Is “Maximizing Shareholder Value” the World’s Dumbest Idea?

For as long as I have been in and around business, the standard mantra has been that the purpose of business is to “maximize shareholder value.” To be sure companies had to make great products for customers and have great and motivated employees, but the real test of anything was whether or not it increased, enhanced or otherwise maximized shareholder value.

For several years a few business leaders, consultants and commentators have made a case that such a dogmatic emphasis was distorting and undermining the health of capitalism and our society. Instead they have exorted business to put customers first and, by extension, employees as well.

Steve Denning, who writes in Forbes and the Harvard Business Review and other publications, has written extensively about the misguidedness of overemphasizing shareholder value. For example, in a February 2015 article for Forbes, Denning wrote:

This week, Marc Benioff, Chairman and CEO of Salesforce [CRM] joined these CEOs and declared in an article in the Huffington Post that this still-pervasive business theory is “wrong. The business of business isn’t just about creating profits for shareholders — it’s also about improving the state of the world and driving stakeholder value.”

“We have an imperative,” says Benioff, endorsing the vision of Professor Klaus Schwab, founder of the World Economic Forum “to shift from creating shareholder value to stakeholder value… corporate management isn’t just accountable to shareholders… businesses must focus on serving the interests all stakeholders — customers, employees, partners, suppliers, citizens, governments, the environment and any other entity impacted by its operations.”

“But we have to do more. We have to build radically higher levels of trust and transparency with all of our stakeholders. We need legions of ‘stakeholder activists’ who seek to hold companies accountable for all constituents, going beyond the role of investor activists, who focus on holding CEOs and boards of directors accountable in terms of share price. Ultimately, the most effective way to create shareholder value is to serve the interests of all stakeholders.”

Denning contrasts Peter Drucker’s view, first articulated in the book, The Practice of Management published in 1954, that “There is only one valid definition of a business purpose: to create a customer,” with what Denning considers a disastrous detour from this thinking caused by people such as professor Michael Jensen and Dean William Meckling of the Simon School of Business at the University of Rochester who

published a seemingly innocuous paper in the Journal of Financial Economics entitled “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.”

The article performed the old academic trick of creating a problem and then proposing a solution to the supposed problem that the article itself had created. The article identified the principal-agent problem as being that the shareholders are the principals of the firm—i.e., they own it and benefit from its prosperity, while the executives are agents who are hired by the principals to work on their behalf.

The principal-agent problem occurs, the article argued, because agents have an inherent incentive to optimize activities and resources for themselves rather than for their principals. Ignoring Peter Drucker’s foundational insight of 1973 that the only valid purpose of a firm is to create a customer, Jensen and Meckling argued that the singular goal of a company should be to maximize the return to shareholders.

To achieve that goal, they academics argued, the company should give executives a compelling reason to place shareholder value maximization ahead of their own nest-feathering. Unfortunately, as often happens with bad ideas that make some people a lot of money, the idea caught on and has even become the conventional wisdom.

The negative and unintended consequence of making shareholder value creation, as measured by stock price, the raison d’être of business and rewarding executives through stock options, has been, according to Denning,

• pervasive short-termism (managing to quarterly results);
• employee disengagement as employees were treated as costs to be shed rather than valuable resources;
• the erosion of customer loyalty as corners are cut;
• financialization of the economy, making it vulnerable financial crashes;
• incentivized CEOs to become financial engineers and to focus on tricks like stock buy-backs and other tactics to increase stock prices rather than figure out productive ways to invest that capital back into the business

I think there is much people in business need to consider and, in some cases, radically re-think, about the biases and assumptions with which we operate, such as a reflexive bowing to the mantra that the over-riding purpose of business is “shareholder value creation.” Roger Martin, a professor at and the former dean of the Rotman School of Management at the University of Toronto, is a thinker and writer for whom I have high regard, wrote last September in the HBR:

As I have written extensively, I would maximize customer satisfaction. My minimums would be: treating employees well, having a positive impact on the environment, living within the spirit (not just the letter) of the relevant laws, and earning a return above the cost of capital. Such a system would make managerial choices as clear-cut and straightforward as pursuing shareholder value maximization. That approach has worked marvelously for Johnson & Johnson, Lego, Unilever, and many other leading companies.

And I have also written elsewhere that, ironically, pursuit of shareholder value maximization does a crummy job of maximizing shareholder value. The reason is that it cannot be pursued directly. Shareholder value only grows when other things – like making customers happy, creating a create environment for employees, being a great corporate citizen – happen. As Aristotle once opined: if you seek happiness, you probably won’t end up happy; but if you seek to lead a worthy life, you are likely to end up happy. Shareholder value and happiness are counterproductive to pursue directly; rather they will happen when other things are pursued.