Practical analysis for investment professionals
23 October 2014

Shareholder Value Maximization: The World’s Dumbest Idea?

If you agree with the economist John Maynard Keynes that “ideas shape the course of history,” then you ought to agree that the history of modern business and finance has been shaped by one influential idea: that the job of a company’s management is to maximize shareholder value. But according to James Montier, a distinguished investment professional and behavioral finance writer, shareholder value maximization is “a bad idea.” He believes it has not added any value for shareholders and has contributed to such major economic and social problems as short-termism and rising inequality.

Montier made his case against shareholder value maximization when delivering the closing keynote address at the 2014 European Investment Conference in London. In his characteristic iconoclastic style with a generous use of ironic humor, Montier labeled shareholder value maximization the way Jack Welch, the former CEO of GE, had once described it in 2009, as “the dumbest idea in the world.”

An Academic Opinion without Much Evidence

Montier said that the idea of shareholder value maximization didn’t come from businesses but rather originated as an opinion in academia and was unsupported by much evidence. It is most directly traced to an op-ed written by economist Milton Friedman in 1970. . . .

Read more on the European Investment Conference blog.

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Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credits: ©CFA Institute

About the Author(s)
Usman Hayat, CFA

Usman Hayat writes about sustainable, responsible, and impact investing and Islamic finance. He is the lead author of "Environmental, Social, and Governance Issues in Investing: A Guide for Investment Professionals," and the literature review, "Islamic Finance: Ethics, Concepts, Practice." He is interested in online learning and has directed three e-courses for CFA Institute: "ESG-100," "Islamic Finance Quiz," and "Residual Income Equity Valuation." The other topics he writes about are macroeconomics and behavioral finance. Previously, he was a content director at CFA Institute. He is a former executive director at the Securities and Exchange Commission of Pakistan (SECP). He has experience working in securities regulation and as an independent consultant. His qualifications include the CFA charter, the FRM designation, an MBA, and an MA in Development Economics. His personal interests are reading and hiking.

29 thoughts on “Shareholder Value Maximization: The World’s Dumbest Idea?”

  1. Savio Cardozo says:

    Hello Usman there are no business owners that I know of (and you would agree that these are shareholders) that would agree with Mr. Montier. David Larrabee raised this subject earlier in September and there was a lively discussion on the topic that ensued. Without raising all the points made there, I can only state that I think that those managers that do not focus on the maximization of shareholder value should be replaced by their shareholders. And their boards should also follow them to the exit signs. Best wishes Savio

    1. Savio,

      Thanks for visiting the blog. As Montier concluded his case against shareholder value maximization, CFA Institute conducted an instant digital poll of conference delegates, mostly seasoned investment professionals, to get their view. Here are the results.

      How sound or flawed is the idea and practice of shareholder value maximization?
      Both the idea and its practice are largely sound (5%)
      The idea is largely sound but the practice is largely flawed (58%)
      Both the idea and practice are largely flawed (31%)
      Undecided (6%)

      1. Savio Cardozo says:

        Thank you Usman, the poll results are interesting. As you may have seen from the comments on David’s blog post on the same subject, there is some confusion as to what “maximization of shareholder value” means. Given this confusion, your poll results are understandable. Perhaps to illustrate my point, consider the owner of a small business, who is both the shareholder and manager. In this case there can be very little doubt that the manager of this business will be maximizing the value of the business from the shareholder’s perspective since they are one and the same person. When you separate the two into different individuals that is when we introduce the principal agent problem. Add to this the creation of corporate boards and you will see why there is confusion about “whose value is it anyway?”. In the end the buck stops with the owners of the business who should be deciding what value they intend to derive from the business, be it short, medium or long term, and then aggressively enforcing this (as in shareholder activism). They leave this decision and execution to the manager and corporate boards at their peril. An example of this is CP Rail (I live in Toronto), which was muddling along until Bill Ackman came along and issued marching orders to deliver shareholder value. Best wishes Savio

        1. Brad Case, PhD, CFA, CAIA says:

          Well said, Savio, except that I do not accept that owners (or agents truly acting in owners’ interest) can truly seek to maximize short-term value without also maximizing long-term value. If you’re doing something that you hope will maximize short-term value (but that also reduces long-term value, because you don’t care about long-term value) then the short-term value will be less. It’s not that people can’t be fooled, but you’re not truly maximizing short-term value–you’re just fooling people.
          The CP Rail example is a good one: I have been fortunate to have owned stock in that company since before Bill Ackman became involved.

          1. Savio Cardozo says:

            Hello Brad
            You raise an interesting point which tells me that you have either an insight into corporate operations or hands-on corporate operational experience.
            The point you raise is one I am passionate about in the work I do – the long term value of short-term decisions.
            The reason for this is that the immediate future (tomorrow, the next three months or even one year) can be predicted with some degree of accuracy.
            Logical decisions made in the short term can be reasonably expected to add value in the medium or long term.
            However there is a short-termism bias that I am not a fan of, and this aspect is what you also decry.
            One example that I am fond of is British Rail outsourcing its rail maintenance operations until real accidents forced it to decide that this was a core part of their business.
            Another Canadian example is the sale of Bruce Nuclear to British Energy – a good idea on paper but questionable long term sustainability.
            I am pleased to hear that you made money on at least one of your investments in Canada.
            The old boys club is alive and kicking here (we still claim allegiance to the Queen of England so if you are thinking Bertie Wooster waking up at 11A and going to the club – yippers as they say) so you can cherry pick when you have the time.
            Always enjoy your thorough analysis.
            Have a nice weekend
            Savio

        2. Savio,

          Thanks for sharing your views. As I’m sure you can understand, these ideas are of James Montier, my role is of the messenger. I am hoping other readers of our blog would address the point that you have raised.

          1. Savio Cardozo says:

            Hello Usman
            Thank you for your thoughtful responses to what is likely to be a debate we will not solve in our lifetime.
            What is somewhat surprising, and even disconcerting, is that there may be folks that may be managing money for their investors (the seasoned investors that you refer to) that would question what I consider to be a fundamental tenet of corporate governance – the duty to the shareholder.
            I guess I must be missing something.
            I take this opportunity to wish you an enjoyable weekend – it is predicted to be a warm one in Toronto – well, relatively speaking.
            Regards
            Savio

        3. Savio,

          Just to clarify, the instant poll result, that I posted above are not on “the duty to the shareholder” but on shareholder value maximization.

  2. Brad Case, PhD, CFA, CAIA says:

    Hoo boy. Thanks for mentioning the earlier blog discussion, Savio. It’s at http://blogs.cfainstitute.org/investor/2014/09/24/maximization-of-shareholder-value-flawed-thinking-that-threatens-our-economic-future/.
    Usman, I think the best part of your discussion (here and at the 2014 European Investment Conference post) is the survey results you report. It’s hard to argue that corporate executives make mistakes–some of them serious–in their attempts to maximize shareholder value; in fact, much of the economic research that you so denigrate (including the research from behavioral finance) is directed toward documenting ways in which corporate leaders hurt shareholder value, and understanding why they do it, with the implicit goal of avoiding the mistakes that allowed it to happen.
    But it’s equally hard to argue that the goal of shareholder value maximization itself is flawed. Maximizing shareholder value does NOT mean sacrificing the long-term health of the corporation to meet quarterly earnings targets: it means maximizing the long-term health of the corporation.
    Usman, comparing the returns of IBM and Johnson & Johnson over a 42-year period–and suggesting that the only difference between them is that one explicitly and publicly sought to maximize shareholder value and the other did not–is silly. You should be as embarrassed to report the comparison as Montier should have been in making it. His “wider” analysis sounds much more interesting, but I have no idea what he means by “adjusting for changes in valuation independent of shareholder value maximization.”
    Again, the goal of shareholder value maximization is not the problem: apart from manipulation, the stock price is the best measure of the long-term health of the corporation, so maximizing it MEANS taking a long-term view and optimizing all aspects of what the corporation does. If executives are failing to optimize all aspects from a long-term perspective, then they are failing to maximize shareholder value; and if they’re doing so persistently, then they should be replaced.

    1. Brad,

      Thank you for visiting the blog. To clarify the point regarding IBM vs Johnson and Johnson, it is stated that the speaker was illustrating his point with “a” case example. If you watch the video, the speaker does clarify that we cannot be cherry picking, and that’s why there is wider analysis comparing the return of the two periods. Please do have a look at the video, 18:00-19:00. The link to the video is given at the end of the post.

      1. Brad Case, PhD, CFA, CAIA says:

        Okay. Thanks, Usman.

        1. Sarah says:

          Brad,

          Didn’t you miss the whole discussion on incentives? How they are tied to the idea of shareholder value maximization and how they have failed the shareholders?

          Sarah

          1. Brad Case, Ph.D., CFA, CAIA says:

            I didn’t miss it, Sarah: if incentives are badly designed, causing executives to take actions that maximize executive compensation but not shareholder value, then incentives are a problem; but if incentives cause executives to take actions that maximize shareholder value, then they’re a solution.
            Or possibly I’ve mis-interpreted your question?

  3. Timothy says:

    James Montier has got it right. This shareholder value maximization is a dumb academic idea. Is it anything other than self-delusion to believe that paying CEO’s millions of $ in incentives is adding value for shareholders? The point is “maximizing” shareholder value has led to “maximizing” financial incentives for management, it is causing the US economy all kinds of problems. Check out the story on Forbes, The Highest-Paid CEOs Are The Worst Performers.

    1. Thank you Timothy for visiting a blog and sharing your views.

      I think you are focusing on incentives, which, as I understand was also a central point made by James Montier.

    2. Savio Cardozo says:

      Hello Timothy
      As we enter the season of annual performance reviews your comment is timely.
      The only point I would add to it is that CEO compensation can/should be controlled by shareholders.
      To the extent that shareholders do not exercise this right it is difficult to lay blame on the CEO.
      Not all CEOs are bad eggs, by and large they are well compensated for the work they do, the responsibility they bear, and the flak they take.
      Their compensation should be commensurate with the value they add to shareholders – if this is one million or one billion so be it – but the shareholders should decide.
      Have a nice weekend
      Savio

      1. Savio,

        I think it is quite difficult to determine how much economic value is added/deleted by a CEO, isolating it from all the other factors at play.

        1. Brad Case, Ph.D., CFA, CAIA says:

          Yes, very difficult. That’s part of the reason that it’s often difficult to determine why a given company has done badly: maybe the board of directors believes the CEO has done well, and compensates him or her accordingly, but the (unknown) truth is that he or she has made poor decisions.

          1. Brad,

            As I understand, the problematic incentives that James Montier was referring to were largely call options and stock ownership. According to James, research in behavioral finance shows that large incentives do not work as expected, therefore, maximizing shareholder value through such incentives doesn’t work.

          2. Brad Case, PhD, CFA, CAIA says:

            Yes, incentive compensation with option-like payoff structures are often a problem because they make the executive’s interests very different from those of the shareholders. It’s the same thing with performance-based compensation for private equity investment managers (e.g., buyouts, venture capital, private real estate, hedge funds).
            With restricted stock ownership the interests of the executives and the shareholders are perfectly aligned. You point out that there may still be problems if the compensation is simply too large; that’s something I don’t know about.
            The important point for this discussion, in my opinion, is that the problem is not with the goal of shareholder value maximization, but with the means used to further that goal. Basically, badly designed incentives can interfere with it.
            Thanks.

          3. Brad and Raj,

            It seems you have a different point of view on the same issues.

            Brad, is saying that”the problem is not with the goal of shareholder value maximization, but with the means used to further that goal”

            Raj is saying that “the idea that SVM theory is good but the practice flawed seems to me a bit like saying communism is fine in principle, it’s just that it gets let down by (all) the practitioners!”

            You can find Raj’s comment here: http://eic.cfainstitute.org/2014/10/23/shareholder-value-maximization-the-dumbest-idea-in-the-world/#more-6125

            I’m sorry that the comments got divided across the two pages on this post, but it’d be good to post further comments here, if possible.

          4. Brad Case, PhD, CFA, CAIA says:

            Thanks for joining the two discussions, Usman.
            Raj, I think the big difference between the incentive pay situation and the communism situation is in external discipline. If we left it up to company executives (or investment managers) to determine their own pay, they might take everything. We recognize this problem, so the power lies with the shareholders, who discipline them partly by determining their compensation. Communism (by which I mean Marxism) fails because it doesn’t even recognize the incentive problem–so in steps oppressive dictatorship. The difference is that shareholder governance can in principle solve the compensation problem so that executives take actions to maximize shareholder value (thereby maximizing the health of the company), whereas oppressive dictatorship can’t solve the problem.

  4. Per Kurowski says:

    Forget it¡

    In terms of short-termism, and rising inequality, the world’s by far dumbest idea, is the pillar of current bank regulations, namely the credit-risk-weighted capital (equity) requirements for banks.

    That regulation allows banks to earn much higher risk adjusted returns on what is perceived as “absolutely safe” than on what is perceived as “risky”, and therefore distort the allocation of bank credit to the real economy.

    That regulation, as a consequence, give banks no incentives to finance a naturally more risky future, and all the incentives to refinance a day by day less sturdy past.

    And that regulation also blocks equal opportunities, and there is nothing that promotes inequality as much as that.

    http://subprimeregulations.blogspot.com

    1. Per Kurowski,

      You have brought an interesting new angle to the discussion. But one may argue that because commercial banks funds themselves largely by deposits (principal protected), they should largely invest in assets that are also principal protected. For assuming the risk of business outcomes, pass through structures like mutual funds are better suited. You may want to read this short post on “limited purpose banking”: http://blogs.cfainstitute.org/investor/2011/07/12/limited-purpose-banking-can-it-fix-the-financial-system/

      1. Per Kurowski says:

        “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 🙂

        1. Per Kurowski,

          Interesting quote!

          I guess the question remains whether commercial banking is the right “ship” for financing business through equity stake. Or is that best done through pass-through structures.

  5. Cheik says:

    James Montier presented Johnson & Johnson as a company that, unlike IBM, did not switch to shareholder value maximization (SVM).

    Wrong!

    In 2013, US Justice department reported that Johnson and Johnson agreed to pay more than $2.2 billion to resolve criminal and civil liability pertaining to outright corrupt practices (to maximize profit). Just because Johnson and Johnson has retained references on its website to some noble sounding mission does NOT mean that it is following that mission. This $2.2 billion settlement is evidence that Johnson and Johnson is also busy maximizing, going even beyond IBM.

    I agree that SVM is a terrible idea but that comparison of IBM and Johnson and Johnson is not right. We need a more coherent and comprehensive case against SVM.

  6. Cheik,

    Thanks for visiting our blog and posting your thoughtful comment.

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