“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.

For at least the past two decades, Americans have been duped into believing that the sole purpose of a corporation is to maximize value for its shareholders. That belief, first promoted in business schools, has been absorbed in the media, in academic circles, and in the political realm -- even progressives like Al Franken have repeated it as if it were indisputable fact. But in reality, it has no basis in the law or American precedent. The maniacal quest to raise share price is bad for eveyone -- even shareholders themselves. This is why scholars, journalists (most recently, Joe Nocera of the New York Times) and even corporate leaders are coming to the realization that the American corporation has made a wrong turn based on a false ideology. No less than Jack Welch, the former CEO of General Electric and a former enthusiast for shareholder value ideology, has done an about-face, calling it "the dumbest idea in the world."

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Fortunately, there's new movement aimed at challenging the destructive ideology shareholder value. AlterNet has been on the forefront of this movement, publishing a series of articles, "Corporations for the 99%" in partnership with William Lazonick, one of America's top authorities on the American business corporation, who, along with AtlerNet's Lynn Parramore and jouranlist Ken Jacobson, set about debunking this dangerous myth. Cornell University law professor Lynn Stout'snew book, “The Shareholder Value Myth,” is a welcome contribution to this movement -- a must-read for anyone who seeks to understand the relationship between corporations and the public and to learn how to overturn a myth that has done incalculable damage to our society and economy. Below is an excerpt from the Introduction to Stout's book. ~Editor

The Dumbest Idea in the World

The Deepwater Horizonwas an oil drilling rig, a massive floating structure that cost more than a third of a billion dollars to build and measured the length of a football field from bottom to top. On the night of April 20, 2010, the Deepwater Horizonwas working in the Gulf of Mexico, finishing an exploratory well named Macondo for the corporation BP. Suddenly the rig was rocked by a loud explosion. Within minutes the Deepwater Horizonwas transformed into a column of fire that burned for nearly  two days before collapsing into the depths of the Gulf of Mexico. Meanwhile, the Macondo well began vomiting tens of thousands of barrels of oil daily from beneath the sea floor into the Gulf waters. By the time the well was capped in September 2010, the Macondo well blowout was estimated to have caused the largest offshore oil spill in history.1

The  Deepwater  Horizondisaster was tragedy on an epic scale, not only for the rig and the eleven people who died on it, but also for the corporation BP. By June of 2010,  BP had suspended paying  its regular  dividends, and  BP common stock (trading around $60  before the spill) had plunged to less than $30 per share. The result  was a decline in BP’s total stock market value amounting to nearly $100 billion. BP’s shareholders were not the only ones to suffer. The value of BP bonds  tanked as BP’s credit rating was cut from a prestigious AA to the near-junk status BBB. Other oil companies working in the Gulf were idled, along with BP, due to a government-imposed moratorium  on further deepwater drilling in the Gulf. Business  owners and workers in the Gulf fishing  and tourism industries struggled to make a living. Finally, the Gulf ecosystem itself suffered  enormous damage, the full extent of which remains unknown today.

After  months of investigation, the  National Commission on the BP Deepwater HorizonOil Spill and Offshore Drilling concluded the Macondo blowout could be traced  to multiple decisions by BP employees and contractors to ignore standard safety procedures in the attempt to cut costs. (At the time  of the  blowout,  the Macondo project was more than a month behind schedule and almost $60  million over budget, with each day of delay costing an estimated $1 million.)2  Nor was this the first time  BP had sacrificed  safety to save time  and money. The Commission concluded, “BP’s safety lapses  have been chronic.”3

The Ideology of Shareholder Value

Why would a sophisticated international corporation make such an enormous and costly mistake? In trying to save $1 million a day by skimping on safety procedures at the Macondo well, BP cost its shareholders alone a hundred thousand times more, nearly $100  billion.  Even if following proper safety procedures had delayed the development of the Macondo well for a full year, BP would have done much better. The gamble was foolish, even from BP’s perspective.

This  book  argues  that the Deepwater Horizondisaster is only one example of a larger problem that  afflicts many public corporations today. That problem might  be called shareholder value thinking. According to the doctrine of shareholder value, public corporations “belong” to their shareholders, and they exist for one purpose only, to maximize  shareholders’ wealth.  Shareholder wealth, in turn, is typically measured by share  price—meaning share price today, not share  price next year or next decade.

Shareholder value  thinking is  endemic in the business world today.  Fifty years ago, if you had asked the directors or CEO of a large public  company what the  company’s purpose was, you might have been told the corporation had many purposes: to provide  equity investors with solid returns, but also to build great products, to provide decent  livelihoods  for employees, and to contribute to the community and the nation. Today, you are likely to be told the company has but one purpose, to maximize its shareholders’ wealth.  This  sort of thinking drives directors and executives to run public  firms like BP with  a relentless focus on raising stock price.  In the quest  to “unlock shareholder value” they sell key assets,  fire loyal employees, and ruthlessly squeeze the workforce  that remains; cut back on product support, customer assistance, and research and development; delay replacing outworn, out- moded,  and unsafe equipment; shower CEOs with stock options and expensive pay packages  to “incentivize” them; drain cash reserves to pay large dividends and repurchase company shares,  leveraging  firms until they teeter  on the brink  of insolvency;  and lobby regulators and Congress to change  the law so they can chase short-term profits speculating in credit default  swaps and other high-risk financial  derivatives. They do these  things even though many individual directors and executives  feel uneasy about such strategies, intuiting that  a single-minded focus on share  price may not  serve the interests of society, the company, or shareholders themselves.

This book examines and challenges the doctrine of shareholder value.  It argues that shareholder value ideology is just that—an ideology, not a legal requirement or a practical necessity  of modern business life. United States  corporate law does not, and never has, required directors of public corporations to maximize either share  price or shareholder wealth.  To the contrary, as long as boards do not use their power to enrich themselves, the law gives them a wide range of discretion to run  public  corporations with other goals in mind, including growing  the firm, creating quality  products, protecting employees,  and serving the public interest. Chasing  shareholder value is a managerial choice, not a legal requirement.

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 Horizondisaster 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 Timesinterview 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.


Lynn Stout is Distinguished Professor of Corporate and Business Law at Cornell University Law School.