The World's Dumbest Idea: Maximizing Shareholder Value [pdf]
gmo.com
gmo.com
I'm not sure where on the list of world's stupidest ideas to put this idea that you can judge a measuring stick by using it to measure its advocates. All Montier has succeeded in demonstrating is that (a) the goal of maximizing shareholder value is so sacrosanct that even someone trying to undermine that goal naturally identifies good results with high share prices and bad with low; and that (b) Montier is really not arguing against the goal of maximizing shareholder value at all, but against the idea that explicitly trying to do so is effective.
And it does seem that maximizing shareholder value is a sort of financial anti-Heisenbug: don't worry about it and there's no problem, but the more intently you focus on it, the worse things get.
Think of yourself trying to solve a maze -- because there are cul-de-sacs, if you took the naive strategy of directly minimizing distance to the goal, you'll just become stuck in a dead end. Yet if you do reach the goal (by another means) the distance will still be minimal (zero). This is basically the concept of local optima in optimization.
Of course, there are other situations, where through careless optimization a measure can become entirely disconnected from the holistic concept it is designed to encourage. Think for example of using "lines of code" as a heuristic for programmer productivity; I could unroll loops to maximize that measure and achieve a much higher value than the most truly productive programmer.
So the question is whether long-term shareholder value is of the first or second type. I think it may be difficult for it to be entirely disconnected from success, although I agree that it is foolish to optimize directly.
Montier's letter is rather more muddled than your comment. He suggests not only that optimizing returns in the short run is a poor strategy for creating long-term value for shareholders, but that the benchmark of share value (even over the long run) is a deficient measure of corporate performance. Everything Montier writes suggests that he believes companies did better (in some sense that he never quite articulates) in the era when managers ran their firms as they saw fit, before the idea took hold that they should try to maximize share value.
So the irony of his argument is the incongruity of demeaning the very benchmark he uses to suggest that J&J has somehow been a better managed company than IBM; the major arc of his argument vitiates the evidence he uses to support it. It is ironic, in the comedic sense, that Montier seems to be so imbedded in the culture of maximizing shareholder value that he invokes that criterion, seemingly reflexively, in the course of his argument against it.
But it's a logical and rhetorical mess, too. Montier's argument is analogous in your maze-solving formulation to claiming that the final distance from the exit is a poor measure of the performance of a maze-solving algorithm while at the same time maintaining that greedy algorithms are worse than random algorithms because it turns out that the greedy ones end up farther from the exit. If you accept the first claim, then the second is a non-sequitur, and advancing the second argument undermines the first.
[I]f we wish to count lines of code, we should not regard them as "lines produced" but as "lines spent": the current conventional wisdom is so foolish as to book that count on the wrong side of the ledger. -- E. W. Dijkstra
At its extremes, it's altruism vs. Dr. Evil. But focusing on delivering to the customer vs. delivering to the shareholder as the first order of business is the differentiator. Do the first, and the second will come naturally. Do the second, and the results of both are questionable.
Berkshire Hathaway exists solely to maximise shareholder value, prima facie. Why else would people buy and hold their shares? Altruism? Warren says it exists to enrich shareholders in the long term.
Are confusing shareholder value with a short-term focus on return?
I understood BH/Google to be implicitly criticizing the myopia of "shareholder value" as that term is usually meant.
http://3rdmoment.blogspot.com/2014/12/stock-performance-in-e...
Person A wants long term growth of the share price so they can sell down in many years to fund their retirement.
Person B wants rapid growth in the share price (even if it eventually kills the company) so they can sell it soon.
Person C isn't much concerned by share price growth, as long as the dividends keep coming each year.
Person D invested because they want to support environmentally-friendly companies.
Person E isn't concerned about tree-huggers, but a lot of people in his town are employed by the company so he wants to support them.
Your challenge, should you choose to accept it: Which of these Shareholders' Value will you maximize?
I believe 1) is mostly true but 2) is not necessarily true and especially should not be true.
It all matters on how badly you want cash. They're not a shareholder unless you've already decided to sell them equity.
The person with the most shares.
I suspect that that's about the only way I ever even get a chance to accept this challenge.
You give B a swift kick out the door, because there is where all the trouble comes from.
Once there, balancing up the interests of A, C, D and E become easier as long as nobody within A, C or E take extravagant living for granted.
Additionally, there is no 'wrong' time horizon for an investment. If one's goal is to buy now and sell in 3 months at a profit, they can absolutely do that.
If management's goal is to maximize growth over the next quarter, even at the expense of long-term results, they can do that. Caveat emptor, my friend.
Unfortunately, B is the only one whose interests are commonly represented in publicly traded US companies these days. B is the prototypical Fortune 500 CEO.
It's also why the B-Corp is becoming increasingly popular, as it can shield management against being sued for not profit maximizing.
As far as satisfying the shareholders, A and C wouldn't invest in the same company (growth vs. mature), Bs are speculators which you should almost always ignore (except when you need to throw them a bone to avoid activist situation). D/E don't really exist in the world of institutional investors, which are the investors you would have a dialog with (retail investors are generally just along for the ride).
This is _extremely_ naive. Google is a good example: you could immediately find a dozen examples where everybody, including them knows that a given solution/service/feature does not serve their users' interest -- it's for money.
It's exactly the other way around, that's why free market works. You focus on financial success, and THAT is going to lead to making your users happy. There are a lot of stories where the best alternative died because of the lack of a reasonable business model; and there are almost zero examples where most successful market participant was not the one with the best _overall_ solution. (Best overall == that is chosen by most of the people. And yes, Microsoft is one of them: we all remember how crappy Win95 was, but some of us might even remember that it did things nothing else on the market was able to do.)
The "users" being referred to are the advertisers.
They say that, but they don't actually do that. If they were prioritizing the long-term interests of their users, they wouldn't be giving away their core services for free and funding them with advertising revenues. That may seem better for users in the short term, but in the long term it means that only services that promise advertising revenues are available; services that lots of users like (e.g., Google Reader), but which don't generate enough advertising revenue, get shut down, no matter what the impact is on users. The best thing for the long-term interests of users is for Google to charge users directly for services; yes, figuring out how to do this for something like Google search is a hard problem, but what is Google for if not to solve hard problems that no other company is in a position to solve?
More here:
The market is not 100% efficient, but it's not extremely far from it either.
Share prices are not something you can 'grow'. The company's future prospects change, and that affects share prices. If the companies will start targeting B, then the market will (very quickly) learn that this doesn't work (i.e. lot of people lose their money because they buy close to the top), and then share prices won't increase.
Person A, B, C don't exist in isolation. C _is_ concerned by share price growth because growing share price still means (despite all the bullshit people read and believe about investing) that the expected future dividends will increase. Person B _does_ care about long-term prospects because he's not the only smart guy in the town and if the company is doomed in the long run then chances are somebody else will sell before B sells. Person A _does_ care about short-term growth -- again because he's not the smartest all the time therefore if the share price drops today then it's usually a good signal about the prospects of tomorrow (I hope nobody argues with that -- if one does, then he's free to make a fortune on the stockmarket...).
D and E is a completely separate story.
Tell that to companies that have used the ZIRP environment to borrow cheap money to buy back their shares. According to Barclays, companies with the largest buyback programs have outperformed the market by 20% since 2008[1].
[1] http://online.wsj.com/articles/companies-stock-buybacks-help...
This notwithstanding, you stated unequivocally that "share prices are not something you can 'grow'" when it is evident that companies have a number of tools at their disposal that can be used quite effectively to manipulate share price, especially over shorter periods of time and in certain kinds of markets.
[1] http://aswathdamodaran.blogspot.com/2014/09/stock-buybacks-t...
The governance wonk's answer is that shareholders should elect board members who will guide management to the risk profile they desire from the investment ... or sell to fund purchases of alternative securities better aligned with their needs. This poses all kinds of real-world problems, from ensuring that management doesn't adopt its own preferred risk profile (where that differs from shareholders'), to the relative costs of organizing many smaller block holders, on the one hand, and consolidated institutional investors, on the other, to the existence (or non-existence) of liquidity and alternative investments.
That line of thinking leads to lots of hard questions about how micro-level market and governance structures play out in the large, as well as the extent to which small-scale investors can organize or consolidate interests (say, via funds) and stay true to their interests as scale.
The first example: IBM and JnJ are in wildly different industries, competing in different markets against different competitors employing vastly different strategies. To use an arbitrary time period (who is to say IBM’s returns 10 years from now won’t trounce JnJ’s), and employ a metric (shareholder returns) that is often out of whack with reality (as Montier himself would acknowledge) isn’t persuasive enough for me.
The second macro example of comparing returns between two totally different time periods also isn't exactly apples to apples either. And also completely ignores the effects of hundreds of other potentially significant factors (interest rates, gdp levels, global trade etc)
This article seems to be a strong case of confirmation bias on his part. Ironical given that he's written a popular book on behavioral investing. (And yes this comment can also be viewed as suffering from a similar bias)
Yes SVM has pitfalls, yes focusing on the customer should be a high priority, however the agency problems Montier describes (management extracting undue value) are solved by neither.
Borrowing from churchill(?) — SVM might be the dumbest idea in how we organize our public markets, except for all the others.
I highly recommend to just get the book [1], it's written very well and in layman terms but here's an extract taken from a review [2] of the same:
"Stout traces the birth of this “fable” to the “oversized effects of a single outdated and widely misunderstood judicial opinion.” Dodge v. Ford Motor Company was a 1919 decision of the Michigan Supreme Court. The opinion’s status as a meaningful legal precedent on the issue of corporate purpose is tenuous at best. Yet, its facts “are familiar to virtually every student who has taken a course in corporate law.” As Stout has observed in the past, “[t]he case is old, it hails from a state court that plays only a marginal role in the corporate law arena, and it involves a conflict between controlling and minority shareholders” more than an issue of corporate purpose generally. The chapter explains quite well that any idea that corporate law, as a positive matter, affirmatively requires companies to maximize shareholder wealth turns out to be spurious. In fact, none of the three sources of corporate law (internal corporate law, state statutes and judicial opinions) expressly require shareholder primacy as most typically describe it. To the contrary, through the routine application of the business judgment rule, courts regularly provide prophylactic protection for the informed and non-conflicted decisions of corporate boards"
[1] "The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public" by Lynn Stout http://www.amazon.co.uk/The-Shareholder-Value-Myth-Sharehold... [2] http://arizonastatelawjournal.org/book-review-the-shareholde...
When recommending it to those who aren't corporate attorneys or otherwise involved in the subject matter, I include a caveat: If this is the only book you read on corporate governance, be aware that it's a controversial and contrarian book packaged for non-lawyers. If its subject were political, I could find and recommend a book arguing the opposite view it in a similar style. I'm not aware of any legal rebuttal that isn't presented in more traditionally legal, less approachable form. It's been reviewed in legal journals, but even most lawyers consider those long-winded and dense.
One is tax policy. A corporation can pay for its capital in three ways: 1) dividends on stock, 2) interest on loans, and 3) stock buybacks to increase the stock price. The first is taxed more highly than the second two. This has a huge influence on corporate behavior. Because payments on loans are not taxed, converting equity to debt increases profits. This funds the entire "private equity" industry, which is really about leveraged buyouts. This bias in favor of loans also increases the involvement of the banking industry in corporate finance.
Loans and investments aren't really that different. They once were; lenders expected to be paid back. Then came junk bonds, where the interest rate is cranked up to compensate for the risk, and the securitiziation of debt, which allowed off-loading the risk onto other investors. (See 2008 financial crisis.)
There's an occasional call to "end the double taxation of dividends". Taxing interest paid and stock buybacks at the same rate would be equally effective. This would be a good time to do that economically, because interest rates are so low.
Stock buybacks are mostly a tax dodge. But that's not the full reason for their popularity. For stockholders, they're no better than dividends. But for stock option holders, which usually include the CEO, they're a windfall. Option holders get nothing when the company pays a dividend and the stock price remains the same. But in a buyback, the stock goes up and they win big. This is one of the major factors driving CEO pay upward. (If you assume CEOs are rational actors as regards their own compensation, much corporate behavior becomes clearer.) Japan doesn't allow stock buybacks for most types of corporations. The US does. It doesn't really benefit anybody but management.
So that's the tax policy argument. It's dull, but important.
As for why companies prioritize shareholders so much, more than they used to, the reason is simple - less fear by companies. Companies used to be afraid that overdoing it would lead to government action. Their business might be nationalized, taken over by the Government. Britain did that to the rail, coal, steel, airline, power and telephone industries. The US never went quite that far, but electric power and telephone companies used to be regulated utilities with rate-of-return regulation, and the airline and trucking industries were regulated by the Civil Aeronautics Board and the Interstate Commerce Commission. In the US, this was a political compromise between big business and small business. Small businesses didn't want big monopolies to have control over their essential services, like power and transportation.
All this changed starting in the late 1970s. Nationalized and regulated businesses were stable, but seemed inefficient. They had no incentive to take risks to improve. The history of the Reagan era is well known, so that doesn't have to be repeated here, but reviewing the history of deregulation is useful. What seems to happen in deregulation of regulated monopolies is that a large number of new companies enter the field, and prices go down. Then most of the new companies go bust, and the winners consolidate. The result tends to be deregulated monopolies. Look at the last 30 years of the telephone industry, from AT&T to lots of little companies and back to AT&T.
There's another source for the decrease in corporate fear - the end of communism. It's hard to realize this now, but from the 1930s through the 1970s, there was real worry in the US that communism might beat capitalism economically. By the 1950s and 1960s, the USSR had a successful space program and was industrializing rapidly. Capitalism had serious ideological competition. In the 1980s, though, it became clear that the USSR couldn't make their system work. It worked for some of the big, centralized stuff - coal, steel, power, and such. But the rest of the economy didn't work very well. With that threat removed, companies could stop worrying about socialism and communism gaining popularity.
Related to this was the decline in labor unions. This has a lot of causes, but the biggest one is simply that unions peaked in the era when industry centered around huge plants with huge numbers of semi-skilled employees. Those were the situations in which unions had the most leverage. There were once steel mills which employed 5,000 people with shovels. If you visit a steel mill today, there will be some shovels around, but they're just for cleanup. You'll see a lot of machinery and not many people. Manufacturing employs 7% of the US workforce. It was around 40% in 1950.
Labor unions once had a big influence on working conditions. When a sizable portion of the workforce was unionized, non-union businesses tended to have working conditions not much worse than union shops. Companies didn't want a labor-organizing campaign. So the 8 hour day and the 40 hour week were standard, and pay tended to follow union levels in non-union businesses. That's disappeared.
As a result of these changes, there's no major political opposition left to "maximizing shareholder value". That's why we're where we are now.
None of the examples you give show this. What they show is that, because of flaws in corporate governance, things that do not maximize shareholder value are being done in the name of "maximizing shareholder value".
I don't follow the logic at all; other than altruism, why would anyone buy shares of a company that wasn't trying to make an excellent sustainable profit over time / increase its share value?
Because they're not trying to make money from the shares increasing in value sustainably; they're trying to make money in other ways. A couple of examples:
* Buying some shares, creating a bubble that causes those shares to increase in value non-sustainably, then selling the shares before the bubble pops;
* Getting compensated in stock options with a low exercise price, taking short-term actions that cause the share price to rise non-sustainably, exercising the options and selling the stock at a higher share price, then using a golden parachute to leave the company, letting others pay the price for the non-sustainable actions.
I will say that it is a complete mess. A lot of businesses today treat their customers and employees like garbage. On the other hand a lot of of the existing unions are parasitic so I understand criticisms on both sides. I can only suggest that it is because we have a very bad form of corporatism run amok in the US. Where regulation does exist it tends to support large companies (which I suppose is not much different from the picture in the 1970s).
The left is afraid of big heartless business. The right is afraid of big inefficient government. We have a wonderful mix of both. Both sides are too busy screaming about the splinter in the other's eye that they miss the log in their own.
> Nationalized and regulated businesses were stable, but seemed inefficient. They had no incentive to take risks to improve. The history of the Reagan era is well known, so that doesn't have to be repeated here, but reviewing the history of deregulation is useful. What seems to happen in deregulation of regulated monopolies is that a large number of new companies enter the field, and prices go down. Then most of the new companies go bust, and the winners consolidate. The result tends to be deregulated monopolies.
How do you combat this? Both seem less than satisfactory.
Hacker News barely supports links, and you want footnotes?
Volatility and CEO pay, Harvard Business Review: https://hbr.org/2011/06/volatility-the-nasty-truth-abo.html
AT&T breakup and reassembly: http://gadgets.boingboing.net/gimages/atthistory.jpg
Union decline: http://www.hup.harvard.edu/catalog.php?isbn=9780674725119
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I'm in Australia where there's a system of dividend imputation. That means that together with dividends one will receive franking credits representing tax that a company has already paid. This has another advantage of really benefitting shareholders on a low income, few as there may be. The corporate tax rate is 30%. The highest marginal tax rate for the median income earner is 32.5%, meaning dividends, as paid out, will typically attract an effective 2.5% tax. Wonderful.
For someone receiving 70c in dividends and earning under $18k a year, they will get another 30c back through their tax return.
It's a pretty nice system and it's astonishing to me that the vast majority of other countries don't do this. It also means that domestic shareholders are advantaged over foreign ones.
Then there's also the government restriction on mergers/acquisitions among the four big banks, which provides stability, consumer benefits, a nice dividend for the shareholders - it provides an actual desire by the banks to create value.
http://en.wikipedia.org/wiki/Qualified_dividend#cite_ref-4 http://en.wikipedia.org/wiki/Rate_schedule_(federal_income_t...
I suppose "stability" is one upside of a government supported quasi-monopoly. Australian banks are an absolute disgrace. I say that as an Australian who returns home from time to time. Charging $2.50 to withdraw money from an ATM?? They get away with gouging customers in ways that simply couldn't happen in the UK or US.
2. Only if you use an ATM not run by your bank or not in your bank's network. There's near enough always going to be a cluster of four ATMs corresponding to the four big banks in any area, at least one of which will be free to withdraw from.
3. Get an account with ING Direct and they will refund you any ATM fees, even those charged by other companies.
Disgrace? Please.
I've shuttled back and forth between the two countries for seven years now, and I can tell you, unequivocally, that you're speaking out of your bumhole.
Visa PayWave transactions in Australia, in July 2014: 58 million
All contactless transactions in the UK, in September 2014: 32 million
And with ING Direct offering 2% cashback (and some banks doing a promotional 5%) on all contactless transactions under $100 things are good. And in the UK contactless is limited to less than A$40, while in Australia it's A$100.
How are buybacks a tax dodge? If they have the desired effect of boosting share price, then there will be increased taxes paid by shareholders when those positions are exited, no?
Also, some people will need dividends for cash flow needs.
Let's see what happens to two companies, one of which pays 10% dividend each year, and the other which increases in price 10% each year. Use a tax rate of 15%.
The first company: Every year we get 10% dividend, pay 15% tax on that, have 8.5% post tax dividend. Reinvest in company.
value = initial * (1.085)^nyears
The second company: Every year it increases in value by 10%. If we ever were to sell we would have to pay 15% tax on appreciation.
value = initial + initial * (1.1^nyears-1) * 0.85
Of course, I guess the argument for it is that it has the favorable effect of encouraging capital investment, that's what it's supposed to do right? I am curious what evidence there is of how well it does that.
According to wikipedia, capital gains were taxed as ordinary income in the U.S. until 1921, and the history since then have gone up and down -- but are currently at their historical low. http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United....
Aren't they better for stockholders as well?
Suppose I have 1 share of stock, and I will sell it two years from now.
If the company pays out dividends, won't those be taxed as income at my marginal rate? Whereas if the company does a stock buy back, then two years down the road the marginal value that would have been paid out in dividends is now captured in the stock price. So instead of paying the marginal rate, I pay capital gains on that amount.
I might be missing something, but it seems like a tax dodge that benefits all (except the government).
With dividends, you pay the tax immediately/that year.
With capital gains, you don't pay until you sell.
If one looks long-term enough, you could also sell when you are in a lower income tax bracket or the government has lowered capital gains for random political reasons.
I'm Canadian, and we have something similar. But it only applies to corporations that are resident in Canada (where Canadian corporate taxes are paid on retained earnings?). I think the intent is to recognize the tax already paid on earnings, not necessarily to make it like taxable like capital gains... but it's all a wash.
It seems that qualified dividends in U.S. are limited in similar ways.
My confusion makes sense in retrospect: I have generally held stock from U.S. markets, so I don't often benefit from the credit. I believe dividends were always counted directly as taxable income.
So... supposing that you're in the U.S. and your stock isn't U.S.-based, wouldn't buybacks always be more tax favorable?
It was clear long before then. There was a lot of fear of the USSR's military capability, but not their economy. One obvious example was Kansas was shipping wheat to the USSR starting in the early 70's to make up for Soviet agricultural shortfalls.
The GDP charts I've seen seem to support the latter: the USSR's developing economy grew significantly faster than the US's developed economy for a sustained period of several decades. The "collapse" of the USSR didn't look so much like an adjustment (i.e. what you would expect if those numbers were completely fictitious) but rather a leveling off of growth. As for your "obvious example," 1. importing food is not necessarily indicative of a shortfall and 2. from what I understand, the central government of the USSR occasionally starved sizable chunks of its population for political reasons rather than due to actual shortfalls (e.g. while simultaneously exporting food).
Most people who follow financial news know that share buybacks increase EPS, but Animats goes a whole level deeper.
As we found out from Wall Street's behavior during the recent crash, executives are rational actors, and what they want is as much as they can take, economy be damned.
Dividends, interest, and repurchases aren't the whole picture. Especially when funders are also insiders, a variety of other (sometimes "soft") benefits reward investment. Much corporate behavior studied in the vein of management conflicts of interest relates to executive compensation and other benefits that may or may not contribute to personal tax base. There is also the matter of trade in securities based on valuation, on public markets and otherwise, by investors of all stripes. Many listed companies have never paid a dividend and probably won't ever pay a dividend. S-1s for well subscribed IPOs often warn pro forma this will be the case. Companies may also adjust the amount and kind of risk they bear to align with one constituency at the expense of another (e.g. management over outsiders, well organized institutional investors over the masses).
While leveraged buyouts are by no means dead, PE is far more than LBOs. The industry predates and has long outlived the 80s LBO boom. The term is a broad umbrella over many different kinds of operators leveraging (or suffering under) various features of our tax system.
Debt and equity still enjoy different rights in liquidation, and contractual covenants and controls accompanying credit are different than rights assigned to equity holders by statute, governing documents, financing agreements, securities laws, and exchange rules. Like the time-remote possibility of dividends from a growth company, different spots in line to the coffer of a healthy operation still affect valuation. Derivatives and public markets can facilitate decoupling of control rights from equity. Instruments can be designed to blend equity and debt characteristics. But debt and equity still confer different rights to affect operations.
It is difficult to speak of stock buybacks out of context; their use is varied, from purely financial to entirely structural. They are not entirely "unregulated", either. Background state corporate law, governing documents, exchange rules, and contracts (including debt documents) impose restrictions on when and how. The board is involved. Markets, public and private, may take note.
It is also difficult to make tax arguments out of context. Even statements about the macroeconomic effects of certain policies have to turn on the prevalence and kinds of tax situations meaningful populations of companies inhabit. Tying the tax effect to rising executive compensation requires at least time-correlating tax policy changes to compensation. I'm not sure that's borne out. There are many additional confounding variables.
Thanks for sharing your opinions. You've got some good back-and-forth started.
Edit: Changed "bankruptcy-remote", which is a term of art in bankruptcy, to "healthy", which makes the point with less risk of confusion.
We on "Hacker Digest" (actually curious, do some people call it that?) would kind of appreciate that.
Much corporate behavior studied in the vein of management conflicts of interest relates to executive compensation and other benefits that may or may not contribute to personal tax base.
Er, yes. Problems include "pay for volatility". If the CEO gets an option grant at market every year, and the stock price is flat, the option is worthless. If there's huge volatility, the option can be exercised at a peak, but is costless in a down year. McKinsey has a nice article on this: https://www.gsb.stanford.edu/sites/default/files/documents/m...
While leveraged buyouts are by no means dead, PE is far more than LBOs. The industry predates and has long outlived the 80s LBO boom. The term is a broad umbrella over many different kinds of operators leveraging (or suffering under) various features of our tax system.
Seldom does "private equity" mean an actual cash purchase by a private party. There's usually debt involved, often taken on by the business being bought. There's also usually some tax gimmick involved. It's interesting how often a business turns around after going private, even with the same management team. See this article on Dell, a year after going private: http://www.cnbc.com/id/102026551
Debt and equity still enjoy different rights in liquidation ... But debt and equity still confer different rights to affect operations.
Yes, debt and equity are not the same thing. But they're a lot closer than they used to be. Here's a piece on startup financing, comparing convertible debt vs. preferred equity. (http://mintonlawgroup.com/?p=173) The classic property of debt is that there is a bounded upside; the best that could happen was that the creditor got their money back with interest. With convertible debt, if the company does well, or even just gets another round of funding, the loan can be converted to stock and the creditor can win big. If the company fails, as creditors they're ahead of all equity holders and maybe even general creditors. It's also not unusual for creditors to demand a seat or seats on the board, even if they don't have equity.
It is difficult to speak of stock buybacks out of context; their use is varied, from purely financial to entirely structural.
Yes, their use is varied. But about 87% of US corporate borrowing since 2009 is for stock buybacks or dividends. (http://www.washingtonpost.com/business/corporations-cant-sto...). This reflects the low, low interest rates the Fed is offering. Equity to debt conversion is so tempting.
It is also difficult to make tax arguments out of context.
Most tax arguments for political campaign purposes are over tax rates over time. There's less public discussion over what is taxed at which rate. That, though, is what a sizable fraction of K Street lobbyists spend their time on. See "http://www.nytimes.com/2014/04/02/business/tax-lobby-works-t..., which notes, on tax breaks, "If you are not at the table, you are on the menu". Relative tax rates for alternatives drive many business decisions. Absolute rates, less so. Over the years, capital gains tax rates have gone up and down without affecting capital spending comparably. See "https://en.wikipedia.org/wiki/Capital_gains_tax_in_the_Unite..., the graph for note 17.
(I suspect I'm boring everyone to death at this point, so I'll stop.)
On the contrary, I, for one, am quite engaged by both your commentary and citations. Thanks!
I have put a few of the links on my reading list.
Where did you get this? Stock buybacks are commonplace in Japan. Try and search "ＴＯＢ 株" or "株式公開買い付け" on Google News (use Google Translate if you can't read Japanese).
Non-dividend-paying stocks are much less common than in the US, but that doesn't mean that buybacks aren't allowed.
Businesses do not exist in empty space but within a society and their primary responsibility is to provide value to this society by providing jobs, goods, services, taxes, research, you name it. Investment and growth are not primary goals, they are just means to the aforementioned responsibilities.
People should invest in a business because of its intrinsic value and not define the value of business by their investments. Financial gains should only be an additional incentive and protection against the risks of investments but not the sole reason for the investment.
If you could argue that maximizing shareholder value naturally aligns with maximizing intrinsic value all would be fine but I can not see how this could be true. It may sometimes be true for long-term investments but for short-term investments the contrary seems to be true. If you only care about the next quarter cutting wages and quality is the easy way to maximize shareholder value but is diametrically opposed to maximizing intrinsic value.
I actually agree with the idea. The quote about shareholder value being a dumb idea from Jack Welch, yeah, sure.
This article is sloppy though. The author side-by-side compares economists speaking in abstract aggregates, press releases from PR-generating-feel-good-organizations (the CEO roundtable thing), publicly stated metrics used by companies for success (IBM), and distribution/influencer strategies (Johnson and Johnson).
It just seems like throwing a lot at the wall and seeing what sticks. Pulling out a 1980's feel-good-PR and contrasting that against Johnson and Johnson remaining focused on doctors, nurses, families...
That's before getting into cherry-picking, survivor's bias, good and bad strategy (Rumelt would savage later-day IBM, not for being profit-focused, but because "doubling earnings per share" is not a strategy)...
...ok, too many problems to list them all. Agree with the general idea; the article isn't so well-thought though.
http://www.economist.com/blogs/buttonwood/2014/12/investing-...
http://www.businessinsider.com/gmos-montier-maximizing-share...
http://www.bloomberg.com/news/2014-12-03/shareholder-value-f...
like a lot of things in economics, a lot of things could have been going on during the switch from 'managerialism' to 'shareholder value' paradigm, so it's not necessarily true that it caused returns to go down. in context the effect Montier talks about is quite small. but it does seem clear that it didn't cause returns to go up meaningfully across the board.
in fact, the effect Montier cites seems to go away if you do a slightly more sophisticated calculation
http://3rdmoment.blogspot.com/2014/12/stock-performance-in-e...
there are a lot of studies that show companies where management has skin in the game do measurably better than companies where they don't.
that being said, there aren't data that would tell you, companies where the CEO will earn $1m or $10m depending on how well the company performs don't do as well as companies where the CEO will earn $20m or $200m.
edit: the question of impact of CEO incentives on stock performance is probably more complicated than what I said. I've seen a lot of studies that show that incentives impact management behavior. but probably most of those behaviors relate to short-term stock outperformance. whether those changes result in long-term outperformance is another question, and whether the incentives even reward long-term outperformance is complicated. https://hbr.org/1990/05/ceo-incentives-its-not-how-much-you-...
Same applies to all non-managerial staff. That is why I love the concept of coops, and I'm sad nobody does them much because they mean empowering your employees to be maximally productive at the expense of "potential profits" for founders and shareholders.
All the incentive systems in companies are all bandaids trying to make up for doing things wrong from the start. If you want to incentivize them to perform to profit, then let them profit as well from the companies success, and they will perform.
From the examples of co-ops that I have examined, it seems that they often fail from internal politics; this is true for both companies which are bought-out by employees, and those founded as co-ops. The examples that I've looked at are only anecdotes, and I do not have a list of citations, but I'd be very interested to hear from anyone who has found differently (as I have no prejudice against them).
There are studies that show that management 'skin in the game' compensation policies have cause an epidemic of control fraud:
http://neweconomicperspectives.org/2014/11/ceo-compensation-...
>that being said, there aren't data that would tell you, companies where the CEO will earn $1m or $10m depending on how well the company performs don't do as well as companies where the CEO will earn $20m or $200m.
Actually there is data, but it demonstrates the exact opposite:
http://online.wsj.com/public/resources/documents/CEOperforma...
Lower paid CEOs perform better.
> We can see this has been a driving force behind the rise of the 1% thanks to a study by Bakija, Cole, and Heim (2012). The rise in incomes of the top 1% has been driven largely by executives and those in finance. In fact, executives and those in finance accounted for some 58% of the expansion of the income for the top 1%, and 67% of the increase in incomes for the top 0.1% between 1979 and 2005. Thus, there can be little doubt that SVM has played a major role in the increased inequality that we have witnessed
He makes a solid argument against companies which employ flawed executive compensation programs - which are without a doubt very common. But so are companies which try to increase shareholder value. Simple correlation doesn't imply causation here. If there's any case to be made here, it's that a flawed compensation scheme leads to a short term optimization of shareholder value (ie. propagation of SVM) and not the other way around.
His argument for the decline in labour share of GDP is even more spurious:
>The role of SVM in declining labour share should be obvious, because it is the flip-side of the profit share of GDP. If firms are trying to maximize profits, they will be squeezing labour at every turn (ultimately creating a fallacy of composition where they are undermining demand for their own products by destroying income).
He completely omits the rising productivity in many industries which simply require a smaller workforce for the same output.
Pointing out well known flaws in an established economic system is hardly noteworthy. Potential alternatives would be much more interesting to talk about.
Behavioral puts human psychology back into the picture.
Montier argues that SVM (shareholder value maximization) is the fig leaf that covers the change in incentivization of CEOs, and one assumes other corporate officers, away from salary and bonus to stock options. Which has been key in bifurcating the 1% away from everyone else.
Or as they say in finance, when a CEO says shareholder maximization, he or she is talking their own book. They're the shareholder they want to maximize.
SVM reframes the dialog in terms of what many people consider legitimate - return money to shareholders - and away from, say, value to employees or to society more generally. Which puts me in mind of another expression, "job creators."
In this world, there is no difference in value to a company to raise money via debt or via equity. However, if we start to violate the 5-6 founding assumptions (i.e. we enter the real world) we find that there significant differences in value of a firm in a given industry who use debt or equity to raise money (or any flavor of security between debt and equity), who pay management via different bonus structures, who keep cash on hand versus pay it out, have underlying assets which are easily saleable or not, and who have different risk profiles.
Maximizing shareholder value is a nice tool to use when evaluating key financial decisions (e.g. how levered a firm should be), but as the other points out is misused or abused due to misaligned management incentives. However, tbe idea isn't intrinsically dumb, the misunderstanding of the value of the idea and how it should be used is what's sometimes wrong and sometimes harmful.
[1] http://en.m.wikipedia.org/wiki/Modigliani%E2%80%93Miller_the...
good lord, treating IBM and JNJ the same? not to mention assuming companies in their various stages should have comparable growth.
you always see these days a new tech company come out 'we are different (like everyone else), we do not care about our stock price blablabla. it doesnt take them very long before they realize that their stock price is critical to their survival.
as almost every tech found out after spitting such garbage, when their stock plummets their talent leaves. they would also find it hard acquiring talent. This is especially true when stock options are a significant incentive - as it almost always is.
this is not to mention the many various social effects of a company whose stock is always in the gutter. you lose customers, become the butt of jokes, etc etc (even though these things have no direct tie to stock price).
Apple, Amazon and Facebook to name three have really set the precedent that they use their money to stay in the game. Amazon invests nearly everything back in. That is actually valuable today more than EPS/P/E Ratios in the best innovative companies. Innovate and win and the shareholders will follow, follow your shareholders only and go right off the cliff to mediocrity.
Companies should be run with stakeholders as the focus. Shareholders being one, but the products/employees/customers/economy they are just as important to success and real growth.
http://www.forbes.com/sites/stevedenning/2011/11/28/maximizi...
The author seems to argue that switching from long term to short term shareholder value maximization hasn't really increased shareholder value (and might have decreased it). So I gather that he is in fact in favor of maximizing shareholder value but that it should be performed on a longer basis.
https://web.archive.org/web/20141206170332/https://www.gmo.c...
http://www.ted.com/talks/nick_hanauer_beware_fellow_plutocra...
I agree with the overall statement but not necessarily all of the analysis. I believe "stakeholder capitalism" is a better corporate structure.
Corporate bylaws would need to be changed to accommodate this.
➔ host www.gmo.com
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And he is comparing change in stock prices based on corporate mantras. He doesnt even adjust for industry, or compare to the overall market during that time. That makes no sense, why is this #1.
- The CEO will push the company to focus on SVM - The increase in wage gap due to high exec pay, like the 1%. - The company might not be helping it's longevity
An alternative would be not to pay exec's with Stock+Options, but focus on Salary+Bonus.
Put that into your quarterly corporate pipe and smoke it.
Some prelim. thoughts: Maximizing shareholder value is accomplished by increasing the value of shares, and presumably share value is the most widely-agreed-upon way to value a business - whether or not it is accurate or takes into account everything it should is another matter, but if you assume that share value is intended to capture the financial value of the business, then to say I want to max. SH value is basically the same thing as saying I want to increase the value of the business, which I think for the most part is a good and acceptable goal.
Here's what I think some of the problems are:
1. Conflation of SHs/Board/Managers.
To me, the real issue here is more that people in power (who are often SHs themselves - CEOs, boards, large SHs) use the "SMV" principal to hide behind self-interested actions - I totally admit this is there prerogative, but it's pretty annoying to see them try to dress it up in some abstract corporate governance value system.
This happens a lot for public companies with activist SHs and/or PE firms - see: Carl Icahn, who buys big stock positions, then publicly pushes management to take actions like sell or spin-off segments in the name of "shareholder value" when just the act of this publishing an open letter or pushing for his own board candidates, etc. will increase the value of his holdings in that very same company - yes, he is trying to max. SH value because he is a major SH!
This also happens with public company CEOs whose comp. is tied to and/or made up of equity, as is pretty much always the case these days. Lots of interesting literature out there about how careerist CEOs (who don't plan on staying at one company for more than a few years) will take highly risky short-term-stock-value-increasing actions that are bad for long-term value, etc.
Interestingly, this is especially true in early-stage companies, where Founders/VCs are often the biggest SHs, on the board and in key management positions (VCs sometimes take operating roles in companies as they hit growth stages or if there has been founder trouble, etc.)
This conflict comes into relief w/r/t to exits where liquidation preference get triggered: sometimes happens that VCs who control the board and hold preferred stock push for a deal where the preferred get $$ back but common gets nothing, even if the common think that it's a bad deal and want to keep pushing ahead in hopes that they can improve the business and exit with some value going to all stakeholders, not just preferred. This was litigated in Trados (see link below), and the court said that in that case, it was OK that the VCs made the deal happen.
Trados summary: http://www.bingham.com/Alerts/2013/10/In-Re-Trados-Incorpora...
(Not equity related, but a new instance of this is the reverse, and plays out in acqui-hire deals: founders are given great job opportunities and RSUs from acquiring company, but VCs get very little if anything and non-technical employees are out of the job. I think in most cases it's a totally fair outcome, just interesting to think about how it works in other instances where the value measurement is different - in acquihires, skill of individuals is the value, not the business, so stock value of the co. plays a much smaller role and the power then rests in the individual holding the skills/ability, not the VCs or the employees running business operations, etc.)
2. Even if it is not the stated or intended goal (as I sincerely believe most good entrepreneurs start business for more than pure financial gain - easier to just work for a hedge fund), almost all tech startups rely on maximizing shareholder value to properly incentivize founders, early employees and attract capital to a much higher degree than public companies. The interesting difference at the early-stage as compared to public companies is that, with no public market, the constituencies are relatively few in number and far more concentrated (founders are board members, managers and SHs, VCs are SHs and board members and advisors, employees are equity holders, very few customers at first, if at all, etc. - as discussed above, this happens a bit in the public market but not in such a concentrated way), so the incentives are much more easily aligned.
VCs are pretty-much-always looking for equity upside, and founders & employees (to significantly varying degrees haha) are more-often-than-not foregoing secure/higher salaries in exchange for potential equity upside - put another way, all founders, VCs and employees pretty much hope for an exit in which their equity is 10X what they had to pay for it.
Again, no founder/VC is saying the goal is to maximize SH value, but at the end of the day we as a community more or less measure success through share value.
That all being said, I love to think about exceptions to this rule: Craiglists = awesome (I hope they beat eBay in court), Kahn Academy is amazing.
Would love to learn about some more!
Risk is also a big part of shareholder value. Some stockholders may want exposure to an operation in the company's industry that isn't highly correlated to the market en masse, with higher risk and possible reward. (This is akin to the VC outlook, backed by redemption rights to pull the plug on any would-be "lifestyle businesses". It also sounds in Trados.) Others, including insiders, may have no way to diversify portfolios that are very heavy in the company's stock, and so prefer less or different risk.
You hint at this by your comment on short-termism of careerist managers, and implicitly by picking stock price (rather than, e.g., book) as value. The trouble with market value of securities is that potential purchasers are diverse in their risk appetites and so value diversely. A buyer and a seller might meet at a price by very different calculations. A price of $x per share doesn't mean that all prospective buyers would value the security at $x, or even that all current holders value at $x. Increasing $x by taking risk that's at odds with shareholder A's portfolio needs doesn't benefit A like it benefits others who need that exposure, especially if A can't efficiently trade for a more suitable substitute.
With respect to acqui-hires, I've seen enough variety and change to wonder whether I've enough firm ground to park a generalization. I've yet to hear of a structure that's purpose-built for locking in people so VCs can extract ransom on acqui-hire (perhaps using debt?). In terms of hired employee talent, there isn't much in the way of leverage against the at-will nature of employment and acqui-hirers' willingness to buy out options and sweat equity. Especially in a state like California that doesn't enforce many non-competes, that raises the question of why the hiring bother with acquiring at all. All sides involved---VCs, companies, and personnel---may be eyeing other benefits. As an entrepreneur (or an investor), "acquired" sounds much better than "abandoned". Talent likes to walk a bridge, rather than take a leap of faith, and keep good teams together. VCs would rather have a runner, but as dogs go, it's not so bad to put more of "your people" in a large company with cash to spend. It may be easier to buy with stock or options than justify an out-sized compensation plan award to existing employees. All the deals I've seen seem "personal" in these kinds of ways. Maybe the personal touch is the real story. Maybe it's just what I've seen and heard.
Concerning alignment in start-ups, I think it's worth pointing out that a lot of language goes into aligning those involved, resulting in potentially many series of diverse equity securities, plus notes and other instruments in between and all around. Everybody wants to get rich, sure, and when people are getting rich, even board meetings can be fun. Nothing like a new-money down-round to remember the house is built on fault lines.
Their index and commodity projections are truly hilarious and they've been claiming this sort of shit for years, generating bottom-decile returns.