3 reasons the world is moving beyond shareholder value
For the past 40 years, a one-dimensional belief has prevailed that the purpose of a corporation is to maximize shareholder value. This belief, developed through the skillful advocacy of economists such as Milton Friedman and Michael Jensen at the University of Chicago in the 1970s, ultimately became the intellectual justification for Wall Street’s mantra that short-term share price serve as a primary lens for making investment decisions.
The belief in shareholder value continues to dominate Wall Street’s thinking and that of the broader investment community, including financial analysts, portfolio managers and individual investors. Yet, cracks are beginning to appear in the shareholder value edifice and are leading to a renewed examination of the factors that should shape investor decisions. Three factors are driving this re-assessment.
First, there is a growing realization within corporate governance circles that shareholder value is only one of a number of performance measures, and its continued influence is not the result of any specific legal requirement related to a company’s mission. Boards of directors are empowered to balance the conflicting interests of different kinds of shareholders. Boards that disproportionately focus on short-term shareholder value to the exclusion of the longer-term health of the company are failing to do their job. This is not a recent belief constructed by proponents of financial reform but, rather, is embodied in the charters of U.S. corporations that have been challenged — and upheld — in case law across many decades. So long as boards were free of conflicts of interest and made a reasonable effort to make informed decisions, courts have not second guessed their judgments on the best interests of the company.
Second, the nature of business risks is changing. Many of these risks are long-term in their evolution but increasingly short-term in their manifestation. They include:
- The increasingly disruptive effects of climate change that is destroying both public and private infrastructure from greater storm frequencies, and expanding stranded assets in agriculture (resulting from water scarcities) and housing (from sea level rise and storm surges.
- The vulnerability of global supply chains from natural disasters or material scarcities that result from national monopolies or political disruption.
- Greater volatility in commodity prices (During the 20th century, for example, there was a 0.5 percent decline in such prices; since 2000, commodity prices have increased more than 100 percent.)
- The changing definition of what is “material” to business operations and has to be reported to auditors and regulatory agencies. As businesses have become more global, the scope of materiality in enterprise risk management has expanded, comprising such issues as quality control from lower tier suppliers, water scarcities, biodiversity, human rights concerns and dysfunctional nation states.
Third, there is a growing contingent of shareholders and investors committed to using environmental, social and governance criteria when making investment decisions. Their influence is demonstrated by the increasing percentage of shareholder resolutions that are sustainability-related as well as the expansion of capital available for renewable energy portfolios.
While largely a niche area for today’s investors, proponents of more sustainable investing have developed important relationships with private equity firms, multi-lateral financial institutions and other thought leaders to contribute an important voice to the re-examination of the shareholder value debate.
Some proponents of sustainable investing have advocated the replacement of shareholder value with “stakeholder value.” While philosophically interesting, the stakeholder value perspective lacks sufficient definition. Further, there is no concurrence on the dashboard of financial metrics to guide risk management or investor decisions. Moreover, it ignores the fact that existing shareholders themselves are robustly diverse and encompass many, if not most, of the interests expressed by stakeholder value proponents.
A positive outcome of the shareholder-stakeholder value debate has been the search for new accounting tools and valuation methodologies. A growing number of global companies are re-assessing the riskiness of their assets. Chief Financial Officers in companies as diverse as ExxonMobil, Microsoft, Unilever, UPS and Walt Disney have instituted internal carbon taxes to change current business performance or they’ve implemented capital investment guidelines on the future cost of carbon to price anticipated risks for their future capital investments.
The debate over shareholder value will continue to gain traction. In a changing and more volatile global economy, the Friedman-Jensen-Wall Street argument that “maximizing shareholder value” is the sine qua non for investors is intrinsically simplistic and foolish. Corporations exist for multiple purposes, and evaluating their performance through a singular performance metric is antithetical to the principles embodied in their corporate charters.
The argument in support of shareholder value is not going away, nor should it. However, in a world driven by changing demographics, disruptive technologies, climatic variability, unstable financial and political systems and market volatility, it needs to be integrated with other performance incentives and measures that encourage directors, management and investors to keep their eye on the fundamentals — namely, liquidity, innovation and productivity, and opportunities and costs of the future.
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