Practical analysis for investment professionals
21 September 2016

Is Shareholder Value Maximization the Dumbest Idea in the World?

For decades, the sole focus of the modern corporation has been maximizing value for shareholders. Their financial gain is the primary focus of the corporate capitalist system.

Is this the best way for a company to achieve sustainable success? Are there other parties who should be taken into account? Is it a zero-sum game between shareholders and other stakeholders, or are their interests aligned?

I recently interviewed Robert Walker, vice president for environmental, social, and governance (ESG) services and ethical funds at NEI Investments, to hear his views on the subject. He has 25 years of experience developing responsible investing products, and has been instrumental in advancing ESG practices in Canadian companies and abroad. At the 2016 Responsible Investment Association (RIA) Conference in Toronto, Walker moderated a panel discussion on maximizing shareholder value.

Anjali Pradhan, CFA: Why do some describe maximizing shareholder value as the dumbest idea in the world?

Robert Walker: Shareholders do not form a homogeneous group, they are heterogeneous.

As a public company, are you trying to satisfy the flash trader or the pension fund that’s going to hold your stock for 60 years? It doesn’t really provide that much guidance to corporate management. Who are you working for? Over what period of time? Which shareholders are you taking into account? It seems very clear on the surface, but in actuality it’s not.

Currently we’re seeing reference to long-term shareholders, which is fair enough. I think that might capture what we mean when we say companies need to take care of their long-term stakeholders.

Shareholders are one group, but there are other stakeholders as well: the local community, company employees, and customers. You don’t want to be poisoning your customers, for example.

There is this idea that shareholder primacy offers dead certainty and that stakeholder theory offers this loosely defined, do-good idea, when actually the opposite is true. There is a fair amount of rigor around identifying who the key stakeholders are and how to engage them. The open question now should be: Is there a hierarchy among stakeholders? I think that’s where this debate over stakeholders has to go.

In the UK, company directors must have a regard for stakeholders, but shareholders are at the top of the hierarchy. If you talk to companies, they like the idea of stakeholders because they don’t want to serve just one group. They recognize the operational risks of focusing on only one stakeholder.

There is a frustration with shareholders to a certain degree due to the demands they place on companies — i.e., don’t miss your earnings estimate otherwise the stock market will kill you. There are a number of surveys of CEOs and CFOs about how this impacts business decision making. A sad majority will sacrifice a long-term investment or R&D budget in order to make sure they don’t miss that earnings estimate, and they know it’s wrong.

McKinsey & Company is working with the Canada Pension Plan Investment Board on a project called Focusing Capital on the Long-Term. This is the same idea — we really need to focus on long-term investing. What is interesting if you read the materials, is that there are quite a number of references to stakeholders so that they could have easily called it “focusing capital on your stakeholders.” The ideas are merging at this stage.

What would you say to an institutional investor that says it is not their fiduciary duty to invest in a socially responsible investment (SRI)?

I would say that’s quite an archaic view. If you’re a mining company trying to extract resources in a region where the local people don’t want you, or [you] face legal barriers, then you’re out of luck. There are a number of examples of companies finding it difficult to get access to resources to exploit.

You can see other issues, other than indigenous rights, such as companies with a poor safety culture. BP is a good example — a rig exploded in the Gulf of Mexico. They suffered a lot as a company, and saw their share price fall through the floor. The failure to pay attention to these kinds of issues clearly can be crippling.

Companies need to pay more attention to them and they are in many cases. They are often ahead of investors because they realize how important these issues are to their operations and their strategy.

How has the issue of indigenous affairs come to the forefront in investing?

The Northern Gateway pipeline by Enbridge was the first project where we felt we had to do a deeper dive into the issue.

In the province of British Columbia, land claims have not been worked out for much of the territory. There’s a question whether this territory has been ceded to the provincial government or another, so the issue has been at the forefront of our minds.

The rise of resource nationalism is not just in Canada, but also in Latin America where different projects have been rejected by national governments and also by regional bodies and local communities.

The ability of local communities to assert their sovereign rights has increased over the last couple of decades. There is a social justice issue. But there’s also the issue that if you are a resource company and you can’t get access to resources, how do you make money? It’s clearly a material issue for companies and their investors.

What is missing that would help mainstream investors embrace responsible investing?

In the retail space, it’s the advisers. They aren’t quite there yet. There has been more attention paid to the plumbing of the system: educating investment analysts and portfolio managers.

The advisers might be the last piece of the puzzle. For a long time, they didn’t have clients asking questions around environmental, social, and governance issues. What I hear now is that they are.

It feels [as though] something has changed. This issue has become important for shareholders, and therefore, is becoming more important for advisers. Luckily, there are now a number of educational opportunities for them to get up to speed.

The global financial crisis and the role that the financial and investment industry played in fostering that crisis have made people think about how to address these types of issues. These profound ethical failures have dropped the entire global economy into the tank. They’ve [become] too obvious to ignore now.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/Jorgenmac

About the Author(s)
Anjali Pradhan, CFA

Anjali Pradhan, CFA, began her career in asset management working for PIMCO, Goldman Sachs, and HSBC. She has held various positions, first in portfolio management and then transitioning to marketing and business development. In addition, Pradhan is co-founder of a consultancy group called Dahlia Capital Advisory that works to help clients in the commercialization of sustainable products and services. While her clients are from across industries, the ultimate focus is on helping investors and asset managers develop and market responsible investment portfolios. Pradhan holds a Bachelor of Commerce degree in Finance from the John Molson School of Business at Concordia University in Montreal.

8 thoughts on “Is Shareholder Value Maximization the Dumbest Idea in the World?”

  1. Savio Cardozo says:

    Hello Anjali
    When Jason Voss raised this subject on this blog sometime back I chimed in then and am still of the opinion that a company should be run only for the benefit of its shareholders.
    Let the shareholders decide what it is important for them, not corporate boards, and certainly not corporate executives.
    Anything else will leave room for playing footsie by board members and executives, and lowered standards of corporate governance.
    To illustrate my point, let’s say you are the sole shareholder of a company with a large environmental and social footprint.
    In whose interest would you like this company to be managed?
    My two cents for the cause.
    Kind regards
    Savio

  2. Your opening premise is dead-wrong: “For decades, the sole focus of the modern corporation has been maximizing value for shareholders. Their financial gain is the primary focus of the corporate capitalist system.”

    For starters, I’ve never understood how to recognize ‘maximization’. How high is maximum.

    More important in my view, the Jensen & Meckling (1976) piece has gotten bum-rap reactions like yours for many years. I can only conclude that your objections, like theirs, are rooted in politics, not in economics or in responsible management.

    Shareholder value-maximization is a result, not a cause. It results from excelling in the performance of the myriad other tasks that any complex business faces every single day. When shareholder value is maximized, so is value to every other constituency–employers, customers, suppliers, and communities.

    Those who support the notion of ‘corporate social responsibility’ fail to understand that the officers of a corporation are likely to make different choices–and, I would argue, self-serving ones, at that–from the choices that the owners of the company would make. Therefore, Left-leaning Democrat Warren Buffett’s career-long practice of refusing to engage in CSR, but instead, to distribute those monies to his shareholders so that they can make better and more-local choices of causes and organizations to support has always struck me as the right one. And if anyone disagrees with that statement and cares to provide specifics, I’d appreciate knowing the names of companies that have a track record of value creation over nearly five decades that is comparable to what Buffett has achieved at Berkshire Hathaway.

    In other words, show us evidence. I won’t hold my breath waiting to see that.

    1. Giorgio Abraini says:

      “the officers of a corporation are likely to make different choices–and, I would argue, self-serving ones, at that–from the choices that the owners of the company would make”

      i think that is the key point. Give the CEO and other Cs stock options, and they’ll try to maximise quarterly earnings (as long as they’re there). Has anyone tried to give them junior subordinated bonds? I bet they’ll make different choices.
      The only way to align the interest of different stakeholders is to give each group of stakeholders a seat at the table.

  3. Fung C.F. says:

    The ideal relationship of a company to its stakeholders are like this…
    Employees – to perform tasks as required in exchange for monetary compensation as well as a progressive career development, if perform well.
    Customers – to make cash payment to company in exchange for good/service that is up to his/her satisfaction.
    Suppliers – to render good/service to the company in exchange for cash payment.
    Lenders – to provide debt funding in exchange for interest income.
    Local communities – company is not obliged but should not cause any social harm to the local communities.

    So, how can the relationship of shareholders with the company is not…
    to provide equity funding in exchange for MAXIMIZATION OF SHAREHOLDER VALUE

  4. Richard says:

    What few will admit is that balancing the interests of shareholders, executives, workers, suppliers, and the community is a zero sum game. When one wins, the others lose. Sorry to bring up a Bernie Sanders example but Walmart, a company whose heirs are among the richest people in America has a workforce whose employees until recently couldn’t afford Thanksgiving dinner.

    The craziness is that we’ve only been in this situation since the early 80s when CalPERS invented shareholder activism. Since then the balance has shifted very heavily to favor shareholders and executives over the other parties involved.

    The consequence is all around us: crumbling infrastructure, stagnant wages, a declining standard of living for many Americans, and troubling concentration of wealth among a very few people. This is not merely of academic interest—too much money in the hands of too few people has toppled many countries.

    Unfortunately academics, economists, and the business press never question the current system; “where will the money come from to pay workers and suppliers, or to invest in their communities?” they plead. “Stockholders would never stand for it.”

    The answer that it’s time to recalibrate the balance away from shareholders and executives and back into communities, suppliers, and of course, workers.

  5. Robert Mudra says:

    Anjali,

    Excellent piece and great comments by Robert Walker at NEI. I think we have to remember that there is still an “agency problem” in corporate America in which, unfortunately, some business leaders put their own personal interests ahead of the longer-term benefit of the corporation, its employees, customers and the communities they serve or do business in.

    In these circumstances, “shareholder value maximization” if often incorrectly used by the bad actors to justify wrong actions that even run counter to the published corporate ethics statements that all employees are generally required to sign. For example, it wasn’t the right thing to falsify vehicle emissions data at Volkswagen…though somebody, somewhere was probably trying to increase market share, drive profits and “maximize shareholder value.” But in the end, shareholder value was destroyed.

    So, what we really need are true leaders of integrity. Call me the optimist but its a lot more fun to design great products and services that really add value and win in the marketplace honestly, which will ultimately benefit the shareholders, employees, customers and the communities that make it all possible.

    ESG and SRI are helpful frameworks for management to use to overcome agency problems as well as to help investors direct their capital away from the bad actors and toward the better performers, who are more likely to win without a major lawsuit, disaster, fraud, etc…

    Bob

  6. Shankar says:

    Useful to also read with Michael Mauboussin and Alfred Rappaport have to say on this topic as they are the pioneers of expectation investing, which set the base for this framework.

    The issue is the concept of competitive advantage period has ceased to exist or if so, reduced substantially due to emergence of disruptive technologies. Hence investments made for the long term tend to get reviewed with a different lens now. I would believe that more than maximisation, it needs to be shareholder value optimisation. I may be accused of playing with words, but I agree with Robert, what is maximum. Also, executive compensation needs to be significantly back ended and annual bonuses need to be capped at much lower levels. Finally, performance review/evaluation has to be more cashflow and EVA based and not EPS based.

    While not relevant, creating shareholder value through buybacks is also a weak sign of managers as it effectively demonstrates inability of management to identify concentric growth and value creating opportunities.

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