Shareholdersvstakeholders

Anewidolatry
Theeconomiccrisishasrevivedtheolddebateaboutwhetherfirmsshouldfocus
mostontheirshareholders,theircustomersortheirworkers

Apr22nd2010| Fromtheprintedition
THEeraofJackWelchcapitalismmaybedrawing
toaclose,predictedRichardLambert,theheadof
theConfederationofBritishIndustry(CBI),ina
speechlastmonth.WhenNeutronJack(so
nicknamedforhisreadinesstofireemployees)ran
GE,hewasregardedastheincarnationoftheidea
thatafirm'ssoleaimshouldbemaximisingreturnsto
itsshareholders.ThisideahasdominatedAmerican
businessforthepast25years,andwasspreadingrapidlyaroundtheworlduntilthefinancialcrisis
hit,callingitswisdomintoquestion.EvenMrWelchhasexpresseddoubts:Onthefaceofit,
shareholdervalueisthedumbestideaintheworld,hesaidlastyear.
InanarticleinarecentissueoftheHarvardBusinessReview,RogerMartin,deanofthe
UniversityofToronto'sRotmanSchoolofManagement,chartstheriseofwhathecallsthe
tragicallyflawedpremisethatfirmsshouldfocusonmaximisingshareholdervalue,andargues
thatitistimeweabandonedit.Theobsessionwithshareholdervaluebeganin1976,hesays,when
MichaelJensenandWilliamMeckling,twoeconomists,publishedanarticle,TheoryoftheFirm:
ManagerialBehaviour,AgencyCostsandOwnershipStructure,whicharguedthattheownersof
companiesweregettingshortshiftfromprofessionalmanagers.Themostcitedacademicarticle
aboutbusinesstothisday,itinspiredaseeminglyirresistiblemovementtogetmanagerstofocuson
valueforshareholders.Convertstothecreedhadlittletimeforotherstakeholders:customers,
employees,suppliers,societyatlargeandsoforth.AmericanandBritishvaluemaximisersreserved
particulardisdainforthestakeholdercapitalismpractisedincontinentalEurope.
Now,MrMartinargues,shareholdervalueshouldgivewaytocustomerdrivencapitalismin
whichfirmsshouldinsteadaimtomaximisecustomersatisfaction.Thisideaiswinningsome
converts.PaulPolman,wholastyearbecamebossofUnilever,aconsumergoodsgiant,recently
saidtotheFinancialTimes,Idonotworkfortheshareholder,tobehonestIworkforthe

consumer,thecustomerI'mnotdrivenandIdon'tdrivethisbusinessmodelbydriving
shareholdervalue.
Norisitjustcustomerswhoareexpectedtobenefitfromabacklashagainstthecultofshareholder
value.MrLambertreportsthatarecentsurveyoftheCBI'smembersfoundthatmostexpectedthat
amorecollaborativeapproachwouldemergewithvariousdifferentgroupsofstakeholders,
includingsuppliersandtheinstitutionsthateducateworkers.AndaforthcomingbookbyVineet
Nayar,thechiefexecutiveofHCLTechnologies,afastgrowingIndianbusinessprocess
outsourcingfirm,takesaquitedifferentpositiontoMrMartin,asisevidentfromitstitle:
EmployeesFirst,CustomersSecond.
Hastheshareholdervaluemodelreallyfailed,however?Thefinancialmeltdownhascertainly
underminedtwoofthebigideasinspiredbyMessrsJensenandMeckling:thatseniormanagers'
payshouldbecloselylinkedtotheirfirm'sshareprice,andthatprivateequity,backedbymountains
ofdebt,woulddoabetterjobofgettingmanagerstomaximisevaluethanthepublicequity
markets.Thebubblesduringthepastdecadeinbothstockmarketsand,later,themarketfor
corporatedebthighlightedseriousflawswithbothoftheseideas,oratleastwiththewaytheywere
implemented.
Afirm'ssharepriceonanygivenday,needlesstosay,canbeaverypoorguidetolongterm
shareholdervalue.Yetbossestypicallyhadtheirpaylinkedtoshorttermmovementsinshare
prices,whichencouragedthemtotakemeasurestopushthesharepriceupquickly,ratherthanto
maximiseshareholdervalueinthelongrun(bywhentheywouldprobablyhavedeparted).
Similarly,privateequityfirmstookontoomuchdebtduringthecreditbubble,whenitwasavailable
onabsurdlygenerousterms,andarenowhavingtomakevaluedestroyingcutsatmanyofthe
companiesintheirportfoliosasaresult.
InsomewaysthecurrenttravailsofGoldmanSachs(seearticle(/node/15954561))epitomisethe
problem.Theinvestmentbankembracedthemaximisationofshareholdervaluewhenitwentpublic
in1999.Althoughitinsiststhatitdoesnotlivequartertoquarter,seniorfiguresfromitsprevious
incarnationasapartnership,whenitnaturallychampionedthelongterminterestsofitsemployees
(thepartners),arguethatitwouldhavebeenmuchmorewaryinthosedaysofanydealsthatmade
aquickbuckattheriskofalienatingcustomers.But,asMrLambertpointsout,Itwasn'tjustthe
bankswhichhadarushofbloodtothehead.Forafewyears,afairnumberofothercompanies
seemedtoputalmostasmucheffortintomanagingtheirbalancesheetsasintowooingtheir
customers.Inhisview,Ifyouconcentrateonmaximisingvaluetoshareholdersovertheshort
term,youputatrisktherelationshipsthatwilldetermineyourlongertermsuccess.
Yetthisneednotmeanthatthevenerationofshareholdervalueiswrong,andshouldbereplaced
byworshipatthealtarofsomeotherbusinessdeity.Mostofthosepreachingreverenceforother
stakeholdersconcedethatthetwoareusuallynotmutuallyexclusive,andindeed,oftenmutually
reinforcing.MrMartin,forexample,admitsthatincreasedshareholdervalueisoneoftheby
productsofafocusoncustomersatisfaction.Likewise,inIndia'stechnologyindustry,where
retainingtalentedstaffisarguablymanagers'hardesttask,MrNayar'sdevotiontoemployees,

whichhesayshashelpedincreaserevenuesandprofits,maybethebestwaytomaximiselongterm
shareholdervalue.
Inotherwords,theproblemisnottheemphasisonshareholdervalue,buttheuseofshortterm
increasesinafirm'ssharepriceasaproxyforit.Ironically,shareholdersthemselveshavehelped
spreadthisconfusion.Alongwithactivisthedgefunds,manyinstitutionalinvestorshaveidolised
shorttermprofitsandsharepriceincreasesratherthanengagingrecalcitrantmanagersin
discussionsaboutcorporategovernanceorexecutivepay.
Givingshareholdersmorepowertoinfluencemanagement(especiallyinAmerica)andencouraging
themtouseitshouldpromptthemandthemanagerstheyemploytotakealongerview.In
America,Congressisconsideringseveralmeasurestobolstershareholdersatmanagers'expense.In
Britain,theFinancialReportingCouncilhasproposedastewardshipcodetoinvigorate
institutionalinvestors.Thisisaphoneywarbetweenshareholdercapitalismandstakeholder
capitalism,aswehaven'treallytriedshareholdercapitalism,saysAnneSimpson,whooversees
corporategovernanceactivismforCalPERS,America'sbiggestpublicpensionfund.Ratherthan
giveuponshareholdervalue,let'shavearealgoatsettingupshareholdercapitalism.

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