Moving away from a Primary Focus on the Shareholder

For as long as many of us can remember increasing shareholder value has been the primary objective for public corporations.  Earnings per share, economic value, return on capital employed are among the key metrics a public organizations use to assess their ultimate value ¹.  Yet, there are growing questions as to whether such singular focus is healthy for organizations and their various stakeholders.  In part one of this entry – I will examine the history behind the rise of shareholder value and challenge its viability as the primary value creator.  In part II, I will talk about some new and more meaningful ways to assess value and examine what has to happen to make this shift.

First, shareholder value has not always been king.  The focus on shareholder value gained strength coming out of the recession of the late 1970s, a rise in hostile take over bids and the deregulation that started during the Carter Administration and went into light speed during the Reagan years.  The increase in the power of shareholder value cannot be attributed to any changes in corporate law.  It was driven from major culture shifts that occurred around the concept of corporate governance.  It was a shift away from a balanced influence of clients, employees, shareholders and other key stakeholders to the primary influence of profitability ².

The question is – has this primacy of focus on shareholder value delivered value to public companies and the executives that lead them?  The theory was that by focusing on shareholder value corporations would move assets from declining sectors to new and more innovative ones.   In addition, the act of the hostile take over was partially aimed at empowering shareholders so that they could hold management accountable to evolve the company ³. Yet, did this theory work out?

“How many companies would spend their wealth on stock buyback programs if their objective was to create wealth? How many companies would see fit to cut R&D expenditures if their objective was to build wealth? How many companies would cavalierly shed long-term, loyal employees, their heads crammed full of information valuable to the company, if their objective was to create wealth? ⁴”

Allan Kennedy – Author of The End of Shareholder Value

In short, the focus on shareholder value has not met its promise.

• Research has shown that this focus has not equated to an increase in corporate performance [Simon Deakon, Ibid, p. 14]
• Only the hostile take over targeted shareholders gained any substantial wealth.
• Other stakeholders have lost power – most importantly the customer and the employees of public companies.

Even more potent is my view that the sole focus on shareholder value is a contributor to the current economic crisis.  The focus on the primacy of stock value and profit allowed the ethical lines to become blurry for some executives and many began to cross ethical lines for the sake of profitability.   This became quite apparent during the Enron and MCI crisis as well as the recent collapse of the capital markets. The ensuing Sarbanes Oxley laws were meant to ensure correct reporting.   And through all of this employees, customers, and innovation have gotten the short end of the stick.

Additionally, if you look at the current auto industry crisis – you can see that leader’s continued to focus on selling the SUV even though these gas guzzlers hurt the environment and supported our continued dependence on foreign oil.   Auto executives took no leadership towards a more innovative and gas efficient product.  In retrospect taking such innovative steps may have caused some stress on their growth but in the long run would have had the industry retooling far ahead of the current crisis.   Yet, given the focus on shareholder value – it was simply more profitable to push out the gas-guzzlers because after all that’s what Americans seemed to want.

In addition, mergers were a big outcome of this focus and if you look at the research you will see that in most cases mergers did not support the growth and profitability of most organizations and in fact in many cases had a negative effect.  Again, the main beneficiaries in mergers tend to be the existing stockholders – not the future ones.  Finally, you are seeing a depletion of shareholder wealth given the bottoming out of the stock market.

In my view, it was a grand experiment that has had questionable success.  So what is the alternative?  In part II, I will focus on how organizations must ultimately recalibrate value as well as highlight the transforming role of the shareholder.

Tags: leadership, primacy of shareholder value, rebalancing corporate value

This entry was posted on Monday, April 6th, 2009 at 9:30 am and is filed under Leadership Development, Strategic Engagement, Trends. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.