Thoughts about the idea of shareholder value

Photo by Ben Sutherland

I was listening to an old HBR.org Ideacast this week titled “The Most Influential Management Ideas of the Decade”. An interesting podcast dealing with even more interesting ideas. But what caught my attention was the first item they talked about. “Shareholder Value as Strategy”. This idea has many facets, and in the podcast itself, they were discussing whether it is on the list because of its success or failure as a concept.

This is an issue I have been grappling with for a while now. This is what I wrote in the past:

Companies have one goal

I believe that companies have only one goal. Ask Eli Goldrat. Their goal is to make a profit for their shareholders. There is only one outcome for a company: profit. Now, don’t get me wrong. I think helping the community and the environment is important and great, but it is not an outcome or a goal of a company. It is a side effect, although sometimes, a good one.

The problem with the idea of “Shareholder Value as Strategy” as with my quote above is the definition of value or profit for shareholders. While the traditional definition (generally speaking) is sustainable, growing dividends, today, most people will think about it as a rise in the stock price of the company’s share. And herein lays a big part of the problem for me, as I think the concept of the public company, as a social enterprise, has outgrown its value. I wrote about it in the past in a post titled “Are public companies creating value or are they suffering from the law of diminishing marginal return”. Here is a short excerpt:

The problem is that the structure of public companies and the stock market creates the wrong incentives. Instead of investors looking for expert managers to ensure their investment grows by creating more value, the investors (directly or indirectly using all kinds of funds) are searching to make profits out of the volatility of the markets.  When you have 1,000$ (or less) invested in a company, you are not interested in the value generation or in drawing dividends, but in the impact on the value of the share, so you can sell it…

I think that stock markets have a diminishing marginal return and we have crossed the point where they become less effective the bigger they get. Perhaps the near future will lead to a surge in the number of private companies.

I was listening to The HBR.org ideacast the same day I started reading Mihaly Csikszentmihalyi book Good Business: Leadership, Flow, and the Making of Meaning. Csikszentmihalyi makes many points relating to this issue, however, this is one quote I particularly felt connected to:

Public ownership of companies is intended to spread the bounty of capitalism widely. But the relationship of stock owners to the companies in which they invest tends to be impersonal. We seldom care about what a firm makes – whether it is cheap weapons, poisonous pesticides, or vacuous entertainment. We pay little attention to how it markets its products, or how it treats its customers, or how it affects the community where it operates. As long as it makes profits, we endorse its management. But let the CEO’s performance slip one-quarter, and we hasten to take our nest egg elsewhere. Not surprisingly young managers learns quickly that the quarterly report is almighty, and live in terror of its recurring shadow ever after

The more I think about the more convinced I become that Shareholder value through rise in stock price is a fundamentally bad idea. It started out as a great idea and has done a lot for the development of the world. In their widest definition, companies are social entities that are supposed to be used for the benefit of society. They do that by maximizing profits. But when profits equates with stock price in today’s modern markets, the original benefit are not always realized. Actually, sometimes, we achieve the opposite. It is time to start re-thinking and re-shaping the way public companies operate and create value.

Elad

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