Andrew Hill writes in the FT about the way opinion is turning against the idea that businesses should focus primarily on maximising shareholder value.
He is reviewing a book by a Canadian academic, Roger Martin, which appears to be a polemic against linking CEO pay to company share price. But it’s interesting also for the background on how the tide has turned on the shareholder value movement:
Prof Martin’s central concern is that the pursuit of shareholder value “simply fails as a unifying theory to produce value in business”
Given that even Jack Welch, the high priest of shareholder value creation while chief executive of General Electric, has since dismissed its strategic primacy as “the dumbest idea in the world”, this argument sounds a little out of date. But Prof Martin is right that the theory continues to distort corporate strategy and that chief executives need to step off the consensus earnings treadmill. “I do think there’s room for leaders to lead, not to be led by the nose-ring by analysts,” he told me recently.
The idea that companies’ principal aim should be to maximise profits for owners came from Michael Jensen and William Meckling’s 1976 paper on the “principal-agent problem”, caused by chief executives allegedly enriching themselves at shareholders’ expense. But Prof Martin’s own research has shown that in the 20 years before 1980, when the shareholder value movement took root, CEO compensation per dollar of income earned at the biggest US companies actually fell. Between 1980 and 1990, it doubled and between 1990 and 2000, when Mr Welch and others were in their pomp, it quadrupled. Returns for shareholders, meanwhile, were better before 1980.
Hill highlights some interesting recommendations from Martin on improving the role of directors:
Recast board directors (who are as susceptible to the principal-agent problem as chief executives) as public servants. Encourage companies to rebuild the civil foundations of business for the mutual benefit of society. Readjust priorities to focus on customers over shareholders.
Cynics may roll their eyes at such prescriptions. But one of the insidious effects of the quest to hit quarterly targets is that it distances executives from the real reasons they are in business. In Prof Martin’s words, it makes them “indifferent to their communities”.