Shareholder Value. It’s a term that solidified in the 1990’s in business schools and business circles around the nation. Even if you don’t know what the term means, you have seen it in action and seen the disasters that occur when it becomes the only important factor to company leadership. First….the definition (which by the way violates every good rule of definitions I have ever seen by using both words of the term in the definition itself):
Shareholder value is the value delivered to shareholders because of management’s ability to grow sales, earnings and free cash flow over time. A company’s shareholder value depends on strategic decisions made by senior management, including the ability to make wise investments and generate a healthy return on invested capital. If this value is created over the long term, the share price increases and the company can pay larger cash dividends to the shareholders.
In layman’s terms? Shareholders are the people who have put money into a company by buying shares that they hold on to. When the company’s share price rises, those shares are worth more than the purchase price, thus netting a profit to the people who own the shares. Shareholder value refers to how much of those profits are generated for the shareholders.
At first blush this would seem to be a good and fair thing. After all, shareholders do have skin in the game by virtue of their purchase of the shares. It only makes sense that they should want to maximize their returns. It logically follows that shareholders (particularly the influential ones who own the largest percentages of the company) would want senior management at the company to do things that would lead to increasing the value of their shares, thus netting more profits for themselves. The problem comes when shareholder value becomes the only driving force in leadership’s decision metrics; when shareholder value takes over the drivers seat to the detriment of any other factor.
It turns out that the focus on maximizing shareholder value has several problems with it:
- There is no legal basis for corporations and senior management to favor shareholders above all. Under US law, the Board of Directors which runs companies are beholden to the corporation itself, and not to shareholders. Thus, they should take a wider view of what good looks like than just what will gain the most value for shareholders.
- It equates share prices (especially if it is a publicly traded company) with The Economy writ large. The only problem is that one of these things (share prices or stock performance) is only one piece of the larger Economy. It’s the equivalent of saying that a tire is the same thing as a car.
- It encourages risky behaviors that will drive up stockholder value in the short term, but those same actions can result in great harm given a longer time horizon. The rise of the Subprime Lending Market is the perfect example for this: It was basically debt that everyone knew would go bad, but you could sell it and make lots of money now. In the short term, this game of hot potato as the packages of bad debt were bought and sold at dizzying speed increased assets and shareholder value. But when it came crashing down? Just ask Bear Stearns about what happened.
- Focusing on maximizing shareholder value is also bad for society as a whole. The ever increasing income inequality of recent years has descended from this shareholder value first mindset. I’ve yet to hear a believable argument for why the greatest income gap since the days of the Robber Barons is a good idea.
Now I started my career in the Nonprofit Sector, a sector I love very much and support whenever I can through volunteering, donations and patronage. As what some characterize as a Xennial, someone who was just graduating college when the economic world decided to collapse, I find the transparency and focus on long-term sustainability in the nonprofit sector refreshing and important to recognize. Being a non-profit does not exclude you from making a profit; if you don’t take in more money than you spend providing services then you aren’t going to be around very long regardless of your tax status. But the focus on using profits to support the organization and plan for more than the next quarterly report is something that appeals greatly to me. I believe this is also the foundation for much greater growth in the long term for any business.
In the interest of improving society, the broader economy, and providing a glimpse into the mindset of the up-and-coming generations (your future clients), I humbly suggest re-thinking your definition of a shareholder.
- Your shareholders are your employees. They are the people who allow you to do the things that make the money for the corporation. Without them, you cannot do the things that make the money; you cease to exist. Maximize their value by investing in them, and you will gain their loyalty and advocacy, which will help you grow in the longer term.
- Your shareholders are your clients. They are the people who pay you the money to provide the services you provide. Without clients, you cease to exist. Maximize their value by building relationships with them, anticipating their needs before they know what their needs are, and filling those needs in a way that allows them to be competitive. They will reward you not only with loyalty, but through ceaseless praise which will help you build your customer base.
- Your shareholders are your community. Your clients and your employees live in towns. They drive on streets. They shop at stores and eat at restaurants. Support the community not just where you are, but where your clients are as well, and don’t do things that will hurt them. These communities will reward you with support, and you can build not only your recruitment base but also your customer base.
- Your shareholders are your shareholders. I’m not trying to downplay the important role that shareholders play in establishing a company and helping it grow. But they are not the be all and end all. They might be front of mind because they may be loud and present on a regular basis, but as a corporation you should balance their needs and wants with all of your other shareholders mentioned above.
Some in the business world may call me naive for thinking this way, and they may be right. But I am willing to bet that I am not. My generation, and those after me, are coming into financial dominance as far as having wealth to spend, and our generations have an almost singular focus on Social Responsibility as a result of having seen the world implode in 2000 and again in 20008. Mutual funds are now rated by Social Responsibility. Entire investment platforms are being created to allow us to invest our money in companies we approve of, whether that be the business that they do or the way that they are governed. Another key factor is something that has been giving CEO’s and Boards headaches lately; the rise of Shareholder Activism. By combining the rise in the Social Responsibility movement with the rise of Shareholder Activism, I’m betting that senior management of the future will not be as myopically focused on Shareholder Value, and companies and society will be much better for it.