Steve Denning
In my article last October, I explained why the idea of maximizing shareholder value, despite being pervasive in the business world and academia, is, as even Jack Welch admits, "the dumbest idea in the world". It has led to the very opposite of what was intended. It has systematically destroyed actual shareholder value and morphed into something quite different: C-suite Capitalism, in which companies are being run principally for the benefit of the C-Suite, creating in the process a massive financial incentives bubble.
Now a law professor, Lynn Stout, has weighed in with her book, The Shareholder Value Myth. She argues that shareholder value is not only dumb and counter-productive: it's legally unsound.
As Jesse Eisinger at ProPublica writes
As Ms. Stout explains, what the law actually says is that shareholders are more like contractors, similar to debt-holders, employees and suppliers. Directors are not obligated to give them any and all profits, but may allocate the money in the best way they see fit. They may want to pay employees more or invest in research. Courts allow boards of directors leeway to use their own judgments. The law gives shareholders special consideration only during takeovers and in bankruptcy. In bankruptcy, shareholders become the "residual claimants" who get what's left over.
A return to ?managerialism'
Professor Stout's book has a good description of the legal basis of the problem but is on less strong ground when it comes to solutions. She calls for a return to "managerialism," where executives and boards of directors run companies without being preoccupied with shareholder value. Companies would be freed up to think about their customers, their employees and even start acting more socially responsible.
Here she misses the point that the theory of shareholder capitalism has morphed into something quite different in practice: C-Suite capitalism, in which the firm is run to a large extent for the benefit of the C-suite and financial intermediaries, resulting in a massive financial incentives bubble, as described in an article by Professor Mihir Desai, the Mizuho Financial Group Professor of Finance at Harvard Business School in the April issue of Harvard Business Review.
Merely freeing the C-suite from any need to give special consideration to shareholders would be like throwing kerosene on a raging fire. It would simply blow the financial incentives bubble even bigger.
If anything, the voice of shareholders needs to be strengthened, not weakened. As Jesse Eisenger writes:
"The era of managerial supremacy was not that successful then and would be more catastrophic now," says Nell Minow, a standard bearer of the corporate governance movement. "The idea of speaking of shareholders as owners is absolutely crucial."
She contends that the idea that shareholders wield too much power is laughable. Shareholders have increasingly been voting against directors only to see them reappointed. Recently, shareholders at a handful of companies have voted the majority of shares against the pay packages of chief executives ? and have been ignored.
Professor Stout's book is concerned about reining in excessive executive compensation but weakening shareholder influence is hardly the way to go about it.
The book argues that the C-suite should get salaries and then bonuses for after-the-fact performance. But this begs answer the question: what is performance? The concept of "managerialism," is a vague concoction of interests, where executives and boards of directors pay attention to shareholder value, customers, employees and social concerns.
Even today, most CEOs already say that "our customers are number one, and "employees are our most important asset" and "we are committed to being good corporate citizens" and "our firm is committed to environmental sustainability". And yet everyone in those firms knows that when it comes to the crunch, what really matters in these firms is the short-term profits. Even though the management talks about multiple goals, it actually has a de facto single bottom line.
Professor Stout's book misses the fundamental point that we have passed into an era of Customer Capitalism. Starting from Peter Drucker's 1973 insight that "the only valid purpose of a firm is to create a customer," firms are now facing a marketplace of intense global competition where the Internet has shifted power has shifted from seller to buyer. The result is that the true bottom line of today's corporations is whether it is delighting its customers by providing a continuous stream of additional value and delivering it sooner.
A business argument, not just an appeal to altruism
The most powerful case for fundamental change from the doctrine of shareholder value comes, not from appeals to altruism, which are unlikely to have much impact, but rather from the business case: the shift from shareholder capitalism to customer capitalism makes a lot more money for the firm, the shareholders, the employees and everyone else.
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