The World's Dumbest Idea: Maximizing Shareholder Value

[Sheilbh]

We agree on something economy-related with Sheilbh

I think chances are we agree on more than we suspect. But that'd make for less fun conversations

[Tamas]

Probably.

[crazy canuck]

Yeah it probably is not solely to maximize shareholder values but to what extent is it true?  I mean how massive is the strawman?  Since companies are supposed to be beholden to the shareholders surely it is not entirely a fabricated idea?  I mean those leftists have plenty of anecdotes they can haul out whenever they want to discuss this topic.

I think it's largely all derived from one or two business writers in the 80s and caught steam from there. Actual CEOs largely will say this is not their goal in running their companies. So I would say it's mostly a strawman.

I think that what the shareholders want collectively is a factor in corporate behavior, but I think that the ownership scheme for large publicly traded corporations that have a diffuse ownership base (i.e. not Wal-Mart or Ford in which a founding family has a huge chunk of voting shares such that outside investors cannot actually prevail in any up or down vote) means that what the shareholders want is not easily or effectively translated into how the corporation behaves. I would instead say an amalgamation of what upper management, larger institutional investors, the board of directors and a few other stakeholders influence how corporations behavior, and they all largely behave differently.

When used as a derisive the concept of "maximizing shareholder value" is largely read to mean a corporation is a slave to its total return (combination of share price increase and dividends) to investors, often in a short term manner.

Corporations all seem to have different strategies. Some really want to maximize market share, even when it means lower profits and thus lower return. Some want to minimize volatility at the cost of losing greater profit potential. AEP (major electric power utility) for example has said it will not build more power plants in "rate deregulated" states. Even though deregulation may offer the potential for greater profits, AEP wants to be a rate regulated utility, which means essentially guaranteed profits (and no direct competition) but at more controlled rates. AEP has said it intends to start moving in to other rate regulated businesses like pipelines and transmission in States where energy deregulation has already happened or appears likely to happen.

I don't think there is any one set "goal" of all CEOs of say, Fortune 500 companies. Instead there are diverse types of investors who invest in these companies and lots of different managers and directors who have different goals in mind for their businesses.

I agree that the change came in the 80s but I think it is more significant then you think.

In the late 80s and even into the early 90s there was a significant debate about the legal obligations executives and officers of a company might owe to shareholders as opposed to the company itself.  This played out on a number of issues but the mantra that eventually prevailed was that the main interest was that of the shareholders.  That view is what set lose the frenzy of stock options which were seen to "tie" executives to the interests of the common shareholder.  But, of course, for the reasons we have already discussed, it was an illusion which lead to dramatic enrichment of the managers who set and received those benefits.

[grumbler]

To add to what Otto is saying, I think that the big change in corporations over the last three decades isn't in CEO compensation, but in the makeups of the boards of directors.  More and more, as the share of individual stock owners declined in the face of institutional stockholders (esp 410k and other retirement funds) there has been a shift in board membership from the big stockholders to the  professional boardies, often CEOs themselves, who are more acceptable to the institutional stakeholders because the professional boardies don't own much (if any) investment in the corporation and thus don't have conflicts of interest with the institutional stakeholders. 

I think this change in the makeup of the people the CEOs work for has changed the behavior of CEOs.

[PJL]

The problem for both large publicly owned corporations and indeed large organisation in general, is that there is a dissonance between the owners and the managers which is caused by a large dilution of control of the entity into many different owners (and types of owners) which means that the owners have very little individual control over the managers unless they act as a collective, which entails various compromises and deals which end up satisfying nobody.

[crazy canuck]

The problem for both large publicly owned corporations and indeed large organisation in general, is that there is a dissonance between the owners and the managers which is caused by a large dilution of control of the entity into many different owners (and types of owners) which means that the owners have very little individual control over the managers unless they act as a collective, which entails various compromises and deals which end up satisfying nobody.

But that has always been true.  It doesn't explain the change which occurred in the late 80s through the 90s. 

Also, this view, and the view of Otto's, to some extent, reflects an importance given to the shareholder as "owner" rather than merely as an investor.  The shareholder does not own the corporation.  Shareholders only own the rights which are attached to the particular shares they have purchased.  And in the case of a common share those rights are limited.

I would argue where things really went wrong was too much emphasis on the rights of the shareholder and not enough on the duties owed to the corporation itself. 

[Sheilbh]

The paper that VM posted actually talks about the change of goals with the example of IBM. In the late sixties they had three (respect for employees, customer service, excellence), in the early nineties their measures of success were shareholder value and customer satisfaction, in 2010 the primary aim was to double earning per share in five years.

[CountDeMoney]

I would argue where things really went wrong was too much emphasis on the rights of the shareholder and not enough on the duties owed to the corporation itself.

Thing is, the days of gray-haired widows and local businessmen being shareholders are long gone, and have been replaced by the financial mega-institutions and fund groups: these are the majority of shareholders now.  And they don't give a shit about duties owed to the corporation.

[CountDeMoney]

The paper that VM posted actually talks about the change of goals with the example of IBM. In the late sixties they had three (respect for employees, customer service, excellence), in the early nineties their measures of success were shareholder value and customer satisfaction, in 2010 the primary aim was to double earning per share in five years.

Some recent reading on IBM:

For Palmisano, managing IBM was all about generating investment returns for the big shareholders. "If you're a small, young company and you're driving revenue without a lot of earnings, you've got a completely different model... The Berkshire Hathaways, the Neuberger Bermans, the Capital Worlds are looking at a longer-term cycle for their investment returns."

Palmisano treated the large shareholders as real owners. "We decided to treat our large shareholders with total transparency, as best we could within regulations. We would meet with them. We'd have a couple of them come in every quarter and talk with the entire senior management team... Fidelity, Capital, BlackRock, T. Rowe, Wellington, Neuberger Berman—the big guys. They would each bring four or five portfolio managers.... They could spend as much time as they wanted with the businesses. The meetings went on for hours."

Palmisano found that the big shareholders supported his primary focus on earnings per share, ahead of growing the business. "Basically, the shareholders were just asking us to be friendly with capital allocation. They wanted more margin expansion and cash generation than top-line growth, because they knew that if we generated cash, we'd give it back to them in the form of a share buyback or a dividend, not a crazy large acquisition that no one else could see value in." And so Palmisano became very friendly.

http://www.forbes.com/sites/stevedenning/2014/05/30/why-ibm-is-in-decline/

"At the end of the day," said Rometty in an interview with CNBC last week, "this is about returning value to shareholders." Yet to many observers, the single-minded focus on returning value to shareholders is precisely what is killing IBM–and destroying real shareholder value.

IBM's focus on boosting the share price has been built on a foundation of declining revenues, capability-crippling offshoring, fading technical competence, sagging staff morale, massive debt-financed share buybacks, pervasive non-standard accounting practices, tax-reduction gadgets, a debt-equity ratio of nearly 174 percent, a broken business model and a flawed forward strategy. Those Potemkin-style tactics can only work for so long, before the business reality becomes evident to all. With IBM's stock down more than 10 percent over the last week, that day may have already arrived.
http://www.forbes.com/sites/stevedenning/2014/10/26/ibms-potemkin-prosperity/

[frunk]

My wife worked for IBM for almost three years (2010-2013).  During that time I think the belt tightening/short sighted focus got worse and worse each year.  By the end she was told that she'd be taking on 1 1/2 additional people's roles, and the promised option to switch positions at the end of three years wasn't there anymore.  She couldn't get out of there fast enough.

[MadImmortalMan]

Against it. Don't tie their rewards to shareholder value (which didn't really happen prior to the 80s) and you'll get them focusing a lot less on shareholder value.

Or grant them stock options that don't vest for ten years. Or a ladder of them going out way into the future.

[crazy canuck]

Against it. Don't tie their rewards to shareholder value (which didn't really happen prior to the 80s) and you'll get them focusing a lot less on shareholder value.

Or grant them stock options that don't vest for ten years. Or a ladder of them going out way into the future.

Or just make them purchase shares like everyone else.  Their job is to run the company not to become speculators in the company.  Judge them on how well they run the company not on how well the market reacts to the company at a given snapshot in time.

[viper37]

Sorry, it's a PDF and rather long.  It makes a couple points in detail that I thought I had observed to be true of the market: first, that companies that explicitly try to maximize shareholder value don't generally deliver better shareholder value than those that do not; second and related, that trying to maximize short-term gains actually hurts shareholders in the long run.

the author has confused many things.

• First off, efficient market hypothesis has nothing to do with corporate responsibility.  It's about how well the information flows in the market.  It's about how the information is reflected in the stock prices.
  
• Second, comparing IBM to J&J on the sole basis of shareholder's return and the fluctuation in earnings while ignoring that they evolve in two different industries, each with their own set of problems... that's stupid.
  
• Third, maximizing shareholder's value is a general concept that has nothing to do with a specific time horizon, short or long.  Nothing is implied there, only that you should seek to increase the shareholder's value, meaning you should refrain from chosing projects that don't generate enough value, i.e., project with a negative net present value (though it's not the only measure used to evaluate a project).  Wich kinda makes sense.  A corporation with no profits goes nowhere.
  
• Fourth, while I'm not too strong on social responsibility, it could also be a way to maximize shareholder's value.  If a project can garner social acceptability, you will reduce your marketing costs to increase your consumer base as your company as a better rep.
  
• Fifth, empirical research has been unable to demonstrate a link between consistant increase in shareholder value and short term profit gains.  Wich means your author's entire theory is bullocks.
  
• And on a general level, all that does is to observe a situation and deduce the cause without any kind of analysis.

[Martinus]

Not exactly pertinent to the discussion, but I attended recently a training course/workshop on accounting, run by a professor of the Edinburgh University and it was brilliant. He also hated the big four and the managerial class with passion.

[Siege]

Why people worry so much about what corporations do with their money?
Economic darwinism. A corporation that does not balance short term earnings with long term will fail, and if it doesn't then it is ok.
I want the US to have the most effective corporations, the ones that advance the technology the fastest and farthest, not the most ineffective corporations, controlled by the gubmint.
Whenever politicians are in charge, we all lose.