Toppling the idol of ‘shareholder value’
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Maximizing shareholder value” is one of those concepts that falls under the adage, “Be careful what you wish for.” I know this because, a long time ago, I was one of those wishing for it.
It seemed like such a good idea at the time, back in the late 1970s and 1980s. For too long, the compensation of top executives was disconnected from any performance criteria, including whether they made money for shareholders. CEOs did pretty much whatever they wanted, with no fear of consequences. Thus, companies that needed to slim down, wouldn’t. Companies that needed to deploy capital more intelligently, didn’t. Executives who should have been fired, weren’t.
Back then, I was hanging around with T. Boone Pickens, the famous “corporate raider” and one of the first to espouse the primacy of the shareholder. His refrain was that shareholders were the real owners of companies, and that corporate executives worked for them. It was a novel idea then, and in time it spread well beyond takeover artists to academics, Wall Street types and finally, corporate executives, especially once they discovered that hitching their pay to the stock price could make them rich. “Corporate raiders” became “shareholder activists”.
The shareholder-value movement did some good, especially in those early years. It became de rigueur for boards to create performance criteria that executives had to meet to get bonuses and stock options. And it was a means of imposing discipline.
But the pendulum has swung too far, and today the ethos embodied by the phrase “maximizing shareholder value” does more harm than good. It has widened income inequality. It has rewarded short-term “make-the-quarter” thinking over long-term value creation. It is the reason companies take on too much debt and perform feats of useless—but stock-price enhancing—financial engineering. It explains why so few companies subsidize the local symphony or art museum any more. It is why drug prices have risen so obscenely, why airlines have made flying such a miserable experience and why wages have remained stagnant even as profits have soared. When shareholders matter more than employees or customers or communities, some people do very well, but the purpose of a corporation becomes warped and society loses.
What prompts these thoughts are two articles I saw late last week. The first was a story on BuzzFeed that crystallized for me just how far astray the “shareholder value” craze has led us. It concerned the decision by American Airlines to give its workers raises worth about $1 billion over three years, even though its labour contracts weren’t up for another two years. Chief executive Doug Parker explained that the raises would lead to better service and hence, higher revenue. In other words, he made the kind of decision that might hurt in the short term but was likely to have long-term benefits.
How did Wall Street react? With fury. The stock was pummelled. One analyst, Kevin Crissey of Citigroup, complained to his clients: “This is frustrating. Labour is being paid first again. Shareholders get leftovers.” One would be hard-pressed to find a better example of how “maximizing shareholder value” can blind people to more important goals and values.
The second article is in the latest issue of Harvard Business Review. Titled “The Error At The Heart Of Corporate Leadership”, and written by two Harvard Business School professors, it is nothing less than an all-out assault on the primacy of shareholder value (academia calls it “the agency model”). The “agency model,” write Lynn Paine and Joseph Bower, can warp “corporate strategy and resource allocation” —and potentially damage the larger economy.
They go on to say: “The agency model’s extreme version of shareholder centricity is flawed in its assumptions, confused as a matter of law, and damaging in practice. A better model would recognize the critical role of shareholders but also take seriously the idea that corporations are independent entities serving multiple purposes and endowed by law with the potential to endure over time. And it would acknowledge accepted legal principles holding that directors and managers have duties to the corporation as well as to shareholders. In other words, a better model would be more company centred.”
When I spoke to Adi Ignatius, the editor of the Harvard Business Review, about what he wanted the article to accomplish, he said that he hoped it would spark a rethinking of shareholder-value dogma. But it’s one thing to show the failings of the shareholder-value model, and another to come up with ways to fix the problem. We certainly don’t want to go back to the days when there were no performance metrics and potentate CEOs weren’t answerable to anyone. Paine and Bower suggest a more company-centric model in which shareholders are an important constituency but not the only one. Their plan is pretty vague—they forthrightly acknowledge that their model “has yet to be fully developed”—and it’s a little hard to envision how it would work in practice.
The essential problem with the over-reliance on shareholder value as the only metric of success is that it creates the wrong incentives. Although the backlash against it is gaining momentum, nothing will change until its critics find new and better incentives. That’s the next step. It can’t come soon enough. Bloomberg
Joe Nocera is a Bloomberg View columnist