Most of us probably think--either from our finance classes or through received wisdom--that publicly traded corporations should maximize shareholder value, almost to the exclusion of all else.
But is this a good idea? Is the obsessive focus on quarterly stock price increases a good thing for investors, managers, and other stakeholders?
An article that from the New York Times suggests that maximizing shareholder value--or, focusing on the short term stock price--actually has pernicious effects on a firm's stakeholders.
I'll admit that I was skeptical when I first started to read this piece. I've read a number of fluffy articles on corporate social responsibility, and thought that the author would go into arguing that corporations need to spend more time on things that they're not well suited to do, such as charity work or environmental activism.
Instead, he's putting forth what I think is a well-reasoned argument for how the current emphasis on shareholder value maximization forces executives to being too focused on short term performance at the expense of long term value creation:
Too many chief executives succumb to the pressure to boost short-term earnings at the expense of long-term value creation. After all, their compensation depends on it. In the lead-up to the financial crisis — to take just one extreme example — financial institutions took on far too much risk in search of easy profits that would lead to a higher stock price.
The one problem I have with the path that the author goes down here is that one can just as easily argue that the real problem is that executives are not focused enough on shareholder value. If executives are too focused on short term thinking in order to please the ever capricious Mr. Market, then they're not pursuing potentially valuable, NPV positive projects that can make the equity more valuable and boost the stock price even more in the long term.
But if this is the case, why aren't managers clever enough to ignore the Wall Street stock analysts and focus instead on building long-term value?
The answer has to do with poor incentives: executives are often paid at least partially in corporate stock options, giving managers an incentive to boost the price of a stock and then cash out their position:
A second argument, though, is that the central idea that led us to elevate shareholders above all others is off-base. According to the reigning academic theory, shareholders are “principals” and management serves as their “agent.” Thus, it is the job of the principals to keep the agents in line. But, said Fox, “The more you treat executives that way, the more they are going to act like mercenaries, and the more they get away from seeing themselves as stewards of an organization with lasting value.”
Monkeys, what say you? How can we reform the short-term culture of Wall Street? Is it even as big a problem as the author suggests?
1
There's pretty twisted logic here.
The argument stated is that maximizing shareholder value should be avoided because it causes myopic behavior that only increases short-term earnings. But does that really make sense? Management teams pursued the short-term to increase their payday at the EXPENSE of the long-term. If they had focused on the long-term, it would have increased shareholder value. The article is basically saying avoid something virtuous because there are examples where people are not behaving in a virtuous fashion. Mmm. . .
2
The real problem is how management compensation works. Not that management teams are trying to increase shareholder value. The goal should be to create more long-term alignments of incentive. For example, have high water marks, clawbacks, longer vesting periods etc.
3
The author says that this all started in 1982 and that companies "have not gotten noticeably better since then". Really? I'd say that was day one of a multi decade bull run with enormous valuation creation. Yes . . . a lot of it crashed 25 years later, but it sure as hell wasn't cause managers were maximizing shareholder value. Actually, towards the end, it was just the opposite.
4
Finally . . . it's all about equilibrium points. If $100 can be taken away from employees and placed into shareholder's pockets, that will increase shareholders value UP TO A POINT. Eventually, it will start to erode shareholder value due to insufficient workforce, brain drain, decrease in morale etc. Similar arguments can be made with other stakeholders.
Value maximization does not necessarily imply acting only for the sake of short-term gain. And I second the longer vesting periods.
nah you should instead maximize stakeholder value...so everyone gets the piece of the pie they're entitled to and everything is rainbows and puppies
The title is very misleading. If instead it was titled, business owners and managers should focus on long-term value creation, instead of unsustainable short-term initiatives, that would be a lot more accurate as to what his point is. Unfortunately, it would also have zero controversy and zero readership.
How shareholders' wealth can be maximized ? (Originally Posted: 12/26/2016)
We say shareholders wealth can be maximized by increasing share price. How shareholders' wealth can be maximized through increase in share price as increase in share price does not affect share capital ? What we really mean by maximizing shareholders' wealth? As share price fluctuates on a daily basis how does it affect shareholders' wealth??
"How shareholders' wealth can be maximized through increase in share price as increase in share price does not affect share capital ?"
Not sure what you mean by this. If my only asset is one share of stock and the price of that stock increases, how does my wealth not increase?
Shareholders' wealth is maximized by maximizing the amount of money you make relative to what you invest as a company (this is what NPV is trying to capture). Adding positive-NPV projects at the company adds expected future wealth, which is captured in rising stock prices. Stock prices change because, among other things, expectations about the actual value generated from these projects change.
Thanks a lot zanderman.
"Activists know nothing about shareholder value" (Originally Posted: 02/24/2017)
ValueAct's Jeff Uben spoke out against hedge funds activists in a recent conference:
Hedge fund activists take a more active role in realizing the value of their investments. They can influence the company's board, management, and sales. From this article, I gather that an activist investor would have more of a vested interest in how a company is doing, which is why sustainable investing would be impactful for the investor. What other qualities (positive and negative) do you think an activist would contribute to sustainable investing? And why is it so bad to make short-term bets if they yield high returns?Forgive my possible ignorance, but isn't he an activist himself? A certain saying about pots and kettles comes to mind...
The return that you require when you're an activist is way higher than what a short-term speculator / investor can reasonably expect to get. This is largely because as an activist you can't hold too many positions and portfolio management is a completely different ballgame if you're a true activist and not a low-key big shareholder. The beauty with activism is that you're your own investment thesis catalyst, hence you need to do less work on that front (i.e. seek out what will happen and when that will prove you right) as long as you're convinced your actions will crystalize a re-rating / turn-around in the business beyond the self-fulfilling share run-up due to your presence being factored in by the rest of the market.
Another Myth on Maximizing Shareholder Value (Originally Posted: 02/12/2014)
If I asked you to explain the responsibility of a for-profit company to its shareholders, what would you say? In a recent op-ed in the Washington Post, Wikipedia founder Jimmy Wales suggests that there is a legal requirement of for-profit companies to maximize returns to shareholders. Now, this wasn't the crux of what his op-ed was discussing, but it is the fact that caught the eye of opinion columnist Harold Meyerson of The Washington Post who states:
In a clever move, Meyerson cites the Wikipedia entries on "Corporation" and "Corporate Law in the United States" to support his position. What's interesting is not how brazenly incorrect and glib Meyerson is in his analysis, but that if he spent 5 more minutes reading Wikipedia articles linked to the two he notes, he would've easily seen the error of his ways. At the very least, he would've noticed that issues relating to the relationship between a for-profit company and its shareholders is more complicated than he makes it out to be.Here is how Meyerson views the idea that it is the responsibility of for-profit companies to maximize returns to its shareholders:
This is absolutely incorrect. While it's likely that Milton Friedman wrote something along those lines, the idea that corporations have a duty to maximize profits for their shareholders does not go back to 1970, it goes back to 1916. Meyerson intellectual failure in this regard could've been avoided with one additional click on Wikipedia. He notes that he read "Corporate Law in the United States", and if he only clicked on "Dodge v. Ford Motor Company" (under subsection "Directos' duties"), which is described as "on directors' duties to the corporation and the community" (something I would've found to be extremely relevent to his piece). Had he done this, he would noticed under the subsection "Judgement" the following passage:
In Meyerson's defense, the construction of his argument and the wording he chooses leaves him plenty of wiggle room. But, that's only if you accept that maximizing profits is a single, isolated event, devoid of any nuance. Meyerson states:
What's peculiar is that Meyerson fails to realize that if a company assumes it'll prosper by hiring more costly workers, building a new factory, or investing in R&D, it is exactly maximizing returns to shareholders. His analysis is myopic in this regard, looking only at a single dividend payment or quarterly statement. Its validity stands upon the most cynical version of the fiduciary responsibility of for-profit companies to their shareholders. This cynicism is shown all the more brightly in his conclusion:
If we think, as Meyerson apparently does, that our own form of capitalism is an institutional edifice of greed, then we should relieve ourselves of all faith in society. If such a damaging force is created by the mere act of people coming together for a common purpose, whether that be one of business or otherwise, it is civilization itself that should be dismantled and discarded. I refuse to believe this is the way forward, but at the same time, I can't see how Meyerson can believe otherwise.
All I'm reading is a lot of arguing of semantics.
Would breaking apart large banks improve shareholder value? (Originally Posted: 07/27/2011)
http://dealbook.nytimes.com/2011/07/27/once-unthinkable-breakup-of-big-…
What do you guys think about this? Any merit to breaking up the Citi and Bank of America's of the finance world?
Hard to say. From a cost of capital perspective for the new spun off biz units clearly not, esp as you include deposit liabilities when you look at their funding structure. And thats what drives nim and equity in this sector. If anything i see these guys clutching onto their biz units to maintain a semblance of comptititveness, as clients still expect seamless integration from comm loans to ipo
how to calc total shareholder return (Originally Posted: 04/03/2014)
Hi guys... how do you properly calculate TSR with dividend adjustments?
Say you want to get the total shareholder return from 12/31/13 to 3/31/14. The company pays a dividend of $.10 on 3/1 and the stock price is $10 at 12/31 and $15 at 3/31.
intuitively it would be (end_price - begin_price + div)/begin_price... but do you have to decrease the begin price to $9.90 because of the dividend?
You are correct. http://en.wikipedia.org/wiki/Total_shareholder_return
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