3 Oct 2013 08:35am

Shareholders versus customers

The mantra of maximising shareholder value has taken on the tone of a commandment – but is it fit for purpose? Financial experts tell Jane Simms why the customer should come first

The widely accepted principle that maximising shareholder value should be the primary goal of a company is being challenged from all sides.

The concept originated in a 1976 academic article in the US, which postulated that the only way to stop executives profiting at the expense of shareholders was to align their interests through a joint commitment to maximising shareholder value.

But while practised by most large corporations in the US and the UK for the best part of 40 years, consensus is growing that maximising shareholder value has achieved the opposite of what was intended. The short-termism, financial manipulation and fraud that it has engendered mean that not only have the interests of other stakeholders been sacrificed, but also that shareholder value has been destroyed, not created.

Jack Welch, the legendary former CEO of General Electric, recently pointed out that “your main constituencies are your employees, your customers and your products”.

Maximising shareholder value has myriad detractors, who point out that it is predicated on two false premises – that directors have a legal duty to maximise shareholder value, and that “the company” and “the shareholders” are one and the same thing. There is no shortage of potential alternatives, yet there remain stalwart apologists too – particularly in the financial and accounting world.



is author of the Cadbury Code on corporate governance and former managing director and chairman of Cadbury Schweppes

I don’t think boards sufficiently appreciate the difference between the company and its shareholders. The two are not synonymous, yet the very concept of ‘shareholder value’ suggests that they are. There is a very clear legal distinction, and the Companies Act specifies that directors owe a duty to the company, not to the shareholders. You are entitled as directors to say ‘we need to take long-term decisions that may not be of immediate benefit to today’s shareholders but are important to the continuity of today’s company’.

Shareholder value is also vexed by the question of who your shareholders are and what exactly they do value

Maximising shareholder value is a very limited concept and distracts everyone from what the purpose of a company is or should be. You have to take a broader view, which encompasses customers and employees at the very least. We didn’t explicitly state it at the beginning with Cadbury – we felt no need to provide the kind of mission statements that companies do now – but from the outset our clear commercial purpose was matched by a clear human purpose. That was part of the Quaker ethos of course: the whole approach is that every individual is of equal worth. We even had women managers at a time when it was very unusual.

We were always at pains to earn the goodwill and respect of our employees, and we valued them – even in 1905 we had a suggestion scheme. But our purpose was never confined to finance.

We also ensure that we provided customers with what they were concerned with, and the support of the community and the wider reputation of the company were extremely important to us. You had to – and still have to – balance a very complex and multifaceted set of issues, as well as balancing the short and the long term.

The notion of shareholder value is also vexed by the question of who your shareholders are and what exactly they do value. Long-term investors who are interested in steady continuing profit growth have very different objectives from the traders who are interested not in the value of the business itself but in the movement of value.

I used to go around the world talking about corporate governance, but in some countries, where big successful family businesses dominated, people were much more interested in how to maintain control of their businesses and pass them on to the next generation in better shape. We’ve got ourselves in a bit of a tangle in the UK and the US because the stock market has become so important. But in much of the rest of the world that’s not the case.



is founder-director of Tomorrow’s Company

The three words – maximising shareholder value – are illogical nonsense. Take ‘maximise’. If you pursue anything to its ultimate, excluding all other dimensions, you do it at all costs, sacrificing everything else. The word should be ‘optimising’ rather than maximising. Then ‘shareholders’: who are they? We are all shareholders, through our pensions and life insurance, but there is an assumption that we want the short-term financial returns that high-frequency traders look for, and intermediaries pursue those returns in a manner such that companies can’t create long-term wealth.

And how do you define ‘value’? Different attributes are valued by different people – but just as price is only one of the things consumers look for, not all shareholders are interested exclusively in financial value.

It is possible to have well-stewarded listed companies, but it is more difficult than for other forms of companies, such as family businesses and long-established private businesses. Stewardship – inheriting assets and passing them on in even better condition – is a much more holistic and long-term concept than shareholder value, encompassing as it does emotional and spiritual as well as financial considerations. We are working with companies and institutional investors to help make it easier to practise good stewardship.

For example, we need to think harder about differential rights for people who are serious about stewardship, because the more share trading is reduced into algorithmic sport, the harder it becomes to invest for the long term. Some of the more thoughtful people in the City are already sympathetic to the idea of a ‘transaction tax’ that shifts the balance of costs and benefits for those who are doing transactions all the time. That is intelligent thinking – treating people in law in proportion to how they are going to treat you.

However, as the economist John Kay pointed out in his review of UK equity markets last year, the stock market is really no longer a medium for raising primary capital, but rather a way for an entrepreneur to exit. It is also becoming less attractive to be on the stock market. As a result, we are moving towards an era where different things will happen. Hybrids like Tata [the Indian conglomerate] and Bertelsmann [the German media multinational] will emerge, where the ownership design includes some kind of trust where the ultimate owner is strong enough to hold the company to its core purpose and values.



is Dean of the Rotman School of Management at the University of Toronto and author of Fixing the Game

A good theory has to work in practice, and there aren’t enough people in the world who create a theory – like maximising shareholder value – and then take it one step further to see if managers can implement it.

What happens is that you give them the imperative to make money for the shareholders, they try to increase profits to that end, but shareholder value falls because the shareholders thought you would earn even more than you did and dump your stock. You’re then in the situation we’re in now where CEOs have to spend most of their time managing the hopes, dreams and expectations of capricious shareholders.

The CEO of a major pharmaceutical company described it to me recently as like having to dole out sweets one at a time, so that shareholders don’t get a sugar rush. He’s smart, and right, but it’s not what anyone ever had in mind. But this is the natural consequence of maximising shareholder value. It doesn’t work because it doesn’t translate into something that is constructive for management to do.

My proposed alternative is to optimise one goal, subject to setting minima for a range of other goals. But I also believe that the primary goal should be ‘maximising customer happiness’ – subject to making in excess of the cost of equity to the equity owners and subject to a stated record on safety, the environment and so on. Maximising customer happiness is in the long term the thing that will allow you to succeed and prosper – which will, of course, make shareholders happy. It would also make the world a better place.



is head of the ICAEW finance direction programme

There is a divide between the supporters and detractors of the maximising shareholder model, but I sit somewhere in between. For example, there may be value in looking at shareholders as a main stakeholder, but focusing on them exclusively leads to dysfunctional behaviour, such as short-termism and excessive risk-taking. You can generate shareholder value, at least in the short term, by doing the wrong things.

A company is always in a position of managing trade-offs, even under the maximising shareholder value primacy model, so adopting an alternative model where you have a more explicit duty to balance the interests of a range of different stakeholders is not likely to be significantly more onerous. If you push any idea to its extreme then there are bound to be negative consequences. The key thing is to be thoughtful.

Under the capitalist system that we have now, those who hold directors to account are the shareholders – though, arguably, the non-executive directors should play a much greater role.



is professor of finance at INSEAD

Lots of people confuse shareholder value with profits or earnings per share, but finance courses teach the definition as ‘the present value of free cashflows from now until infinity, discounted at a rate that reflects the risks of these cashflows’. This is a long-term concept. Maximising shareholder value is not the same thing as maximising short-term profits or earnings per share or manipulating stock prices through accounting fraud.

People need to think analytically, not emotionally: big bonuses, shareholder value and ethical behaviour are not mutually exclusive

Also, those who claim the market is obsessed with short-term profits need to remember the internet boom. Many dotcom start-ups made no profits, but had a high share price in the expectation that they would deliver huge value in the future. The market’s expectations about the internet were largely wrong, and the main beneficiaries of the internet boom are customers, because they can buy products so cheaply. The stock price should reflect the present value of future cashflows, but sometimes the market is inefficient.

Another misunderstanding is that anyone who evaluates decisions on the basis of consequences for shareholder value does not care about other stakeholders. Stakeholder-value types argue for ‘inclusiveness’, but look at any discounted cashflow spreadsheet and it is inclusive – revenues are to do with customers, salaries are to do with employees, costs with suppliers, and so on.

What we don’t do, however, is trade them off against each other. How would you do that? You could use it to justify anything you wanted to do.

Banks lost money not because CEOs were trying to maximise shareholder value, but because they were trying to maximise their bonuses. Executives have been stealing money from stockholders for 2,000 years. We need to try to resolve that by better aligning their interests. One way of doing that is to have contracts that tie executives in to a longer-term commitment, but those could prove counter-productive so you have to hope that people will respect implicit contracts and behave ethically.

In a capitalist economy it is reasonable to assume that shareholders have an implicit contract that the management will maximise their interests. So respect for such implicit contracts is an ethical responsibility. What’s more, as a company needs shareholders – the survival of a corporation with widely dispersed ownership depends on the survival of this implicit contract.

No one teaching finance courses would say we aren’t going to teach maximising shareholder value.

That would be unethical. People need to think analytically, not emotionally: big bonuses, shareholder value and ethical behaviour are not mutually exclusive.



assistant professor in finance at London Business School

Maximising shareholder value should be the primary model. There are good reasons for this, based on more than 100 years of research. Economists argue that if you could design a system that maximises the welfare of society it would probably look more like the shareholder value model than anything else.

However, I do agree that the word should be ‘optimisation’ or ‘constrained maximisation’ to imply that you maximise shareholder value subject to ethical, legal and other constraints. I don’t disagree with the other objectives that are talked about either – obviously protection of the environment, employees, customers and so on are important. But how do you achieve them? Can you trust corporations to do these things, or do you rely on the legal system, as we do now?

Some of these other objectives – ‘maximising customer happiness’ and so on – come from outside the finance/accounting/economics sphere, from disciplines like organisational behaviour and sociology. But really what they are saying is very much what we have been saying all the way along – that long-term value is important. Of course short-term value maximisation is wrong, and business schools would never advocate that. Short-termism is a violation of shareholder value,but this is a problem of corporate governance rather than being an intrinsic flaw in the shareholder value model.

Corporate governance and the fundamental goal of the firm (such as maximising shareholder value) are two separate things. Governance problems are ubiquitous, regardless of corporate objective – and, in fact, they are likely to be worse outside a shareholder value model. Who would hold managers accountable, and how much more difficult would it be to raise finance, for example?

Instead of changing the underlying objective of the firm, we should instead be focusing on corporate governance, especially to remove the focus on short-term earnings.

On the executive front you could rewrite contracts so that if what executives do reduces overall value then they have to pay back their compensation or take a pay cut. The shareholder side is tougher, but having more long-term activist shareholders would help.

Jane Simms