The Shareholder Value Myth (2013)

http://www.europeanfinancialreview.com/?p=883

by Tomte • 8 years ago

104 83 8 years ago

I think the contribution of the shareholder value myth to overall economic inequality also bears mentioning. When companies optimize for short-term share price, the primary beneficiaries are short-term traders and activist investors, that is, people who already have a lot of money; employees generally suffer, as do small investors who tend to invest for the long term.

_ptgt• 8 years ago

I hear the bogeyman of "short-termism" brought up a lot here, but how accurate is this characterization of investor behavior actually?

The best performers in today's market are decidedly not short-term focused. Amazon and Netflix barely turn a profit, even though they could. Ditto for Tesla (well, maybe they couldn't atm even if they wanted to). The entire tech sector, which has been on a tear, is similarly long-term focused. Snap's stock, for example, isn't being hit because it's not profitable, but it's getting hot because its user base is plateauing (i.e. negative long-term signal).

Do a lot of (most?) companies focus on the short-term? Definitely! But that's rational behavior even from a societal resource allocation perspective. Imagine you're Walgreens, Target, P&G, Kroger, JCrew, or one out of another thousand "boring" (i.e. low upside) companies (like most others). If the upside at your company is limited, why throw money money at "long-term" thinking? It makes more sense to maximize profits now and return profits to shareholders who will in turn invest in the Amazons, Googles, Teslas, etc. who have the technological infrastructure and human capital to generate better returns per dollar of long-term spending.

The end result (which is happening) is that most companies by volume focus on the short-term because most companies in the US are working in a mature market with a well-explored product and have limited upside, while a small number of companies with large upside get a disproportionate share of investment.

hakfoo• 8 years ago

I suspect the problem with Snap specifically is less the user plateau itself, and more that it changes the discussion about profitability and value.

As long as the user base is growing exponentially, most questions about valuation and revenue can be hand-waved away. It's a bit dot-com boom still, maybe crossed with a too-big-to-fail mindset, but if the CEO says "our service has 2 billion users, growing 10% quarterly" that still pacifies a lot of investors without any further concern about revenue-per-user. If you've got enough eyeballs, somehow money materializes.

Once we figure out that, say, "Peak Snapchat is 180 million users +/-10%", it becomes a lot more quantifiable to figure out "each user had to generate $23.45 of value per month to justify the company's valuation." And that means asking hard questions about the business.

As for long-term and short-term investments, the more I think about it, the more the "technical debt" concept seems like it has real value for thinking about companies.

A lot of firms take on the corporate equivalent of technical debt all over the place. Deferring maintenance or extending equipment lifecycles, cutting back on training programs that yield cheap promote-from-within employees. Renting knowledge they should own (excessive consultancy and third-party service providers). It always comes back to "let's polish some stuff in the short term, and if we're lucky it won't hurt our long term viability too much." A focus on maximum dividends is likely being bought with at least some technical debt.

Of course, this type of debt never appears on a balance sheet for investors.

usrusr2• 8 years ago

Your point about how Netflix and the like are quite the opposite of short term profit maximizers is a very interesting one, because they apparently are not what people expect when lamenting the absence of long-termism (otherwise there wouldn't be much absence to lament), quite the opposite actually.

So what is that difference? It must be long term bets vs long term stability. A long bet can only be consumed in the literal sense, by selling, until there is nothing left. Whereas a dividend producer will keep producing until failure. It's almost like give a fish/teach to fish. A good portfolio of bets may well be more profitable overall than a bunch of dividends producers (and thanks to the market, we can cash in on those bets at or own pace! (and even bet on greater fools, but that's a different story well deserving of double-nested parens)).

But in the context of retirement, there is one important difference: the cashing in of bets forces us to think about our mortality when we plan our payout (no matter how formal or not the payout plan is), whereas with dividend producers this is only an optimal (even if important) optimization.

With a sufficiently wide spread and high volume, you could realistically live off whatever meagre or fat harvest your retirement package provides each year, and leave all dreams and worries about valuation to your future inheritors. It would not matter at all wether you'd live five years into your retirement or fifty.

bobthepanda3• 8 years ago

The problem is that companies that just chugged along and paid a dividend have basically died out in favor of companies that borrow against their long term profits for not a lot of upside other than short-term boosts in share price. A lot of recent failures and bankruptcies can be attributed to this phenomenon.

grosjona• 8 years ago

> Amazon and Netflix barely turn a profit, even though they could

Could they? That is speculative. Nobody knows what would happen if these companies started increasing their profit margins. It definitely would affect consumer behaviour in a negative way; we just don't know how significant the impact would be.

Also, I don't think that the strategy of trying to monopolize the entire world economy under a few central authorities is going to work in the end so in that sense maybe Amazon and Netflix actually do think short term.

skookumchuck7• 8 years ago

If a company focuses on the short term to the detriment of the long term, the investors will figure that out and the stock will tank. The only way short term-ism can be profitable to shareholders is if the people selling at the high have inside information that the company is hollowed out.

I seriously doubt that subterfuge can be perpetrated successfully quarter after quarter.

zby2• 8 years ago

Matt Levine repeatedly writes about it with a very good explanation: it would be strange to think that companies should always grow - from time to time there are better investment opportunities outside the company and it makes sense that in such circumstances the company returns money to the shareholders so that they can invest it somewhere else. That outflow of money from the company to the market is interpreted as short-termism - because buying shares by the company looks as if the company tried to increase its share prices instead of making investments.

jonhendry183• 8 years ago

Private equity firms are notorious for being focused on the short term, to the point of doing LBOs to acquire firms and in the process encumbering the acquired firm with a debt load that cripples its ability to compete.

The PE firm may also make the acquired company take on additional debt in order to pay dividends. Or it may sell off assets of the company in order to take dividends out.

The PE firm doesn't get hurt if one of their looted companies goes bust, so there's no incentive to keep the acquired company healthy and viable. PE firms are like parasitic wasp larvae eating their prey from inside.

Just this year this sort of thing drove Toys R Us out of business, and iHeartMedia into chapter 11 bankruptcy.

foobarian• 8 years ago

It always bugged me how vague the rule was. Without specifying a time window the maximization doesn't mean anything.

AmericanChopper6• 8 years ago

The shareholders themselves specify the time window by exerting control over the board, and by selectively investing in companies that coincide with their own objectives.

nitwit005• 8 years ago

If you meet the expectations of the first group of shareholders, by raising the value of their stock as they wanted, they'll just sell to a new group that expects another increase.

AmericanChopper6• 8 years ago

I can’t believe that somebody could write a whole book based on such a contrived premise. Shareholders don’t control a company? They do, they control who sits on the board, and the board controls the company. Shareholders aren’t entitled to a company’s profits? They’re entitled to its dividends, if they think the company isn’t paying enough dividends they can elect a new board. Shareholders don’t own a company? They own its profits and they control its decision making. Some semantic of the word “own” is pointless. You could argue that shareholders don’t often exert this control against incumbent management, but that is only because management most often respect shareholder primacy. When shareholders invest their savings in public companies they’re trusting them to grow those savings. If you’re not operating in the interest of shareholders, then your public company will not survive long.

JumpCrisscross• 8 years ago

Business owners don’t have singular goals. Neither do shareholders. Profits are important. But short-term earnings aren’t everything, to whole business owners nor shareholders. Some managers like to pretend they are, because hitting a single quantitative short-term goal is easier than running a business, and that’s the problem discussed here.

AmericanChopper6• 8 years ago

Did you read the article? Because that’s pretty tangential to most of what it brings up. It’s also not an accurate description of reality. Different investors have different horizons, and different companies operate with different horizons for their missions. If there’s any myth here it’s that all investors are singularly focussed on the next quarters profits, or even that most of them are. Most of the people on this board have probably worked at a company with a cap that’s 20x it’s revenue, or at least know somebody who has. There’s a whole sector of investors who are willing to invest in companies that lose money year after year on the premise that they may one day make a profit.

ThatMightBePaul• 8 years ago

Actually, they are NOT entitled to dividends. That's part of the myth, and is covered in the book. You should give it a read. The author covers some historical cases which are often misinterpreted, and lead to the confusion. In the case of dividends entitlement, the case you're drawing from is https://en.wikipedia.org/wiki/Dodge_v._Ford_Motor_Co.

She's a lawyer and professor in precisely this area. You could read the wikipedia article, and try to confirm your bias. Or, you can read the book, written by an expert, and broaden your perspective.

AmericanChopper6• 8 years ago

You’re (perhaps intentionally) confusing profits and dividends. Based on the type stock a shareholder owns, they are absolutely entitled to their share of dividends.

The authors point is that a company is not obliged to pay all its profits in devisends. Without any proper explaination, the author draws the conclusion that shareholders aren’t entitled to any of the companies profits. This completely ignores to irrefutable truths

1) Not paying dividends does not automatically mean not maximising shareholders benefit. There’s unlimited ways a company can invest their profits in things other than dividends that will still benefit shareholders.

2) The shareholders control the company’s decision making. They elect the board, and the board controls the entire company.

The authors entire argument relies on pointless semantics and a highly selective view of reality. The same selective view you’ve displayed by acting as if profits and dividends are the same thing, and ignoring corporate governance structures.

analog312• 8 years ago

Shareholders don’t control a company? They do, they control who sits on the board, and the board controls the company.

Well, yes and no. The best or most powerful negotiator controls the company, and everybody who has an interest in the business (investors, creditors, employees, customers, suppliers, the public) can seek the power to manipulate the company on behalf of their own self interest. Shareholders can certainly partake in that process as well. But there's no law that guarantees that their interests have primacy over those other groups.

AmericanChopper6• 8 years ago

Being a good negotiator isn’t going to overturn a shareholder vote or a board decision. You’re trying to say that corporate governance doesn’t exist because in some cases it can be inefficient.

elvinyung5• 8 years ago

Here's a weird, slightly roundabout analogy I like to use.

The premise of the paperclip maximizer thought experiment is as follows: suppose you program a (sufficiently advanced) robot to maximize the number of paperclips. It might start by -- reasonably -- collecting all the paperclips it could find, and bringing them to you.

But after it does that, it might also realize that it could convert other things into paperclips — things like raw metal, other machines, and the atoms in the human body.

Basically, the paperclip robot says "maximize the number of paperclips at all costs." The corporation says "maximize shareholder value at all costs."

How can you be sure that the goals you've programmed into a sufficiently-complex system are actually beneficial to the people using the system?

marcosdumay• 8 years ago

As long as you keep wealth disparity under control, make sure people don't get stuck in poverty, correctly tax externalities, enforce honest marketing, and deal with a lot of other small details, shareholder value maximization is nearly optimal in being beneficial to the people using the system.

As a bonus, it also creates a nice incentive for saving and investing into the future. What is hard to achieve on most systems.

elvinyung5• 8 years ago

Yes, as long as...

I totally agree that checks and balances -- in the abstract, some form of all-to-all coordination between the different components of the system -- are probably the easiest way to healthcheck any system like this. Otherwise you fall into "multipolar traps" [1] where each actor, working independently and acting game-theoretically optimally, can throw the system into undesirable states.

Checks and balances should be implemented. But is this adequately true in the actually-existing implementation of the system?

[1] https://slatestarcodex.com/2014/07/30/meditations-on-moloch/

jtolmar• 8 years ago

Shareholders and keeping wealth disparity under control are at odds. As long as people are able to buy investments and own the profits of those investments, those people are paid proportionate to how much money they have, making their wealth over time an exponential function, which is inherently unequal even to other exponential functions with slightly different rates of return, and even more unequal to anyone stuck making money linearly by selling their labor.

I'd love to hear a good solution for this within a market system.

jopsen2• 8 years ago

Lol, I would wager that shareholder value maximization is far from "optimal"!

In the face of poor human judgement it might be one of the more robust resource allocation schemes available to us. But optimality should never be claimed without proof.

closeparen2• 8 years ago

How can you be sure that the goals you've programmed into a sufficiently-complex system are actually beneficial to the people using the system?

An impossible task indeed. That's the great thing about a market. The system designer doesn't have to understand what "actually beneficial" means, and participants don't have to take their word for it. People don't sign over value to companies unless they value what they're getting in return.

miketery• 8 years ago

While good in principal and as good as we can get today, we need to be aware of it's flaws. In particular, that certain stakeholders can manipulate, or have outsized influence on the market, as a result the system no longer operates as efficiently as it could, it begins to atrophy more or less.

I guess this is why we hold on dearly to principals of liberty and freedom. To ensure that proper feedback mechanisms exist to keep an honest system.

Edit: and rule of law. Especially application of said law without preferential treatment.

elvinyung5• 8 years ago

What is your measure of "good"? Are you putting the people before the system, or the system before the people?

mrow84• 8 years ago

My wife's sister is a paediatric oncologist in India. People come to her when their kids get sick, and she does her analysis and gives them a diagnosis, which might be that there is a fairly high probability that their child is going to die. Sometimes people go away and get Ayurvedic "treatments" for their child's cancer, which claims an efficacy of 100%. After those "treatments" have failed, the parents return, now with children who were much more sick than before, and often when there is nothing that can be done, and so they end up watching their children die.

All of which to illustrate why even though this statement:

People don't sign over value to companies unless they value what they're getting in return.

reads as convincing, when taken in isolation, it actually says very little when held up against the harsh light of reality. Optimising towards a stupid goal is still stupid.

_bxg1• 8 years ago

This is why regulation is necessary for capitalistic organizations to have a net positive effect on society. Companies are fantastic at maximizing profits (through productivity and efficiency), but that's far too simplistic a goal to not become destructive at some point.

Regulation by the government - the representative of the actual society, instead of just a handful of shareholders - channels the raw energy of capitalism towards the good of society through incentives and penalties (against companies' profits, their sole motivators). Otherwise corporations are just a bunch of really big dogs chasing cars, leaving destruction in their wake.

anticensor4• 8 years ago

companies' profits, their sole motivators

Their primary motivators. You cannot profit in exchange for nothing. It is always profit/loss in exchange for a particular business.

crazygringo2• 8 years ago

What’s more, directors viewed themselves not as shareholders’ servants, but as trustees for great institutions that should serve not only shareholders but other corporate stakeholders as well, including customers, creditors, employees, and the community.

Citation needed. This sounds like rose-colored glasses to me. I don't believe such a golden age ever existed.

Nor was share price assumed to be the best proxy for corporate performance.

Since when have shareholders cared about anything except getting rich?

Many corporations formed in the late eighteenth and early nineteenth centuries... They structured their companies to make sure the business would provide good service at a reasonable price – not to maximize investment returns.

Somebody tell the robber barrons this? They apparently didn't get the message.

It was once believed (at least by academic economists) that the market price of a company’s stock perfectly captured the best estimate of its long-term value. Today this idea of a perfectly “efficient” stock market has been discredited...

Citation needed again. Because if anybody has a better idea of how to judge companies' long-term value, then they'll become extremely, extremely rich.

I'm sorry, but this article is absolute nonsense.

There are valid reasons why one might argue that the end goal of corporations shouldn't be to maximize shareholder value, and how governments should create policies towards that end, but this article doesn't even begin to touch on them...

usrusr2• 8 years ago

Since when have shareholders cared about anything except getting rich?

How about staying rich? The idea of providing non-trading shareholders with a reliable stream of dividends for the rest of their lives is very different from that of looking good in fashionable metrics to maximize stock price now.

crazygringo2• 8 years ago

To repeat what I said above: if you can figure out how to distinguish those two, then you'll become extremely, extremely rich. Good luck! :)

learc83• 8 years ago

Many corporations formed in the late eighteenth and early nineteenth centuries... They structured their companies to make sure the business would provide good service at a reasonable price – not to maximize investment returns.
Somebody tell the robber barrons this? They apparently didn't get the message.

Your ellipses left off the qualifiers. The author isn't talking about all companies. They are specifically talking about companies that were founded in part to provide services for investors as opposed to just return on investment--companies where people invested because they wanted the company to exist so that they could be customers. There's even a citation for this in the foot notes.

CamTin2• 8 years ago

Pre-breakup AT&T is a tangible example for people old enough to remember. AT&T shareholders certainly did well with their monopoly position, and the early days of the Bell System were certainly not public-spirited (the company directors were Yankee misers in the mold of Venderbilt, though not on as grand a scale), but eventually the Bell System became, as a regulated monopoly, not appreciably different from any other arm of government. The Bell System breakup was roughly equivalent to a privatization of a national industry ala British Rail rather than a trust-busting ala the Standard Oil breakup.

There is an excellent John Books (of /The Go-Go Years/, among others) tome on the subject, published just before the breakup: https://www.goodreads.com/book/show/1323717.Telephone

phkahler• 8 years ago

> > Nor was share price assumed to be the best proxy for corporate performance. > Since when have shareholders cared about anything except getting rich?

You get rich by taking the profits of the company through dividends. Anyone trying to get rich from selling the stock is playing the greater-fool game.

Share price is nice, but it's not the best game to be playing.

andyidsinga• 8 years ago

"Closer inspection thus reveals the idea of a single “shareholder value” to be a fiction. Different shareholders have different values"

This is great when arguing with someone in the office who emphatically states "we need to maximize shareholder value!"

response: which shareholder: short term? long term? diversified? non-diversified? customer shareholders?

m12k• 8 years ago

This reminds me of one of the concepts from Zen in the Art of Archery - by focusing too much on wanting to hit the target, you're not using your full attention on perfectly performing the actions that would actually allow you to hit the target.

baybal22• 8 years ago

Unlike what popular opinion suggests, there, there is no legal requirement for directors to maximize shareholder value. In USA, as far as I know, there is not a single law saying that.

Unless something like that written in big, bold letters in company's charter, there is literally nothing like that a director of public company should care about.

torstenvl4• 8 years ago

Have you performed a fifty-state survey on this?

How do you square your assertion with Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) and the subsequent need to enact section 102(b)(7)?

anticensor4• 8 years ago

That only applies immediately before insolvency or immediately after acquistion. Primary motive does not mean no action of a corporation is allowed to lower its short term profit.

anticensor4• 8 years ago

written in big, bold letters in company's charter

Banks and insurance companies have that.

sonnyblarney3• 8 years ago

This article is riddled with bad logic and makes no reasonable assertions, in fact some of them fare just false.

We can have a debate about 'shareholder primacy' but this is not it.

"Consider first Friedman’s erroneous belief that shareholders “own” corporations. Although laymen sometimes have difficulty understanding the point, corporations are legal entities that own themselves, just as human entities own themselves. What shareholders own are shares, a type of contact between the shareholder and the legal entity that gives shareholders limited legal rights. In this regard, shareholders stand on equal footing with the corporation’s bondholders, suppliers, and employees, all of whom also enter contracts with the firm that give them limited legal rights."

This is essentially rubbish, debt holders, suppliers and employees all have a relationship but they are not the firm. The firm does not exist independently of shareholders.

nopassrecover• 8 years ago

The firm certainly does exist independently, e.g. see Salomon v A Salomon & Co Ltd

https://en.m.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_L...

sonnyblarney3• 8 years ago

It's not a matter of legality, it's a matter of pragmatism.

Shareholders own and run the company. A majority of shareholders can effectively do anything they want with it, it's theirs.

That a corporation may possibly exist independently is a corner case.

It doesn't matter, the logic of the article is twisted.

It implies that profits can be used by the board of directors for whatever reason, obviously. But that board is elected by shareholders to carry out their bidding, and they are a proxy of shareholders, thereby abnegating the logic of the argument.

"The business judgment rule ensures that, contrary to popular belief, the managers of public companies have no enforceable legal duty to maximize shareholder value"

My god man, the board will act in the best interest of the shareholders or ultimately they'll get the boot. If the shareholders are dispersed and can't coordinate themselves, they'll have less power and see more go to the next entity with power, probably the executives.

simonCGN• 8 years ago

What kind of propaganda website ist that?

Never heard to that magazine.

The Shareholder Value Myth (2013)

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