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Is Maximizing Shareholder Value Poisonous?

Andrew Rudin | Jul 22, 2017 204 views 14 Comments

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If you grab your favorite marketing book and boil away process diagrams, statistics, and literary fluff, just two words will remain: create value.  Easy-sounding advice, but for most executives, it’s wicked hard. An ideal place for opportunists to step in and promote simple answers and quick remedies.

Business leaders have an insatiable appetite for how-to’s on value creation. And they get a nonstop barrage of erudition from practitioners, self-anointed experts, and academics who cobble salads of trendy verbs, nouns, adjectives and industry jargon, producing inscrutable sentences to solve the insoluble. Maximize/Optimize/Leverage [fill in words]! Measure this! Control that! Be laser-focused on [name of thing]!

Some recommendations show great insight. But others are obvious admonitions and bland platitudes hawked as panaceas, hacks, and fixes for whatever strategic impediment wanders into a CXO’s crosshairs. Useful or not, many are shamelessly aimed at a goal few have dared to question: maximizing shareholder value.



Until now. People have started to recognize that maximizing shareholder value has a central role in harming other stakeholders. The problem is growing. In the name of maximizing shareholder value, crucial employee benefits are being slashed, workers and contractors are hired and churned at whim, and producers with sketchy labor and supply chain practices are awarded contracts – as long as they maintain the highest quality at the lowest cost. Who cares if the widget was made in a firetrap factory by laborers required to work 80-hour weeks, with no overtime pay differential?  Magnanimity and fairness, once emblems of corporate pride, have been expunged from C-Suite vocabulary. Hey, stock prices don’t increase without trade-offs!

Customers are suffering, too – mentally, physically, and financially. Faulty product designs cause injury or death, as we saw recently with GM and Takata. Companies weaken customer service, often under the guise of improving it. “As part of our commitment to our loyal customers, we are now automating . . .” Every customer support rep I’ve spoken to this year has dutifully reminded me that I can take care of my transaction or inquiry through a website. “I can step you through setting up a profile, if you like . . .” Part of the script, I suppose, but what a humiliation to be required to pull the rug out from under your own job, one conversation at a time!

With public trust in corporations waning, a new type of social-media superhero has emerged: the “disaster specialist,” to rush in post-debacle and patch things up with aggrieved customers. They bring “field-tested industry best practices.” Reassuring to know, if you’re prone to repeating widely-publicized mistakes. And when employee morale tanks, a different group of consultants waits at the door, promoting “surefire” ways to rekindle worker passion. Meanwhile, in the executive office, all’s well. Why worry, when your stock price streaks on a heavenly trajectory? There’s a hefty bag of bonus money waiting at the end of the rainbow.

This is a perverse system, in every sense of the word. In the name of maximizing shareholder value, companies routinely decimate their vital infrastructure and brand equity, then pay steeply to repair and rebuild. Some companies complete this circuit more than once. “The non-investor stakeholders? Let them eat cake!”

Maybe if we humanized those likeliest to get hurt, things could improve. For starters, we should stop calling investors, employees, customers, and vendors stakeholders, and instead refer to them as people. “It would be a funnier story if it weren’t for the tragic aspects of American capitalism in the 21st century,” wrote Matthew Stewart in a Wall Street Journal review of Duff McDonald’s book about Harvard Business School, titled The Golden Passport (Schools of Mismanagement: a Modern Business Education Provides Theories and Metrics But No Moral Center, April 22, 2017).

How did this happen? Stewart writes that in the 1980’s, Harvard Business School “suddenly embraced the notion that managers are just a shareholder’s idea of roadkill – and that it is positively bad for shareholders to possess anything resembling a moral conscience. If there is a villain painted in a single shade of black in Mr. McDonald’s version of history, it is Michael Jensen, the economist and Harvard Business School professor who supplied the intellectual rationalizations for the leveraged buyout boom, the CEO compensation boondoggle, and the rampant financialization of the economy. In Mr. McDonald’s tale, Mr. Jensen shows up ‘spewing out ridiculous blanket claims such as . . . “shareholders gain when golden parachutes are adopted.”’ Forty years ago, I drank the same Kool-Aid as an undergraduate business student.

For his part, Jensen was influenced by an op-ed article by Milton Friedman that appeared in The New York Times Magazine on September 13, 1970 (A Friedman Doctrine – The Social Responsibility of Business is to Increase Its Profits) that has become “the most read, misread, and referenced article ever written by a Nobel Laureate economist.” wrote James Heskett (Should Management be Primarily Responsible to Shareholders?, Harvard Business Review, May 9, 2017). “And It’s still being argued today. Friedman argued that the best way for managers to contribute to the social good was by maintaining a single-minded focus on profit, acting as agents for shareholders who put their capital at risk investing in their companies . . . Of greater importance than the issue posed in the article’s title was the proposition that followed: Because shareholders are owners of a corporation, professional managers and directors are their agents, primarily responsible for carrying out their wishes and creating value for them.”

According to Stewart, Harvard Business School produced “magic sticks that promised to answer every human need with a handy spreadsheet. In the more recent chapters of the history, the scariest parts are where the faculty take the spreadsheets off campus.” Among the locations Stewart is referring to is the customer-facing side of business. The retail sales floor. The Point-of-Sale terminal at Target, Home Depot, and Walmart. Online commerce. B2C, B2B and B2G. Neighborhoods monitored hundreds or thousands of miles away by wonky marketers and data scientists using predictive analytics dashboards.

Friedman’s and Jensen’s ideas have permeated into a “river of self-love that is America’s management-ideology complex,” as Stewart describes it. Every day, putrid bubbles of pomposity rise up from the sediment: United Airlines drags a paying passenger from one of its planes, initially defending its action. Wells Fargo systemically exploits its customers and employees so its president and senior managers can receive multi-million dollar bonuses tied to stock price. Theranos coerces its employees into silence to conceal the dangerous technology flaws in its widely-installed blood assay equipment. This is Mr. Friedman’s “single-minded focus on profit” at work. If he were alive today, Friedman would object to my characterization. “There is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud,” he wrote. It took society nearly fifty years to fully recognize that Friedman’s view had great potential for harm. Today, many people simply ignore every word he wrote after profits. No doubt, some believe his sentence ends with that word.

In the 1990’s, the privately-held company I worked for was acquired by a firm traded on the NASDAQ, and a massive cultural shift overtook the sales organization almost immediately. Some salespeople who regularly provided great support for their customers became pariahs for not making goal. They were flushed, to use the indelicate vernacular of the profession, meaning they were fired. “Everything’s changed,” we were regularly reminded at our monthly sales pep talks. “Investment analysts are looking closely at our revenue performance, and it’s imperative that we hit our number every quarter.” Did our buyout and concomitant obsession with satisfying the analysts’ revenue expectations increase customer satisfaction? Did it motivate the company to invest more in customer support? Did it improve morale? It’s a fallacy to believe that on-target revenue production means employees and customers are happy, or that “top revenue producers” have delighted customers.

Should we replace maximizing shareholder value as management’s objective? If so, what goes in its place? The core issue is allegiance. “Harvard Business School Professors Joseph Bower and Lynn Paine propose that the primary allegiance of managers and their boards should be to the health of the corporation, not the maximization of shareholder value [emphasis, mine]. The rationale for this includes the arguments that managers can be held legally accountable while shareholders ‘have no legal duty to protect or serve the companies whose shares they own,’” writes James Heskett. And it’s immaterial whether investors have morals or personal integrity. Under maximize shareholder value, governance is not automatically granted a role in how companies are managed. In fact, governance can threaten shareholder value. In business, there’s no such thing as an immutable truthEven the notion of shareholders as owners of a company has been called into question.

The widespread practice of prioritizing shareholder value maximization seems odd, given the ambiguity over their role and rights in the development and implementation of corporate strategies and tactics. This becomes especially problematic when ensuring high returns to shareholders exacts heavy costs on others who are similarly vital for creating value.  For example, decisions that benefit shareholders, such as increasing short-term profitability through downsizing, can be catastrophic not only for customers and employees, but for the communities and the ecosystems of enterprises that depend on them to thrive. To make financial ratios more attractive, companies often reduce or eliminate essential long-term investments in research and development. In some cases, a company’s most valuable assets can be sold or leveraged to provide investors with immediate, substantial financial returns, while jeopardizing a company’s overall vitality. Few could argue that outcomes for customers, employees, and suppliers are fairly protected under this system.

If maximize shareholder value is so bad, why have so many companies embraced the idea? First, companies need investment capital to launch, grow, and fund new development. Those who put their money at risk deserve to be rewarded – and should be. Second, according to Heskett, “One reason the theory has predominated is that it is simple and straightforward. Shareholder value is easy to measure. Agency theory [the idea that a company’s managers and directors are responsible for carrying out the wishes of an organization’s owners and shareholders] simplifies the mission for managers; they need only serve one primary master [emphasis, mine].”

The problem is, converting to another corporate edict – one that is ostensibly healthier, more egalitarian, and more long-term focused – is complicated, as this passage from NCR Corporation’s annual report, excerpted from an article, Two points of view: The Point of Shareholder Wealth Maximization, illustrates:

“. . . board of directors no longer believe that shareholders is [sic] the only constituent to whom they are responsible”. (Wang, Jia and Dewhirst, H. Dudley, 1992). Explicitly, shareholder value maximization is not the only goal of the company, a company can’t do well without caring the interests of customers, suppliers, employees, or government environment . . . Stakeholders are constituencies who play an important role in the fortunes of the company. Their primary mission is to create value for stakeholders.”

That can work when the activities involved in value creation for all stakeholders are harmonious and aligned. But they are not. A point that Michael Jensen picks on:

“Stakeholder theory effectively leaves managers and directors unaccountable for their stewardship of the firm’s resources . . . plays into the hands of managers by allowing them to pursue their own interest at the expense of the firm’s financial claimants and society at large. It allows managers and directors to devote the firm’s resources to their own favorite causes – the environment, arts, cities, medical research – without being held accountable.”

I think his worry that managers will pursue disparate goals like aiding environmental causes or solving world hunger is overblown. Isn’t that the role of leadership – to keep everyone in the organization on the same page, so to speak? Here, Jensen backpedals, and provides a tiny concession:

“But . . . No company can create great value for its shareholders without stable growth of revenue, which comes from the relationship with customers, suppliers, bankers or government and so on.”

I agree with this last point. But I also recognize that with diminishing consumer trust, growing wealth inequality, and information power skewing back to corporations, Jensen and I are looking at business through the same rose-colored glasses.

Society cannot assume that by focusing on fulfilling the interests of shareholders we will produce consistently benign outcomes for others. We need something better than maximizing shareholder value as a managerial marching order. I’m just not sure exactly what it should be.

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14 Responses to Is Maximizing Shareholder Value Poisonous?

  1. Gautam Mahajan July 23, 2017 at 9:59 pm (176 comments) #

    Wonderful article, Andy.
    I have written about this in my book “Value Creation” and quoted others who have said the same thing as you.
    Short termism has become so prevalent that the average CEO life is 2 years….What is he going to do? Milk as much before he goes, and to that he has to improve short term results. Farewell, long term

  2. Andrew Rudin July 24, 2017 at 7:07 am (240 comments) #

    Hi Gautam: thanks for your comment about CEO tenure. I looked this up, and here in the US, the median tenure is 4.9 years at the 500 largest companies, according to Fortune (see http://fortune.com/2015/05/06/ceo-tenure-cisco/).

    Are companies that define success by other measures better companies? Are there differences when those measurements are long-term? It would be interesting to take a broader look at a company’s success to see if there’s a connection between that and the length of a CEO’s tenure. Then, comparing those measurements to shareholder return over the same time period. Such a study might already have been conducted. First, we’d need consensus on what ‘health’ means.

    A few well-known CEO’s have been in their jobs for many years, as described in the Fortune article. For example, Warren Buffet at 59 years, and Fred Smith of FedEx at 42 years. Are CEO’s who intend to stay in their jobs for the long run less vulnerable to optimizing short-term results? Are they less likely to run down the rat holes of bonus opportunism compared to other CEO’s? What if comp was based on proxy measures for ‘stability’ like preservation of jobs and low customer churn? This would open up new risks and would undoubtedly create new ways to ‘game’ the system. But maybe these measurements – and others – could be considered.

    This would be interesting to dissect, and could point toward a better approach than maximizing shareholder value.

  3. Michael Lowenstein July 24, 2017 at 12:12 pm (1320 comments) #

    As you note, a myopic, slavish, obsessive focus on shareholder value maximization can be toxic and destructive, in part because it can harm other stakeholders, principally employees and customers. We are on the same page with the concept of STAKEHOLDER value optimization. I encourage everyone to read books like Firms of Endearment and Conscious Capitalism, because the ideas defined and executed by companies identified as exemplars in these books have created strong cultures, employee ambassadorship, customer advocacy, and high/sustained profitability.

  4. Carolyn Grant July 24, 2017 at 4:43 pm (2 comments) #

    A great article! I recently attended Australian Institute of Company Directors refresher course and was appalled that whilst shareholder and shareholder value was one every one of the 76 slides. Not once was customer mentioned. As boards and advisors continue to look at revenues and expenses and pay for external resources around our legal, financial and governance obligations, the customer is still a passing reference seen as a front line task which management will report on. Times are a changing people and it seems that many boards and management have no desire to step up and start actively looking at the competitive landscape, at consumer demand and acquiring and retaining the “right” employees. Middle management have a real struggle getting the attention of those who are “business as usual mode”.

    I wonder if we changed slides to reflect the interests of the customer and employees as the drive to delivering sustainable shareholder value – if focus may change. And if delivering customer value was the deliverable how many businesses may have taken different approaches?

  5. Gautam Mahajan July 25, 2017 at 2:31 am (176 comments) #

    So we have to change business thinking, read MBA school teaching. None of those MBA schools who can make a difference are not interested in change as their model works. The European schools are more innovative. U of Vermont has changed its MBA course to be a Master’s in Sustainable development that covers much of this.

    I am asking MBA schools to give degrees in Master’s or Value Creation or Master’s of Value Management: from MBA to MVC or MVM

    We need to do something

  6. Sam Klaidman July 25, 2017 at 7:00 am (61 comments) #

    This is a very thought provoking article – thanks.

    First, in a 2002 article “Trading Off Value Creation and Value Appropriation: The Financial Implications of Shifts in Strategic Emphasis” by Natalie Mizik and Robert Jacobson the authors report on a study of firm’s strategic emphesis on either (customer) value creation or (shareholder) value appropriation and assessed the impact of the emphasis on stock return.

    To summarize their findings:

    When the firm has better-than-expected earnings they focused on enhancing value appropriation. In other words, when things were good the shareholders wanted their share or “make hay while the sun is shinning.”

    When the firm was not doing well financially, the financial markets responded positively to an increasing emphesis on creating customer value.The shareholders wanted the firms to get back to strong financial results so they could extract more value.

    This leads to the second key point. Operating in any extreme is dangerous. Too much of a good thing is too much! Because company financial results are highly dependent on many complex factors, shifting emphasis can drive employees and customers nuts and cause Boards to change CEO’s before their decisions have had a chance to yield meaningful results.

    Businesses have to strike a balance between the two extremes and always be creating customer value and sharing some of the benefits with the shareholders. And any changes in strategy must be subtle so as not to confuse the customer base and the employees.

  7. Andrew Rudin July 25, 2017 at 12:59 pm (240 comments) #

    Michael, Carolyn, Gautam, and Sam: Thank you for your comments. I agree with Sam that businesses must strike a balance. But it takes the skills of a funambulist to equitably address the interests of investors, employees, customers, and suppliers – all of whom play significant value-producing roles in a company’s operations. Giving primacy to investor needs seems dangerous, but until now, people have largely assumed that what’s good for investors is good for the company. We have seen how that myopia causes serious harm and trouble.

    As some have suggested, maybe our predominant assumption should be the opposite: what’s good for the company will ultimately be good for investors. In many instances, short-term investor gains will be sacrificed, potentially drying up an important source of growth capital. But if businesses were less concerned with fast growth, and more concerned with sustaining long-term value, that might obviate some of the problem.

    It’s hard to examine this issue without recognizing that concentrating on business growth as a success metric has much to do with the short-term strategies and tactics that may help investors, but harm almost everyone else.

  8. Sam Klaidman July 25, 2017 at 1:45 pm (61 comments) #

    Andy – about tightrope walkers. You are correct, which may be why the lifespan of a CEO is so short but that’s why they get the big bucks. If the job is so difficult then more people should be content with less money and perks an not put themselves in such an untenable job. If enough people say no to the job the Boards will start rethinking their strategy and goals.

    But I am an optimist!

  9. Gautam Mahajan July 25, 2017 at 9:24 pm (176 comments) #

    Andy, Sam:
    I am in agreement. That is why we started the Journal of creating Value (jcv.sagepub.com) and are setting up Value creation Centers and changing MBA thinking. Difficult to change mindsets when investors are looking for quick returns, but at least a start and important that people like Andy start and keep the debate up. Come to the first global conference on Creating Value in the UK in May 2018 http://www.dmu.ac.uk/about-dmu/schools-and-departments/leicester-castle-business-school/the-first-global-conference-on-creating-value.aspx

  10. Andrew Rudin July 26, 2017 at 7:08 am (240 comments) #

    Hi Gautam: The conference agenda looks promising as a forum for sharing ideas and learning about this topic. I’ll consider attending.

    Changing ‘MBA thinking’ seems a daunting task, and I’m interested in whether you’re making inroads into this in the US, and if so, how you’re doing it. While there are pervasive ideas in graduate b-schools, they don’t often hew to exactly the same principles for teaching, or offer the same courses as requirements for graduation. That leaves room for examining value creation and, in particular, encouraging future managers to question whether maximizing one group’s interests serves the interests of the enterprise or society.

  11. Andrew Rudin July 26, 2017 at 7:57 am (240 comments) #

    Some of the commenters on this thread might be interested in the following excerpt from a book, The Ten Principles Behind Great Customer Experiences by Matt Watkinson:

    “Focusing on maximizing shareholder value brings the CEO into direct conflict with the interests of customers since it is not possible to fully satisfy both the real market and the expectation [investor] market simultaneously: I can’t seek to create the products or services that will most delight the customer while also trying to maximize my profit over the next three months.

    Faced with a choice, the CEO’s attention is focused on the expectation market since they are not only incentivized to do so, but it is far easier to manipulate the expectations of the stock market, or ‘game the game’, than it is to create genuinely brilliant experiences for the customer. It’s not just the customer who loses, it’s the whole company. Research published in The Journal of Accounting and Economics points to an alarming discovery: a majority of executives admit to freely sacrificing the future of their companies in order to meet the whims of the expectation market.

    The inevitable consequence is that customers, employees, and ironically, even the shareholders lose out. Ethics and values evaporate, and even the long-term health of the organization is sacrificed for short-term gains. The moral authority of business diminishes with each passing year, as customers, employees, and average citizens grow increasingly appalled by the behavior of business, and the abundant greed of its leaders.”

    Unless senior executives recognize the dangers of prioritizing the needs of investors over everyone else, corporations are destined to create lots more wreckage.

  12. Gautam Mahajan July 26, 2017 at 11:08 pm (44 comments) #

    U of Vermont has made a start with a sustainable development MBA
    Others are creating Customer Value and Value Creation courses, such as U of Montana
    I sincerely urge all of you who believe in what Andy is saying to join our Value Creation movement. Write to me at [email protected]

  13. Guido Thys July 29, 2017 at 4:05 am (3 comments) #

    Andrew, thank you for providing the historical background of a situation against which a rapidly increasing number of people are actively revolting.
    It’s been an important aspect of my previous three books (on management and entrepreneurship) and the pivotal issue in my forthcoming book on customer value (all in Dutch, I’m afraid).

    One thing I take the liberty of adding to your exposé is that imho the solution has been around since the 1950s in the form of the Nash Equilibrium. “Customer First” can never win the fight against shareholder power, but “live and let live” might do better. I think it is included in the “forgotten” part of Friedman’s sentence.
    As Goldratt wrote: one company can only have one goal. As most people would agree: that goal is to create value. As you write: organisations consist of people. I would add: we divide them into types of “stakeholders”, based upon the value they expect from the organisation. And as Nash implied: stakeholders should look after their own interests AND those of the organisation. In order words: play the game to win but don’t destroy the game while doing that.

  14. Andrew Rudin July 31, 2017 at 7:36 am (240 comments) #

    Hi Guido: thank you for your contribution to this discussion. I look forward to reading your upcoming book after you have an English translation. Spanish works, too. You make an interesting point that ‘customer first’ can never win the fight against shareholder power.’ I hadn’t thought of the challenge that way, but your comment underscores the difficulty that many of us encounter when hearing about ‘the importance of a customer-first strategy.’

    Attempting to adopt a ‘customer-first’ strategy in the context of an organization bent on maximizing shareholder value is a non-starter – comparable to pushing a weighty boulder uphill. It’s worth calling out the dissonance right away, rather than going through the aggravating motions of ‘putting customers at the center of everything we do,’ only to have those efforts batted down when they threaten shareholder value. It’s inevitable that they will.

    If goal congruence exists between maximizing shareholder value, corporate value, and customer value, it’s probably more coincidence than a design outcome. If more companies followed your advice to play the game to win, but not to destroy the game in the process, we might experience less commercial and social wreckage.

    I’m curious about your thoughts for implementing ‘live and let live’ as a goal-oriented business strategy. It sounds like a great approach, but seems antithetical to everything I’ve learned and experienced.

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