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“The Dumbest Idea in the World”: Corporate America's False - and Dangerous - Ideology of Shareholder Value

Part of a critical new movement, Lynn Stout's must-read new book exposes the lie behind the destructive trend of running public companies for the sole purpose of raising the stock price.

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Nevertheless, by the  1990s,  the idea  that  corporations should  serve only shareholder wealth as reflected in stock price came to dominate other  theories of corporate purpose. Executives, journalists, and business school professors alike embraced  the  need  to maximize  shareholder value with near-religious fervor. Legal scholars argued  that corporate managers ought to focus only on maximizing the shareholders’ interest in the firm, an approach they somewhat misleadingly called “shareholder primacy.” (“Shareholder absolutism” or “shareholder dictatorship” would be more accurate.)

It  should  be noted that  a handful of scholars  and  activists continued to argue  for “stakeholder” visions of corporate purpose that gave corporate managers breathing room to consider the  interests of employees, creditors, and  customers. A small number of others  advocated for “corporate  social responsibility” to ensure that public companies indeed served the public  interest writ large. But by the turn  of the millennium,  such alternative views of good corporate governance had been reduced to the status of easily ignored minority reports. Business and  policy elites  in the  United States and much of the rest of the world as well accepted as a truth that should not be questioned that  corporations exist to maximize shareholder value.4

Time for Some Questions

Today, questions seem called for. It should be apparent to anyone who reads the newspapers that Corporate America’s mass embrace of shareholder value thinking has not translated into better corporate or economic  performance. The  past  dozen years  have  seen  a daisy  chain  of costly  corporate disasters, from  massive  frauds  at Enron, HealthSouth, and  Worldcom in the early 2000s, to the near-failure and subsequent costly taxpayer  bailout  of many  of our largest  financial  institutions in 2008, to the BP oil spill in 2010. Stock market returns have been miserable, raising the question of how aging baby boom- ers who trusted in stocks for their  retirement will be able to support  themselves in  their   golden  years.  The population of publicly  held  U.S. companies is shrinking rapidly  as for- merly public  companies like Dunkin’ Donuts and  Toys“R”Us “go private”  to escape  the  pressures of shareholder-primacy thinking, and  new  enterprises decide not to sell  shares to outside investors at all. (Between 1997 and 2008, the  number of companies listed  on  U.S.  exchanges declined from 8,823 to only 5,401.)5  Some experts worry America’s public corporations are losing their  innovative edge.6  The National Commission found that an underlying cause of the Deepwater Horizon disaster was the fact that the oil and gas industry has cut back significantly  on research in recent  decades,  with the result  that  “knowledge  and  experience within  the  industry may be decreasing.”7

Even former champions of shareholder primacy are beginning to rethink the wisdom of chasing shareholder value. Iconic  CEO Jack Welch,  who ran GE with an iron fist from 1981 until his retirement in 2001, was one of the earliest, most vocal, and most influential adopters of the shareholder value mantra. During his  first five years at GE’s helm, “Neutron Jack” cut the number of GE employees by more than a third. He also eliminated most of GE’s basic research programs. But several years after retiring from GE with more than $700 million in estimated personal wealth, Welch observed in a Financial Times interview about the 2008 financial crisis that “strictly speaking, shareholder value is the dumbest idea in the world.”8
 

Revisiting the Idea of “Shareholder Value”

Although shareholder-primacy ideology still dominates business and academic circles today, for as long as there have been public corporations there have been those who argue they should serve the public interest, not shareholders’ alone. I am highly sympathetic to this view. I also believe, however, that one does not need  to embrace either a stakeholder-oriented model of the firm, or a form of corporate social responsibility theory,  to conclude that shareholder value thinking is destructive. The gap between shareholder-primacy ideology as it is practiced today, and stakeholders’ and the public interest, is not only vast but much wider than it either must or should be. If we stop to examine the reality of who “the shareholder” really  is—not an abstract creature obsessed with the single goal of raising the share  price of a single firm today, but real human beings  with the capacity to think for the future and to make binding commitments, with a wide range  of investments and interests beyond the shares they happen to hold in any single  firm, and  with consciences that make most of them concerned, at least a bit, about the fates of others, future generations, and  the planet—it soon becomes  apparent that conventional shareholder primacy harms not only stakeholders and the public, but most shareholders as well. If we really want corporations to serve the interests of the diverse human beings  who ultimately own their  shares  either directly or through institutions like pension and mutual funds, we need to seriously reexamine our ideas about  who shareholders are and what they truly value.

This  book  shows how the  project of reexamining shareholder value thinking is already underway. While the notion that managers should  seek to maximize  share  price  remains conventional  wisdom in many  business circles  and in the press,  corporate  theorists  increasingly  challenge  conventional  wisdom.  New scholarly articles  questioning the effects of shareholder-primacy thinking and  the wisdom  of chasing shareholder value seem to appear daily. Even more important, influential economic  and  legal experts  are proposing alternative theories of the  legal structure and  economic  purpose of public corporations that show how a relentless focus on raising the share price of individual firms may be not only misguided, but harmful to investors.

These  new theories promise to advance our understanding of corporate purpose far beyond  the  old, stale  “shareholders- versus-stakeholders” and “shareholders-versus-society” debates. By revealing how a singled-minded focus on share price endangers many shareholders themselves, they also demonstrate how the perceived gap between the interests of shareholders as a class and those of stakeholders and the broader society in fact may be far narrower than  commonly  understood. In the process,  they also offer better, more  sophisticated, and  more  useful  understandings of the role of public corporations and of good corpo- rate governance that  can help business leaders,  lawmakers, and investors  alike ensure  that  public  corporations reach  their  full economic potential.