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Why shareholder value is a problem for long-term financial health

A recent article in Harvard Business Review (HBR) questions whether maximising shareholder value should be the main goal for corporate managers. This is in according with what's known as 'agency theory', which starts with the premise that shareholders are the owners of the company and therefore have ultimate authority over the business and how it is managed. The theory, which was first discussed by academic economists in the 1970s, addresses problems that might arise due to differences in the goals or desires of the principal (shareholders) and the agent (corporate executives).

Shareholders in an accountability vacuum

The notion that shareholders are the company's 'highest authority' is somewhat problematic, however, given that they have limited liability for the actual business practices of the company (therefore no accountability) and often they have little familiarity with business practice and strategy. Moreover, they are often anonymous. The authors of the HBR article writes: “Agency theory has yet to grapple with the implications of the accountability vacuum that results from accepting its central—and in our view, faulty—premise that shareholders own the corporation.”

They argue that this corporate structure, with power skewed in the hands of faceless shareholders, could have damaging effects on corporate strategy and resource allocation. The danger is that corporate executives are under pressure to deliver consistent returns, while curbing risky investments that could in fact lead to future growth and innovation. The HBR authors argue that a better corporate structure would be more company-centred: “A better model would recognize the critical role of shareholders but also take seriously the idea that corporations are independent entities serving multiple purposes and endowed by law with the potential to endure over time. And it would acknowledge accepted legal principles holding that directors and managers have duties to the corporation as well as to shareholders.”

9 ways companies can move away from shareholder dominance

In his blog for Ethical Systems, Jeremy Willinger comments on the HBR article and writes: “Today’s businesses have morphed into revenue generators designed to squeeze every ounce of productivity and profit from its people and operations. Many corporate leaders see their role as the facilitator of shareholder enrichment.”

So if corporates are to move away from the accepted agency-based (or shareholder-centric) model, what exactly would a company-centric governance model look like. Willinger summarises the following key features that we could expect to see in a new business-focused model:

  1. a staggered board to facilitate continuity and the transfer of institutional knowledge;
  2. more board-level attention to succession planning and leadership development;
  3. more board time devoted to strategies for the company’s continuing growth and renewal;
  4. closer links between executive compensation and achieving the company’s strategic goals;
  5. more attention to risk analysis and political and environmental uncertainty;
  6. a strategic (rather than narrowly financial) approach to resource allocation;
  7. a stronger focus on investments in new capabilities and innovation;
  8. more-conservative use of leverage as a cushion against market volatility; and
  9. concern with corporate citizenship and ethical issues that goes beyond legal compliance.

These nine more business-focused practices could build a stronger ethical culture within companies, which is a way of building reputation and enabling sustainable success. Willinger argues that companies with a longer-term focus (i.e., not a short-term focus on creating shareholder value) could enable companies to allocate capital and resources in more innovative initiatives, which could increase strategic renewal and investment in the future.

CTMfile take: The HBR article and the Ethical Systems blog on it are both quite thought-provoking and they might touch upon a subject that's quite central in many discussions involving CFOs and treasury. Would your financial division be able to allocate resources more efficiently and with a more strategic, long-term view, if you didn't have to worry about the primary goal of ensuring value for shareholders?

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