Is "Shareholder Value" Real?

The concept of shareholder value was first articulated fully in a 13 September 1970 New York Times article by the late University of Chicago economist Milton Friedman, who asserted that the "social responsibility" of a corporation was "to increase its profits." (Full article available in PDF format here) Friedman wrote,

In a free-enterprise private-property system a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.

There's a lot of latitude in "conforming to the basic rules of the society", isn't there?

But there's apparently another problem: According to Cornell Law professor Lynn A. Stout, shareholders aren't really the owners of the corporation.

As explained by ProPublica reporter Jesse Eisinger in an article published in yesterday's New York Times, Prof. Stout believes that "shareholders are more like contractors, similar to debtholders, employees and suppliers." (Prof. Stout's ideas are fully explored in her new book, The Shareholder Value Myth.)

Prof. Stout explains that, legally, "shareholders [get] special consideration only during takeovers and in bankruptcy." And what you as a manager or board member should focus on when a company is in bankruptcy (or sufficiently weak to be the promising target of a takeover) is very different from what you should focus on when a company is doing well, she says.

By focusing on "shareholder value," she argues, and especially by aligning executive pay with stock-market share performance, companies have become more and more concerned with short-term solutions. Worse yet, thanks to the corporate governance movement which has been pushing for the pay-for-performance alignment, "Investors are actually causing corporations to do things that are eroding investor returns."

Prof. Stout would prefer that corporations return to "managerialism", "where executives and directors run companies without being preoccupied with shareholder value."

Really? Shareholders have that much power? Boards are that preoccupied with shareholders' concerns? Given the number of non-binding shareholder resolutions that corporate boards claim to "consider seriously" (and then ignore), I'd have said that shareholders still have a long way to go before they can be accused of undue influence. (Click here for a recent blogpost on shareholder "revolts")

As Eisinger writes, Prof. Stout does "share some goals with the corporate governance movement." She agrees that executive pay scales are "out-of-whack", and she believes in the need for a "Robin Hood tax" (a tax on securities trading, that would thereby discourage "zero-sum, socially useless trading").

I'm not a lawyer, so I can't argue the merits of Prof. Stout's argument about whether or not, by law, shareholders are indeed the company's owners.

But I'm glad to see another voice raised against the simplistic "shareholder value" argument. Even in Friedman's original article, we can see a bigger picture. The real problem with Prof. Friedman's argument is that his gaze is so narrowly focused on the corporation that even as he mentions the broader society in which the corporation exists, he doesn't see it.

Because of course corporations don't exist in a vacuum. They are run by employees and serve customers, all of whom are not only consumers (in economic terms) but citizens (in broader political terms). They have social networks. They have ethical concerns and values. And, generally speaking, they want to live lives that reflect those concerns and values. Which means that the corporations for which they work should reflect those values and concerns, too.