Is ‘shareholder value’ bad for business?
It sounds like great management philosophy—but critics say we need to get back to a broader vision of the purpose of corporations
The uprising against the owners of Market Basket that’s been unfolding over the past several weeks looks at first like a classic showdown between the powers that be and the little guys who would. In one corner stands a coalition of board members and major shareholders who think it should be returning higher profits; in the other, a crowd of employees fiercely devoted to the recently fired CEO, who won their loyalty by paying high wages, providing generous benefits, and handing out regular bonuses. Amazingly, even customers have joined the revolt, turning Market Basket stores into ghost towns and costing the company millions of dollars in losses.
There's something heartwarming about workers risking their necks in the name of a beloved former boss. But to observers who know how modern corporations work, the protests can seem a little naive: After all, everybody knows that a corporation is an entity whose first job is to maximize profits and deliver the highest return possible to its owners. As some commentators have noted, Market Basket is a business, and demanding that its investors forgo profits in service of some greater good goes against everything we know about the natural laws of capitalism.
Unless, of course, it doesn't.
Experts on the history of business say the Market Basket saga is a window onto something deeper than a power struggle among the Demoulas clan that owns it. They see it as emblematic of a war over the future of the American corporation—what its purpose is, how it should be run, and whom it should be engineered to benefit. They argue that maximizing profit and shareholder value—an approach to running companies that drives investment on Wall Street and serves as the closest thing to modern management gospel—is only one way of defining corporate success, and a fairly new one at that.
"This controversy is the tip of an iceberg," said James Post, coauthor of the 2002 book "Redefining the Corporation" and a professor emeritus at Boston University School of Management. "And what's below the iceberg is a much larger debate about the relationship between shareholders and all of the other parties that help account for the success of a company."
Post and others argue that a well-run company can—and should—be managed in a way that benefits not just the investors who own its stock, but a wide range of constituents. As opposed to "shareholders," they call these people "stakeholders": a group that includes employees, customers, suppliers, and creditors, as well as the broader community in which the company operates, and even the country that it calls home. According to that view, Market Basket's employees and customers are essential to the firm's success and, thus, rightful beneficiaries of its prosperity.
Importantly, it's not just antimarket leftists who are making this point: It's pro-business thinkers who want to see a more competitive future for American corporations. Critics like Post argue that the singleminded emphasis on profits and shareholder value—which took hold in the corporate world during the 1980s—has actually hurt corporations in a number of ways, giving their leaders the wrong kinds of incentives, gutting their future in pursuit of short-term profits, and often draining them of their real value and putting them at odds with their communities.
To take seriously the idea of a "stakeholder"-oriented corporation is to realize that firms like Market Basket, which we rely on in our daily lives and which rely on us in return, don't have a fixed role in a capitalist society, but rather exist as tools that can serve a variety of functions. While "shareholder value" is attractive in its simplicity, a look at its track record suggests it might be an idea that has reached its sell-by date.
Today, it’s widely taken for granted that the American corporation functions as a standalone, self-interested entity responsible exclusively to its investors. But it wasn’t always this way. “The early corporations were chartered by the state to meet a social purpose,” Post said. “Sometimes it was to build highways, sometimes it was to run banks, but there was always public purpose that went with the grant of a charter.” The message was straightforward: People who owned incorporated companies ran them at the pleasure of the state, and, in exchange for various legal protections, had a responsibility to do more than enrich themselves.
Though such demanding legislative charters had long fallen out of use by the mid-20th century, when American corporations entered what is widely considered their golden age, historians say that many executives nevertheless held onto the notion that they were overseeing entities with a role in society, and were responsible for creating more than the value that existed on paper. "They viewed their job as a sort of stewardship of an economic and social institution," said Lynn Stout, a professor at Cornell University Law School and the author of "The Myth of Shareholder Value."
During this era of so-called managerial capitalism, which began roughly in the 1920s, corporations were seen by both their managers and much of the American public as institutions that mattered in themselves: They produced useful products, gave workers and their families a stable and often long-term source of income, and played a role in the cities and towns where they did business. A company like IBM or General Motors could be the heart of an entire ecosystem of suppliers, investors, and even civic institutions.
But a change was coming to American capitalism. Facing unprecedented competition from Europe and Asia, these long-stable firms began to look like sleepy behemoths. And economists had begun to worry that top executives had become so powerful they were running companies with their own personal interests at heart, lining their pockets at the expense of the stockholders who, in theory, should have been benefiting in proportion to the company's success.
The solution to all these problems, famously articulated by the University of Chicago free market economist Milton Friedman in a 1970 New York Times article, was an elegant one: By framing the corporation purely in terms of its monetary value to shareholders, and setting aside the notion that it might be a valuable entity in and of itself by virtue of what it did, corporate America suddenly had an easy way to measure performance. The scheme had a kind of moral clarity: The risk of operating a company is borne by stockholders, so they're the ones who deserve to reap the rewards.
A well-managed company, then, would have a high stock price that reflected the best possible use of its assets. A poorly managed one was a target for a new class of investor—the corporate raider—who saw big companies as collections of assets that could be bought, broken up, and sold at a profit.
CEOs got the message: The point of running a company was to keep the share price high. And to keep their eyes on the target, boards started tying executive pay to the share price, by paying CEOs with stock options that were much more valuable than their paper salary. In the wake of the "shareholder value" revolution, everything except the value of a company's stock—including its impact on the lives of its employees, its contracts with suppliers and retailers, whether it was liked or hated by its customers—came to be seen as almost irrelevant. Everything you needed to know about how a company was doing was believed to be reflected in its share price.
By the 1990s, the notion that a CEO had an obligation to maximize shareholder value had become an unquestioned mantra taught in business schools; ordinary people assumed it was simply the way of the world. "People think it was brought down from Mount Sinai by Moses, as the 11th Commandment," said Richard Sylla, a professor who specializes in the history of financial institutions at NYU Stern School of Business, and the coauthor of a recent article in the journal Daedalus critiquing the notion of shareholder supremacy. "If you're younger than 50 or 60, you've lived in a world where everyone taught you that this is what a corporation is supposed to do—maximize profit and shareholder value. But the world used to be different."
The philosophy of shareholder supremacy, initially a reform to curb irresponsibility in managers, has ended up causing significant problems of its own, say Sylla and other critics. CEOs became obsessed with stock price at the expense of all other considerations. Some, like the executives at Enron, went so far as to defraud their own stockholders by engineering bogus profits. Countless others made short-sighted decisions intended to goose earnings, keep investors happy, and enrich themselves—all without regard for the long-term health of their companies.
The broader social effects of the shift toward shareholder value are clear, critics say, with wages stagnating and unemployment remaining stubbornly high even as the stock market has rebounded after the recession. Meanwhile, if the point was to benefit shareholders, it's not clear that worked either. Roger Martin, the former dean of the Rotman School of Management at the University of Toronto, points out in his 2011 book, "Fixing the Game," that from 1933 to 1976, returns on investment in the S&P 500—the decades immediately before the "shareholder value" took hold—were actually higher than they have been since. And Stout notes that in the 20 years after 1993, when a change to the tax code encouraged corporations to tie executive compensation to share price, investors in the S&P 500 saw returns that were slightly worse than what they were getting during the 40 years prior. The life expectancy of S&P 500 companies, meanwhile, has been cut dramatically—from around 70 years in the 1920s to 15 years today.
"We have been dosing our public corporations with the medicine of shareholder value thinking for at least two decades now," Stout has written. "The patient seems, if anything, to be getting worse."
As the effects of shareholder supremacy have begun to make themselves evident—Stout points to Sears and Motorola as examples of companies that have been hollowed out in the name of stoking share prices—an alternative approach to running a corporation, known as the stakeholder model, began gaining purchase among academics and business leaders. This model, as described by its proponents, recommends taking a less simplistic and short-term view of what makes a company successful, and calls for measuring its value not just in terms of profits and stock price, but the total impact it has on the lives of people who come into contact with it. There are clear reasons this might be better for employees, customers, and their communities. In the long run, say thinkers like Stout and Post, it is going to be better for the competitiveness of the American company. Pointing to firms like Market Basket, they argue that stakeholder-focused companies are ultimately more stable and financially healthy—a win, ultimately, for the very shareholders being forced to make room at the trough for other interested parties.
Though lots of prominent companies now take pains to cultivate reputations as conscientious corporate citizens, would-be reformers want something more. “All that stuff is just window dressing,” said Stout, referring to philanthropic programs financed by big corporations in the name of good PR. “Corporate social responsibility means running a business that contributes to public welfare—that’s the moral defense of capitalism. Business should be a force for good, not for the enrichment of a few small individuals.”
But the prospect of actually getting CEOs on board with that vision involves some formidable obstacles. The most important might be that, thanks to the structure of American finance, the "shareholder value" model has become the only philosophy that CEOs have any real incentive to follow. They are still compensated heavily with stock, so they benefit disproportionately from its performance. And their largest and noisiest shareholders tend to be investment firms that have far more interest in quarterly earnings growth than in the long-term health of any one company.
One set of solutions starts with the observation that stock price has been a powerful incentive in finance in part because it's a nice, simple number. Based on that insight, a number of new metrics have been proposed that would take into account a corporation's social contributions in addition to its profits. Another category of ideas resides in the realm of the law: One proposal, discussed by Sylla and former IBM executive Ralph Gomory in their recent Daedalus paper, centers on changing the tax code to provide benefits to companies that maximize their total contributions to America's gross domestic product, which would reward paying high wages and discourage offshoring. Another, advocated by Stout, would impose new charges on what she calls "socially useless" stock trading, which would reduce the profitability of short-term trading in a company's stock, and theoretically lift some of the pressure on CEOs to govern only for the near term.
Ultimately, what might have the best chance of changing minds in the business world are examples of companies that have pursued the stakeholder model and flourished as a result. If Market Basket is an example of such a company—as the remarkable solidarity of its employees and customers suggests it is—then proof that the model works might lie in the impressive growth and annual revenues that the chain has managed to pull off despite spreading the wealth around to all those who play a part in generating it. As an institution, Market Basket matters in New England in a way that a company narrowly focused on pleasing its investors could never be, by making it possible for thousands of people to live more prosperous middle-class lives, and tens of thousands of other people to feed their families more easily. With that in mind, whoever ends up in control of Market Basket once the dust settles will have to decide how to run a company that has been carrying on its shoulders significantly more than a few bags of groceries.