
The Shareholder Value Myth (2013) - Tomte
http://www.europeanfinancialreview.com/?p=883
======
ScottBurson
I think the contribution of the shareholder value myth to overall economic
inequality also bears mentioning. When companies optimize for short-term share
price, the primary beneficiaries are short-term traders and activist
investors, that is, people who already have a lot of money; employees
generally suffer, as do small investors who tend to invest for the long term.

~~~
chibg10
I hear the bogeyman of "short-termism" brought up a lot here, but how accurate
is this characterization of investor behavior actually?

The best performers in today's market are decidedly _not_ short-term focused.
Amazon and Netflix barely turn a profit, even though they could. Ditto for
Tesla (well, maybe they couldn't atm even if they wanted to). The entire tech
sector, which has been on a tear, is similarly long-term focused. Snap's
stock, for example, isn't being hit because it's not profitable, but it's
getting hot because its user base is plateauing (i.e. negative long-term
signal).

Do a lot of (most?) companies focus on the short-term? Definitely! But that's
rational behavior even from a societal resource allocation perspective.
Imagine you're Walgreens, Target, P&G, Kroger, JCrew, or one out of another
thousand "boring" (i.e. low upside) companies (like most others). If the
upside at your company is limited, why throw money money at "long-term"
thinking? It makes more sense to maximize profits now and return profits to
shareholders who will in turn invest in the Amazons, Googles, Teslas, etc. who
have the technological infrastructure and human capital to generate better
returns per dollar of long-term spending.

The end result (which is happening) is that most companies by volume focus on
the short-term because most companies in the US are working in a mature market
with a well-explored product and have limited upside, while a small number of
companies with large upside get a disproportionate share of investment.

~~~
jonhendry18
Private equity firms are notorious for being focused on the short term, to the
point of doing LBOs to acquire firms and in the process encumbering the
acquired firm with a debt load that cripples its ability to compete.

The PE firm may also make the acquired company take on additional debt in
order to pay dividends. Or it may sell off assets of the company in order to
take dividends out.

The PE firm doesn't get hurt if one of their looted companies goes bust, so
there's no incentive to keep the acquired company healthy and viable. PE firms
are like parasitic wasp larvae eating their prey from inside.

Just this year this sort of thing drove Toys R Us out of business, and
iHeartMedia into chapter 11 bankruptcy.

~~~
qeternity
> The PE firm doesn't get hurt if one of their looted companies goes bust, so
> there's no incentive to keep the acquired company healthy and viable.

What?! The “BO” in LBO stands for buy out, meaning the PE shop buys the whole
company. Of course bankrupting a company you own is a bad thing. I think what
you really mean to imply is that someone buys the company later from an LBO
shop (maybe even the public in an IPO) and then it goes bust. Does this
happen? Of course. But you’re also conveniently ignoring all the enormous
PE/LBO success stories. You may not morally approve of the industry, but if
there was no value, who would buy a company from the likes of KKR?

~~~
jonhendry18
"Of course bankrupting a company you own is a bad thing."

Not if you already got your profit out of it and aren't carrying any of the
losses. The company's creditors and employees take the loss, not you.

------
elvinyung
Here's a weird, slightly roundabout analogy I like to use.

The premise of the _paperclip maximizer_ thought experiment is as follows:
suppose you program a (sufficiently advanced) robot to maximize the number of
paperclips. It might start by -- reasonably -- collecting all the paperclips
it could find, and bringing them to you.

But after it does that, it might also realize that it could convert other
things into paperclips — things like raw metal, other machines, and the atoms
in the human body.

Basically, the paperclip robot says "maximize the number of paperclips at all
costs." The corporation says "maximize shareholder value at all costs."

How can you be _sure_ that the goals you've programmed into a sufficiently-
complex system are actually beneficial to the people using the system?

~~~
marcosdumay
As long as you keep wealth disparity under control, make sure people don't get
stuck in poverty, correctly tax externalities, enforce honest marketing, and
deal with a lot of other small details, shareholder value maximization is
nearly optimal in being beneficial to the people using the system.

As a bonus, it also creates a nice incentive for saving and investing into the
future. What is hard to achieve on most systems.

~~~
jtolmar
Shareholders and keeping wealth disparity under control are at odds. As long
as people are able to buy investments and own the profits of those
investments, those people are paid proportionate to how much money they have,
making their wealth over time an exponential function, which is inherently
unequal even to other exponential functions with slightly different rates of
return, and even more unequal to anyone stuck making money linearly by selling
their labor.

I'd love to hear a good solution for this within a market system.

~~~
skookumchuck
> I'd love to hear a good solution for this within a market system.

Your wealth won't expand forever, because we all die.

~~~
elvinyung
Wealth and power still get concentrated in families and corporations. I would
argue that these are just as valid "agents" as the individual.

~~~
skookumchuck
Families tend to dissipate wealth. The Rockefellers have long since dropped
away in wealth, for example. So have the Kennedys.

Corporations are owned by shareholders, who die and pass their wealth on to
the government, family, and various charities.

------
crazygringo
> _What’s more, directors viewed themselves not as shareholders’ servants, but
> as trustees for great institutions that should serve not only shareholders
> but other corporate stakeholders as well, including customers, creditors,
> employees, and the community._

Citation needed. This sounds like rose-colored glasses to me. I don't believe
such a golden age ever existed.

> _Nor was share price assumed to be the best proxy for corporate
> performance._

Since when have shareholders cared about anything except getting rich?

> _Many corporations formed in the late eighteenth and early nineteenth
> centuries... They structured their companies to make sure the business would
> provide good service at a reasonable price – not to maximize investment
> returns._

Somebody tell the robber barrons this? They apparently didn't get the message.

> _It was once believed (at least by academic economists) that the market
> price of a company’s stock perfectly captured the best estimate of its long-
> term value. Today this idea of a perfectly “efficient” stock market has been
> discredited..._

Citation needed again. Because if anybody has a _better_ idea of how to judge
companies' long-term value, then they'll become extremely, extremely rich.

I'm sorry, but this article is absolute nonsense.

There are valid reasons why one might argue that the end goal of corporations
shouldn't be to maximize shareholder value, and how governments should create
policies towards that end, but this article doesn't even begin to touch on
them...

~~~
learc83
>Many corporations formed in the late eighteenth and early nineteenth
centuries... They structured their companies to make sure the business would
provide good service at a reasonable price – not to maximize investment
returns.

>Somebody tell the robber barrons this? They apparently didn't get the
message.

Your ellipses left off the qualifiers. The author isn't talking about all
companies. They are specifically talking about companies that were founded in
part to provide services for investors as opposed to just return on investment
--companies where people invested because they wanted the company to exist so
that they could be customers. There's even a citation for this in the foot
notes.

~~~
CamTin
Pre-breakup AT&T is a tangible example for people old enough to remember. AT&T
shareholders certainly did well with their monopoly position, and the early
days of the Bell System were certainly not public-spirited (the company
directors were Yankee misers in the mold of Venderbilt, though not on as grand
a scale), but eventually the Bell System became, as a regulated monopoly, not
appreciably different from any other arm of government. The Bell System
breakup was roughly equivalent to a privatization of a national industry ala
British Rail rather than a trust-busting ala the Standard Oil breakup.

There is an excellent John Books (of /The Go-Go Years/, among others) tome on
the subject, published just before the breakup:
[https://www.goodreads.com/book/show/1323717.Telephone](https://www.goodreads.com/book/show/1323717.Telephone)

------
andyidsinga
> "Closer inspection thus reveals the idea of a single “shareholder value” to
> be a fiction. Different shareholders have different values"

This is great when arguing with someone in the office who emphatically states
"we need to maximize shareholder value!"

response: which shareholder: short term? long term? diversified? non-
diversified? customer shareholders?

------
sonnyblarney
This article is riddled with bad logic and makes no reasonable assertions, in
fact some of them fare just false.

We can have a debate about 'shareholder primacy' but this is not it.

"Consider first Friedman’s erroneous belief that shareholders “own”
corporations. Although laymen sometimes have difficulty understanding the
point, corporations are legal entities that own themselves, just as human
entities own themselves. What shareholders own are shares, a type of contact
between the shareholder and the legal entity that gives shareholders limited
legal rights. In this regard, shareholders stand on equal footing with the
corporation’s bondholders, suppliers, and employees, all of whom also enter
contracts with the firm that give them limited legal rights."

This is essentially rubbish, debt holders, suppliers and employees all have a
relationship but they are not the firm. The firm does not exist independently
of shareholders.

~~~
nopassrecover
The firm certainly does exist independently, e.g. see Salomon v A Salomon & Co
Ltd

[https://en.m.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_L...](https://en.m.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_Ltd)

~~~
sonnyblarney
It's not a matter of legality, it's a matter of pragmatism.

Shareholders own and run the company. A majority of shareholders can
effectively do anything they want with it, it's theirs.

That a corporation may possibly exist independently is a corner case.

It doesn't matter, the logic of the article is twisted.

It implies that profits can be used by the board of directors for whatever
reason, obviously. But that board is elected by shareholders to carry out
their bidding, and they are a proxy of shareholders, thereby abnegating the
logic of the argument.

"The business judgment rule ensures that, contrary to popular belief, the
managers of public companies have no enforceable legal duty to maximize
shareholder value"

My god man, the board will act in the best interest of the shareholders or
ultimately they'll get the boot. If the shareholders are dispersed and can't
coordinate themselves, they'll have less power and see more go to the next
entity with power, probably the executives.

~~~
cjalmeida
> If the shareholders are dispersed and can't coordinate themselves, they'll
> have less power and see more go to the next entity with power, probably the
> executives.

Change shareholders to voters, executives to elected official, then you have a
time tested example of power grab. Checks and balances are important in both
cases.

~~~
sonnyblarney
The ratio is rather different, and that makes a difference.

In many companies, merely a handful of entities can make up most of the power,
or nearly most of it. Shareholders that matter can usually fit in a room, and
have a conversation.

With 300 000 to 1 as we see in politics ... it's a little different.

------
AmericanChopper
I can’t believe that somebody could write a whole book based on such a
contrived premise. Shareholders don’t control a company? They do, they control
who sits on the board, and the board controls the company. Shareholders aren’t
entitled to a company’s profits? They’re entitled to its dividends, if they
think the company isn’t paying enough dividends they can elect a new board.
Shareholders don’t own a company? They own its profits and they control its
decision making. Some semantic of the word “own” is pointless. You could argue
that shareholders don’t often exert this control against incumbent management,
but that is only because management most often respect shareholder primacy.
When shareholders invest their savings in public companies they’re trusting
them to grow those savings. If you’re not operating in the interest of
shareholders, then your public company will not survive long.

~~~
JumpCrisscross
Business owners don’t have singular goals. Neither do shareholders. Profits
are important. But short-term earnings aren’t everything, to whole business
owners nor shareholders. Some managers like to pretend they are, because
hitting a single quantitative short-term goal is easier than running a
business, and that’s the problem discussed here.

~~~
AmericanChopper
Did you read the article? Because that’s pretty tangential to most of what it
brings up. It’s also not an accurate description of reality. Different
investors have different horizons, and different companies operate with
different horizons for their missions. If there’s any myth here it’s that all
investors are singularly focussed on the next quarters profits, or even that
most of them are. Most of the people on this board have probably worked at a
company with a cap that’s 20x it’s revenue, or at least know somebody who has.
There’s a whole sector of investors who are willing to invest in companies
that lose money year after year on the premise that they may one day make a
profit.

~~~
skookumchuck
The irony of the theory that American companies are all focused on short term
profits at the cost of long term profits is that it is refuted by simply
looking at graphs of the S&P 500 over the decades.

The theory also requires that the aggregate of investors are fools.

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foobarian
It always bugged me how vague the rule was. Without specifying a time window
the maximization doesn't mean anything.

~~~
AmericanChopper
The shareholders themselves specify the time window by exerting control over
the board, and by selectively investing in companies that coincide with their
own objectives.

~~~
nitwit005
If you meet the expectations of the first group of shareholders, by raising
the value of their stock as they wanted, they'll just sell to a new group that
expects another increase.

~~~
AmericanChopper
Which a company can provide by continuing to meet its planned objectives. If
investors don’t like a companies strategic planning, they can either change
the management, or sell their shares. If enough of the shareholders don’t like
the management, and if there aren’t any investors available who do to buy
their stake, then either it’s management or their planning will change. There
a multiple ways for shareholders to exert their control over a company.
There’s a huge pool of investors in the world, and they all want different
things. Some of them will exert pressure to maximise short term returns,
ohters won’t. The system itself does not intrinsically put any downward
pressure on investment horizons.

------
m12k
This reminds me of one of the concepts from Zen in the Art of Archery - by
focusing too much on wanting to hit the target, you're not using your full
attention on perfectly performing the actions that would actually allow you to
hit the target.

------
baybal2
Unlike what popular opinion suggests, there, there is no legal requirement for
directors to maximize shareholder value. In USA, as far as I know, there is
not a single law saying that.

Unless something like that written in big, bold letters in company's charter,
there is literally nothing like that a director of public company should care
about.

~~~
torstenvl
Have you performed a fifty-state survey on this?

How do you square your assertion with _Smith v. Van Gorkom_ , 488 A.2d 858
(Del. 1985) and the subsequent need to enact section 102(b)(7)?

~~~
anticensor
That only applies immediately before insolvency or immediately after
acquistion. Primary motive does not mean no action of a corporation is allowed
to lower its short term profit.

~~~
baybal2
Not to say that the legal logic of that case was defeated numerous times

~~~
anticensor
European JSCs (inc. equivalent) have a codified requirement of returning
shareholder dividend at least once in 5 years. Is there a similar codified law
in the US requiring public companies to return profit every quarter?

~~~
torstenvl
No, not in any state I've practiced in. I suspect there is no such legal
requirement in any U.S. jurisdiction. However, shareholders and their boards
expect growth.

Additionally, note the distinction between profit and growth. For a long time,
Amazon grew a lot and shareholders saw returns in terms of stock price, but
the company itself made little to no profit.

------
simonCGN
What kind of propaganda website ist that?

Never heard to that magazine.

