The Shareholder Value Myth

by Lynn Stout

  Nevertheless, as described in the recent Brookings report, shareholder primacy is such a seductively simple idea that it continues to be taught in law schools, business schools, and economics departments. This is disturbing because, as the report’s author observes, “If schools emphasize a particular set of values or approaches, it will reverberate for decades to come. These values will determine how business leaders and lawyers behave, professional association standards are set, and policies are adopted.”152

  The good news is that among experts, shareholder value dogma shows signs of being in decline. To return to Thomas Kuhn, the shareholder primacy paradigm is failing, and alternative paradigms are rising to take its place. This book has explored a suite of new, more nuanced theories of corporate purpose and shareholder interest. These alternatives share a common theme: they all sever the supposed linkage between “shareholder value” and shareholder welfare by showing how different shareholders have different interests and values. They also all suggest how giving managers discretion to balance among different shareholders’ competing interests can ultimately serve the interests of investors as a class, over time, better than a strict shareholder primacy rule would.

  In the process, the new thinking on shareholder value also goes a long way toward resolving, at least in a practical sense, the century-long Great Debate on the purpose of public corporations. Conventional shareholder primacy stands on the brink of intellectual failure. To survive it must evolve into a new, more complex, and more subtle understanding of what shareholders really want from corporations. This understanding acknowledges that it may be impossible to define the “purpose” of the corporation in terms of a single, easily measured goal, and that the objective of any particular corporation may be best determined not by regulators, judges, or professors, or even by any individual shareholder or group of shareholders, but by a board of directors. That board is charged with serving the best interests of (as case law puts it) “the corporation and its shareholders”—including long-term shareholders, shareholders eager to make ex ante commitments to stakeholders, diversified shareholders, and prosocial shareholders. Expanding our understanding of the nature of “the shareholder” this way benefits not just investors, but the rest of us as well.

  Notes

  Notes to the Introduction

  1. National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling, Deep Water: The Gulf Oil Disaster and the Future of Offshore Drilling (January 2011).

  2 Id., 2.

  3 Id., 218.

  4 Henry Hansmann and Reinier Kraakman, “The End of History for Corporate Law,” 89 Georgetown Law Review 439 (2001).

  5 David Weild and Edward Kim, “A Wake-Up Call for America,” Grant Thornton Capital Market Series 1 (November 2009).

  6 John Kao, Innovation Nation: How America is Losing Its Innovation Edge, Why It Matters, and What We Can Do to Get It Back (New York: Free Press 2007). A study by the Information Technology and Innovations Foundations recently concluded that in a study of 40 developed and developing nations from 1999 and 2009, “The United States has made the least progress of the 40 nations/regions in improvement in international competitiveness and innovation over the last decade.” Robert D. Atkinson & Scott Andes, The Atlantic Century: Benchmarking EU & U.S. Innovation and Competitiveness (February 2009).

  7 National Commission, Deep Water, 229.

  8 Francesco Guerrera, “Welch Condemns Share Price Focus,” Financial Times (March 12, 2009), www.ft.com/intl/cms/s/0/294ff1f2–0f27–11de-ba10–0000779fd2ac.html#axzz1eHkdklrf.

  9 Iman Anabtawi, “Some Skepticism About Increasing Shareholder Power,” 53 University of California Los Angeles Law Review 561, 564 (2006).

  10 “Capitalism’s Waning Popularity: Market of Ideas: A Global Poll Shows an Ideology in Apparent Decline,” Economist 70 (April 9, 2011).

  Notes to Chapter One

  11 Adolf Berle and Gardiner Means, The Modern Corporation and Private Property (New Brunswick, U.S.A. and London: Transaction Publishers, 1991, originally published 1932).

  12 William W. Bratton and Michael L. Wachter, “Shareholder Primacy’s Corporatist Origins: Adolf Berle and ‘The Modern Corporation,’” 34 Journal of Corporation Law 99, 100–103 (2008).

  13 William T. Allen, Jack B. Jacobs and Leo E. Strine, Jr., “The Great Takeover Debate: A Meditation on Bridging the Conceptual Divide,” 69 University of Chicago Law Review 1067 (2002).

  14 Berle and Means, The Modern Corporation.

  15 Adolf A. Berle, “Corporate Powers as Powers in Trust,” 44 Harvard Law Review 1049 (1931).

  16 E. Merrick Dodd, “For Whom Are Corporate Managers Trustees?” 45 Harvard Law Review 1148 (1932).

  17 Adolf A. Berle, The 20th Century Capitalist Revolution (New York: Harcourt, Brace, 1954), 169.

  18 Milton Friedman, “The Social Responsibility of Business is to Increase Its Profits,” New York Times Magazine 32 (September 13, 1970).

  19 Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Vol. 3, No. 4 Journal of Financial Economics 305 (October, 1976).

  20 Steven M. Teles, The Rise of the Conservative Legal Movement: The Battle for Control of the Law (Princeton, New Jersey and Oxford: Princeton University Press, 2008) 216.

  21 Brian J. Hall, “Six Challenges in Designing Equity-Based Pay,” 15 Accenture Journal of Applied Corporate Finance (2003) 23, cited in Jill E. Fisch, “Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy,” 31 Journal of Corporation Law 639 n.5 (Spring 2006).

  22 Lucian Bebchuk and Jesse M. Fried, Pay without Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, Massachusetts: Harvard University Press, 2006).

  23 Jeffrey N. Gordon, “The Rise of Independent Directors in the United States, 1950–2005: Of Shareholder Value and Stock Market Prices,” 59 Stanford Law Review 1529, 1530 (2007).

  24 Henry Hansmann and Reinier Kraakman, “The End of History for Corporate Law,” 89 Georgetown Law Review 439 (2001).

  25 Hansmann and Kraakman, “The End of History,” 440–441.

  26 Id., 468.

  27 Margaret M. Blair, “Post Enron Assessments of Comparative Corporate Governance” (2002), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=316663.

  Notes to Chapter Two

  28 Tina Rosenberg, “A Scorecard for Companies with a Conscience,” New York Times (April 4, 2011), http://opinionator.blogs.nytimes.com/2011/04/11/a-scorecard-for-companies-with-a-conscience. Similarly, Times columnist Joe Nocera defended GE’s ruthless exploitation of corporate tax loopholes on the grounds that “the executives who run America’s corporations have a fiduciary duty to maximize profit for their shareholders.” Joe Nocera, “Who Could Blame GE?” New York Times (April 4, 2011), www.nytimes.com/2011/04/05/opinion/05nocera.html.

  29 Marjorie Kelly, The Divine Right of Capital: Dethroning the Corporate Aristocracy (San Francisco: Berrett-Koehler Publishers, 2001, 2003), 54.

  30 Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power (New York, London, Toronto, Sydney: Free Press, 2004).

  31 Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919).

  32 Einer Elhauge, “Sacrificing Corporate Profits in the Public Interest,” 80 New York University Law Review 733, 772–75 (2005).

  33 Id., 684.

  34 For examples, see Stephen M. Bainbridge, “Director Primacy: The Means and Ends of Corporate Governance,” 97 Northwestern University Law Review 547, 574–75 (2003); Joel Bakan, The Corporation 36; Marjorie Kelly, The Divine Right of Capital 52–53.

  35 Blackwell v. Nixon, Civ. A. No. 9041, 1991 WL 194725, at *4 (Del. Ch. Sept. 26, 1991).

  36 The federal Circuit Court for the District of Columbia recently struck down an SEC attempt to impose a “proxy access” requirement that public corporations give certain shareholders access to company funds to solicit proxies. Business Roundtable et al. v. Securities and Exchange Commission, No. 10
–1305 (D.C. Cir., July 22, 2011).

  37 Delaware General Corporation Law, Section 102 (2011).

  38 Lynn A. Stout, “Why We Should Stop Teaching Dodge v. Ford,” 3 Virginia Law & Business Review 163 (2008).

  39 Delaware General Corporation Law, Section 101 (2011).

  40 Stout, “Why We Should Stop Teaching,” 169.

  41 Id.

  42 Id., 170.

  43 Margaret M. Blair and Lynn A. Stout, “A Team Production Theory of Corporate Law,” 85 Virginia Law Review 247, 293 (1999).

  44 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (1985).

  45 Shlensky v. Wrigley, 95 Ill. App.2d 173, 237 N.E.2d 776 (1968).

  46 Air Products and Chemicals, Inc. v. Airgas Inc., Civ. 5249-CC, 5256-CC (Del. Ch., Feb. 15, 2011) 92, citing Paramount Communications Inc. v. Time, Inc., 571 A.2d 1140, 1150 (Del. 1990).

  47 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).

  48 Lynn A. Stout, “Why We Should Stop Teaching Dodge v. Ford,” 3 Virginia Law & Business Review, 163, 171–172 (2008).

  Notes to Chapter Three

  49 William T. Allen, Jack B. Jacobs and Leo E. Strine, Jr., “The Great Takeover Debate: A Mediation on Bridging the Conceptual Divide,” 69 University of Chicago Law Review 1067 (2002); Margaret M. Blair and Lynn A. Stout, “A Team Production Theory of Corporate Law,” 85 Virginia Law Review 247 (1999); Einer Elhauge, “Sacrificing Corporate Profits in the Public Interest,” 80 New York University Law Review 733 (2005); D. Gordon Smith, “The Shareholder Primacy Norm,” 23 Journal of Corporation Law 277 (1998).

  50 Henry Hansmann and Reinier Kraakman, “The End of History for Corporate Law,” 89 Georgetown Law Review 439 (2001).

  51 For a classic example, see Lucian Bebchuk and Jesse M. Fried, Pay without Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, Massachusetts: Harvard University Press, 2006).

  52 Martin Lipton and Paul K. Rowe critique this view in “Pills, Polls, and Professors: A Reply to Professor Gilson,” 27 Delaware Journal of Corporate Law 1 (2002).

  53 A recent SEC attempt to impose just such a “proxy access” rule on public companies was struck down by a federal court. Business Roundtable et al. v. Securities and Exchange Commission, No. 10–1305 at 12 (D.C. Cir., July 22, 2011).

  54 Milton Friedman also expressed this view still earlier in his bestseller Capitalism and Freedom (Chicago, Illinois: University of Chicago Press, 1962).

  55 Roger Martin, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL (Boston, Massachusetts: Harvard Business Review Press, 2011), 11.

  56 Richard A. Posner and Kenneth E. Scott, The Economics of Corporation Law and Securities Regulation (Boston and Toronto: Little, Brown and Company, 1980), 39–56.

  57 Frank H. Easterbrook and Daniel R. Fischel, The Economic Structure of Corporate Law (Cambridge, Massachusetts and London: Harvard University Press, 1991).

  58 Hansmann and Kraakman, “The End of History,” 468.

  59 Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” 81 Journal of Political Economy 637 (1973).

  60 Easterbrook and Fischel, The Economic Structure of Corporate Law, 36–37.

  61 Lynn M. LoPucki, “The Myth of the Residual Owner: An Empirical Study,” Washington University Law Quarterly 1341, 1343 (2004).

  62 Lynn A. Stout, “Bad and Not-So-Bad Arguments for Shareholder Primacy,” 75 Southern California Law Review 1192–95 (2002).

  63 Delaware General Corporation Law, Section 170 (2011).

  64 Id.

  65 Delaware General Corporation Law, Sections 108, 170 (2011).

  66 American Law Institute, Restatement (3d) of Agency, Section 1.01 (2006).

  67 Delaware General Corporation Law, Section 141 (2011).

  68 Robert Charles Clark, Corporate Law (Boston and Toronto: Little Brown, 1986), 95.

  69 Margaret M. Blair and Lynn A. Stout, “A Team Production Theory of Corporate Law,” 85 Virginia Law Review 247, 303 (1999).

  70 Lynn A. Stout, “Bad and Not-So-Bad Arguments for Shareholder Primacy,” 75 Southern California Law Review 1189, 1203–124 (2002).

  71 Hansmann and Kraakman, “End of History,” 443 (emphasis added).

  72 Frank H. Easterbrook and Daniel R. Fischel, The Economic Structure of Corporate Law (Cambridge, Massachusetts and London: Harvard University Press, 1991), 38.

  73 Mark J. Roe, “The Shareholder Wealth Maximation Norm and Industrial Organizations,” 149 University of Pennsylvania Law Review 2063, 2065 (2001).

  Notes to Chapter Four

  74 Renee Adams and Daniel Ferreira, “One Share-One Vote: The Empirical Evidence,” 12 Review of Finance 51 (2008).

  75 Valentin Dimitriv and Prem C. Jain, “Recapitalization of One Class of Common Stock into Dual-Class: Growth and Long-Run Stock Returns,” 12 Journal of Corporate Finance 342 (2006).

  76 Sanjay Bhagat and Bernard S. Black, “Independent Directors” (2008), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1139191.

  77 Sanjay Bhagat and Richard H. Jefferis, The Econometrics of Corporate Governance Studies (Cambridge and London: MIT Press, 2002); Lawrence Brown and Marcus Caylor “Corporate Governance and Firm Operating Performance,” 32 Review of Quantitative Finance and Accounting 129 (2009).

  78 Id.

  79 “Schumpeter: Corporate Constitutions: The World Knows Less about What Makes for Good Corporate Governance Than It Likes to Think, Economist 74 (October 30, 2010), www.economist.com/node/17359354.

  80 See, e.g., Dan R. Dalton, et al., “The Fundamental Agency Problem and Its Mitigation,” 1 Academy of Management Annals 1–64 (December 2007).

  81 Roberta Romano, “The Sarbanes Oxley Act and the Makings of Quack Corporate Governance,” 114 Yale Law Journal 114 (2005).

  82 Sanjai Bhagat, Brian Bolton and Roberta Romano, “The Promise and Peril of Corporate Governance Indices,” 108 Columbia Law Review 1814 (2008).

  83 Business Roundtable et al. v. Securities and Exchange Commission, No. 10–1305 at 12 (D.C. Cir., July 22, 2011).

  84 For example, one recent study of hedge funds concluded that “hedge funds are not short-term in focus” because they had a median holding period of 12 to 20 months. Alon Brav, et al., “Hedge Fund Activism, Corporate Governance, and Firm Performance,” Vol. 63, No. 4 Journal of Finance 1731 (2008).

  85 Margaret M. Blair, “Shareholder Value, Corporate Governance, and Corporate Performance: A Post-Enron Reassessment of the Conventional Wisdom,” 61 (2003), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=334240.

  86 Jeffrey N. Gordon, “The Rise of Independent Directors in the United States, 1950–2005: Of Shareholder Value and Stock Market Prices,” 59 Stanford Law Review 1529, 1530 (2007).

  87 Roger Martin, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL (Boston, Massachusetts: Harvard Business Review Press, 2011), 63.

  88 Citibank lobbying played a central role in the 1999 passage of the Gramm-Leach-Bliley Act, which lifted banking restrictions and has been cited as a cause of the 2008 crisis. Financial Crisis Inquiry Commission, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (New York: Public Affairs, 2011), 55. Similarly, Enron lobbied for the passage of the 2000 Commodity Futures Modernization Act, which deregulated deriviatives markets and has also been cited as a cause of the crisis. See Lynn A. Stout, “Derivatives and the Legal Origin of the 2008 Credit Crisis,” 1 Harvard Business Law Review 1, 26 (2011).

  89 David Weild and Edward Kim, “A Wake-Up Call for America,” Grant Thornton Capital Market Series 1–2 (November 2009).

  90 John C. Coates, “Explaining Variation in Takeover Defenses: Blame the Lawyers,” 89 California Law Review 1301, 1397 (2001).

  91 Jennifer G. Hill, “Then and Now: Professor Berle and the Unpredictable Shareholder,” 33 Seattle University Law Review 1017 (2010).

  92 Where only about 20 percent
of U.S. public corporations pay regular dividends, more than half of U.K. firms do. Stephen P. Ferris, Nilanjan Sen, and Ho Pei Yui, “God Save the Queen and Her Dividends,” 79 Journal of Business 1149–1150 (2006).

  93 For a survey of efficient market theory, see Lynn A. Stout, “The Mechanisms of Market Efficiency: An Introduction to the New Finance,” 23 Journal of Corporation Law 635 (2003).

  Notes to Chapter Five

  94 For a survey of efficient market theory, see Lynn A. Stout, “The Mechanisms of Market Efficiency: An Introduction to the New Finance,” 23 Journal of Corporation Law 635 (2003).

  95 Id.

  96 John Quiggen, Zombie Economics: How Dead Ideas Still Walk among Us (Princeton, New Jersey and London: Princeton University Press (2010).

  97 Fischer Black, “Noise,” 41 Journal of Finance 533 (1986).

  98 William W. Bratton, “Hedge Funds and Governance Targets,” 95 Georgetown Law Review 1375, 1410 (2007).

  99 Leo E. Strine, Jr., “One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?,” 66 Business Law 1, 11 (2010).

  100 According to the Federal Reserve, about 36 percent of corporate equities are held by households, 25 percent by mutual funds, and 17 percent by private and government pension funds. Federal Reserve Statistical Release, Flow of Funds Accounts, www.federalreserve.gov/releases/z1/Current/z1r-4.pdf (June 9, 2011) 92, Table L.213.

  101 Aspen Institute Business and Society Program, Overcoming Short-Termism: A Call for a More Responsible Approach to Investment and Business Management (September 9, 2009), www.aspeninstitute.org/publications/overcoming-short-termism-call-more-responsible-approach-investment-business-management.