Beware the myth of ‘shareholder value’

How do you stop the financial crisis from happening again? By giving more power to shareholders, say many. But the idea that empowering legions of shareholders will lead to better policies is surely a myth.

Cornell law professor Lynn Stout argues that shareholders rarely help in achieving responsible organisations. Her latest book, ‘The Shareholder Value Myth’ looks at the prevalence of the “shareholder value” idea, and concludes that it’s more intellectual fashion rather than rule of business.

“Shareholders have more power today than they’ve ever had, and managers are more accountable. The results have been pretty bad,” she writes. “For 20 years, the corporate governance lobby has responded to every scandal by clamouring for more shareholder power, and by tying managers to share prices.”

Stout traces the obsession with shareholder value back to an article by economist Milton Friedman in 1970. Friedman wrote that the social responsibility of companies is to increase profits. Another highly influential 1976 paper said that shareholders are owners, and managers merely their agents.

In fact, says Stout, shareholders are not “owners”. “As a legal matter, corporations are legal persons that own themselves,” she says. “The relationship between the shareholder and the firm is a contractual relationship, just as someone who works for Apple, or someone buying an Apple bond, enters into a contract. The fact you own Apple shares doesn’t mean you can waltz into an Apple store and take an iPad.”

The “shareholder value dogma” has the effect of turning everyday investors, who would normally support “pro-social” corporate behaviour, into “functional psychopaths”, she says.

“We need to stop teaching that shareholders own corporations, and that companies are well run when managers maximize shareholder value. Legally, it’s quite shockingly incorrect.”

“But there’s also no solid evidence that shareholder power produces better results. In fact, there is some evidence that the more power we give shareholders the worse results we get.”

Stout wants to de-link executive pay and share-price performance, and to introduce a tax on share transfers to discourage short-term holdings. She wants us to re-examine the established beliefs about our market system.

Although the book focuses on the role of shareholders in the US, its core ideas can easily be applied to the UK. Shareholder-value thinking dominates the business world, and many business leaders routinely chant the mantras that public companies “belong” to their shareholders and that the proper goal of corporate governance is to maximize shareholder wealth.

But shareholder primacy has not met its promises, and the idea that more shareholder input will magically resolve these problems is, for most business owners, miles from the reality of responsible business life.

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