Disspelling Shareholder Value As A Driver Of Corporate Growth.

Beginning in the 1970’s, the desire to maximize corporate profits coupled with the fear of losing market share drove corporate executives to do whatever was necessary to please the only constituents who mattered in the corporate board room – the shareholders.

Thus was born a corporate Executive Suite dogma emphasizing shareholder value as the barometer of corporate “Success”.   Success became measured by the rate of return to shareholders and the short-term track record of the share price, and became such a pervasive corporate pursuit that it enveloped business school curriculums – emphasizing to students a shareholder-first ideology and providing them with tools to manipulate share prices and quarterly earnings reports.

How did we get to this point?  Trace back to the end of World War II.  In North America especially, the economic climate after the war was one of want and void of wealth.  Yet from that environment spawned a 30-year economic boom, driven mainly by the innate human desire for wealth generation and something more out of life.  But when the pendulum swung too far the other way to excess profits, as Jia Lynn Yang points out in her 2013 Washington Post article “Maximizing Shareholder Value: The Goal That Changed Corporate America”, competition in the 1970’s increased, thereby eroding company profits and, ultimately, shareholder returns.[1]

Yang cites a study done by Roger Martin, former dean of the Rotman School of Management at the University of Toronto, to show how an emphasis on shareholder returns as a barometer of performance has not provided the desired results for a corporations constituents.  He calculated that from1932 until 1976, the real compound annual return on stocks on the S&P 500 index was 7.6 percent, compared to a comparable return of 6.4 percent from 1976 to the present.  Martin attributes the higher annual performance over the earlier period to an era of “managerial capitalism”- recognized as a time in which managers sought to balance the interest of shareholders with those of employees, customers, and society at large. [2]

This ideal synchronizes with the leadership habits held by other corporate managers of the era; for example, Charles Erwin Wilson, CEO of General Motors from 1946 to 1953, believed that the aspirations of the corporation should coincide with and facilitate the aspirations of society, a belief firmly articulated in his report before a Senate Commission Inquiry during which he stated “What is good for the country is good for General Motors, and vice versa”.

Contrastingly, the post-1976 era – described as the era of “shareholder capitalism” – narrows the pipe of corporate pursuits to focus almost exclusively on shareholder returns.  This era saw the proliferation of corporate raiders executing Leveraged Buyouts (LBO’s).  Their game was to recognize and purchase, through cash, stock, or a combination of both, companies that owned assets with values greater than the market placed their stock prices at.

They exploited the market’s tendency to abdicate valuation due diligence on asset-heavy enterprises by purchasing the entities, retaining profitable operations (usually one or two) and dispensing of the remaining highly valuable assets to augment the bank account and sanitize the balance sheet (using cash to extinguish debt that produced inadequate returns) (see “Barbarians’ At The Gate”, required study for all who intend to participate in corporate North America).

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Concomitant excess expenses, such as wages, salaries and unnecessary overhead, were dissected from the model to present a pristine machine ready to generate “above-average returns”.  In the wake, many believed that the interests of employees, customers, and the idea of a corporation’s operations contributing to the sustainment of the local and federal economy were sacrificed so that individuals and investors could maximize wealth.

The conversion of mentalities from that of hard work, thrift, and drive to provide societal growth of the pre-170-s era to one of individual and investor greed of the 1970’s and forward has in part contributed to the consensus among some in other countries that North America has become a continent where its corporations and investors are immersed in a mentality of entitlement, and in some minds has abrogated North America as the purveyor of corporate responsibility.   However, a remnant from the old era still remains.

Martin states that it’s no coincidence that companies that maintain a strong customer focus, such as Apple, Johnson & Johnson, and Proctor & Gamble, consistently provide better returns for their shareholders than companies claiming to put shareholders first.

In her book, “The Shareholder Value Myth”, Cornell University Law Professor Lynn Stout calls for a return to “Managerialism” -  where executives and directors run companies without being preoccupied with shareholder value.  Then, they’re free to think about customers and their employees and even to start acting in a more socially responsible manner.  Shareholders would have a limited “almost safety net” role, Stout says.[3]

Of course, balance is required to at least provide the ground rules for corporate participation that sees financial performance reconcile with stakeholder and societal ideals and requirements.  At the nucleus of any corporations Mission Statement, however, should be the principle that its corporate strategy center around customers and all other constituents that its operations depend on, come into contact with, and affect, including local, national, and international economies that it participates in.

Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick.  He leads the firm’s consulting and strategy practice and works with companies to enhance their Analytics, Forecasting , and Data Optimization functions.  The practice’s focus includes quantitative forecasting, corporate and unit strategy and planning.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/BurgessKilpatrick for more information on our firm.

[1] Yang, Jia Lynn, Maximizing Shareholder Value: The Goal That Changed Corporate America, www.washingtonpost.com, August 23, 2013

[2] Martin, Roger L., Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL, Harvard Business Review Press, 2011.

[3] Stout, Lynn, The Shareholder Value Myth, Berrett-Koehler Publishers, Inc., San Francisco, 2012.