The Shareholder Value Myth | Lynn Stout

Summary

The 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

• 📜 The idea that corporations exist solely to maximize shareholder value is a relatively new concept, emerging in the late 1970s or early 1980s.
• 🏭 Prior to this, corporations were viewed as social and economic institutions with a responsibility to serve various stakeholders, including customers, employees, creditors, and communities.
• 🌐 The shift to shareholder value maximization influenced regulatory bodies like the Securities Exchange Commission and tax codes, giving shareholders more power and influence.
• 📉 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.
• 💡 Companies are reinvesting less of their profits back into the business, which some believe is affecting innovation and the overall health of corporations.
• 🤔 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.
• 📚 The script argues that the shareholder value philosophy is more of an ideology without strong backing from corporate law or corporate economics.
• 📖 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.
• 👨‍⚖️ 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.
• 🤝 Shareholders are not the owners of corporations; they own a contract with the corporation called a share of stock, which grants them limited rights.
• 🌟 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

00:00

📊 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.

05:00

📘 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.

10:01

🌐 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.

Keywords

💡Shareholder Value

The concept of 'Shareholder Value' refers to the idea that corporations exist primarily to maximize the wealth of their shareholders. It is a central theme in the video, which challenges this notion by arguing that it is a relatively new ideology that has not historically been the sole purpose of corporations. The script points out that maximizing shareholder value has not necessarily led to increased shareholder returns and has been accompanied by negative consequences such as reduced reinvestment and innovation.

💡Managerialism

Managerialism is an economic theory that predates the focus on shareholder value, emphasizing that corporations should serve multiple stakeholders, including customers, employees, creditors, and communities. The video script explains how managerialism was replaced by the shareholder value ideology in the late 20th century, which has had significant impacts on corporate governance and policy.

💡Securities Exchange Commission (SEC)

The SEC is a U.S. government agency responsible for enforcing securities laws and regulating the securities industry. The video script mentions how the SEC has passed rules that have given shareholders more power and influence over corporations, which is a direct result of the shift towards the shareholder value ideology.

💡Tax Deductibility

Tax deductibility refers to the ability of a corporation to deduct certain expenses from its taxable income. The script discusses a 1993 tax rule change that required companies to tie executive pay to performance metrics, often interpreted as share price, to qualify for tax deductions, thereby reinforcing the focus on shareholder value.

💡Business Judgment Rule

The Business Judgment Rule is a legal principle that protects directors from personal liability for actions taken in what they believe to be the best interests of the corporation. The video explains that this rule, rather than a requirement to maximize shareholder value, is what guides the actions of corporate directors.

💡Residual Claimants

In the context of the video, 'Residual Claimants' refers to the argument that shareholders are entitled to the remaining profits of a corporation after all other obligations have been met. The script refutes this by stating that corporations are their own residual claimants and that shareholders only receive dividends at the discretion of the Board of Directors.

💡Universal Investors

Universal Investors are individuals who have a wide range of interests and investments, and who want corporations to be run in ways that align with all of their interests, not just maximizing share price. The video script argues that most real shareholders fall into this category, caring about more than just short-term stock performance.

💡Short-term vs. Long-term Shareholders

The video script distinguishes between short-term and long-term shareholders based on their investment horizon and interests. Short-term shareholders, such as activist hedge funds, may prioritize immediate stock price increases, while long-term shareholders are more concerned with sustainable business practices and future growth.

💡Diversified Shareholders

Diversified shareholders are those who have investments spread across multiple companies. The video script explains that these shareholders may be more concerned with fair competition and the overall health of the market, as opposed to those with concentrated holdings in a few companies who might prioritize short-term gains at the expense of other investments.

💡Pro-social Shareholders

Pro-social shareholders are those who are concerned about the social and ethical implications of a corporation's actions. The video script suggests that most shareholders fall into this category, valuing corporate behavior that is ethical and beneficial to society, the environment, and future generations.

💡Psychopath

In the context of the video, a 'Psychopath' is used to describe a hypothetical shareholder who is solely focused on maximizing personal gain in the short term, even at the expense of others or by breaking rules. The script argues that such individuals are rare among the general population and likely represent a small minority of shareholders.

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