by Lynn Stout
Praise for The Shareholder Value Myth
“This book threatens to trigger an avalanche of new thinking about corporations. Written by one of the most respected theorists in corporate governance, it takes aim at the smug ‘profit-only’ complacency found in business schools and boardrooms. Anyone who reads it will be forced to think—and think again.”
—Thomas Donaldson, Mark O. Winkelman Professor, The Wharton School, University of Pennsylvania
“The only antidote to prevailing bad theory is calm, careful, plainspoken, and relentless argumentation that peels away the distracting layers of abstract mumbo jumbo to expose the lunacy of the underlying theory for all to see. Lynn Stout does the world a great favor in exposing shareholder value theory for what it is: flawed and damaging theory. Comprehensive yet brief, profound yet enjoyable, this is a must-read for anyone who cares about the future of democratic capitalism.”
—Roger Martin, Dean, Rotman School of Management, University of Toronto, and author of Fixing the Game
“It is widely believed that corporations exist solely to maximize profits. It is also widely believed that this corporate purpose is prescribed by law. Lynn Stout shows that these influential beliefs are both wrong and very likely destructive.”
—Ralph Gomory, Research Professor, New York University; President Emeritus, Alfred P. Sloan Foundation; and former Senior Vice President for Science and Technology, IBM Corporation
“Professor Stout is a leader of a growing group of corporate executives, economists, lawyers, and thoughtful investors who have embraced the concept that corporations should, and indeed must, be managed in the interests of all their constituents. This book is a very readable explanation of the adverse impact that ignoring the interests of all constituents and short-termism have had on not just employees, customers, suppliers, communities, and the economy as a whole but the very shareholders themselves.”
—Martin Lipton, Senior Partner, Wachtell, Lipton, Rosen & Katz
“Lynn Stout raises a critical question about American capitalism: what is the purpose of the public corporation? For too many years there has been an uncontested assertion that all that matters is creating shareholder wealth. This is an underlying cause of many of the ills facing American society, and this is therefore a critically important book!”
—Jay Lorsch, Louis Kirstein Professor of Human Relations, Harvard Business School, and author of Back to the Drawing Board (with Colin B. Carter) and Pawns or Potentates
“Lynn Stout presents a thoroughly researched and articulated case against shareholder value exclusivity. It serves the grand purpose of illuminating the debate in the hope of finding a reasoned result.”
—Ira Millstein, Director, Columbia Law School and Columbia Business School Program on Global, Economic, and Regulatory Interdependence, and Theodore Nierenberg Adjunct Professor of Corporate Governance, Yale School of Management
“Lynn Stout’s engaging book deals a knockout blow to the mantra of ‘shareholder value’ that has come to dominate corporate boardrooms in the last two decades. While she makes her case in a readable and entertaining way, her message is very serious: the obsession that the business community has with maximizing shareholder value is making US corporations weaker, not stronger.”
—Dr. Margaret M. Blair, Professor of Law, Milton R. Underwood Chair in Free Enterprise, Vanderbilt University Law School
“Lynn Stout kicks another brick off of the mantle of short-termism, showing again why choosing to myopically focus on short-term value not only can destroy longer-term performance but also is legally inconsistent with leading corporate governance principles, incentives, and actions that aspire to more sustainable value creation—over the long term and for all stakeholders, including shareholders.”
—Dean Krehmeyer, Executive Director, Business Roundtable Institute for Corporate Ethics
THE
SHAREHOLDER VALUE MYTH
How Putting Shareholders
First Harms Investors,
Corporations, and the Public
LYNN STOUT
The Shareholder Value Myth
Copyright © 2012 by Lynn Stout
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First Edition
Paperback print edition ISBN 978-1-60509-813-5
PDF e-book ISBN 978-1-60509-815-9
IDPF e-book ISBN 978-1-60509-816-6
2012-1
Cover design: Nicole Hayward
Project management: Lisa Crowder, Adept Content Solutions, Urbana, IL
Full-service book production: Adept Content Solutions, Urbana, IL
Contents
Preface
INTRODUCTION: “THE DUMBEST IDEA IN THE WORLD”
PART I: DEBUNKING THE SHAREHOLDER VALUE MYTH
Chapter One The Rise of Shareholder Value Thinking
Chapter Two How Shareholder Primacy Gets Corporate Law Wrong
Chapter Three How Shareholder Primacy Gets Corporate Economics Wrong
Chapter Four How Shareholder Primacy Gets the Empirical Evidence Wrong
PART II: WHAT DO SHAREHOLDERS REALLY VALUE?
Chapter Five Short-Term Speculators versus Long-Term Investors
Chapter Six Keeping Promises to Build Successful Companies
Chapter Seven Hedge Funds versus Universal Investors
Chapter Eight Making Room for Shareholder Conscience
CONCLUSION: “SLAVES OF SOME DEFUNCT ECONOMIST”
Notes
Index
About the Author
Preface
Back when I was a law school student in the early 1980s, my professors taught me that shareholders “own” corporations and that the purpose of corporations is to “maximize shareholder value.” I was just out of college at the time and not very familiar with the business world, so this made sense enough to me. When I first began lecturing and writing in business law myself, I incorporated the shareholder value thinking that I had been taught into my own teaching and scholarship.
It soon became apparent to me there was a problem with this approach. The more I read business law cases, the more obvious it became that U.
S. corporate law does not, in fact, require corporations to maximize either share price or shareholder wealth. My first reaction was puzzlement and frustration. Shareholder value thinking was almost uniformly accepted by experts in law, finance, and management. Why then, I asked myself, wasn’t it required by the actual rules of corporate law?
In 1995, I spent some time as a guest scholar at the Brookings Institution in Washington, D.C. While there I was lucky enough to get to know Margaret Blair, an economist also interested in corporations. Blair offered a novel answer to my question: maybe corporate law was right and the experts were wrong. Maybe there were good reasons why corporate directors were not required to maximize shareholder value.
That conversation with Blair began my nearly two decades of investigation into the question of corporate purpose. My sense that something was wrong with shareholder value thinking was only heightened when Enron, a firm obsessed with raising its share price and a supposed paragon of “good corporate governance,” collapsed in fraud and scandal in 2000.
Writing both alone and with Blair, I published articles on the question of corporate purpose and sought out the work of other academics willing to question the theoretical and empirical validity of “shareholder primacy.” Meanwhile, I was becoming involved in the business world myself as an advisor to and a director of profit and nonprofit organizations. I took every opportunity to ask the business executives, corporate lawyers, and individual and institutional investors I dealt with how they thought corporations really worked. The more I listened to their answers, the more I grew to suspect that “maximize shareholder value” is an incoherent and counterproductive business objective.
Put bluntly, conventional shareholder value thinking is a mistake for most firms—and a big mistake at that. Shareholder value thinking causes corporate managers to focus myopically on short-term earnings reports at the expense of long-term performance; discourages investment and innovation; harms employees, customers, and communities; and causes companies to indulge in reckless, sociopathic, and socially irresponsible behaviors. It threatens the welfare of consumers, employees, communities, and investors alike.
This book explains why. It is written to be of use for law and business experts, but it is also written to be understood by executives, investors, and informed laypersons—indeed anyone who wants to understand why corporations do what they do, and how we can help corporations do better.
Although it would be near-impossible for me to thank everyone who generously gave me ideas, suggestions, or support as I wrote this book, I would like to acknowledge the special contributions and inspiration provided by Ralph Gomory and Gail Pesyna at the Sloan Foundation; Judy Samuelson at the Aspen Institute; and Steve Piersanti and the wonderful staff at Berrett-Koehler. This is their book as well.
Lynn Stout
February 2012
INTRODUCTION
“The Dumbest Idea in the World”
The Deepwater Horizon was an oil drilling rig, a massive floating structure that cost more than a third of a billion dollars to build and measured the length of a football field from bottom to top. On the night of April 20, 2010, the Deepwater Horizon was working in the Gulf of Mexico, finishing an exploratory well named Macondo for the corporation BP. Suddenly the rig was rocked by a loud explosion. Within minutes the Deepwater Horizon was transformed into a column of fire that burned for nearly two days before collapsing into the depths of the Gulf of Mexico. Meanwhile, the Macondo well began vomiting tens of thousands of barrels of oil daily from beneath the sea floor into the Gulf waters. By the time the well was capped in September 2010, the Macondo well blowout was estimated to have caused the largest offshore oil spill in history.1
The Deepwater Horizon disaster was tragedy on an epic scale, not only for the rig and the eleven people who died on it, but also for the corporation BP. By June of 2010, BP had suspended paying its regular dividends, and BP common stock (trading around $60 before the spill) had plunged to less than $30 per share. The result was a decline in BP’s total stock market value amounting to nearly $100 billion. BP’s shareholders were not the only ones to suffer. The value of BP bonds tanked as BP’s credit rating was cut from a prestigious AA to the near-junk status BBB. Other oil companies working in the Gulf were idled, along with BP, due to a government-imposed moratorium on further deepwater drilling in the Gulf. Business owners and workers in the Gulf fishing and tourism industries struggled to make a living. Finally, the Gulf ecosystem itself suffered enormous damage, the full extent of which remains unknown today.
After months of investigation, the National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling concluded the Macondo blowout could be traced to multiple decisions by BP employees and contractors to ignore standard safety procedures in the attempt to cut costs. (At the time of the blowout, the Macondo project was more than a month behind schedule and almost $60 million over budget, with each day of delay costing an estimated $1 million.)2 Nor was this the first time BP had sacrificed safety to save time and money. The Commission concluded, “BP’s safety lapses have been chronic.”3
The Ideology of Shareholder Value
Why would a sophisticated international corporation make such an enormous and costly mistake? In trying to save $1 million a day by skimping on safety procedures at the Macondo well, BP cost its shareholders alone a hundred thousand times more, nearly $100 billion. Even if following proper safety procedures had delayed the development of the Macondo well for a full year, BP would have done much better. The gamble was foolish, even from BP’s perspective.
This book argues that the Deepwater Horizon disaster is only one example of a larger problem that afflicts many public corporations today. That problem might be called shareholder value thinking. According to the doctrine of shareholder value, public corporations “belong” to their shareholders, and they exist for one purpose only, to maximize shareholders’ wealth. Shareholder wealth, in turn, is typically measured by share price—meaning share price today, not share price next year or next decade.
Shareholder value thinking is endemic in the business world today. Fifty years ago, if you had asked the directors or CEO of a large public company what the company’s purpose was, you might have been told the corporation had many purposes: to provide equity investors with solid returns, but also to build great products, to provide decent livelihoods for employees, and to contribute to the community and the nation. Today, you are likely to be told the company has but one purpose, to maximize its shareholders’ wealth. This sort of thinking drives directors and executives to run public firms like BP with a relentless focus on raising stock price. In the quest to “unlock shareholder value” they sell key assets, fire loyal employees, and ruthlessly squeeze the workforce that remains; cut back on product support, customer assistance, and research and development; delay replacing outworn, outmoded, and unsafe equipment; shower CEOs with stock options and expensive pay packages to “incentivize” them; drain cash reserves to pay large dividends and repurchase company shares, leveraging firms until they teeter on the brink of insolvency; and lobby regulators and Congress to change the law so they can chase short-term profits speculating in credit default swaps and other high-risk financial derivatives. They do these things even though many individual directors and executives feel uneasy about such strategies, intuiting that a single-minded focus on share price may not serve the interests of society, the company, or shareholders themselves.
This book examines and challenges the doctrine of shareholder value. It argues that shareholder value ideology is just that—an ideology, not a legal requirement or a practical necessity of modern business life. United States corporate law does not, and never has, required directors of public corporations to maximize either share price or shareholder wealth. To the contrary, as long as boards do not use their power to enrich themselves, the law gives them a wide range of discretion to run public corporations with other goals in mind, including growing the firm, creating quality products
, protecting employees, and serving the public interest. Chasing shareholder value is a managerial choice, not a legal requirement.
Nevertheless, by the 1990s, the idea that corporations should serve only shareholder wealth as reflected in stock price came to dominate other theories of corporate purpose. Executives, journalists, and business school professors alike embraced the need to maximize shareholder value with near-religious fervor. Legal scholars argued that corporate managers ought to focus only on maximizing the shareholders’ interest in the firm, an approach they somewhat misleadingly called “shareholder primacy.” (“Shareholder absolutism” or “shareholder dictatorship” would be more accurate.)
It should be noted that a handful of scholars and activists continued to argue for “stakeholder” visions of corporate purpose that gave corporate managers breathing room to consider the interests of employees, creditors, and customers. A small number of others advocated for “corporate social responsibility” to ensure that public companies indeed served the public interest writ large. But by the turn of the millennium, such alternative views of good corporate governance had been reduced to the status of easily ignored minority reports. Business and policy elites in the United States and much of the rest of the world as well accepted as a truth that should not be questioned that corporations exist to maximize shareholder value.4
Time for Some Questions
Today, questions seem called for. It should be apparent to anyone who reads the newspapers that Corporate America’s mass embrace of shareholder value thinking has not translated into better corporate or economic performance. The past dozen years have seen a daisy chain of costly corporate disasters, from massive frauds at Enron, HealthSouth, and Worldcom in the early 2000s, to the near-failure and subsequent costly taxpayer bailout of many of our largest financial institutions in 2008, to the BP oil spill in 2010. Stock market returns have been miserable, raising the question of how aging baby boomers who trusted in stocks for their retirement will be able to support themselves in their golden years. The population of publicly held U.S. companies is shrinking rapidly as formerly public companies like Dunkin’ Donuts and Toys“R” Us “go private” to escape the pressures of shareholder-primacy thinking, and new enterprises decide not to sell shares to outside investors at all. (Between 1997 and 2008, the number of companies listed on U.S. exchanges declined from 8,823 to only 5,401.)5 Some experts worry America’s public corporations are losing their innovative edge.6 The National Commission found that an underlying cause of the Deepwater Horizon disaster was the fact that the oil and gas industry has cut back significantly on research in recent decades, with the result that “knowledge and experience within the industry may be decreasing.”7