Archive

Posts Tagged ‘shareholder value’

Economic consequences of Shareholder Value Maximization (SVM)

Insead has recently published a short article (1) in which they try to draft the economic consequences of the SVM principle first made explicit by Milton Friedman. (2)

I will here only made some brief comments on several statements that I consider not rigorously introduced. Read more…

The Conference Board on Corporate Governance models

In a report published in July 2013 by the Conference Board, Leslie N. Silverman and Julie L. Yip-Williams expose their views about the “Shareholder Value Corporate Governance Model”.

 

They start by citing Berle`s (1932) statement that the purpose of a corporation is increasing shareholders` wealth.  In a big corporation with no relevant shareholder, power needs to be deposited by them on directors, so that they control the managers`s activities and assure the corporation fulfills its duty. They also cite Prof. Merrick Dodd, who advocated for a corporation looking also for the public good of other constituencies, as a tool created by the government.

 

In any case, they argue, the Corporation has been successful in providing wealth to both society and shareholders in the last four centuries, and public and academic opinion goes from one model to another from time to time. Since 1930 and until the 60`s, Dodd`s approach was predominant, and managers had a strong independence from shareholders. This was the time of the big conglomerates, as growth was much in connection with the managers` interests. But the view that these conglomerates and managers`discretion somehow destroyed wealth and were too difficult to manage gave way to the shareholder value model of the 80`s, a model that has been dominant until the end of the 20th century.

 

Nevertheless, the authors outline the existence of certain problems in the model, that is mainly focused on share price as a target:

 

–         Short-termism

–         Under-investment

–         Pressure by predominant institutional investors,

–         Excessive risk-taking

–         In an academic perspective, some also argue shareholders do not really own the corporation, but they have a contract to supply capital, as any other provider.

 

So, what are the actual stakeholder-type alternatives to the shareholder value model?

 

Two examples have been brought forward by stakeholders` model supporters:

 

First, a German labor-oriented model: it has a two-tier board structure, with a Supervisory Board, (executive body that in big firms has a third of members named by employees), and a Management Board, (composed by senior managers, and in big firms one also nominated by employees, the labor director). In that way there is a kind of co-decision by shareholders and employees, which is supposed to engender better employee training and security efforts, higher commitment by employees, and a longer-term oriented behavior by the firm.

Second, Japan`s state-oriented model. The state is involved in big corporations`businesses, on behalf of stakeholders and public interests. State officials ideally act on behalf of those interests in a long-term perspective.

 

Academic approaches differ: some support one stakeholder group above others, such as those advocating for a Customer-first model; or those advocating for society`s public good; but others do not prioritize any group: for instance, some argue that contract are not efficient in distributing the income generated by the firm, so that the board (a third independent party) must do it; others support the idea that each group should be represented in the board, so that all interests are considered by this body.

 

When evaluating actual models, the authors consider them more a result of particular history of each country than a model that can be exported. Models where stakeholder groups are represented are said to be even more problematic, in terms of the internal board malfunction they might entail. In general, those models are difficult to implement in countries where the shareholder value model is and has been predominant, as in the USA.

 

A new proposal: a Modified Shareholder Value model.

 

For those countries, a model where directors have the authority to take care of other stakeholders` interests is then proposed by Silverman and Yip-Williams.

 

The Business Judgement Rule protects directors in doing so, as a Court will not analyze informed decisions by disinterested directors, even if the decision harms the sharehoders` wealth. Directors in fact are generally not legally forced to blindly pursue the maximization of  shareholder value, but the best interest of the corporation, or of all shareholders, and in doing so, they usually consider other constituencies interests.

 

And the change also involves some other relevant elements, according to Barton (McKinsey): first, Boards would pursue longer-term goals; second, directors should be aware of the fact that stakeholders` interests do not oppose those of shareholders in the long-term; and third,  directors must act like owners, to compensate the rational “absenteism” of retail investors.