The business judgment rule ensures that, contrary to popular belief, the managers of public companies have no enforceable legal duty to maximize shareholder value.18 Certainly they can choose to maximize profits; but they can also choose to pursue any other objective that is not unlawful, including taking care of employees and suppliers, pleasing customers, benefiting the community and the broader society, and preserving and protecting the corporate entity itself. Shareholder primacy is a managerial choice -- not a legal requirement.
Debunking the Shareholder Value Myth: Evidence
Which leads to the question of the empirical evidence. As noted above, the law does not require corporate managers to maximize shareholder value. But this certainly is something managers can opt to do. And certain corporate governance strategies -- putting more independent directors on boards, tying executive pay to share price, removing "staggered" board structures that make it harder to oust sitting directors -- are widely recognized as effective means to make managers embrace raising share price as their primary objective. If shareholder primacy theory is correct, corporations that adopt such strategies should do better and produce higher investor returns than corporations that don't. Does the evidence confirm this?
Surprisingly, the answer to this question is "no." Researchers have spent decades and produced scores of studies seeking to prove that shareholder primacy generates superior business results. Yet there is a notable lack of replicated studies finding this.19 For example, one survey looked at more than a dozen studies of supposedly shareholder-hostile companies that used dual-class share structures to disenfranchise public investors. Some studies found dual-class structures had no effect on corporate performance; some found a mild negative effect; and some studies found a positive effect (in one case, a strongly positive effect), exactly the opposite of what shareholder primacy theory predicts.20
But more important, studies that examine whether supposedly shareholder value-maximizing strategies improve the performance of an individual company for a year or two are looking in the wrong place and at the wrong time period. Individual shareholders may perhaps care only about their own investing returns in the near future. But policymakers and governance experts should care about public equity returns to investors as a class, over longer periods. As already noted, if we look at returns to public equity investors as a class, over time, the shift to shareholder primacy as a business philosophy has been accompanied by dismal results.
Why? The answer may lie in recognizing that shareholder value-increasing strategies that are profitable for one shareholder in one period of time can be bad news for shareholders collectively over a longer period of time. The dynamic is much the same as that presented by fishing with dynamite. In the short term, the fisherman who switches from using baited lines to using dynamite sees an increase in the size of his catch. But when many fishermen in the village begin using dynamite, after an initial increase, the collective catch may diminish steadily. Shareholders may experience the same regrettable result when they push managers to "maximize shareholder value."
There Is No Single Shareholder Value
To understand why shareholder primacy can be compared to fishing with dynamite, it is useful to start by recognizing an awkward reality: there is no single "shareholder value." Shareholder primacy looks at the world from the perspective of a Platonic shareholder who only cares about one company's share price, at one moment in time. Yet no such Platonic entity exists.
"Shareholders" actually are human beings who happen to own shares, and human beings have different interests and different values. Some shareholders plan to hold long-term, to save for retirement; others are speculators, eager to reap a quick profit and sell. Some shareholders want companies to make long-term commitments that earn the loyalty of customers, employees and suppliers; others may want to profit from opportunistically exploiting stakeholders' commitments. Some investors are undiversified (think of the hedge fund manager whose human and financial capital are both tied up in the fate of one or two securities). Most are diversified, and worry about the performance of multiple companies as well as their own health, employment prospects, and tax burdens. Finally, some shareholders may not care if their companies earn profits by breaking the law, hurting employees and consumers, or damaging the environment. But others are "prosocial," willing to sacrifice at least some investment returns to ensure the companies they invest in contribute to, rather than harming, society.
It is these divisions between shareholders' interests that allow some shareholders to profit by pushing companies to adopt strategies that harm other shareholders. The divisions make it possible for shareholders to "invest with dynamite," as it were.
Investing With Dynamite
As an example, consider the conflict between short-term and long-term investors. 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, and it is widely recognized that some business strategies can raise share price temporarily while possibly harming the company's long-term prospects. Examples include cutting expenses for marketing or research and development; siphoning off cash that might otherwise be invested for the future through massive dividends or share repurchase plans; taking on risky leverage; and selling off all or part of the company. Hedge funds and other activist investors are famous for pushing boards to adopt such strategies. (Consider Carl Icahn's recent efforts to get Transocean to pay out dividends rather than reducing its debt.)21 This is profitable for the activists, who typically sell immediately after the share price rises. But over time, this kind of activism diminishes the size and health of the overall population of public companies, leaving investors as a class with fewer good investing options.
A similar dynamic exists when it comes to how companies treat stakeholders like employees and customers. Shareholders as a class want companies to be able to treat their stakeholders well, because this encourages employee and customer loyalty ("specific investment").22 Yet individual shareholders can profit from pushing boards to exploit committed stakeholders -- say, by threatening to outsource jobs unless employees agree to lower wages, or refusing to support products customers have come to rely on unless they buy expensive new products as well. In the long run, such corporate opportunism makes it difficult for companies to attract employee and customer loyalty in the first place. Some investors profit, but again, the size of the total investing "catch" declines.
Conflicts of interest between diversified and undiversified shareholders raise similar problems. For several years, BP paid large dividends and kept its share price high by cutting safety corners to keep expenses down. Undiversified investors who owned only BP common stock benefited, especially those lucky enough to sell before the Deepwater Horizon disaster. But when tragedy finally struck, the BP oil spill damaged not only of the price of BP shares, but also BP bonds, other oil companies operating in the Gulf, and the Gulf tourism and fishing industries. Diversified investors with interests in these other ventures would have preferred that BP focused a bit less on maximizing shareholder value. Similarly, consider the irony of a pension fund portfolio manager whose job is to invest on behalf of employees pushing companies to raise share prices -- by firing employees. This harms not only investors who are also employees, but all investors, as rising unemployment hurts consumer demand and eventually corporate profits.
Finally, consider the differing interests of asocial investors who do not care if companies earn profits from illegal or socially harmful behaviors, and prosocial investors who don't want the companies they invest in to harm others or violate the law. The first group wants managers to "unlock shareholder value" at any cost, without regard to any damage done to other people or to the environment. The second group does not. Asocial investing -- one might even call it sociopathic investing23 -- may not harm corporate profits in the long run. Thus it presents a different problem from other shareholder value strategies, discussed above, that reduce long-run investing returns. But it presents ethical, moral, and economic efficiency problems of its own.
Which Shareholders and Whose Values?
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