The Shareholder Value Myth (2013)
europeanfinancialreview.com
europeanfinancialreview.com
The best performers in today's market are decidedly not short-term focused. Amazon and Netflix barely turn a profit, even though they could. Ditto for Tesla (well, maybe they couldn't atm even if they wanted to). The entire tech sector, which has been on a tear, is similarly long-term focused. Snap's stock, for example, isn't being hit because it's not profitable, but it's getting hot because its user base is plateauing (i.e. negative long-term signal).
Do a lot of (most?) companies focus on the short-term? Definitely! But that's rational behavior even from a societal resource allocation perspective. Imagine you're Walgreens, Target, P&G, Kroger, JCrew, or one out of another thousand "boring" (i.e. low upside) companies (like most others). If the upside at your company is limited, why throw money money at "long-term" thinking? It makes more sense to maximize profits now and return profits to shareholders who will in turn invest in the Amazons, Googles, Teslas, etc. who have the technological infrastructure and human capital to generate better returns per dollar of long-term spending.
The end result (which is happening) is that most companies by volume focus on the short-term because most companies in the US are working in a mature market with a well-explored product and have limited upside, while a small number of companies with large upside get a disproportionate share of investment.
As long as the user base is growing exponentially, most questions about valuation and revenue can be hand-waved away. It's a bit dot-com boom still, maybe crossed with a too-big-to-fail mindset, but if the CEO says "our service has 2 billion users, growing 10% quarterly" that still pacifies a lot of investors without any further concern about revenue-per-user. If you've got enough eyeballs, somehow money materializes.
Once we figure out that, say, "Peak Snapchat is 180 million users +/-10%", it becomes a lot more quantifiable to figure out "each user had to generate $23.45 of value per month to justify the company's valuation." And that means asking hard questions about the business.
As for long-term and short-term investments, the more I think about it, the more the "technical debt" concept seems like it has real value for thinking about companies.
A lot of firms take on the corporate equivalent of technical debt all over the place. Deferring maintenance or extending equipment lifecycles, cutting back on training programs that yield cheap promote-from-within employees. Renting knowledge they should own (excessive consultancy and third-party service providers). It always comes back to "let's polish some stuff in the short term, and if we're lucky it won't hurt our long term viability too much." A focus on maximum dividends is likely being bought with at least some technical debt.
Of course, this type of debt never appears on a balance sheet for investors.
So what is that difference? It must be long term bets vs long term stability. A long bet can only be consumed in the literal sense, by selling, until there is nothing left. Whereas a dividend producer will keep producing until failure. It's almost like give a fish/teach to fish. A good portfolio of bets may well be more profitable overall than a bunch of dividends producers (and thanks to the market, we can cash in on those bets at or own pace! (and even bet on greater fools, but that's a different story well deserving of double-nested parens)).
But in the context of retirement, there is one important difference: the cashing in of bets forces us to think about our mortality when we plan our payout (no matter how formal or not the payout plan is), whereas with dividend producers this is only an optimal (even if important) optimization.
With a sufficiently wide spread and high volume, you could realistically live off whatever meagre or fat harvest your retirement package provides each year, and leave all dreams and worries about valuation to your future inheritors. It would not matter at all wether you'd live five years into your retirement or fifty.
Do you mind sharing some examples of said bankruptcies?
Toys R Us, Vitamin World, Gymboree, Payless, Aeropostale, Limited, Claire, Pacific Sunwear, Sports Authority, and Wet Seal were all fairly common chains in America. And this is just the examples in retail.
Could they? That is speculative. Nobody knows what would happen if these companies started increasing their profit margins. It definitely would affect consumer behaviour in a negative way; we just don't know how significant the impact would be.
Also, I don't think that the strategy of trying to monopolize the entire world economy under a few central authorities is going to work in the end so in that sense maybe Amazon and Netflix actually do think short term.
Not really. They could simply stop re-investing in the company, and then that money would become profit.
When betting on technology companies in the long term, you're betting on two things: continued growth and the absence of a competitor that disrupts their business model or industry. To avoid the latter, you need research and development to stay competitive.
I seriously doubt that subterfuge can be perpetrated successfully quarter after quarter.
take any particular company and multiply it by the size of the whole market and you see what we see today: short term thinking across industries, LBOs, big bonuses for executives even in failing companies (toys r us etc)
so, while in any one particular company, yes shareholders wouldn’t put up with that behavior long-term, across the whole market they still get payouts, still have more stable investments that pay dividends etc even if there are those bad actors that wreck companies for thier own will
slightly off-topic, but, for every company that maximizes it’s short-term value, there is usually collateral damage to the people who work there (and thier families), sufferimg low wages, bad conditions, mass layoffs)...that to me is the real issue...
Sometimes that incentive is aligned with shareholders and people working at the said company, but not always.
It would be interesting to look at new methods of corporate governance for making these type of decisions, that involves the investors and people working in the company more directly.
As for involving workers in the company governance - this is common in Europe, I know that at least in Germany and Norway at some size of the enterprise the workers elect representatives for the board.
I think a board seat for employee representative is one way - I'm interested in broader direct democracy type approaches of corporate governance. Blockchain and DAOs feel like an interesting match for this, since many types of corporate activity - bookkeeping, shares (tokens) and token holder voting can be done on the blockchain. We are exploring this with https://Aragon.one
The PE firm may also make the acquired company take on additional debt in order to pay dividends. Or it may sell off assets of the company in order to take dividends out.
The PE firm doesn't get hurt if one of their looted companies goes bust, so there's no incentive to keep the acquired company healthy and viable. PE firms are like parasitic wasp larvae eating their prey from inside.
Just this year this sort of thing drove Toys R Us out of business, and iHeartMedia into chapter 11 bankruptcy.
Then you have Amazon which is assaulting every large retailer. Who has less time to visit a store than parents? The last thing a parent wants to do is make extra trips to stores when they do not have to.
When I heard about TRU going under recently, I was surprised. I had assumed they already went out of business years ago because of Amazon.
No. Bain, KKR, and Vornado took TRU private in 2005, in the process loading up TRU with debt. TRU was spending $400 million a year for paying off that debt, money which would have undoubtedly helped had it been invested in online operations or store refreshes, etc.
The private equity firms hoped to dump TRU on the market with an IPO, which TRU filed for in 2010 but that never took place, probably because it was crippled with debt by the geniuses who did the LBO.
What?! The “BO” in LBO stands for buy out, meaning the PE shop buys the whole company. Of course bankrupting a company you own is a bad thing. I think what you really mean to imply is that someone buys the company later from an LBO shop (maybe even the public in an IPO) and then it goes bust. Does this happen? Of course. But you’re also conveniently ignoring all the enormous PE/LBO success stories. You may not morally approve of the industry, but if there was no value, who would buy a company from the likes of KKR?
Not if you already got your profit out of it and aren't carrying any of the losses. The company's creditors and employees take the loss, not you.
The premise of the paperclip maximizer thought experiment is as follows: suppose you program a (sufficiently advanced) robot to maximize the number of paperclips. It might start by -- reasonably -- collecting all the paperclips it could find, and bringing them to you.
But after it does that, it might also realize that it could convert other things into paperclips — things like raw metal, other machines, and the atoms in the human body.
Basically, the paperclip robot says "maximize the number of paperclips at all costs." The corporation says "maximize shareholder value at all costs."
How can you be sure that the goals you've programmed into a sufficiently-complex system are actually beneficial to the people using the system?
As a bonus, it also creates a nice incentive for saving and investing into the future. What is hard to achieve on most systems.
I totally agree that checks and balances -- in the abstract, some form of all-to-all coordination between the different components of the system -- are probably the easiest way to healthcheck any system like this. Otherwise you fall into "multipolar traps" [1] where each actor, working independently and acting game-theoretically optimally, can throw the system into undesirable states.
Checks and balances should be implemented. But is this adequately true in the actually-existing implementation of the system?
[1] https://slatestarcodex.com/2014/07/30/meditations-on-moloch/
how does the natural ecosystem balance itself? I think that as long as each actor has enough degrees of freedom to exploit any loophole in any other actor, the system will self balance (by which, i mean become stable).
[1] https://press.princeton.edu/titles/8853.html
[2] http://www.wcbbf.org/pdf/balanceofnature/8.pdf
[3] https://journals.sagepub.com/doi/abs/10.1177/096366250506302...
I'd love to hear a good solution for this within a market system.
Your wealth won't expand forever, because we all die.
Corporations are owned by shareholders, who die and pass their wealth on to the government, family, and various charities.
My understanding is that upper-middle-class fortunes today are attributed more to cultural norms and posh school districts than to trust funds.
In the face of poor human judgement it might be one of the more robust resource allocation schemes available to us. But optimality should never be claimed without proof.
An impossible task indeed. That's the great thing about a market. The system designer doesn't have to understand what "actually beneficial" means, and participants don't have to take their word for it. People don't sign over value to companies unless they value what they're getting in return.
I guess this is why we hold on dearly to principals of liberty and freedom. To ensure that proper feedback mechanisms exist to keep an honest system.
Edit: and rule of law. Especially application of said law without preferential treatment.
All of which to illustrate why even though this statement:
> People don't sign over value to companies unless they value what they're getting in return.
reads as convincing, when taken in isolation, it actually says very little when held up against the harsh light of reality. Optimising towards a stupid goal is still stupid.
Regulation by the government - the representative of the actual society, instead of just a handful of shareholders - channels the raw energy of capitalism towards the good of society through incentives and penalties (against companies' profits, their sole motivators). Otherwise corporations are just a bunch of really big dogs chasing cars, leaving destruction in their wake.
Their primary motivators. You cannot profit in exchange for nothing. It is always profit/loss in exchange for a particular business.
Citation needed. This sounds like rose-colored glasses to me. I don't believe such a golden age ever existed.
> Nor was share price assumed to be the best proxy for corporate performance.
Since when have shareholders cared about anything except getting rich?
> Many corporations formed in the late eighteenth and early nineteenth centuries... They structured their companies to make sure the business would provide good service at a reasonable price – not to maximize investment returns.
Somebody tell the robber barrons this? They apparently didn't get the message.
> It was once believed (at least by academic economists) that the market price of a company’s stock perfectly captured the best estimate of its long-term value. Today this idea of a perfectly “efficient” stock market has been discredited...
Citation needed again. Because if anybody has a better idea of how to judge companies' long-term value, then they'll become extremely, extremely rich.
I'm sorry, but this article is absolute nonsense.
There are valid reasons why one might argue that the end goal of corporations shouldn't be to maximize shareholder value, and how governments should create policies towards that end, but this article doesn't even begin to touch on them...
How about staying rich? The idea of providing non-trading shareholders with a reliable stream of dividends for the rest of their lives is very different from that of looking good in fashionable metrics to maximize stock price now.
>Somebody tell the robber barrons this? They apparently didn't get the message.
Your ellipses left off the qualifiers. The author isn't talking about all companies. They are specifically talking about companies that were founded in part to provide services for investors as opposed to just return on investment--companies where people invested because they wanted the company to exist so that they could be customers. There's even a citation for this in the foot notes.
There is an excellent John Books (of /The Go-Go Years/, among others) tome on the subject, published just before the breakup: https://www.goodreads.com/book/show/1323717.Telephone
You get rich by taking the profits of the company through dividends. Anyone trying to get rich from selling the stock is playing the greater-fool game.
Share price is nice, but it's not the best game to be playing.
This is great when arguing with someone in the office who emphatically states "we need to maximize shareholder value!"
response: which shareholder: short term? long term? diversified? non-diversified? customer shareholders?
We can have a debate about 'shareholder primacy' but this is not it.
"Consider first Friedman’s erroneous belief that shareholders “own” corporations. Although laymen sometimes have difficulty understanding the point, corporations are legal entities that own themselves, just as human entities own themselves. What shareholders own are shares, a type of contact between the shareholder and the legal entity that gives shareholders limited legal rights. In this regard, shareholders stand on equal footing with the corporation’s bondholders, suppliers, and employees, all of whom also enter contracts with the firm that give them limited legal rights."
This is essentially rubbish, debt holders, suppliers and employees all have a relationship but they are not the firm. The firm does not exist independently of shareholders.
https://en.m.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_L...
Shareholders own and run the company. A majority of shareholders can effectively do anything they want with it, it's theirs.
That a corporation may possibly exist independently is a corner case.
It doesn't matter, the logic of the article is twisted.
It implies that profits can be used by the board of directors for whatever reason, obviously. But that board is elected by shareholders to carry out their bidding, and they are a proxy of shareholders, thereby abnegating the logic of the argument.
"The business judgment rule ensures that, contrary to popular belief, the managers of public companies have no enforceable legal duty to maximize shareholder value"
My god man, the board will act in the best interest of the shareholders or ultimately they'll get the boot. If the shareholders are dispersed and can't coordinate themselves, they'll have less power and see more go to the next entity with power, probably the executives.
Change shareholders to voters, executives to elected official, then you have a time tested example of power grab. Checks and balances are important in both cases.
In many companies, merely a handful of entities can make up most of the power, or nearly most of it. Shareholders that matter can usually fit in a room, and have a conversation.
With 300 000 to 1 as we see in politics ... it's a little different.
The theory also requires that the aggregate of investors are fools.
She's a lawyer and professor in precisely this area. You could read the wikipedia article, and try to confirm your bias. Or, you can read the book, written by an expert, and broaden your perspective.
The authors point is that a company is not obliged to pay all its profits in devisends. Without any proper explaination, the author draws the conclusion that shareholders aren’t entitled to any of the companies profits. This completely ignores to irrefutable truths
1) Not paying dividends does not automatically mean not maximising shareholders benefit. There’s unlimited ways a company can invest their profits in things other than dividends that will still benefit shareholders.
2) The shareholders control the company’s decision making. They elect the board, and the board controls the entire company.
The authors entire argument relies on pointless semantics and a highly selective view of reality. The same selective view you’ve displayed by acting as if profits and dividends are the same thing, and ignoring corporate governance structures.
Well, yes and no. The best or most powerful negotiator controls the company, and everybody who has an interest in the business (investors, creditors, employees, customers, suppliers, the public) can seek the power to manipulate the company on behalf of their own self interest. Shareholders can certainly partake in that process as well. But there's no law that guarantees that their interests have primacy over those other groups.
And that's just in the nominially shareholder-democratic sphere of things that are actually brought before shareholders. Most things simply aren't, and furthermore, in public companies, management essentially CAN'T tell shareholders more than is required by the SEC, because that means making the information public, for their competitors to see and plan around.
In short, shareholder democracy "sounds good, doesn't work." Management has total, dictatorial power, except in the case of major institutional investors like mutual fund managers or investment banks, who often as a matter of policy always support management. Even when they don't, they're so far removed from the people whose money it is that they're using to exercise their power that they may as well be classed with the manager class. Rarely, very wealthy individuals can exercise substations control as investors. More often, they are management as well (e.g. Zuckerberg's control of Facebook is as a manager, not as a shareholder.)
Unless something like that written in big, bold letters in company's charter, there is literally nothing like that a director of public company should care about.
How do you square your assertion with Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) and the subsequent need to enact section 102(b)(7)?
Additionally, note the distinction between profit and growth. For a long time, Amazon grew a lot and shareholders saw returns in terms of stock price, but the company itself made little to no profit.
Stopping operations, liquidating all the assets, and putting the whole mess in a savings account... that would eliminate local troughs, but is so obviously not in the shareholders' best interests that it might even violate the duty of good faith.
Banks and insurance companies have that.
Never heard to that magazine.