The Shareholder Value Myth: A Critical Examination

The idea that a company's sole purpose is to maximize shareholder value has been a dominant force in business for decades. This myth has led many companies to prioritize short-term gains over long-term sustainability.

Research has shown that companies that focus on shareholder value often sacrifice employee well-being and community investment. For example, a study found that companies that prioritize shareholder value tend to have lower employee satisfaction rates and higher turnover rates.

In reality, shareholder value is not a fixed or measurable concept. It's a subjective goal that can be influenced by various factors, such as accounting practices and market conditions. This means that companies can manipulate their financial reports to make it appear as though they're creating value for shareholders.

Many experts argue that the pursuit of shareholder value has led to a culture of short-termism, where companies focus on meeting quarterly earnings expectations rather than making long-term investments in their businesses.

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The myth that shareholders own corporations is just that – a myth. Lynn Stout, a Distinguished Professor of Corporate and Business Law at Cornell, wrote in her book The Shareholder Value Myth that corporations are independent entities that own themselves.

Shareholders own shares of stock in corporations, but they don't own a percentage of the assets or profits. They have a limited set of rights in a limited set of circumstances.

Corporate law doesn't impose any enforceable legal duty on corporate directors or executives of public corporations to maximize profits or share price. This is a common misconception that has been debunked by experts.

Corporations are controlled not by shareholders, but by boards of directors empowered to employ corporate assets toward almost any lawful end. This means that boards have a lot of flexibility in making decisions that benefit the corporation, not just shareholders.

The business judgment rule is a key concept that protects corporate boards from interference by courts. As long as a board can claim its members honestly believe their decisions are best for the corporation in the long run, courts won't intervene.

The myth of shareholder primacy has been perpetuated by influential thinkers, including Milton Friedman, who wrote in 1970 that the social responsibility of business is to increase its profits. He argued that shareholders own the business and that corporate managers should prioritize their interests above all else.

However, this idea is based on a flawed assumption that shareholders are the only ones who matter. In reality, corporations have a broader range of stakeholders, including customers, employees, and the community.

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The shareholder value myth has been debated by economists and business scholars for decades. One of the key arguments against it is that it ignores the interests of other stakeholders, such as employees, customers, and communities.

Some critics argue that the sole focus on shareholder value can lead to short-term thinking and decisions that harm the long-term sustainability of a company. For example, prioritizing quarterly earnings over investments in research and development can stifle innovation.

The concept of "stakeholder theory" has been proposed as an alternative to shareholder value, emphasizing the importance of considering the interests of all stakeholders in business decision-making.

The Shareholder Primacy Theory suggests that a company's only responsibility is to its shareholders, who are seen as the owners of the business. This theory was popularized by Milton Friedman in a 1970 New York Times Magazine essay.

Friedman argued that a company's social responsibility is to increase its profits, and that shareholders could separately spend their money on social actions if they wished to do so. He also stated that there is only one social responsibility of business: to use its resources and engage in activities designed to increase its profits.

The Friedman doctrine became the raison d'être of many business leaders and board members, who summarized it as "maximize shareholder value." However, this theory has been challenged by some experts.

Lynn Stout, a Distinguished Professor of Corporate and Business Law at Cornell, wrote in her 2012 book that the legal case for shareholder primacy is weak. She argued that corporations are independent entities that own themselves, and that shareholders own shares of stock in corporations with limited rights.

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Stout also pointed out that U.S. corporate law doesn't impose any enforceable legal duty on corporate directors or executives to maximize profits or share price. Instead, corporate boards are subject to the "business judgment rule", which allows them to make decisions that may not necessarily benefit shareholders in the short term.

The rise of shareholder primacy thinking began in the 1970s with the Chicago School of free-market economists, who argued that economic analysis could reveal the proper goal of corporate governance. This goal was to make shareholders as wealthy as possible, according to economists like Milton Friedman and Michael Jensen.

The public corporation as we know it today was born in the late 1800s and didn't reach its full maturity until the early twentieth century. This marked a significant shift from private or closely held companies, where stock was held by a single shareholder or small group of shareholders.

In the early 1900s, a new type of business entity emerged, issuing stock to thousands or even tens of thousands of investors. These investors owned only a small fraction of the company's shares.

The publicly held corporation had arrived by the 1920s, with household names like American Telephone and Telegraph (AT&T), General Electric (GE), and the Radio Company of America (RCA). Real control and authority over these companies was now vested in boards of directors.

Boards of directors hired executives to run firms on a day-to-day basis, making them the ones in charge of daily operations.

Robert Greenleaf believed that servant leaders should prioritize serving all stakeholders, not just shareholders. This mindset is reflected in his definition of a servant-leader business, where the company serves those who produce and those who use its products or services.

A key aspect of this approach is economic success, both in the short and long term. The business should be regarded as socially responsible by all interested parties, including employees, vendors, owners, customers, suppliers, and government agencies.

Robert Greenleaf's vision for servant-leader businesses emphasizes the importance of serving all stakeholders, not just shareholders. This approach prioritizes the well-being of everyone involved in the business, from employees to customers.

By adopting a servant-leader approach, businesses can foster a positive and sustainable environment that benefits everyone. This, in turn, can lead to long-term economic success and a reputation as a socially responsible organization.

In the US, courts have consistently refused to hold directors liable for failing to maximize shareholder value.

The Business Judgement Rule affords directors the discretion to act in the manner they deem most appropriate, provided their actions are not tainted by personal conflicts of interest.

Courts have consistently ruled in favor of directors, even when their decisions may seem counterintuitive, such as in the Shlensky v Wrigley case, where the director of the Chicago Cubs refused to install lights for night games, citing concerns for the surrounding environment.

In the Shlensky v Wrigley case, the court ruled that it was not their role to make business judgments when no evidence of fraud, illegality, or conflicts of interests was present.

The Delaware case of Air Products Inc v Airgas Inc. further illustrates this point, where the directors of Airgas refused a lucrative takeover bid by Air Products, despite it significantly increasing the value of the company's shares.

The court in the Air Products Inc v Airgas Inc. case maintained that it is to the directors' discretion to decide what is in the company's best interests in the long term, and that no obligation exists in law to maximize shareholder value in the short term.

In Germany, companies are required by law to prioritize the interests of their stakeholders, not just shareholders. This approach is reflected in the German Codetermination Law, which gives employees a significant say in the company's decision-making process.

The French have a unique approach to corporate governance, with a strong emphasis on social responsibility. This is evident in the country's corporate governance codes, which require companies to consider the interests of their employees, customers, and the wider community.

In the UK, the concept of "enlightened shareholder value" has gained traction, encouraging companies to prioritize long-term value creation over short-term profits. This approach recognizes that a company's success is closely tied to the well-being of its employees, customers, and the environment.

In contrast, the US has a more traditional approach to corporate governance, with a focus on maximizing shareholder value at all costs. This has led to a culture of short-termism, where companies prioritize quarterly earnings over long-term sustainability.

The Nordic countries, including Sweden and Denmark, have a strong tradition of social responsibility and stakeholder engagement. Companies in these countries are expected to prioritize the interests of their employees, customers, and the wider community, alongside those of their shareholders.

The shareholder value myth has its roots in the philosophical and ideological aspects of corporate governance. Milton Friedman's 1970 article "The Social Responsibility of Business is to Increase its Profits" argued that businesses have a sole responsibility to maximize shareholder value.

This idea has been perpetuated by the Efficient Market Hypothesis (EMH), which suggests that financial markets are informationally efficient and that prices reflect all available information. The EMH has been widely accepted and has influenced the way companies are managed.

The pursuit of shareholder value has led to a focus on short-term gains, often at the expense of long-term sustainability and social responsibility. As seen in the example of Enron, prioritizing shareholder value can lead to catastrophic consequences when companies prioritize profits over people and the environment.

Stakeholder Theory is a concept that has been around since the 1960s, with R. Edward Freeman being considered the "father of stakeholder theory" after publishing his book "Strategic Management: A Stakeholder Approach" in 1984.

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The primary stakeholders for a business are generally considered to be customers, employees, suppliers, communities, and shareholders. In stakeholder theory, companies should not ignore these constituencies, and they shouldn’t maximize for one group (such as shareholders).

Freeman's theory argues that companies impact various stakeholders that have an “interest or concern in an organization.” This means that businesses should consider the needs and interests of all their stakeholders when making decisions.

According to stakeholder theory, companies should reasonably balance their responsibilities to their primary stakeholders, rather than prioritizing one group over the others.

Here are some key reasons why stakeholder theory makes sense:

Ideology Appeals because it taps into our deep-seated desires for meaning and purpose.

Our brains are wired to seek patterns and connections, and ideology provides a sense of coherence and unity that can be incredibly appealing.

Ideology can also be a powerful tool for social bonding, as it creates a sense of shared identity and community among its adherents.

People are more likely to be drawn to an ideology that resonates with their existing values and beliefs, making it a personal and relatable experience.

Ideology can also serve as a coping mechanism for uncertainty and chaos, providing a sense of control and order in a complex world.

By offering a clear and simple explanation for the world, ideology can be a comforting and reassuring presence in our lives.