The Shareholder Value Myth | Lynn Stout
Summary
TLDRThe video challenges the widely held belief that shareholders own corporations and that corporations should maximize shareholder value. This ideology, which emerged in the late 1970s and 1980s, replaced the earlier view of corporations as social institutions serving various stakeholders. The speaker argues that the shareholder value approach has led to negative outcomes, such as fewer public companies, reduced corporate longevity, and lower reinvestment and innovation. Additionally, legal and economic analyses do not support the notion that corporations must prioritize shareholder value, highlighting the diverse and complex interests of real shareholders.
Takeaways
- đ The idea that corporations exist solely to maximize shareholder value is a relatively new concept, emerging in the late 1970s or early 1980s.
- đ Prior to this, corporations were viewed as social and economic institutions with a responsibility to serve various stakeholders, including customers, employees, creditors, and communities.
- đ The shift to shareholder value maximization influenced regulatory bodies like the Securities Exchange Commission and tax codes, giving shareholders more power and influence.
- đ Despite the focus on shareholder value, the number of publicly listed companies in the U.S. has significantly decreased, and the life expectancy of public companies has also declined.
- đĄ Companies are reinvesting less of their profits back into the business, which some believe is affecting innovation and the overall health of corporations.
- đ€ The shareholder value maximization philosophy is questioned as it does not seem to have increased shareholder value, with returns being slightly less than in the managerial era.
- đ The script argues that the shareholder value philosophy is more of an ideology without strong backing from corporate law or corporate economics.
- đ Corporate law, as reflected in state codes and corporate charters, does not require maximizing shareholder value but allows corporations to be run for any lawful purpose.
- đšââïž Case law is mixed, with some judges advocating for shareholder value maximization, while others, like Supreme Court Justice Alito, suggest that corporations are not required to maximize profits at the expense of everything else.
- đ€ Shareholders are not the owners of corporations; they own a contract with the corporation called a share of stock, which grants them limited rights.
- đ Real shareholders have diverse interests and are not solely focused on short-term stock price gains; many are concerned with the long-term sustainability and ethical conduct of corporations.
Q & A
What was the common belief about corporations before the late 1970s or early 1980s?
-Before the late 1970s or early 1980s, corporations were viewed as social and economic institutions that were supposed to serve many different constituencies, including shareholders, customers, employees, creditors, local communities, and possibly society as a whole. This philosophy was known as managerialism.
What significant shift occurred in the business world around the 1970s and 1980s?
-Around the 1970s and 1980s, the business world shifted from managerialism to the belief that shareholders owned corporations and that they should maximize shareholder value. This new ideology began to influence business practices, rules, and policies.
How did the Securities Exchange Commission respond to the shift towards shareholder value maximization?
-The Securities Exchange Commission passed several new rules designed to give shareholders of the corporation more power and influence over their boards of directors, in response to the shift towards shareholder value maximization.
What change in the tax code in 1993 was influenced by the shareholder value ideology?
-In 1993, a new rule was introduced stating that companies wanting tax deductibility must tie their executive pay to an objective performance metric, which often meant that share price became the determining factor in executive compensation.
Why has the shareholder value maximization approach been criticized?
-The shareholder value maximization approach has been criticized because it doesn't seem to be working well for corporations. It has been associated with a decline in the number of publicly listed companies, reduced corporate life expectancy, less reinvestment, and even reduced shareholder returns.
What does the speaker claim about the legal basis for the shareholder value maximization ideology?
-The speaker claims that there is no legal basis for the shareholder value maximization ideology. Corporate law, as reflected in state codes and corporate charters, does not require corporations to maximize shareholder value but allows them to be run for any lawful purpose.
According to the script, what does the business judgment rule protect directors from?
-The business judgment rule protects directors as long as they operate in what they honestly believe is the best interest of the corporate entity, without requiring them to maximize shareholder profits or value.
What is the speaker's argument against the economic theory that shareholders are the residual claimants of corporations?
-The speaker argues that corporations, as legal persons, own themselves and that shareholders own a contract with the corporation called a share of stock, which gives them limited rights. Shareholders are not the residual claimants; the corporation itself is, and it is the Board of Directors that decides on dividend payments.
How does the speaker describe the typical shareholder according to the shareholder value maximization ideology?
-The speaker describes the typical shareholder in the shareholder value maximization ideology as a hypothetical 'platonic shareholder' who only cares about the stock price of one company at one moment in time, which is an unrealistic and overly simplified model.
What are some of the interests that real shareholders have, according to the script?
-Real shareholders have many differing interests, including long-term investment goals, diversified holdings, concerns about the company's impact on the environment and society, and ethical standards that they do not want their companies to violate.
What does the speaker suggest about the percentage of shareholders who might be considered 'psychopaths' in their investment approach?
-The speaker suggests that while psychopaths exist, they usually account for only two to four percent of the population, and this is probably true for shareholders as well, implying that most shareholders are not solely focused on immediate profit at the expense of others or breaking rules.
Outlines
đ The Myth of Shareholder Primacy
This paragraph discusses the misconception that corporations exist solely to maximize shareholder value, a concept that became prominent in the late 1970s and early 1980s. Prior to this, corporations were viewed as social and economic institutions serving various stakeholders, including customers, employees, creditors, and communities. The shift to shareholder value maximization influenced SEC rules and tax codes, leading to a focus on share price as a performance metric for executive pay. However, this ideology has not improved shareholder returns or corporate longevity, with a decline in public companies and reduced reinvestment. The paragraph suggests that the shareholder value philosophy lacks support from corporate law and economics and may be contributing to negative outcomes for corporations.
đ Corporate Law and Shareholder Value Misconception
The second paragraph delves into the legal perspective on the shareholder value maximization myth. It clarifies that corporate law, as reflected in state codes and corporate charters, does not mandate maximizing shareholder value. Instead, directors are protected by the business judgment rule, which allows them to operate in the best interest of the corporation without the obligation to maximize shareholder profits. The paragraph also refutes the economic argument that shareholders own corporations, explaining that corporations are legal persons that own themselves, and shareholders hold contracts (shares) with limited rights. The focus on shareholder value is criticized for being unrealistic and not representative of the diverse interests of actual shareholders.
đ The Diversity and Ethical Considerations of Shareholders
The final paragraph addresses the diversity of shareholders and their varying interests, which are often at odds with the concept of maximizing shareholder value. It highlights the differences between short-term and long-term investors, diversified and concentrated shareholders, and the broader implications of focusing solely on stock price. The paragraph emphasizes that most shareholders are also human beings with a conscience, who care about social, environmental, and ethical issues. It argues against the narrow view of shareholders as profit-maximizing entities, suggesting that a more balanced approach to corporate governance would better serve the interests of all stakeholders, including shareholders themselves.
Mindmap
Keywords
đĄShareholder Value
đĄManagerialism
đĄSecurities Exchange Commission (SEC)
đĄTax Deductibility
đĄBusiness Judgment Rule
đĄResidual Claimants
đĄUniversal Investors
đĄShort-term vs. Long-term Shareholders
đĄDiversified Shareholders
đĄPro-social Shareholders
đĄPsychopath
Highlights
The concept that shareholders own corporations and should maximize shareholder value is a relatively new idea, emerging in the late 1970s or early 1980s.
Prior to this, corporations were viewed as social and economic institutions serving various constituencies, not just shareholders.
The shift in philosophy from managerialism to shareholder value maximization influenced corporate governance, SEC rules, and tax codes.
Despite widespread adoption, shareholder value maximization has not increased shareholder value or improved corporate performance.
The number of publicly listed companies in the U.S. has significantly decreased since the 1990s.
The life expectancy of public companies has also declined, with Fortune 500 companies lasting much shorter periods on the list.
Corporations are now reinvesting less of their profits back into the business compared to historical rates.
There is a belief that companies are becoming less innovative under the shareholder value maximization model.
The shareholder value philosophy is criticized as an ideology without factual, legal, or economic backing.
Corporate law does not mandate maximizing shareholder value; it allows corporations to be run for any lawful purpose.
Case law shows courts do not require directors to maximize shareholder profits, but rather protect them under the business judgment rule.
Economic theory does not support the notion that shareholders own corporations or are entitled to residual profits.
Shareholders are not the same; they have differing interests, particularly in terms of short-term vs. long-term focus.
Diversified shareholders may have different concerns compared to those invested in a single or few companies.
Real shareholders often have a conscience and ethical standards, opposing profit at the expense of others or breaking rules.
Most shareholders are 'pro-social,' concerned about the interests of others, the planet, and future generations.
The shareholder value maximization model oversimplifies the complex interests and roles of real shareholders.
The transcript challenges the shareholder value myth and calls for a reevaluation of corporate purpose and responsibility.
Transcripts
I'd like to talk about a very common but
mistaken idea and that is the idea that
shareholders own corporations and that
all corporations are supposed to do is
quote maximize shareholder value close
quote
now the first thing that is important to
realize about this idea is that it's
pretty new up until the late 1970s or
early 1980s people in business had a
very different idea about what
corporations were and what they were
supposed to do corporations were viewed
as great social institutions social and
economic institutions that were supposed
to serve many different constituencies
including not only shareholders but also
their customers their employees their
creditors and their local communities
maybe even society as a whole and this
philosophy was called managerialism but
managerialism gets replaced around the
1970s early 1980s by this new idea that
shareholders owned corporations and that
they should maximize shareholder value
and this idea actually starts to change
the business world it influences the
rules that the Securities Exchange
Commission passes so that the Securities
Exchange Commission passes several new
rules that are designed to give the
shareholders of the corporation more
power and more influence over their
boards of directors it influences the
tax code where in 1993 we get a new rule
that says that companies that want tax
deductibility must tie their executive
pay to a so-called objective performance
metric which means that share price
becomes the determining factor in how
much executives are paid and this idea
gets embraced by an entire generation of
professors and political leaders and
policymakers and especially business
leaders who all collectively come to
believe that corporations belong to
shareholders and that they should be run
to maximize shareholder value and here
is the problem although this idea now
drives much of the American business
sector it doesn't seem to be working out
that well
it doesn't work out that well for
corporations the number of publicly
listed companies in the United States
has dropped for more from more than nine
thousand at the beginning of the 1990s
too fewer than four thousand today the
life expectancy of public companies has
declined even more severely the average
member of the fortune 500 was on that
list for 75 years a few decades ago
today the average fortune 500 company
can only be expect to be on that list
for about 15 years companies are cutting
back on their reinvestment it used to be
that companies reinvested 40% or more of
their profits back in the business now
it's less than 10% a lot of people
believe that our companies are becoming
less innovative and when you look at
shareholder returns the odd thing is
that maximizing shareholder value
doesn't seem to have increased
shareholder value shareholder returns
are if anything slightly less than they
were in the managerial estera
what's going wrong the problem with this
shareholder value philosophy is that
it's really just an ideology almost a
religion it's not backed up by the facts
it's not backed up by corporate law and
it's not backed up by corporate
economics once you understand what
corporations really are we've already
looked at some of the evidence and we've
seen how the embrace of shareholder
value thinking has been accompanied by
declining numbers of corporations
declining corporate less life expectancy
reduced innovation reduced investment
and even reduced shareholder returns but
when we look at the law of corporations
it really doesn't make sense so first of
all let's see what corporate law as
reflected in state codes and the
charters of corporations themselves says
about what corporations are supposed to
do codes and charters don't say
corporations have to maximize
shareholder value what they say is that
corporations can be run for any lawful
purpose no requirement of maximizing
shareholder value even though someone
creating a company could put that in the
Charter if they wanted to I've been
looking for that in charters for years
I've never seen it now when we look at
case law it's a little bit more
confusing
because judges say different things
about what corporations are supposed to
do some judges in some cases say they
should pursue profits or shareholder
value other judges in other cases say
differently for example Supreme Court
justice alito recently said in the Hobby
Lobby decision that modern corporation
law does not require companies to
maximize profits at the expense of
everything else and many do not
so what judges say is kind of all over
the law but good lawyers don't pay
attention to what judges say about their
thinking good lawyers pay attention to
the part of the case we call the holding
that is what will the court actually
require a corporation to do and when you
look at the holdings of corporate law
cases instead of what judges say what we
call mere dicta the holdings are very
clear courts simply will not require the
directors of corporations to try to
maximize shareholder profits or
shareholder value instead directors are
protected by something called the
business judgment rule which says that
as long as the directors are operating
in what they honestly believe is the
best interest of the corporate entity
then they are protected there are a
couple of cases where the directors of
companies have been required to pay out
dividends to shareholders but if you
look at those cases you'll see very
quickly those are actually not cases
about what corporations are supposed to
do there are cases that involve a
conflict between a majority controlling
shareholder and a minority shareholder
and the payouts were made to the
minority as a matter of fairness in
those particular closely held companies
so corporate law does not support the
shareholder value myth when you look at
economics economic theory doesn't
support the notion that you have to
maximize shareholder value either let's
start with the idea that shareholders
own corporations legally that's just
plain wrong corporations as legal
persons own themselves what shareholders
own is a contract with the corporation
called a share of stock that gives
shareholders very limited rights just as
creditors have debt contracts with
corporations and employees have
employment contracts shareholders don't
own companies companies own themselves
a more sophisticated version of this
economic argument says that shareholders
are the so called residual claimants in
corporations entitled to every penny
that's left over after the corporation
has met its obligations to other
stakeholders like creditors or taxing
authorities or employees again that's
legally erroneous a corporation is its
own residual claimant shareholders don't
get anything from the corporation except
dividends and it's the Board of
Directors that decides whether or not
the company will pay dividends now at
this point people who have taken
corporate finance are likely to object
but if the corporation doesn't pay
dividends then the money will be saved
and it will increase the value of the
stock so isn't the money the
shareholders anyway to which I say no
actually it's not because remember it's
the Board of Directors that decides what
to do with corporate profits they could
retain them and increase the value of
the company's shares but they can also
use those profits to pay employees
higher salaries to make philanthropic
contributions to invest more in research
and development to provide better
customer support or even to pay taxes
instead of moving their companies
offshore to eliminate their US tax
burden so neither in the law nor in the
economics is there any basis for this
notion that somehow shareholders owned
corporations and corporations are
supposed to maximize shareholder value
and if you start to think about whose
shareholders really are you'll quickly
realize that idea doesn't even make
sense perhaps the biggest flaw in the
shareholder value myth is it's
fundamentally mistaken idea about whose
shareholders really are shareholder
value maximization talk assumes that all
shareholders are the same and that all
they care about is what's happening to
the company's stock price actually all
they care about under this theory is
what's happening to the stock price
tomorrow they're not even worried about
the stock price five or ten years from
now and this very simplified model of
what you might almost call a platonic
shareholder a hypothetical platonic
shareholder who only care
about the stock price of one company at
one moment in time is completely
unrealistic real shareholders are people
and they have many differing interests
they're not all the same for example one
big difference among shareholders is
whether they're thinking short-term or
long-term most people who are investing
in the stock market are investing for
retirement or perhaps a child's college
tuition or some other long term project
but there are some shareholders
especially for example activists hedge
funds that buy shares intending to hold
them for a year or maybe two years at
most those two groups have very
different interests long-term
shareholders want the company to invest
for the future and take care of its
employees and customers so it'll operate
sustainably over time
short-term hedge funds don't care
anything that gets the stock price up in
the next year is good enough for them
and there are lots of ways to get the
stock price up by taking on leverage by
cutting research and development by
firing employees lots of ways to get the
stock price up in the short term but
many of them end up hurting the company
in the long term which is a problem for
long-term shareholders another key
difference among shareholders is whether
they're diversified that means they own
stock and lots of different companies or
whether they only own stock and one or
two companies if you're a diversified
shareholder you care whether your
corporation is making money by doing
something anti-competitive that's
hurting the profits at another
corporation you also own if you own
stock and bonds you don't want your
company leveraging in a fashion taking
on debt that is in a fashion that drives
up the share price but makes it less
likely your bonds will be paid off but
if all you own is stock in a single
company or maybe stock in two or three
companies which is typical for many
hedge funds then you don't care about
the consequences for other investments
you just care about getting that share
price up at that one company preferably
tomorrow and remember real shareholders
are not just shareholders they're also
employees and customers and citizens and
taxpayers they want their corporations
to make money
not by ruining the environment or firing
them and causing them to lose their job
or producing shoddy products that they
regret buying or failing to pay taxes
corporate taxes so that individual tax
rates go up
most people are what we call universal
investors who have a wide range of
interests and want our companies to be
run in ways that are consistent with all
of our interests not just this focus on
share price finally and really this is
good news most real shareholders are
also real human beings who have a
conscience and who care about others and
have ethical standards they don't want
their companies to profit from polluting
or laying off people unnecessarily or
cheating or abusing their customers as
in the case of for example Volkswagen
that was cheating on its emission
standards or United which was just
embroiled in a controversy over
maltreatment of passengers most
shareholders are what we call pro-social
meaning they understand and they are
happy to be concerned about the
interests of other people the planet and
future generations what do we call a
shareholder or for that matter what do
we call anyone who only focuses on
making as much money for themselves in
the immediate future even if this
involves harming others or breaking the
rules we call that person a psychopath
and the evidence suggests that while
psychopaths exist
they usually account for only two to
four percent of the population and
that's probably true for shareholders as
well
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