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2.6 Is Shareholder Value Maximization the Right Objective?
In their widely cited book The Value Imperative—Managing for Superior Shareholder Returns, McTaggart, Kontes, and Mankins (1994) write,
Maximizing shareholder value is not an abstract, shortsighted, impractical, or even, some might think, sinister objective. On the contrary, it is a concrete, future-oriented, pragmatic, and worthy objective, the pursuit of which motivates and enables managers to make substantially better strategic and organizational decisions than they would in pursuit of any other goal. And its accomplishment is essential to the welfare of all the company’s stakeholders, for it is only when wealth is created that customers will continue to enjoy a flow of new, better, and cheaper products and the world’s economies will see new jobs created and old ones improved.McTaggart, Kontes, and Mankins (1994), chap. 1.
Implicit in this statement are three important assumptions, all of which can be challenged:
- Shareholder value is the best measure of wealth creation for the firm.
- Shareholder value maximization produces the greatest competitiveness.
- Shareholder value maximization fairly serves the interests of the company’s other stakeholders.
With respect to the first assumption, it can be argued that “firm value,” which also includes the values to all other financial claimants, such as creditors, debt holders, and preferred shareholders, is a better indicator of wealth. The importance of distinguishing between firm value and shareholder value lies in the fact that managers and boards can make decisions that transfer value from debt holders to shareholders and decrease total firm and social value while increasing shareholder value.
The second assumption—that shareholder value maximization produces the greatest long-term competitiveness—can also be challenged. An increasingly influential group of critics, which also includes a substantial number of CEOs, thinks product-market rather than capital-market objectives should guide corporate decision making. They worry that companies that adopt shareholder value maximization as their primary purpose lose sight of producing or delivering a product or service as their central mission and that shareholder value maximization creates a gap between the mission of the corporation and the motivations, desires, and capabilities of the company’s employees who only have direct control over real, current, corporate performance. They note that shareholder value maximization is simply not inspiring for employees, even though they often share in some of the gains through benefit, bonus, or option plans. To many of them, shareholders are nameless and faceless, under no obligation to hold their shares for any length of time, never satisfied, and always asking, “What will you do for me next?” Worse, they say, not only does shareholder-value appreciation fail to inspire employees, it may encourage them to view maximizing one’s financial well-being as a legitimate or even the only goal. Instead, they want companies to create a moral purpose that not only provides a clear focus on creating competitive advantage for the company but also unites its purpose, strategy, goals, and shared values into one overall, coherent management framework that has the power to motivate constituents and the legitimacy of the corporation’s actions in society.Ellsworth (2002), p. 6.
The third assumption—that shareholder maximization is congruent with fairly serving the interests is the firm’s other stakeholders—is perhaps most controversial. Proponents of shareholder value maximization—including many economists and finance theorists—are adamant that maximizing shareholder value is not only superior as a fiduciary standard or management objective but also as a societal norm. Jensen (2001), for example, writes,
Two-hundred years of research in economics and finance have produced the result that if our objective is to maximize the efficiency with which society utilizes its resources (that is to avoid waste and to maximize the size of the pie), then the proper and unique objective for each company in the society is to maximize the long-run total value of the firm. Firm value will not be maximized, of course, with unhappy customers and employees or with poor products. Therefore, consistent with “stakeholder theoryA theory that corporate value cannot be maximized unless the corporation concerns itself with all its constituent stakeholders.” value-maximizing firms will be concerned about relations with all their constituencies. A firm cannot maximize value if it ignores the interest of its stakeholders.Jensen (2001), pp. 297–317.
McTaggart et al. (1994) also believe shareholder value maximization allows managers and boards to resolve any conflicts to everyone’s long-term benefit. Consider, for example, their prescription for resolving trade-offs between customer- and shareholder-focused investments:
As long as management invests in higher levels of customer satisfaction that will enable shareholders to earn an adequate return on their investment, there is no conflict between maximizing shareholder value and maximizing customer satisfaction. If, however, there is insufficient financial benefit to shareholders from attempts to increase customer satisfaction, the conflict should be resolved for the benefit of shareholders to avoid diminishing both the financial health and long-term competitiveness of the business.McTaggart et al. (1994), chap. 1.
Not surprisingly, stakeholder theorists take a different point of view. They argue that shareholders are but one of a number of important stakeholder groups and that, like customers, suppliers, employees, and local communities, shareholders have a stake in and are affected by the firm’s success or failure. To stakeholder theory advocates, an exclusive focus on maximizing stockholder wealth is both unwise and ethically wrong; instead, the firm and its managers have special obligations to ensure that the shareholders receive a “fair” return on their investment, but the firm also has special obligations to other stakeholders, which go above and beyond those required by law.Freeman (1984), p. 17.
More recently, Ian Davis, managing director of McKinsey, criticized the shareholder value maximization doctrine on altogether different grounds. He observed that, in today’s global business environment, the concept of shareholder value is rapidly losing relevance in the face of the larger role played by government and society in shaping business and industry elsewhere in the world:
In much of the world, government, labor and other social forces have a greater impact on business than in the U.S. or other more free-market Western societies. In China, for example, government is often an owner. If you’re talking in China about shareholder value, you will get blank looks. Maximization of shareholder value is in danger of becoming irrelevant.Davis (2006, November 1).
Finally, a growing number, including CEOs, while not questioning that shareholder value maximization is the right objective, are concerned about its implementation. They worry that the stock market has a bias toward short-term results and that stock price, the most common gauge of shareholder wealth, does not reflect the true long-term value of a company. Lucent Technologies CEO Henry Schacht, for example, has stated, “What has happened to us is that our execution and processes have broken down under the white hot heat of driving for quarterly revenue growth.”Henry Schacht, quoted in Fortune, July 7, 2003, and referred to in Martin, “The Coming Corporate Revolt” (2003), p. 1.