
The myth of shareholder capitalism (2010) - _delirium
http://hbr.org/2010/04/the-myth-of-shareholder-capitalism/ar/1
======
_delirium
The main takeaway, as I read it, is that the widespread belief that CEOs are
legally obligated to maximize shareholder value is not really borne out by
legal precedent or the current understanding of legal scholars (though it's
widely taught by management scholars). The current law appears to be that,
while CEOs can be _fired_ by shareholders, as long as the shareholders choose
to retain them, the CEOs have a wide range of leeway for what values they can
legally take into account when making decisions. Those values don't have to be
solely focused on maximizing shareholder returns, and courts will generally
not second-guess them except in really extreme cases (though shareholders are
welcome to second-guess them by voting in a new board that fires the CEO).

~~~
Tycho
Isn't this pretty much the same as any employee-employer/owner relationship?
The employee can do what they want a lot of the time but at some point they'll
have to answer for their decisions and if it's found they weren't acting in
their employer's interest they can expect to get fired.

~~~
mjw
I think as the employee gets a larger and larger influence over decisions
about their own compensation, the line between 'failure to do your job
correctly in the best interests of your employer' and 'embezzling funds'
becomes more and more blurry. And the latter of course is more than just a
firing issue. So perhaps not quite the same, although where exactly you draw
the line I guess is subjective.

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zipdog
"31 of 34 directors surveyed (each of whom served on an average of six Fortune
200 boards) said they’d cut down a mature forest or release a dangerous,
unregulated toxin into the environment in order to increase profits. Whatever
they could legally do to maximize shareholder wealth, they believed it was
their duty to do"

The article points out that this isn't the case. What's interesting to me is
the idea that this activity maximizes shareholder wealth anyway. It might
maximize the value of entities holding shares in a short-term outlook, but on
a long-term outlook (10 year horizon) this is foolish not just because it
weakens the brand of the company, but risks future contracts (boycotts from
public pressure), and opens settlement possibilities (even a legally released
toxin can result in settlements if they were aware it was dangerous at the
time).

~~~
seabee
The long-term outlook only matters to long-term investors. If you can carry
out such activities discreetly such that those investors are oblivious, you
can reap the profits by selling up before the shit hits the fan. There are
enough sociopaths [0] in business that this situation must have occurred
several times over.

[0] [http://www.forbes.com/sites/jeffbercovici/2011/06/14/why-
som...](http://www.forbes.com/sites/jeffbercovici/2011/06/14/why-some-
psychopaths-make-great-ceos/)

------
hammock
Here is a much clearer article on the same issue.

<http://www.directorship.com/stout-shareholders-as-owners/>

One excerpt: _Under the doctrine known as the business judgment rule, a
shareholder can’t successfully sue a board for failing to maximize shareholder
value. To the contrary, directors enjoy wide legal discretion to sacrifice
“shareholder value” in order to protect employees, customers, creditors and
the community._

------
hncommenter13
Never ever treat a blog post on legal issues as definitive when written by
non-lawyers, especially when it cites no sources.

I'm not a lawyer, but the statement "we conducted a systematic analysis of a
century’s worth of legal theory and precedent" is utter twaddle. There are
disciplines of law on which people build _careers_ attempting to sort out
these issues.

Worse yet, a post that discusses conflict between shareholders' interests and
directors' actions in the context of an acquisition but that doesn't even
mention Revlon duties, which arose from the seminal case in this area
([http://en.wikipedia.org/wiki/Revlon,_Inc._v._MacAndrews_%26_...](http://en.wikipedia.org/wiki/Revlon,_Inc._v._MacAndrews_%26_Forbes_Holdings,_Inc.)),
is seriously suspect. The case law has evolved significantly since then and it
is difficult for those without legal training to fully grasp (not to mention
that US corporate law has its quirks, which two academics from other countries
may not be fully familiar).

Point being, this is a complex area on which there are hundreds of publishing
corporate law professors and practitioners. The "myth" is a strawman.

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pjschlic
This is a simple matter of people doing what they are incentivized to do. The
vast majority of directors have incentives tied to short term gains (short
term in the sense of a company - quarterly or yearly), and so their actions
are to seek short term gains. They might _say_ they are required to act in the
best interest of the stock holder... but it just so happens that they have
compensation which is tied to short term gains in the stock price.

~~~
WalterBright
I don't believe the conventional wisdom that the stockholder only cares about
short term gains. I see, over and over, share prices punished because the
stockholders do not see the company doing well long term, and vice versa.

~~~
drumdance
Really? What do you think would happen to a stock that missed it's quarterly
earnings estimate?

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DanielBMarkham
I think we're mixing up a bit of stuff, mainly the training and legal
structure of corporations and the actions their directors might or might not
take.

Let's be very clear: directors who release a toxin into the environment, if
done purposely, will end up in jail. Corporations who do it accidentally will
end up paying for damages. If they don't, that's a failure of our criminal
justice system, not the way corporations are formed. most directors may be
very amoral sorts only caring for the bottom line. That's fine. Our system is
full of folks only looking for short term gain, yet the greater good is still
served. That's the beauty of our system. No matter how hard we try and how
much we want it, nobody has ever created a complex system of people that
worked solely on altruism.

What it looks like to me is that directors have evolved corporations into sort
of a representative republic. Shareholders elect them to be autonomous and
free to manage as they see fit -- not move hither and fro based on the
opinion-of-the-day. Just like with Congress, there's probably a very good
reason corps have evolved like this. It'd be interesting to see a study of
more participatory shareholders and how things shook out. I'm willing to bet
there are a lot of problems with direct shareholder rule and that what we're
seeing is at least a local maximum.

~~~
jbooth
Representative republic, really? I'm not advocating to burn the whole system
to the ground or anything but I'd say you're overstating the not-brokenness of
it in 2011.

As far as going to jail for being sociopathic burdens on society, well this
one's hot off the presses, nobody goes to jail from Citibank or Goldman for
committing fraud:
[http://www.usatoday.com/money/industries/banking/story/2011-...](http://www.usatoday.com/money/industries/banking/story/2011-10-19/sec-
citigroup-mortgage-securities-fraud/50825740/1)

I don't have access to their books but it's likely they made more money on the
fraud than they paid in the fine. Goes doubly for Goldman.

And that's just externality-brokenness. I don't think the corporations even
function as a representative republic. How do you explain HP's board? Or any
of the nepotism that seems to happen across many similar boads so regularly?
How many non-board-member-shareholders exercise any influence whatsoever?

~~~
yummyfajitas
_...nobody goes to jail from Citibank or Goldman for [allegedly] committing
[civil, not criminal] fraud..._

Fixed that for you.

Note that neither Citi nor Goldman were convicted of fraud, they merely
settled with no admission of wrongdoing to make it go away. Further, even if
convicted, you don't go to jail for civil offenses.

 _I don't have access to their books but it's likely they made more money on
the fraud than they paid in the fine._

From the article: "The payment includes the fees and profit Citigroup earned,
plus $30 million in interest and a $95 million penalty."

In Goldman's case, the settlement money does not subtract the money Goldman
_lost_ on ABACUS.

~~~
jbooth
Hey, I know you work in finance on your own, and that's fine, good luck to
you, but "too big to fail" should include things like "don't make a bunch of
terrible bets and then hoodwink your customers into taking the fall on those
bets for you".

Sounds like they did great on the deal to me, considering the alternative was
to be the last one holding those CDOs when they exploded. If I were them, I'd
call that fine the cost of doing business for a great business decision.

~~~
yummyfajitas
_... "too big to fail" should include things like "don't make a bunch of
terrible bets and then hoodwink your customers into taking the fall on those
bets for you"._

I don't understand the mechanics of this. It should be illegal for "too big to
fail" banks to sell a security when they believe it's price will go down?
Should it also be illegal to buy when one believes a security is going up?

 _...the alternative was to be the last one holding those CDOs when they
exploded..._

Goldman was the last one holding (some tranches of) ABACUS when the housing
market collapsed. That's why they lost money.

Incidentally, I no longer work in finance.

~~~
jbooth
So, the mechanic that did happen is that those banks were holding a ton of
CDOs, and unloaded as many as they could before they exploded by calling their
customers and saying "Hey, check this out, these bonds are super-hot right
now, great deal, you should buy it".

As far as the mechanics of my perfect system, "too big to fail" should be done
away with, along with proper enforcement of our existing fraud laws. We'll
have eliminated the means (smaller banks) and motive (deterred by steep
penalties) for this happening again. As of now, I don't see what's changed
since 2008.

That settlement's ridiculous. A few hundred million for each bank? How many of
these things did they take off their balance sheet in 2007-2008 while selling
them to their customers as perfectly good bonds?

~~~
yummyfajitas
_We'll have eliminated the means (smaller banks)..._

Smaller banks wouldn't be able to sell securities they believe will go down? I
didn't realize that buying low and selling at the peak required scale.

 _As of now, I don't see what's changed since 2008._

That's because you aren't paying attention. The I-Banks are now bank holding
companies, the regulators have laid claim to several floors of their buildings
and are imposing massive new programs, the banks have figured out that they
need more stringent underwriting standards for homeowners and have drastically
cut back on loans [1].

[1] The market for home loans is now over 90% Fannie/Freddie - strangely, the
agencies haven't figured out that home loans should be reduced.

~~~
jbooth
More, smaller banks means more diversity and less chance that a few of them
can endanger the whole system.

As far as the I-Banks being bank holding companies now, I'm seeing more stuff
under fewer roofs than there was before.. that seems less stable to me.

I don't actually have an answer for how to fix the problem, I'm just worried
that we haven't had the kind of systemic change that we need. A little more
auditing doesn't change anything, the banks pay a lot more than the regulatory
agencies so they'll be able to capture them.

------
neilk
What about Dodge v. Ford Motor Company?

<http://en.wikipedia.org/wiki/Dodge_v._Ford_Motor_Company>

This is the case which is often cited to establish that the corporation's
primary duty is to its shareholders, and that this duty overrides all others.

EDIT: never mind, this is already discussed in the article. Sorry.

~~~
hammock
Fans of shareholder primacy almost always cite the nearly century old case of
Dodge v. Ford as their primary legal support for the idea of shareholder
primacy. But Dodge v. Ford was really a shareholder-versus-shareholder dispute
in a close corporation.

Similarly, the second case typically cited—Revlon v. Mac- Andrews & Forbes
Holdings, Inc., is also legally irrelevent. In Revlon, the Delaware Supreme
Court held that an end-game situation where the directors of a publicly traded
firm had decided to sell the company with a controlling shareholder—in effect,
terminating the corporation’s existence as a public firm—the board had a duty
to maximize shareholder wealth.

But subsequent Delaware cases have made it clear that if the directors of the
firm decide not to sell at all, or prefer to do a stock-for-stock exchange
with another public company, the infamous Revlon doctrine no longer applies.

For example, in Paramount Communications, Inc. v. Time, Inc., the Delaware
Supreme Court upheld directors’ right to “just say no” to a hostile offer,
even though the offer was at a premium over the market price for the company’s
stock.

Source <http://www.directorship.com/stout-shareholders-as-owners/>

~~~
neilk
California just created a whole new class of corporation for people who wanted
a different standard of behavior, which could include social and environmental
concerns.

[http://venturebeat.com/2011/10/11/benefit-corporations-
calif...](http://venturebeat.com/2011/10/11/benefit-corporations-californi/)

So was that unnecessary? Could such behavior be compatible with the standard
corporate model?

~~~
gojomo
I think it was unnecessary; California should have just made a statutory
affirmation that _any_ corporation may choose whatever goals its owners
decide.

There's a reasonable argument to be made that's already the case, and the
opposing idea – that 'maximizing profits' or 'maximizing shareholder value' is
a legal requirement – is just a persistent misunderstanding.

I think such a misunderstanding is fed by some on both the right and left. On
the right, some want to celebrate a singular, elegant rule for moving all
decisions into an economic model. On the left, some want to smear the very
idea of corporations as amoral at the core.

Neither view respects the idea of a corporation as a voluntarist coordination
mechanism. A corporation is its shareholders' property, and just like any
other property, may be deployed in any legal manner the owners see fit.

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mmaunder
The article seems to be confusing fiduciary duty with accountability. As a
director, if you make your shareholders unhappy enough, they will fire you. If
you breach your fiduciary duty, they will sue you. The article is only
addressing breach of fiduciary duty. So I don't agree with conclusion that "In
short, directors are to a great extent autonomous.".

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Bo102010
In 2005, Reason magazine had an excellent discussion with Milton Friedman,
John Mackey (Whole Foods), and T.J. Rodgers (Cypress Semiconductors) that is
relevant to this discussion
([http://reason.com/archives/2005/10/01/rethinking-the-
social-...](http://reason.com/archives/2005/10/01/rethinking-the-social-
responsi/print)).

