Why Shareholder Value and Not Stakeholder Value?
While the debate on the issue of shareholder value vs. stakeholder value has been on-going for decades, it re-gained prominence on August 19 when the Business Roundtable, a gathering (for lack of a more accurate term) of nearly 200 CEOs of the world’s largest corporations, said that maximizing shareholder value can no longer be a company’s sole purpose. This statement replaces the one that same gathering issued in 1997, when it declared that maximizing shareholder value was the only focus of a corporation.
This kicked the dust off the debate and many people have since pronounced themselves in favor of the new declaration. In our opinion, the debate is misguided. Investor value creation cannot exist without proper treatment of stakeholders. Yet, attempting to focus on all stakeholders will lead to stagnation or erratic decision making, and that is why shareholder value should still be management's North Star.
Before we continue, it is important that we give you our definition of shareholder value. While similar to the general definition used elsewhere, our definition adds two crucial words: long-term and sustainable. And so, using our terminology, shareholder value is the generation of long-term, sustainable wealth for the owners of the firm. In our close to 40 years of history we never felt the need to add these qualifiers to the term, but the defensive posture of the Business Roundtable upon the pressure exercised by Senators Elizabeth Warren and Bernie Sanders, and the misconception inculcated in large part by Wall Street that “shareholder value” means “quarterly profit,” forces us to do so.
Maximizing long-term, sustainable shareholder value cannot take place without an appropriate management of stakeholders’ interests. If the company does not properly compensate employees and does not provide a safe working environment, shareholder value will suffer due to personnel attrition and lack of motivation among the workforce. If the firm is not a responsible member of the community, it may hurt its brand and reputation, ultimately constraining shareowner value. An organization that does not provide a valuable product or service to a customer will see that customer creating shareholder value elsewhere.
Cynics may say that this argument has been used before and that firms claim they take care of stakeholders but only do so in cases where it does not detract from investor value creation. They will use incidents like BP and the Deepwater Horizon spill as examples of why shareholder value reigning supreme is the problem. Yet they would be missing point. BP and its partners were never truly managing for long-term shareholder value. They were managing for short-term quarterly profit and in that quest decided to restrict investment in safety. In fact, shareholder value suffered greatly as the firm’s share price is still down by 33% compared to where it was before the spill. Those are billions of dollars for investors. If the firm was indeed managing for value, the investments in training, oversight, and safety would have been made, and the incident and its costs to shareholders could have been avoided.
In order to successfully manage for long-term shareholder value, a firm must align its internal processes with that objective. This means that employees get rewarded for creating long-term value and not for delivering on quarterly profits. It means that capital allocation decisions are based on value-maximizing initiatives, including the health, safety, and environmental types. It means that the firm internalizes the fact that dumping chemical waste into water ways will lead not only to penalties, but will be a reputational and, hence, value-destroying mistake.
Shareholder value maximization, under its correct definition, should still be the key objective of any firm. The Business Roundtable’s fear to stand up to Wall Street on the one hand, and Senators Warren and Sanders on the other, should not change that.