The Myth of the “Shareholder Value Myth”

Stout’s disparagement of “shareholder value” begins with the disconnect between a corporate board’s legal requirement versus its economic imperative.  Contrary to popular belief, boards have no legal obligation to maximize shareholder value.  The evolution of fiduciary duties plus the business judgment rule sets the legal bar far below “maximization,” which leaves directors plenty of leeway to take risks without fear of being dragged into court every time an investment fails.  Stout believes, and I agree, that this legal order has served shareholders and our overall economy very well.  But the reason this low legal bar works is because the board’s economic imperative is far less forgiving.

If you aren’t aiming to maximize returns to your shareholders, then you’re doing something else.  There is nothing wrong with pursuing other social goals that coincide with shareholder value, but if your “success” comes at the expense of your shareholders, you will lose them.  The competition for capital is fierce.  It crosses industry lines and national borders.  It never ebbs or wanes.  There is little room for slacking off in the pursuit of shareholder value.

Stout does not so much disagree with this characterization of the shareholder value imperative as she defines it away.  She asserts that “shareholder value thinking” leads to short-term behaviors and illusory results that don’t actually lead to long-term value creation.  But what Stout is describing is not a goal problem; it’s a knowledge problem.  The market cannot distinguish what managers claim to be a focus on shareholder value versus the reality of their behavior.  If it could make that distinction, it would immediately discount sub-optimal decisions and actions into the stock price.  In other words, Stout rejects management claims that their behavior actually enhances shareholder value, yet accepts their labeling of their bad behavior as “shareholder value thinking.”

She next attacks the practical underpinnings of “shareholder value” with the question “which shareholders?”  She is not the first to suggest that “the shareholder” is an academic construct with no referent in reality, but this misses an important part of reality.  So what if some of your hedge fund investors don’t really care about long-term value creation?  So what if your “social responsibility” investors may not care about shareholder value at all?  If you can’t produce returns to your investors over time, you can’t compete for capital, and your firm will die.  However ephemeral “the shareholders” may seem as a theoretical construct, the life and death of companies based on their ability to generate returns to them is concrete.

Stout’s main evidence of the damage wrought by the pursuit of “shareholder value” is the decline of the public corporation during the last 20 years, when she claims the shareholder value mantra gained ascendancy.  In other words, in a period when more companies seemed to embrace shareholder value, shareholder value has actually stalled, and the number of public companies has precipitously declined, down by 40 percent since their peak in the late 1990s.

We can acknowledge the dysfunctional behaviors Stout cites as among the reasons for this decline, and still see this as an example of correlation without causation.  Many other things have happened in the last 20 years that provide a more compelling explanation for the decline of public companies.  For instance, the short-termism that Stout bemoans is the direct consequence of new disclosure rules that have severely constrained the ability of companies to communicate with their investors, putting an artificially high market focus on earnings announcements.  More generally, corporate regulations have grown like well-fertilized weeds, making it much more costly to become and to remain a public company.  However, at the same time that the “shareholder value” mantra was gaining popularity among the declining number of public companies, it has thoroughly dominated thinking in large private companies, whose number has grown five-fold over the same period, and whose market value has grown even more.

Language has consequences.  Stout’s condemnation of “shareholder value” plays into a larger stigmatization of the idea from anti-corporate critics (of which Stout is not).  The main effect of that stigmatization is likely to be managers edging away from that ideal.  In my experience, encouraging managers to ignore shareholder value unmoors them from the only governing objective that makes sense for a for-profit firm.  In its stead, they substitute fuzzy notions of multiple objectives or stakeholder goals, which effectively means substituting their personal, subjective ideas about what the firm should be doing in lieu of a single-minded concern about what residual claimants will need to see in return for their continued support.  The fact that we can’t perfectly see or quantify shareholder expectations, or perfectly understand how our actions today will translate into returns that they will appreciate, is no excuse for throwing up our hands, and saying we should just do what feels right, regardless of how it will show up to our shareholders in the one number that will, in fact, actually matter to them.