Joe Nocera had a great column recently on shareholder value, based in part on a recent feature we published in HBR. In it, he pauses to consider why the idea of putting shareholders first might ever have made sense to anyone other than investors:
It seemed like such a good idea at the time, back in the late 1970s and 1980s. For too long, the compensation of top executives was disconnected from any performance criteria, including whether they made money for shareholders. CEOs did pretty much whatever they wanted, with no fear of consequences. Thus, companies that needed to slim down, wouldn’t. Companies that needed to deploy capital more intelligently, didn’t. Executives who should have been fired, weren’t.
But, as Nocera writes, be careful what you wish for.
In “The Error at the Heart of Corporate Leadership” in HBR, Joseph Bower and Lynne Paine take issue with shareholders’ primacy, writing that:
We are concerned that the agency-based model of governance and management is being practiced in ways that are weakening companies and—if applied even more widely, as experts predict—could be damaging to the broader economy. In particular we are concerned about the effects on corporate strategy and resource allocation. Over the past few decades the agency model has provided the rationale for a variety of changes in governance and management practices that, taken together, have increased the power and influence of certain types of shareholders over other types and further elevated the claims of shareholders over those of other important constituencies—without establishing any corresponding responsibility or accountability on the part of shareholders who exercise that power. As a result, managers are under increasing pressure to deliver ever faster and more predictable returns and to curtail riskier investments aimed at meeting future needs and finding creative solutions to the problems facing people around the world.
Instead, they put forward a “company-centered” model:
A better model, we submit, would have at its core the health of the enterprise rather than near-term returns to its shareholders. Such a model would start by recognizing that corporations are independent entities endowed by law with the potential for indefinite life. With the right leadership, they can be managed to serve markets and society over long periods of time.
It is helpful to remember, as Nocera does, why shareholder primacy might have ever been appealing. But I’m squarely with Bower and Paine that it’s gone much too far. (Whether agency theory has been a productive academic framework for studying firms is a separate question.) I’m a bit less convinced that activist investors are the primary culprit (see here, here, here, here) and the question of whether firms are too short-term focused remains a matter of debate (see here, here, here) but these are quibbles. Shareholders are taking home a larger and larger share of the economic pie, and that’s a deeply troubling phenomenon.
My favorite formulation in the Bower/Paine piece is this one:
It is important to note that much of what activists call value creation is more accurately described as value transfer. When cash is paid out to shareholders rather than used to fund research, launch new ventures, or grow existing businesses, value has not been created. Nothing has been created. Rather, cash that would have been invested to generate future returns is simply being paid out to current shareholders.
This is the right way to think about companies’ job in the economy: to create real economic value, not just paper value, and not just to transfer value from one group to another. The main way to create value is through innovation. But would a move away from shareholder primacy help or hurt?
In one view, a move away from shareholder primacy helps innovation, as companies feel free to reinvest profits into R&D, and to spend more on training workers. In another view, absent pressure from shareholders incumbents get too cozy, and a “company-centered” model prioritizes the needs of existing organizations over the creation of new ones. That latter situation would be a problem, since we have good evidence linking firm entry and exit with economic growth and job creation.
I see no reason why a move away from shareholder primacy should lead to a less dynamic economy; the opposite seems more likely. You can imagine a 2×2 matrix, with Dynamic/Complacent on one axis and Shareholders-First/Balanced on the other. Over the past 50 years, the U.S. economy moved from the Balanced side of the grid toward Shareholders-First. There’s at least some evidence that the economy became less dynamic over that very same period of time.
Dynamic+Balanced clearly seems like the best part of the grid to be in. Putting the interests of shareholders on a more equal footing with the interests of employees, customers, and broader society seems like a step in the right direction.