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Is The Tyranny Of Shareholder Value Finally Ending?
Maximizing shareholder value: the dumbest idea in the world
Maximizing shareholder value is a powerful idea. It is simple. It is elegant. It is intuitive. It has at least one big problem: it doesn’t work.
As Roger Martin wrote in 2010: “Have shareholders actually been better off since they displaced managers as the center of the business universe? The simple answer is no.” It became steadily more apparent that focusing attention solely on shareholder value in the short term tended to lead to the management to do things that destroyed long-term shareholder value. The stagnation of Coca-Cola after Goizueta’s departure and the precipitous decline of GE’s market cap since Jack Welch’s departure have been startling.
Lorsch and Fox write in HBR: “There’s a growing body of evidence (for example, Rosabeth Moss Kanter’s “How Great Companies Think Differently,” HBR November 2011) that the companies that are most successful at maximizing shareholder value over time are those that aim toward goals other than maximizing shareholder value.”
And even Jack Welch himself had second thoughts. In 2009, he gave an interview with the Financial Times and said, “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.”
Shareholder value morphs into C-suite capitalism
Even worse, shareholder capitalism morphed into something else: C-suite capitalism. “Maximizing shareholder value” turned out to be the disease of which it purported to be the cure. Roger Martin writes that between 1960 and 1980, CEO compensation per dollar of net income earned for the 365 biggest publicly traded American companies fell by 33 percent. CEOs earned more for their shareholders for steadily less and less relative compensation. By contrast, in the decade from 1980 to 1990, CEO compensation per dollar of net earnings produced doubled. From 1990 to 2000 it quadrupled.
Since 2000, the situation has only deteriorated. According to Professor Mihir Desai, the Mizuho Financial Group Professor of Finance at Harvard Business School, over-compensation of the C-suite has produced a giant financial incentives bubble, that is inexorably pushing the US economy into decline. His 2012 HBR article makes clear that overcompensation of the C-suite is not merely an issue of “fairness” or “whining by the 99 percent”. The phenomenon is having disastrous business consequences, including a serious misallocation of capital and talent, repeated governance crises, rising income inequality and an overall decline of the US economy.
At the heart of the disaster, according to Desai, is market-based compensation—the idea that the C-Suite and financial managers should be compensated by the issuance of stock. The idea was intended to align managers’ interests with those of shareholders, but the result has been the opposite. According to Desai, the idea of market-based compensation is “intellectually flawed” and “a foundational myth.”
Even more disastrously, the skewed incentives and huge unearned windfalls have given rise to righteous but unwarranted belief in entitlement: the inhabitants of the C-suite “now consider themselves entitled to such rewards. Until the financial incentives bubble is popped, we can expect misallocations of financial, real and human capital to continue.”
Those who cannot remember the past are condemned to repeat it.
Maximizing shareholder value: the dumbest idea in the world
Maximizing shareholder value is a powerful idea. It is simple. It is elegant. It is intuitive. It has at least one big problem: it doesn’t work.
As Roger Martin wrote in 2010: “Have shareholders actually been better off since they displaced managers as the center of the business universe? The simple answer is no.” It became steadily more apparent that focusing attention solely on shareholder value in the short term tended to lead to the management to do things that destroyed long-term shareholder value. The stagnation of Coca-Cola after Goizueta’s departure and the precipitous decline of GE’s market cap since Jack Welch’s departure have been startling.
Lorsch and Fox write in HBR: “There’s a growing body of evidence (for example, Rosabeth Moss Kanter’s “How Great Companies Think Differently,” HBR November 2011) that the companies that are most successful at maximizing shareholder value over time are those that aim toward goals other than maximizing shareholder value.”
And even Jack Welch himself had second thoughts. In 2009, he gave an interview with the Financial Times and said, “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.”
Shareholder value morphs into C-suite capitalism
Even worse, shareholder capitalism morphed into something else: C-suite capitalism. “Maximizing shareholder value” turned out to be the disease of which it purported to be the cure. Roger Martin writes that between 1960 and 1980, CEO compensation per dollar of net income earned for the 365 biggest publicly traded American companies fell by 33 percent. CEOs earned more for their shareholders for steadily less and less relative compensation. By contrast, in the decade from 1980 to 1990, CEO compensation per dollar of net earnings produced doubled. From 1990 to 2000 it quadrupled.
Since 2000, the situation has only deteriorated. According to Professor Mihir Desai, the Mizuho Financial Group Professor of Finance at Harvard Business School, over-compensation of the C-suite has produced a giant financial incentives bubble, that is inexorably pushing the US economy into decline. His 2012 HBR article makes clear that overcompensation of the C-suite is not merely an issue of “fairness” or “whining by the 99 percent”. The phenomenon is having disastrous business consequences, including a serious misallocation of capital and talent, repeated governance crises, rising income inequality and an overall decline of the US economy.
At the heart of the disaster, according to Desai, is market-based compensation—the idea that the C-Suite and financial managers should be compensated by the issuance of stock. The idea was intended to align managers’ interests with those of shareholders, but the result has been the opposite. According to Desai, the idea of market-based compensation is “intellectually flawed” and “a foundational myth.”
Even more disastrously, the skewed incentives and huge unearned windfalls have given rise to righteous but unwarranted belief in entitlement: the inhabitants of the C-suite “now consider themselves entitled to such rewards. Until the financial incentives bubble is popped, we can expect misallocations of financial, real and human capital to continue.”
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