Alan Mitchell: Will the real shareholder value please stand out?

In the wake of the Enron and the WorldCom scandals, ways are being sought to protect shareholders, but should they be protected? asks Alan Mitchell

What should we do post-Enron and WorldCom? The current focus is to look for new ways to protect shareholders by tightening accounting regulations, beefing up audits, creating new Chinese walls between analysts and investment bankers, and so on.

Such measures may or may not be helpful. But without a change in the attitudes, motivations and priorities of the people who have to enforce such rules, little lasting benefit will accrue. The real culprit is not “bad apple” management, but the ideology of shareholder value.

Here are some arguments against “shareholder capitalism”. First, it is a false necessity. False necessities are designed to persuade people to do things they wouldn’t do otherwise – usually because it’s against their interest. As Oliver Cromwell once observed, they are one of the greatest deceits one man can impose upon another.

We have to maximise shareholder value, we are told, because otherwise the share price will fall and the company will be taken over. Yet we also “have to” offer customers superior value or else they’ll desert the company, and it will go under anyway. Ditto with employees.

Cromwell said the divine right of kings – a prior claim by the king over all others – was a false necessity. Shareholder value is in the same category of false prior claims. We don’t need it to prosper.

In fact, as a sectarian slogan designed to favour one group over another, it tends to be self-defeating. It fails to motivate – and sometimes positively demotivates – the very people who it needs to achieve its goal: employees. Apart from a tiny handful of senior executives, how many employees jump out of bed each morning saying excitedly: “Oh good, another day; another chance to enrich shareholders”?

The slogan is also content-free. As per Alice in Wonderland, people use it to mean what they want it to mean. There are some sensible people who argue that the only way to maximise shareholder value is by delighting customers and motivating employees: it’s a by-product of other good things. There are others, however, for whom the end justifies any means. Like Al Dunlap-style asset stripping. Like creating an acquisition engine that endlessly pumps up its share price by devouring ever more targets. Like financial engineering.

Yet the slogan itself does nothing to distinguish between the two. Instead, it happily accommodates both saints and sinners under the same banner. Which explains both its enormous success – and its power to damage.

Part of that damage stems from its encouragement of unnatural, extreme behaviour. Nature rarely goes for maximisation. It goes for balance. Most attempts to maximise a single element within a balanced system – to have too much of a good thing – are toxic. To be healthy, you need some sugars and fats in your diet. But if you maximise their intake, you get ill.

With shareholder value, this toxicity has its own internal runaway-train logic. You can never know if you have actually achieved maximum profits or share prices. No matter how wonderful the performance, you can always look back and say: “it might have been better”. The ensuing attempt to stretch things ever further eventually breaks them.

So what of the justifications for maximising shareholder value? There are four. Three are false, and one is misplaced.

First, it’s said that shareholders should be compensated for risk. But the practice of selling the shares of companies that under-perform passes that risk on to somebody else. It also changes the nature of that risk. This is not the risk of the entrepreneur creating new wealth. It is the risk of the gambler betting on share-price movements. Should gamblers be compensated for risk taking?

Second, it’s said that by providing equity funding, investors make it possible for companies to generate wealth. Naturally, they should earn a return on this investment. Yet the fact is, over the past 20 years, net equity funding of business in the US has been negative, to the extent of $540bn (&£354.9bn). Via mechanisms such as share buy-backs, shareholders have not been investing in business, they’ve been disinvesting. “Shareholder” and “investor” are not the same, any more.

There’s a good, simple reason for this. Real companies that create real goods and services generate real cash. Once they’ve passed the initial start-up phase, they tend to become self-funding. Shareholder investment is a life-stage practicality, not an eternal verity. That’s why nowadays the most common purpose of shareholder investment is funding corporate buying sprees, which tend to destroy more wealth than they create.

The third justification for prioritising shareholder value is that even if shareholders are not investing new money, they still own the company, which should therefore be run in their interests. In reality, however, this is not a modest defence of a basic right, but an aggressive extension of a property claim. You may have an inalienable right to own things such as offices and factories, but a company is made up of people. The shareholder claim to “own” companies is actually a claim of ownership over people. It is not a forward-looking vision. It’s a throwback to feudalism.

The fourth justification for shareholder value is that it provides discipline. Without it, managers and workers alike would become smug, lazy and unfocused. The concern is real, but the remedy is misplaced. It’s not shareholder value that provides this crucial discipline; it’s competition to win and keep customers.

Which is where we get to the real problem with shareholder value. Quite simply, it is not a marketing concept. It does not focus on customers. In fact, it positively takes managers’ eyes off the customer ball. At least profit is a function of real business performance, which demands that you create real value for customers. But ultimately, shareholder value is a function of the company’s stock price which, as we know, is not always correlated to business performance. Focusing on shareholder value therefore encourages you to invest your energy managing the stock price, not in managing the business. Ring any bells for anyone?


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