Lynn Stout | March 15 2016 | evonomics
The dominant business philosophy debunked
By the end of the 20th century, a broad consensus had emerged in the Anglo-American business world that corporations should be governed according to the philosophy often called shareholder primacy. Shareholder primacy theory taught that corporations were owned by their shareholders; that directors and executives should do what the company’s owners/shareholders wanted them to do; and that what shareholders generally wanted managers to do was to maximize “shareholder value,” measured by share price.
Today this consensus is crumbling. As just one example, in the past year no fewer than three prominent New York Times columnists have published articles questioning shareholder value thinking. Shareholder primacy theory is suffering a crisis of confidence. This is happening in large part because it is becoming clear that shareholder value thinking doesn’t seem to work, even for most shareholders.
Consider the example of the United States. The idea that corporations should be managed to maximize shareholder value has led over the past two decades to dramatic shifts in U.S. corporate law and practice. Executive compensation rules, governance practices, and federal securities laws, have all been “reformed” to give shareholders more influence over boards and to make managers more attentive to share price. The results are disappointing at best. Shareholders are suffering their worst investment returns since the Great Depression; the population of publicly-listed companies has declined by 40%; and the life expectancy of Fortune 500 firms has plunged from 75 years in the early 20th century to only 15 years today.
Correlation does not prove causation, of course. But in my book The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public, I explore the logical connections between the rise of shareholder value thinking and subsequent declines in investor returns, numbers of public companies, and corporate life expectancy. I also show that shareholder primacy is an abstract economic theory that lacks support from history, law, or the empirical evidence. In fact, the idea of a single shareholder value is intellectually incoherent. No wonder the shift to shareholder value thinking doesn’t seem to be turning out well — especially for shareholders.
Debunking the Shareholder Value Myth: History
Although many contemporary business experts take shareholder primacy as a given, the rise of shareholder primacy as dominant business philosophy is a relatively recent phenomenon. For most of the twentieth century, large public companies followed a philosophy called managerial capitalism. Boards of directors in managerial companies operated largely as self-selecting and autonomous decision-making bodies, with dispersed shareholders playing a passive role. What’s more, directors viewed themselves not as shareholders’ servants, but as trustees for great institutions that should serve not only shareholders but other corporate stakeholders as well, including customers, creditors, employees, and the community. Equity investors were treated as an important corporate constituency, but not the only constituency that mattered. Nor was share price assumed to be the best proxy for corporate performance.