholder value as the sole criterion for judging corporate performance rests on the claim that unless we have a single, objective measure to judge how well directors and executives are running firms, these corporate agents will run amok. As economist Michael Jensen has put the argument, “Any organization must have a single-valued objective as a precursor to purposeful or rational behavior. . . . It is logically impossible to maximize in more than one dimension at the same time . . . Thus, telling a manager to maximize current profits, market share, future growth profits, and anything else one pleases will leave that manager with no way to make a reasoned decision. In effect it leaves the manager with no objective.”148 According to Jensen, “[t]he solution is to define a true (single dimensional) score for measuring performance for the organization.”149
This perspective ignores the obvious human capacity to balance, albeit imperfectly, competing interests and responsibilities. Every day, parents with more than one child must balance the interests of competing siblings (not to mention balancing their children’s welfare against their own). Judges routinely balance justice against judicial efficiency. Teachers balance the interests of students who are quick against those who are slow, professors balance teaching demands against research and scholarship, shopkeepers balance the hope of making one more sale against the desire to get home in time for the family dinner. This is not to say balancing interests is easy. But the fact that it can be hard doesn’t mean it can’t be done. It is done every day. Balancing interests—decently satisfying several sometimes-competing objectives, rather than trying to “maximize” only one—is the rule and not the exception in human affairs.
A second, related argument is that even if the conventional principal-agent model of the corporation is flawed, it is the only model that reliably tells us what corporations should do. Alternative theories of corporate purpose—for example, stakeholder welfare theories, or team production theories—are controversial, and perhaps more important, don’t always give clear guidance in particular cases on what, exactly, directors and managers should adopt as the company’s goal. If you onl
y have one tool at hand, the argument goes, that is the tool that you must use.
This argument overlooks the possibility that, sometimes, a tool can be so obviously inappropriate and ill-suited to a particular task that we are better off leaving it to gather dust in the toolbox. Suppose you are a doctor trying to help a patient with a stomachache, and your only tool is a chainsaw. By blithely picking up the chainsaw and setting to work, you would make matters much worse than they already are.
Similarly, when we insist on gauging the performance of the American corporate sector solely by the share price performance of individual companies, we are ignoring the diverse interests and values of different shareholders to focus only on those of a very narrow subset that is particularly short-sighted, opportunistic, indifferent to external costs, and lacking in conscience. Collectively, we might do far better if we are willing to tolerate some ambiguity about what the ultimate purpose of the corporate entity should be. As former Delaware Chancellor William T. Allen has put it, “It is perhaps too much to expect us, as a people—or our law—to have a single view of the purpose of an institution so large, pervasive and important as our public corporations. These entities are too important to generate that sort of agreement.”150
Paying Attention to Reality
Abandoning the quixotic and ultimately self-defeating idea that corporate success and corporate purpose can and should be measured by a single objective metric allows us to understand a host of otherwise-puzzling realities of corporate law and practice. Perhaps the most obvious is how public corporations managed to develop and thrive in the first place, despite the awkward fact that they are controlled not by shareholders or bondholders but by boards of directors empowered to employ corporate assets toward almost any lawful end. Thanks to dispersed shareholders’ rational apathy and the business judgment rule, for most of the twentieth century directors of public companies who did not breach their loyalty duties enjoyed virtually unfettered discretion to set corporate policy, even over shareholders’ vocal objections. This without doubt increased “agency costs,” and often left directors with less than crystal-clear guidance on their ultimate goal. It did not, however, stop American public corporations from producing excellent results for investors as well as for employees, consumers, and communities.
More recently, as shareholder value thinking has gained traction and boards have become more attuned to shareholder demands, investor returns have, if anything, declined instead of improving. Meanwhile, truly public companies are disappearing. Many firms are going private, fewer are going public, and large numbers of the companies that do go public (Google, LinkedIn, Zynga) are adopting dual-class voting structures that disenfranchise public investors. This suggests that shareholder primacy may work fine as long as the shareholder in question is an individual or small group, and the corporation essentially a closely held company. But the disappearance of the classic U.S. public corporation provides indirect evidence that shareholder primacy is not an attractive or effective business model for companies with dispersed public shareholders.
Some Lessons from the New Thinking
That possibility offers a host of important lessons for corporate managers, policymakers, and investors themselves. Turning first to the managers who run corporations, the new work on corporate purpose teaches that directors and executives do a disservice to their firms and their investors if they use share price as their only guiding star. To build enduring value, managers must focus on the long term as well as tomorrow’s stock quotes, and must sometimes make credible if informal commitments to customers, suppliers, employees, and other stakeholders whose specific investments contribute to the firm’s success. Moreover, emphasizing share price can harm shareholders’ other economic and personal interests, including the prosocial interests of shareholders willing to sacrifice some profits in return for greater corporate social responsibility.
Thus, if executives and especially boards of directors want to truly promote “shareholder value,” they need to embrace the discretion that corporate law grants them to use their power and authority over the firm as a means to address (as Iman Anabtawi puts it) “the need for mediating the various and often conflicting interests of shareholders themselves.”151 We should not expect boards to do a perfect job of mediating these “various and often conflicting” shareholder interests. However, there is no reason to think boards can’t mediate well enough that shareholder interest-balancing by a board is preferable to a board that slavishly responds only to the concerns of the most short-sighted, opportunistic, undiversified, and unethical subset of shareholders. In this vein, boards should keep in mind that balancing becomes especially difficult if the heavy weight of self-interest is added to one side of the scale. Stock options and other compensation schemes that tie executive or director pay primarily to share price undermine corporate managers’ motivation to pursue more authentic visions of shareholder value.
Second, if we want to keep public corporations as a vibrant force in the America economy, policymakers and would-be reformers need to stop reflexively responding to every business crisis or scandal du jour by trying to “improve” corporate governance by making boards and executives more “accountable” to certain shareholders’ demands. For over two decades, the Congress, the SEC, and a variety of private “policy entrepreneurs” have successfully pushed through a number of individually modest but collectively significant corporate regulations designed to make managers more focused on shareholders and shareholder wealth. Examples include the SEC’s 1992 proxy rule changes making it easier for institutional investors to coordinate their corporate lobbying efforts; the 1993 tax code changes encouraging public companies to tie executive pay to objective performance metrics like stock price; the SEC’s 2002 rule requiring mutual funds to publicly disclose how they vote the shares held in their portfolios (which discourages funds from habitually voting with management); certain provisions of the 2002 Sarbanes-Oxley Act that require audit committees of public companies to be comprised entirely of independent directors; and the SEC’s 2010 elimination of broker voting of customer shares (brokers, too, routinely voted with management). These “reforms” have failed to raise either investor returns or shareholder satisfaction. There is no reason to think that continuing to promote “shareholder democracy” through even more rules, like the SEC’s controversial proxy access proposal, will do a better job of serving shareholders’ collective welfare. To the contrary, while such supposedly shareholder-friendly regulations may provide an immediate windfall to certain types of shareholders (especially undiversified hedge funds that hold shares for only a year or two), they may ultimately work against the interests of most shareholders as a class.
Third and relatedly, investors themselves—including not only individual retail investors, but especially institutional investors like mutual and pension funds that are supposed to ultimately serve the interests of their individual beneficiaries—need to rethink the common assumption that anything that raises the share price of a particular company at a particular time necessarily serves investor welfare. Conventional shareholder primacy implicitly assumes that a share price increase necessarily means a commensurate increase in investor well-being. The new scholarship on the nature and purpose of the corporation logically severs this supposed linkage. Proposals to promote greater “shareholder democracy” or to “incentivize” executives by tying their pay to stock price can attract strong political support from vocal minority shareholder groups, like hedge funds, that hope to reap windfall gains by temporarily increasing the share price of particular companies at particular times. But there is reason to suspect such strategies ultimately hurt the “investing class” as a whole.
Ideas about Corporations Matter
The time has come to liberate ourselves from the tyranny of shareholder value thinking. In the interest of maximizing shareholder value, corporate directors have de-staggered their boards, adopted share-based executive compensation schemes, and cut back on research and dev
elopment and employee benefits in order to meet quarterly earnings estimates. In the interest of shareholder value, pension and mutual funds, and even individual investors, have joined with hedge funds to pressure boards to “unlock value” through repurchases and asset sales, while turning a blind eye to questions of corporate responsibility and ethics. Regulatory changes have played a role in moving Corporate America closer to the standard shareholder-oriented model, but the most important factor has been the business world’s own intellectual embrace of shareholder primacy ideology. Investors and managers alike have come to accept shareholder value thinking as the necessary, if sometimes unattractive, foundation of the business world.
John Maynard Keynes famously said that “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is 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 the slaves of some defunct economist.” Viewed dispassionately, shareholder value ideology shows all the signs of a defunct economist’s idea. It is inconsistent with American corporate law; misstates the economic structure of public companies; and lacks persuasive empirical support. Not only does shareholder value ideology fail on inductive grounds, it is riddled with deductive flaws as well, especially its premise that the only shareholder whose values should count is the shareholder who is myopic, untrustworthy, self-destructive, and without a social conscience.
