The failing doctrine of shareholder value maximization

In the last decades of the 20th century management as a profession has fallen into a deep crisis. The preceding decades had revealed a promising development: From the beginning of the 20th century, companies hired professional managers who supervised companies on behalf of the owners. As dedicated professionals they took into consideration the long-term interests of all stakeholders.

However, the rise of neoliberalism – in politics and science – put shareholders in the role of the owners of listed companies. Increasing shareholder value became the primary task of a company’s management.

The income of top managers – worldwide – increased explosively during the last years of the century because their remuneration package consciously consists of a large part of shares (options). The idea is that shareholders’ interests were guarantied if they coincided with the financial interests of managers. Professional managers sold – so to say – their soul[1].

Recently, a prominent business school has disclosed the unsustainability of this view. Cass Business School, part of City University of London, initiated for two years the Purpose of the Corporation Project[2]. This project was completed in Brussels on 28th September 2016 in a meeting of scientists, politicians and business leaders from Europe and the US.

Maximization of shareholder value is inherently a short-term policy. It has several effects that harm the profitability and even its existence in the long term:

• Declining investment in research and development
• Irresponsible risk-taking
• Externalities like loss of confidence from society, undermining monetary stability and exploitation of the environment
• Cost reduction resulting in restructuring and related closure of business establishments (mergers, acquisitions, buyouts)
• Tax evasion, limiting the resources for investment in infrastructure

The only viable perspective is a “corporate purpose” in favour of the creation of value for all stakeholders and to contribute to social welfare and environmental quality.

The final report is build on five so-called Modern Governance Statements regarding business law, management, accounting, economics and public policy. These statements are based on an extensive review of literature. A significant number of scientists have discussed and approved each statement.

Here is a selection of edited quotes from the five statements:

• Almost in any country, the answer to the question ‘who owns a company with a legal personality’ is ‘the company itself’. By no means shareholders do.
• Companies can raise capital, for instance by issuing shares. Shareholders are entitled to receive dividends and to raise their voice in a number of clearly defined subjects.
• In almost all legislations the fiduciary duties of the management of a company include its long-term survival.
• No law requires management to pursue maximum profits for shareholders. If they do, it is because they succumb to pressure from activist shareholders or for their own gain.
• In the ’90s monitoring the reporting of companies passed from national governments and parliaments to the International Accounting Standards Board. As a result, the focus of the reporting narrowed to the provision of information to investors and the calculation of the assets based on market value.
• The idea of a social partnership between civil society institutions – including businesses – went lost.

The final report of the Purpose of the Corporation Project[3] kept two options to managers and shareholders: Whether persisting the current direction, which will ultimately result in the disappearance of the company or redesigning the company as a social institution serving the interests of all stakeholders.

How? Here is a selection of the recommendations in the report.

1. Values (“Purpose”)

• Companies explain their values and goals and define their responsibilities with respect to all stakeholders such as employees, customers and shareholders and society and nature al large.
• Management establishes the implications of the purpose for strategy and (investment) policy and also how to reduce associated risks.
• Companies accentuate their intentions with regard to the achievement of social objectives by adopting the status of B(enefit) Corporation.

2. Operating as a community

• The intensified control of the employees has resulted in loss of their engagement and quality of their work as well.
• Employees who organize their work independently perform better and feel more satisfied. After all they have product and market knowledge and maintain relationships with suppliers and customers.
• New organizations deploy less hierarchy, reduce of the number of managers and transfer management tasks to employees.

3. Revision income stimulus

• Top management will receive a fixed salary that is part of the remuneration structure of the company. All incomes are transparent.
• Variable remuneration applies to all employees and is linked to the achievement of long-term objectives and the satisfaction of the customers as well.

4. Participation of stakeholders

• Representation of employees, clients and shareholders in the board and in the General Meeting will strengthen the relationship between the company (management) and its stakeholders

5. Search for patient capital

• Distinguishing between different categories of shareholders will stimulate stewardship by shareholders with a long-term interest.
• Making shareholders’ rights dependant from the duration of their involvement in the company.

6. Protection from hostile takeovers

• In order to protect their long-term policy, companies deploy mechanisms to prevent hostile takeovers, for instance by transferring shares to a foundation.

7. Reporting

• The method of reporting is geared to long-term policy. The Integrated Reporting Framework is an alternative for common accounting rules who intend to inform investors in the first place
• The main goal of reporting is disclosure of value creation in the broadest sense, including in relation to non-financial capital.

The Purpose of the Corporation Project has provided a new benchmark for corporate governance, the financial world and professional managers. But it is also a new benchmark for the relation between society and business. Finally, it is a signal for shareholders to avoid short-term thinking.

[1] In 1993 CEO’s of the top 25 companies in the US earned 195 times the salary of an average worker. In 2012 their salaries were raised to 354 times the salary of an average worker. Institute for Policy Studies
1112 (16th Street NW, Suite 600)
Washington, DC 20036

[2] Overview of the background of the project: https://goo.gl/vNJQjr

[3] The final report reads like an up-to-date introduction to corporate governance: “Corporate Governance for a changing world: Final Report of a Global Roundtable Series” https://goo.gl/bdEaQp