Shareholder Value: Outdated and an Obstacle to Corporate Success

The pursuit of increased shareholder value is much overrated, may hurt corporations and is certainly not the legal requirement some CEOs hold it to be.

In her book The Shareholder Value Myth, legal scholar Lynn Stout of the Clarke Law Institute at Cornell University Law School spells out that under current US legislation boards of directors are beholden to the corporation only. Hence, they are to balance the interests of all stakeholders: Workers, customers, creditors, suppliers, society and – yes – shareholders.

Though recent court rulings and a few legislative initiatives seem to favour shareholders, the primacy of their interest is by no means established in US law. Indeed the notion that shareholder value must reign supreme is a relatively new one.

As a corporate ideology, shareholder value was first proposed at the University of Chicago in the late 1960s. It was seen as a way to revert the worrying decline in the competitive prowess of US industry. At the time it seemed to make some sense: Force executives out of their complacency (and ivory towers), have them pay more attention to the bottom line and encourage risk-taking and innovation.

However recent academic studies conclude that shareholder value as a guiding principle has now run its course. The latest financial upheavals have clearly shown that the more a bank is beholden to its shareholders, the likelier it is to fail and become the recipient of public bailout monies. A misguided focus on shareholder value must be added to the roster of causes for the crash.

“However recent academic studies conclude that shareholder value as a guiding principle has now run its course.”

The body of empirical evidence undermining the wisdom of pursuing shareholder value is impressive. Since the notion took hold in the 1990s and became the guiding principle of corporate America, the performance of the stock market has been lacklustre at best while the number of publically traded companies has declined sharply.

The UK, where shareholders have a bigger say than most anywhere else, saw its corporate sector shrink close to insignificance. It now can claim only three spots on Fortune Magazine’s list of the hundred largest corporations in the world (two of which – Shell and Unilever – it has to share with the Dutch).

Business-guru Jim Collins, formerly a professor at Stanford University, has found that in the long run the most successful corporations are those that are guided by broader goals and principles than shareholder value only. According to Mr Collins maintaining a narrow focus on a return on equity does not ensure success and indeed might hamper a corporation’s growth and profitability.

Another complaint levelled against the relentless pursuit of shareholder value is that it might not be best for society at large, particularly when corporations exploit natural resources or depend on public trust as is the case with banks.

Furthermore, it doesn’t seem sensible to elevate shareholders, who may – and often do – sell their interests at a moment’s notice, to a position of maximum authority. A corporation at the mercy of jittery or fickle shareholders will find it difficult to credibly commit to any long-term plan or policy.

Former General Electric CEO Jack Welch in 2009 famously remarked that shareholder value is “the dumbest idea in the world”. While that may be somewhat of an overstatement, fact remains that it certainly is no panacea for the challenges faced by corporations today.

The current trend to award more and more power to shareholders, even in the face of monumental failures, is rather worrisome. Corporate responsibility and corporate community involvement – the central theme in the upcoming CFI.co issue – demand a more balanced approach and, perhaps, a rethinking of the corporations’ role in society.