Three Longs & Three Shorts

Shareholder value isn’t past its sell-by date as a corporate goal

We featured a piece a couple of weeks ago, reigniting the debate on whether the sole purpose of a corporate is to maximise shareholder value like Friedman brought to believe in his now famous essay 50years ago or to deliver value to all stakeholders – workers, suppliers, environment and the society at large. In this piece for the Project Syndicate, Raghuram Rajan, the former RBI Governor and a Professor at Chicago’s Booth School of Business, says it needn’t be an either-or as the two can be self-reinforcing if the objective is framed properly:
“A corporation’s stated objectives should help guide its choices. If all stakeholders are essential, then none are. In an attempt to please everyone, the Business Roundtable will probably end up pleasing no one. Recent evidence even suggests that the corporations that signed on to the group’s “stakeholder capitalism” statement have been more likely to lay off workers in response to the pandemic, and less likely to donate to relief efforts.
…there is a deeper argument for Friedman’s view, based on the recognition that managers will not necessarily squeeze everyone else to favour shareholders. Because shareholders get whatever is left over after debt holders are paid their interest and workers their wages, management can maximize shareholders’ “residual claim” only if it expands the size of the corporate pie. To the extent that management must satisfy everyone else before looking to shareholder interests, it already does maximize value for all.
True, some would counter that the imperative to boost quarterly profits leads to cost cutting in areas like worker training. But if companies want to maximize their shares’ value, they will train workers, encourage sustainable practices from their suppliers, and foster lasting relationships with customers instead of ripping them off. Put another way, even if CEOs do focus primarily on share prices, that doesn’t mean the stock market only rewards actions that boost this quarter’s earnings. Amazon showed little profit for years, but is thriving because it invested so much in its business.
Moreover, when quarterly results do affect share prices, it is often because the short term has been interpreted as a credible reflection of the long term. By the same token, instead of trying to boost short-term profits by sacrificing the long term, corporate managers would do better to explain their strategy and encourage investor patience. And if market analysts do not buy their argument, perhaps they have a point, and new management may be in order. It is up to good corporate boards to decide. They can certainly encourage managers to take a longer-term view. Vacuous statements about serving all stakeholders need [not] be issued.
as a recent McKinsey & Company report shows, more corporations are becoming “purpose-driven.” Among the benefits are stronger revenue growth (by attracting socially conscious customers), greater cost reduction (such as through energy or water efficiency), and better worker recruitment (making “doing good” an employment perk).”
So, in effect, there is no debate in the first place as long as long term shareholder value is not confused for short term shareholder profits. However, there are conflicts of interests to be resolved:
“None of these targets is at odds with the objective of maximizing shareholder value. Corporate purpose is useful only insofar as it enthuses critical constituencies. If purpose is meant to please everyone, however, it will introduce an impossible standard and backfire. The key is for management to make clear how it will choose between different constituencies when trade-offs must be made.
For example, when Google withdrew from a US government program to develop artificial intelligence for military purposes, it signalled that its employees’ objections were more important than the interests of a large, lucrative client. As a result, Google employees and customers all have a better sense of how the company weighs their interests.”
However, Rajan warns against corporations crossing the boundaries, especially on political issues:
“…there is the growing issue of corporate political influence and speech. Many stakeholders now want companies to weigh in on issues such as the restrictions on LGTBQ+ rights in some US states. Generally speaking, interventions outside a company’s business interests raise questions of legitimacy: Whose views are being represented? Management? But managers were appointed for their competence to run the firm, not their political views. Stakeholders? Which set and on what basis?”