What is maximizing shareholder wealth
Maximizing shareholder value is valuable
Shareholder value and the allegedly short-term pursuit of profit are under criticism. However, this is based on a wrong understanding of the maximization of shareholder value. By Adriano B. Lucatelli
In the wake of the global financial crisis, the shareholder value concept has fallen into disrepute. It is generally said that the focus on maximizing shareholder wealth is too one-sided and short-sighted. The exclusive control based on the earnings value of equity only leads to the sidelines. All that is required is a departure from shareholder value thinking.
The criticism is not new. As early as 1992, the American professors Robert Kaplan and David Norton propagated the Balanced Scorecard (BSC) as a management tool. According to the BSC, management should strive for different goals at the same time. In addition to financial, non-financial dimensions such as customer and production processes should also be included in the decision-making process. In other words, all interest groups or stakeholders should be welcomed.
The BSC concept does not say anything about the desired or optimal mix (“balanced”) of the dimensions, nor does it lead to a result sheet (“scorecard”) that would help management to make clear and unambiguous decisions. Rather, the management can determine the mix itself to the detriment of the equity capital provider and thereby become the arbiter of the various interest groups.
In the German-speaking area, too, there has been anger for a long time. Fredmund Malik has been promoting a new approach for over a decade, namely customer value. Consistent customer orientation would automatically serve the interests of the shareholders. Malik seems to overlook the fact that with this approach one should set up a cooperative rather than a stock corporation. In fact, it makes sense to set up a cooperative when the client receives the added value of doing business.
Recently, not only professors have distanced themselves from the shareholder value concept, but also representatives of multinational companies. Jack Welch, former head of General Electric, scourged the concept as a “stupid idea” in a conversation with the Financial Times in 2009, and Nestlé boss Paul Bulcke defended it in an article in the NZZ (October 23, 14) shared value concept pursued by his company.
“Concerned” investors have also spoken out against maximizing shareholder wealth. James Montier from the investment company GMO makes, as was to be read in an article in the NZZ of December 8, 14, that shareholder value thinking is partly responsible for today's economic and social problems. The short-term nature of decisions leads to absurd results. The average term of office of business leaders is now only 6 years, and the length of time their companies stayed in the S&P 500 has almost halved to 15 years since the 1970s.
He obviously does not accept that the world is changing faster today than it was four decades ago. At Montier, the digitization of economic processes and globalization do not seem to be reasons for Schumpeter's creative destruction. And he elegantly omits that the use for share buybacks is largely promoted by the policy of cheap money of the state monetary authorities.
Whether BSC, Customer Value or Shared Value: What they all have in common is the criticism of the short-term pursuit of profit. The top management receives wrong incentives from the shareholder value system, it is objected. In order to show better figures every quarter, important investments that will only pay off in the distant future would be postponed or one-off financial engineering measures would be carried out.
However, this criticism is based on a misunderstanding of the shareholder value concept. Due to the focus on all income expected in the future, the shareholder value approach is geared towards the long term. The misunderstanding may come from the fact that stock markets are very efficient and react quickly to new information. Even measures that have a long-term effect and often only pay off in monetary terms in the distant future are immediately reflected in the stock exchange prices.
A shareholder-oriented business policy does not lead to short-term decisions and does not conflict with external stakeholders. For example, deliberately violating pollution laws goes against maximizing shareholder wealth. In addition, a healthy financial basis for a company is in the interests of all stakeholders. Because only a healthy company can guarantee the regular payment of wages, an attractive working environment, happy customers, satisfied suppliers and reliable payment of taxes.
The bottom line is: Only with the shareholder value approach is internal competition for scarce resources placed on an objective basis. The formally unrestricted right of ownership and disposal of the shareholders in particular means that all other interests are automatically taken into account. These reasons make it obvious that the shareholder value concept proves to be superior to other approaches in practice.
Adriano B. Lucatelli is a financial author and lecturer at the University of Zurich.
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