Shareholder value model: myth or reality?

Today the whole world faces current changes as a result of  the world crisis which took place on 2008. In fact, according to the mistakes made by the USA government, banks, rating companies and other companies prior to a crisis, we are all waiting for the improvements not only in the way of doing business, but in the theories and concepts too. And in this post I want to explain my quite critical view on what’s going on right now.

Shareholders wealth maximization model shareholder_valuebecome the most important and valuable concept in the end of 19th century. Despite the existence of Peter Drucker’s theory about “firm is for creating customers” and Chalmers Johnson’s statement that company is for “securing state policy objectives”, shareholders value concept has become the most significant one. And the relevant question is “Why”?

Why companies up to maximizing shareholders wealth? What about customers? Employees? Investors? What about good corporate citizenship, after all?

The whole concept states that all the objectives mentioned above, they don’t matter. The idea of shareholders wealth is above them all! And, at this point, as Jack Welsh said, “shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… Your main constituencies are your employees, your customers and your products.”

So, it is absolutely seen, that there are some problems with this concept. I will provide you with the most significant ones.

short_term_objectivesThe first thing is concentration on the short-term objectives. ”The shift in corporate governance in the US was disproportionately skewed to a ”shareholder model” that promoted an increasing reliance by US non-financial firms on financial investments designed to maximize short-term returns to shareholders”.

Most companies focusing on quick profit results forget about long-term goals and problems. And in reality this mind-set could harm not only product and customers, but even eco-systems and the economic situation as a whole.

Secondly, despite the fact that according to the theory shareholders are principals and directors are their agents, everybody acts according to their own self-interest. And here is where a problem of regulation arises. Carrot and stick motivation strategy has become a widely-used one in today’s reality.  And despite the fact that the CEO can be fired if shareholders are not satisfied with his/her actions, this option can lead to the company’s failure as much as to its success.

Thirdly, the distinction between expectations and reality is still there. danger_expectationsFor a company a real market is a market where they can build a real plant, make real product for real customers and earn real money. The expectations market is a market where investors look at what companies do on the real market and try to imagine what they would do in the future. And based on this imagining they decide how much they will pay for the stock of a certain organization.

According to these statements, the expectations market is not tied completely to the real market, which creates a problem of the stock price measuring. The expectations regulate the volatility of a single company, which influences the whole market volatility. However, the problem is that if the stock price will go up, according to expectations, it will be hard for a company to  meet consumers’ needs after it. And due to this fact the only way for a company is to start to speculate on the consumers’ needs, raising them even more and doing something crazy (sometimes).

In fact, these problems are not the only ones connected with shareholders value theory. However, even thinking about this concept in a critical way allows us to understand how unreal it is. In fact, this guidance leads to the quick wealth increasing of certain amount of people instead of creating value and stabilization of company’s well-being.

This system worked prior to the crisis. The 2008 events show us the incompetence of this model. However, despite all logical thoughts, this model is still in use today. And, in my personal opinion it will be used until the next crisis. And maybe even longer.

Roots of this idea are buried deeply in the human nature, because everybody in  the  modern world wants to get more profit for less effort. And this concept allows it to be real. It won’t be easy to develop or even create a new model. And everybody understands it. But some things should be done.

Video is attached for the ones who want to get more information about the “shareholder value” theory.

http://www.youtube.com/watch?v=s5Eoy988728

References:

  1. Aglietta, Michel, and Rebérioux, Antoine (2005), Corporate Governance Adrift: A Critique of Shareholder Value, Cheltenham: Edward Elgar;
  2. Guerrera, Francesco (2009), ”Welch condemns share price focus”, Financial Times, 13 March;
  3. Wolf, Martin (2001), ”Taking other people’s money”, Financial Times, 10 January.
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One Response to Shareholder value model: myth or reality?

  1. harza123 says:

    Nice article. Shareholder wealth maximization model or philosophy has worked quite well in US tens of years, there are lots of amazing great companies in US. But I think it has it’s weak points too and it is not perfect. Internet has made it easier and cheaper to trade shares and then this novelty high frequency trading where some market participant can own company shares even only fractions of of second. Even institutional investors own shorter period of times company shares now than they did earlier.

    So would it be good to put some time limit when you become a real shareholder of some company and can vote in shareholder meetings or get dividends? Like only after owning shares one month or 6 months, 1 year or so. Currently there are not difference between shareholders, whether you have owned company stock 1 minute or 1 year or 5 years,all are same shareholders.

    So some extra benefits for those longer term shareholders that have owned company shares longer and are committed to company, really know something about it and support longer-term value creation of company and its management, not some short term gimmicks that to support share price in short term.

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