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The Dumbest Idea In The World: Maximizing Shareholder Value

376 points by DanielRibeiro 15y ago

cbr 15y ago
This argues against maximizing the stock price in the short term. Nothing about shareholder value beimg the wrong metric.
- rayiner 15y ago
  It argues against using shareholder value as the metric for the purposes of incentivizing managers.
mixmax 15y ago
"In today’s paradoxical world of maximizing shareholder value, which Jack Welch himself has called the dumbest idea in the world, the situation is the reverse. CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services." Maybe the real genius of Steve Jobs was to actually spend his time running Apple, creating real products and services instead of playing the expectations game with investors and shareholders.
- WalterBright 15y ago
  Jobs certainly wound up maximizing shareholder value. Maybe the shareholders aren't so easily fooled.
  - yuhong 15y ago
    But the key thing is that Jobs did it the right way instead of meeting short-term expectations.
    - alexqgb 15y ago
      Exactly. Healthy profits are the (inevitable?) result of a well run business, which requires attention being paid to a variety of factors, not just the bottom line. Failing to understand this, and focusing exclusively - or even disproportionally - on the bottom line, is likely to improve it in the short run, diminish it in the medium run, and destroy it in the long run.
      - WalterBright 15y ago
        Take a look at the P/E values for various companies. Ones with a high P/E are clearly those where the shareholders believe there is long term growth in the profits, and are willing to forego current profits to get it. I really do not buy into the popular idea that shareholders are only interested in short term results. If that were true, then marginally smarter investors would regularly make themselves huge fortunes by buying undervalued stocks.
tokenadult 15y ago
First I slogged through the submitted article. It had some interesting anecdotes about betting on professional football in the early 1960s in the United States, which the author takes as an analogy to the current stock market. I searched back through the list of earlier Steve Denning articles on Forbes to try to find one previously posted to HN that I remember for its silliness and lack of connection with reality. On my part, I can't see I disagree a lot with the idea that publicly traded joint-stock companies do well to attend to the needs of customers, to build long-term value, but the author seems to embroider that claim with a lot of hysteria about the future of capitalism. Precisely because he can point to successful examples (Johnson and Johnson, Procter & Gamble, and Apple), it seems to me that what he identifies as an idea that leads companies astray can be responded to as a market opportunity for other companies to achieve the goal of maximizing shareholder value (over the long term) by the instrumental means of attending to customer needs. I'm not sure that the author has added any new insight here that isn't well known to owners and operators of businesses. (Has the author ever owned any business in the real economy besides promoting his own writing?)
chrismealy 15y ago
It's called Enronitis. If you expect managers to be ruthless about shareholder value you'll wind up with managers who are ruthless about benefitting themselves. The Enron problem is ... the predictable result of too strong of a share-centered view of the public corporation... Corporate law demands that managers simultaneously be selfless servants and selfish masters. On the one hand, it directs managers to be faithful agents, setting aside their own interests entirely in order to act only on behalf of their principals, the shares. On the other hand, in the service of this extreme altruism, they must ruthlessly exploit everyone around them, projecting on to the shares an extreme selfishness that takes no account of any interests but the shares themselves. Having maximally exploited their fellow human corporate participants, managers are then expected to selflessly hand over their gains... Altruism and rationally self-interested exploitation are extreme and radically opposed positions, psychologically and politically. ... For managers, one easy resolution of these tensions is a simple, cynical selfishness in which managers see themselves as entitled, and perhaps even required, to exploit shareholders as ruthlessly as they understand the law to require them to exploit everyone else. ... Internally, the share-centered paradigm is just as self-destructive. Corporations succeed because they are not markets and do not follow market norms of behavior. Rather, they operate under fiduciary norms as a matter of law and team norms as a matter of sociology. However, the share-centered paradigm of corporate law teaches managers to treat employees as outsiders and tools to corporate ends with no intrinsic value. Just as managers are unlikely to learn simultaneously to be selfish maximizers and selfless altruists, they are unlikely to be simultaneously cooperative team players and self-interested defectors. Thus, the share-centered view undermines the prerequisite to operating the firm in the interests of shareholders. ... Managers constructing the firm as a tool to the end of share value maximization treat the people with whom they work as means, not ends. ...they learn as part of their ordinary life to break ordinary social solidarity. Learning to exploit ruthlessly is surprisingly difficult. ... But cynicism can be learned, and managers subjected to the powerful incentives of the share value maximization principle do eventually learn it. ... This training, however, surely creates cynics, not faithful agents. ... A manager whose lived experience is a pretense of selflessness (with respect to employees, customers and business partners) covering real disinterested exploitation (on behalf of shares) is unlikely to suddenly see himself as “in a position in which thought of self was to be renounced, however hard the abnegation” and voluntarily hand over these hard-won gains of competitive practice to his principal. If you can properly lie to your subordinates, why not lie to your superior as well? ... In the end, the cynicism of the share value maximization view must eat itself alive. -- http://slackwire.blogspot.com/2011/04/selfish-masters-selfless-servants.html http://slackwire.blogspot.com/2011/04/selfish-masters-selfle...
fmkamchatka 15y ago
I'm not familiar with football betting but it seems to me that the initial example is not a very good analogy. In the case of shareholders, someone initially lent money to the company in exchange for shares (owning part of the company) from which the company benefits. On the other hand, betting on a football team's success doesn't increase its odds of winning, hence it wouldn't make sense for the team to comment or apologize on the outcome of the bet.
rayiner 15y ago
Coincidentally, I just read about this in "Animal Spirits" a recent book on behavioral economics and the market. It mentions Welch's view and analyzes a lot of similar situations.
Hominem 15y ago
Yep, it is easier to increase profit by cutting costs, so that is what people will do to hit their numbers.In the long term, it is akin to burning your clothes to stay warm.
- plainOldText 15y ago
  Cutting costs alone is not necessarily a bad thing. Cutting costs at the expense of the customer is though. And when I say expense I mean the customer gets a crappier service or product. I just wanted to make it clear for people reading around here. I don't think they should regard strategies that involve cutting costs necessarily evil.
  - Hominem 15y ago
    Oh, of course I agree you should not be profligate. And there are times you have no choice if you are hemorrhaging money. I work with middle managers who let contractors go and sit on projects months at a time in order to get cost cutting bonuses. It is just working the same numbers on a smaller scale.
acslater00 15y ago
"Meanwhile real performance was declining. From 1933 to 1976, real compound annual return on the S&P 500 was 7.5 percent. Since 1976, Martin writes, the total real return on the S&P 500 was 6.5 percent (compound annual)." Hmm...where have I seen those numbers before. Oh right! He's measuring his control period from the bottom of the great depression. Sounds legitimate to me! This is so hacky it makes me laugh. You can argue that a focus on short-term shareholder value is bad for various reasons, but a focus on long-term shareholder value is incontrovertibly good for shareholders, long-term. In practice, it is also basically equivalent to the author's other view of focusing on "customers", whatever the hell that means. Or focusing on "real performance" metrics like profit, as though you can do one without doing the other. If CEO pay is tied to long-term stock performance, the problem of gaming the short term earning expectations goes away. Full stop. My new years resolution is to not click on link-bait anymore.
- adamtmca 15y ago
  This guy was on the CBC a few months ago and I was basically screaming at my radio. One choice portion of the show was when the interviewer (who was lapping it up) asked what would be a good alternative to the stock market. He proposed bonds. He even went so far as to say that bonds would reduce the amount of volatility we see in the economy by reducing the impact of the "expectations market". Yes. Replacing equity financing with debt sounds like a reasonable solution to reducing volatility. What an absolute fraud.
  - maigret 15y ago
    But ultimately stocks have to pay a dividend. I agree that a bond-only system would lead to a lot of junk bonds, but mainly because lot of stocks are also junk. In any case, some bonds belong to a balanced portfolio. Too much people have too much of stock in their portfolio (also too much real estate, but that's another topic).
- sitkack 15y ago
  At least is spawned a discussion here, but the lead is so full of flawed reasoning by analogy that it made me sick as a rainbow.
mhartl 15y ago
There is only one valid definition of a business purpose: to create a customer. No. The one valid definition of a business purpose is this: A business should do what the owners want it to do. Otherwise, the notion of ownership loses meaning. If the owners want to create lots of customers, they do that. If they would rather have a smaller number of highly profitable customers, they do that. If they want to create a nice side business so that they can surf in the summer and snowboard in the winter, they do that. Scottish philosopher David Hume drew an essential distinction between factual matters—is—and moral matters—ought. Asking "What should a business do?" looks like a Humean ought, but it's actually a Humean is. A business is a vehicle for achieving the ends of its owners. How then can we make sense of the maxim "a business should maximize shareholder value"? In certain kinds of businesses—especialy those owned by a large number of shareholders—the interests of the owners may generally conflict, but they can usually agree on one thing: maximize the value of the company. This describes virtually all publicly traded companies and many family businesses as well. It doesn't describe, e.g., my present business (the Ruby on Rails Tutorial), which I created as a 4-Hour Work Week–style product company to let me relax for a while, travel the world in style, and have the financial freedom to develop longer-range plans for world domination. Its purpose is definitely not to maximize shareholder value; I'm the only shareholder, so it does whatever I damn well tell it to do. Let the owners worry about what a company ought to do. Unless you're an owner, it's none of your business.
- sliverstorm 15y ago
  Where on earth did you get the ridiculous idea that your business can do what you want it to? [/sarcasm]
  - deleted 15y ago
    [deleted]
- barrkel 15y ago
  Incorporation is a privilege granted by society; and property rights are never absolute. What you state is extremely individualistic, but it is unrealistic and naive for the same reason. I understand your exhortation, but it does not amount to an argument. For example, most large companies with broad shareholder bases have no owner interests that you can easily point to; the shareholder base has collective action problems, and frequently cannot meaningfully affect the company. I think you're at risk of deriving an ought from an is yourself. You take capitalist ownership structures, which exist for the hopeful progress of society at large, but you infer an ought from them, that the only thing that is fair is that ownership is absolute in control over what it owns.
Sniffnoy 15y ago
This wouldn't be so much a problem if "shareholder value" were taken to mean "the value one can get by holding a share" (i.e. profits) rather than "the value one can get by selling a share"...
- yardie 15y ago
  There are also dividends.
forensic 15y ago
Shareholder value is just the latest politically correct justification. Our society used to be based on concepts like honor. Honor was something you had to earn and something you could lose. To maintain your honor you had to demonstrate certain qualities: truthfulness, earnestness, fairness, politeness, genuine service toward shared superordinate goals (e.g. the country, humanity, the community). At some point, our society decided that lying is no longer dihonorable as long as you are doing it to maximize shareholder value or to sell your product. We no longer publically shame and dishonor those caught in bald-faced lies. Inordinately selfish people always justify their behaviour using socially acceptable statements. What has changed is that our society now lets them get away with it. ANY lies are now OK as long as they say "I was maximizing shareholder value." They will not be socially ostracized, will not be publicly shamed, and often will not even be criticized. People will, in fact, apologize for them. People see Wall Street crash-creators testifying at Congress answering "I do not recall" to 100% of the questions. Instead of dishonoring those liars as the liars that they obviously are... our society just does nothing. It's okay that they lied. It's just business you know. We expect our business leaders to be dishonorable. "It's not the CEOs fault that he knowingly polluted the entire river for 20 years. He was just maximizing shareholder value, discharging his fiduciary duty, we can't hold him personally responsible. It is wrong to shame him and his family, it is wrong to ostracize him from decent company, it is wrong to even criticize him publicly in the newspapers." Either this mentality changes in a hurry, or the entire country is going to go the way of Detroit.
- beagle3 15y ago
  > Our society used to be based on concepts like honor. Nostalgia isn't what it used to be. Society was never based on honor; it was always about worshiping those who succeeded, regardless of how bad they had been, as long as they did some good at some point. see, e.g. Rockefeller, Carnegie, Mellon & Gates in recent times, and basically all fondly remembered kings and barons in earlier times. Society adapts, in part, by giving socially acceptable deeds a normative description and concept. The socially acceptable statements lag the deeds, not lead them. > People see Wall Street crash-creators testifying at Congress answering "I do not recall" to 100% of the questions. Instead of dishonoring those liars "These liars" applies equally well to congress as to those wall street execs (with whom the former are figuratively, "in bed", and have been for the last century or so) Really, the only thing that has changed is ease of access to information. Human greed, actions and norms as reflected by social response, by and large, haven't.
dhx 15y ago
The actions flowed from the company credo which is engraved in granite at the entry to company headquarters, which makes crystal clear that customers are first, then employees, and shareholders absolutely last. Why do businesses attempt to create hierarchical order where order doesn't exist? A business with extremely happy customers, happy employees and low return on investment (including other non-monetary value) for shareholders is a failed venture. Ranking stakeholders by their importance makes it easy to create harmful (and often implicit) rules and practices that fail to address the needs of all stakeholders. Companies should instead encourage employees to think about decisions from a wide range of perspectives including customer satisfaction, employee morale and business profitability. Creating a new procedure or rule that employees must adhere to could greatly please customers. However it may create extra menial and unappealing work for employees, lowering morale to harmful levels. It could cost the company a lot of resources that would be better spent elsewhere.
1gor 15y ago
The statement 'maximizing shareholders value' is meaningless without the timeframe. The correct phrasing is to 'maximize shareholders value in the long term'. The 'long term' bit is crucial, and it is not reflected in today's management incentives. The choice that managers of public companies are facing is the well known "Consume vs. Invest". Or, in the terms of an evolutionary fitness landscape, "Exploit vs. explore". If a manager wants to maximize his next quarter's earnings, he could stop new product development, shut down customer service and equipment maintenance departments and sell, sell, sell. He could have a short short-term spike in profitability, but in the long term the company won't survive. He has exploited his current position but has failed to explore, to look to the new opportunities and threats, and to provide for the future. (Note: the manager could also buy a portfolio of high-yielding/high risk securities hoping that the crash will not happen before his next bonus is due. This is the same thing -- maximising short-term gains at the expense of the long-term prospects of the company). The manager could also overexplore, that is to overinvest in customer and product development, purchase the newest equipment and end up with a croud of excited customers and an exciting new technology/product, but no liquidity left in the bank to live to see it taking over the market. "Maximizing shareholders value" idea got a bad press, because it has become associated with the 'exploit' approach. Managers endanger the long-term prospects of the company because they can be paid well for achiving relatively short-term goals. But the working definition should be "Maximizing shareholders value in the long term" Let's make the law that the managers' options can only be excersized after 10 years. That'll do the trick.
- shasta 15y ago
  Yes. The article frustratingly kept identifying "maximizing shareholder value" as the problem and the naive "delight customers" as the solution. Maximizing shareholder value would be much more closely aligned with society's interests if shareholders had the information needed to distinguish real value being built from a company being strip mined.
  - quanticle 15y ago
    You need a second constraint. The shareholders have to care about long-term value. Many institutional shareholders don't care and have no incentives to care about long term value. To them, firms are not long term investments - they are merely symbols moving up and down on a price chart. If your symbol moves down too often, they'll pull money out of your firm, even when those gyrations are being caused by forces completely outside your control (natural disasters, or sector-wide trends).
xianshou 15y ago
I notice Steve Jobs is consistently mentioned in the present tense...did the author write this a while ago and forget to run it by his editor, or did he simply miss all of October?
- xianshou 15y ago
  Also interesting: Mr. Denning self-plagiarizes the concluding three sentences of his previous article verbatim. http://www.forbes.com/sites/stevedenning/2011/11/16/why-are-fannie-freddie-ceos-paid-so-much/2/ http://www.forbes.com/sites/stevedenning/2011/11/16/why-are-... Like all great obvious, radical ideas, in the first instance it will be rejected. Then it will be ridiculed. Finally it will be self-evident and no one will be able to remember why anyone ever thought otherwise.
  - stevedenning 15y ago
    Interesting? Yes hopefully. Plagiarism is "the unauthorized use or close imitation of the language and thoughts of another author and the representation of them as one's own original work." By definition, one can't plagiarize one's own writing. In the 1000+pages of stuff on the blog, it's true that some important ideas are emphasized more than once.
    - sless 15y ago
      No, it is plagiarism. It is a blatant copy of Arthur Schopenhauer, "All truth passes through three stages: First, it is ridiculed; Second, it is violently opposed; and Third, it is accepted as self-evident."
      - stevedenning 15y ago
        Thanks for the reference. I've added a note..
- stevedenning 15y ago
  Good point. The sentences were written before his death. I've fixed them now.
pmuhar 15y ago
Even though I know exactly what the article is about, I wish it wasnt written in relation to football/gambling terms as a lot of people are not football fans or avid gamblers, myself included.
valuegram 15y ago
While I understand the idea behind this article, it was hard to get beyond the initial metaphor, which I find highly misplaced. In sports, for the most part, the only fact that matters is a win. with the exception of rare subjective ranking systems (such as coaches polls in college football), the quality of a win doesn't matter. Of course if a coach is playing in these systems, and not doing enough to meet the expectations of the fan base, there will definitely be repercussions. In the business world, a profit of $0.01 is very different from a profit of $1.00. Of course there are numerous valuation models, but the amount of profit/revenue/etc almost always matters, as opposed to sports which use a binary valuation system (win or loss). I appreciate the overall message, and believe that the market is willing to embrace this sort of logic. Jeff Bezos is a great example of a leader focusing on long term performance and being rewarded for it.
TheFuture 15y ago
Another egghead uni prof who's spent his life getting a paycheck from the gov telling us what's wrong with capitalism that he's never participated in. If shareholders (ie owners) want short term leadership, that's what they get. No one is forcing you to sell your shares every time the stock price moves. Buy and hold.
josh33 15y ago
Each of the following words opens up the door for semantic debate: "Maximizing" - when? In the short term or long term? "Shareholder" - who? People who own actual shares or the broader definition of stakeholders who have a vested interest in the company (employees, the community around the business, owners, etc.)? "Value" - what? Dollar value? Happiness? Customer satisfaction? Employee satisfaction?
pge 15y ago
I agree with the overall viewpoint of the article, so just adding an observation on how we got here. Tying management compensation to shareholder value is a good idea; the problem is in the measurement of shareholder value. If the public markets were efficient, and market cap was an accurate reflection of value, the system would not be as broken as it is. The public markets have become a casino, where investors are often playing a game, not investing in companies they truly understand, and whose value they have analyzed. Market cap is no longer strongly correlated with company performance (revenue, net income, cash flow, customers, etc). A return to a rational market would realign incentives, and stock-based compensation would work, but that's a lot to ask...
- yummyfajitas 15y ago
  If the public markets were efficient, and market cap was an accurate reflection of value, the system would not be as broken as it is. If you believe the public markets are not efficient, how long will it be before you are rich?
  - Andrew_Quentin 15y ago
    It is inefficient for everyone not just one person or one group. An individual therefore is not able to easily exploit the inefficiencies as they are in the same position as everyone else.
    - yummyfajitas 15y ago
      I think you are using the word "efficient" in a nonstandard way. Could you please define your terms?
- GrowMap 15y ago
  Has it ever occurred to you that whoever has the most money can manipulate stock prices so any investor is in not one of the insiders is a mark? It boggles my mind that so few investors realize the game is certainly rigged and they ARE going to consistently lose. Why not just go to a casino? There - at least theoretically - you know what the takeout is and can decide whether you get enough "fun" from your losses to make you think it worthwhile. Gambling is gambling and the house always wins.
Vitaly 15y ago
He misses the point. Focusing on the customer IS maximizing shareholder value. Its just its focusing on a much longer timeframe. If you want the most money this year - you play the stock market or accounting games. If you want the most money the company will earn this century... well, you focus on very very different things. And customer's loyalty is one of the top.
GrowMap 15y ago
What a marvelous discussion because it encourages the inherently self-absorbed to reveal their belief systems which nearly always include the worship of self, money, and power as their only true gods. I highly recommend they all watch the Canadian Documentary 'The Corporation' which clearly illustrates why corporations ARE like psychopaths - and generally run by people who also meet the definition. The movie is available free online. Corporations as they currently exist are inherently unethical and unsustainable because by focusing on short term gain and stock values they are destroying the real value they once had. Either social responsibility and long term goals must be injected back into corporations or they need to be boycotted by everyone with a conscience or ideally have their corporate charters revoked.
scotty79 15y ago
What is a write-down that is being referred to in this article?
mmaunder 15y ago
Another example of a company in addition to J&J and P&G that the article mentions who focuses on customers is Amazon. Bezos recently was punished via a 30% drop in Amazon stock price because he is ploughing all his net income into the Kindle Fire, even though Amazon's revenue growth is exponential and has been for a decade. Shareholders in the public market right now are focused on "value stocks" in the Buffet and Ben Graham sense and if you don't match value stock heuristics with a dividend and growing net income, you will be punished even if you're 100% focused on creating new customers.
- refurb 15y ago
  This is slightly off topic, but it's something I really hated about business school. Sure J&J did a great job with the Tylenol poisoning case. However, they've lost over $1B in revenue in the last year or so because they consistently failed to produce drugs that meet federal guidelines. Not to mention the "unofficial recall" where they paid people to go into stores and buy up all the J&J products so that they wouldn't have to conduct an official recall. J&J is probably the most messed up company right now.
anantzoid 15y ago
I wish I could understand this.
prewett 15y ago
A lot of what the author complains about has been around for years. Short term gains at the expense of long term growth? Yup. Executives manipulating something to make their company look good? Yup. Read "The Intelligent Investor" or "Common Stocks and Uncommon Profits", which give examples of things companies did 50 and 30 years ago.
nonsequ 15y ago
Roger L. Martin, the author of the book hawked in this article, is also a director at RIM. Maximizing shareholder value indeed! That said, Roger is correct (incidentally or not) in my book to criticize the short-term casino nature of the public equity market buyers and sellers. Too often they forget that as shareholders of a stock they are part-owners in the enterprise; rather they only desire to see the price tag on their stock certificate go up in the next minute so they can sell for a profit. That kind of thinking can poison a company. The lesson I draw from this is that it matters who your investors are. Once you've sold part of the company, you must take into account the desires of your new partners, even if they are a teeming mass of the investing public. After all, you make the choice of whom you sell to. Some corporate leaders attempt to 'manage' their way out of this by massaging earnings the way Jack Welch did. I personally think the best way to handle this is by open education. Warren Buffett writes an elegant and informative letter each year and answers questions alongside Charlie Munger for four or five hours straight at the Berkshire meeting. If your business is too volatile, too secretive, or too sensitive to be explained to the public, you probably shouldn't be doing an IPO in the first place. It occurs to me that Roger's best hope is to change the minds of RIM shareholders declaring open season on the board. It is naive of Roger Martin to think that his book and Denning's sensationalist hawking of it will do anything to soften the ire of RIM's shareholders. By the same token, it was naive of RIM's leaders not to take into account the fact that once they sold shares to the public, it became the public's company.

376 points by DanielRibeiro 15y ago

cbr 15y ago

This argues against maximizing the stock price in the short term. Nothing about shareholder value beimg the wrong metric.

rayiner 15y ago
It argues against using shareholder value as the metric for the purposes of incentivizing managers.

mixmax 15y ago

"In today’s paradoxical world of maximizing shareholder value, which Jack Welch himself has called the dumbest idea in the world, the situation is the reverse. CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services." Maybe the real genius of Steve Jobs was to actually spend his time running Apple, creating real products and services instead of playing the expectations game with investors and shareholders.

WalterBright 15y ago
Jobs certainly wound up maximizing shareholder value. Maybe the shareholders aren't so easily fooled.
- yuhong 15y ago
  But the key thing is that Jobs did it the right way instead of meeting short-term expectations.
  - alexqgb 15y ago
    Exactly. Healthy profits are the (inevitable?) result of a well run business, which requires attention being paid to a variety of factors, not just the bottom line. Failing to understand this, and focusing exclusively - or even disproportionally - on the bottom line, is likely to improve it in the short run, diminish it in the medium run, and destroy it in the long run.
    - WalterBright 15y ago
      Take a look at the P/E values for various companies. Ones with a high P/E are clearly those where the shareholders believe there is long term growth in the profits, and are willing to forego current profits to get it. I really do not buy into the popular idea that shareholders are only interested in short term results. If that were true, then marginally smarter investors would regularly make themselves huge fortunes by buying undervalued stocks.

tokenadult 15y ago

First I slogged through the submitted article. It had some interesting anecdotes about betting on professional football in the early 1960s in the United States, which the author takes as an analogy to the current stock market. I searched back through the list of earlier Steve Denning articles on Forbes to try to find one previously posted to HN that I remember for its silliness and lack of connection with reality. On my part, I can't see I disagree a lot with the idea that publicly traded joint-stock companies do well to attend to the needs of customers, to build long-term value, but the author seems to embroider that claim with a lot of hysteria about the future of capitalism. Precisely because he can point to successful examples (Johnson and Johnson, Procter & Gamble, and Apple), it seems to me that what he identifies as an idea that leads companies astray can be responded to as a market opportunity for other companies to achieve the goal of maximizing shareholder value (over the long term) by the instrumental means of attending to customer needs. I'm not sure that the author has added any new insight here that isn't well known to owners and operators of businesses. (Has the author ever owned any business in the real economy besides promoting his own writing?)

chrismealy 15y ago

It's called Enronitis. If you expect managers to be ruthless about shareholder value you'll wind up with managers who are ruthless about benefitting themselves. The Enron problem is ... the predictable result of too strong of a share-centered view of the public corporation... Corporate law demands that managers simultaneously be selfless servants and selfish masters. On the one hand, it directs managers to be faithful agents, setting aside their own interests entirely in order to act only on behalf of their principals, the shares. On the other hand, in the service of this extreme altruism, they must ruthlessly exploit everyone around them, projecting on to the shares an extreme selfishness that takes no account of any interests but the shares themselves. Having maximally exploited their fellow human corporate participants, managers are then expected to selflessly hand over their gains... Altruism and rationally self-interested exploitation are extreme and radically opposed positions, psychologically and politically. ... For managers, one easy resolution of these tensions is a simple, cynical selfishness in which managers see themselves as entitled, and perhaps even required, to exploit shareholders as ruthlessly as they understand the law to require them to exploit everyone else. ... Internally, the share-centered paradigm is just as self-destructive. Corporations succeed because they are not markets and do not follow market norms of behavior. Rather, they operate under fiduciary norms as a matter of law and team norms as a matter of sociology. However, the share-centered paradigm of corporate law teaches managers to treat employees as outsiders and tools to corporate ends with no intrinsic value. Just as managers are unlikely to learn simultaneously to be selfish maximizers and selfless altruists, they are unlikely to be simultaneously cooperative team players and self-interested defectors. Thus, the share-centered view undermines the prerequisite to operating the firm in the interests of shareholders. ... Managers constructing the firm as a tool to the end of share value maximization treat the people with whom they work as means, not ends. ...they learn as part of their ordinary life to break ordinary social solidarity. Learning to exploit ruthlessly is surprisingly difficult. ... But cynicism can be learned, and managers subjected to the powerful incentives of the share value maximization principle do eventually learn it. ... This training, however, surely creates cynics, not faithful agents. ... A manager whose lived experience is a pretense of selflessness (with respect to employees, customers and business partners) covering real disinterested exploitation (on behalf of shares) is unlikely to suddenly see himself as “in a position in which thought of self was to be renounced, however hard the abnegation” and voluntarily hand over these hard-won gains of competitive practice to his principal. If you can properly lie to your subordinates, why not lie to your superior as well? ... In the end, the cynicism of the share value maximization view must eat itself alive. -- http://slackwire.blogspot.com/2011/04/selfish-masters-selfless-servants.html http://slackwire.blogspot.com/2011/04/selfish-masters-selfle...

fmkamchatka 15y ago

I'm not familiar with football betting but it seems to me that the initial example is not a very good analogy. In the case of shareholders, someone initially lent money to the company in exchange for shares (owning part of the company) from which the company benefits. On the other hand, betting on a football team's success doesn't increase its odds of winning, hence it wouldn't make sense for the team to comment or apologize on the outcome of the bet.

rayiner 15y ago

Coincidentally, I just read about this in "Animal Spirits" a recent book on behavioral economics and the market. It mentions Welch's view and analyzes a lot of similar situations.

Hominem 15y ago

Yep, it is easier to increase profit by cutting costs, so that is what people will do to hit their numbers.In the long term, it is akin to burning your clothes to stay warm.

plainOldText 15y ago
Cutting costs alone is not necessarily a bad thing. Cutting costs at the expense of the customer is though. And when I say expense I mean the customer gets a crappier service or product. I just wanted to make it clear for people reading around here. I don't think they should regard strategies that involve cutting costs necessarily evil.
- Hominem 15y ago
  Oh, of course I agree you should not be profligate. And there are times you have no choice if you are hemorrhaging money. I work with middle managers who let contractors go and sit on projects months at a time in order to get cost cutting bonuses. It is just working the same numbers on a smaller scale.

acslater00 15y ago

"Meanwhile real performance was declining. From 1933 to 1976, real compound annual return on the S&P 500 was 7.5 percent. Since 1976, Martin writes, the total real return on the S&P 500 was 6.5 percent (compound annual)." Hmm...where have I seen those numbers before. Oh right! He's measuring his control period from the bottom of the great depression. Sounds legitimate to me! This is so hacky it makes me laugh. You can argue that a focus on short-term shareholder value is bad for various reasons, but a focus on long-term shareholder value is incontrovertibly good for shareholders, long-term. In practice, it is also basically equivalent to the author's other view of focusing on "customers", whatever the hell that means. Or focusing on "real performance" metrics like profit, as though you can do one without doing the other. If CEO pay is tied to long-term stock performance, the problem of gaming the short term earning expectations goes away. Full stop. My new years resolution is to not click on link-bait anymore.

adamtmca 15y ago
This guy was on the CBC a few months ago and I was basically screaming at my radio. One choice portion of the show was when the interviewer (who was lapping it up) asked what would be a good alternative to the stock market. He proposed bonds. He even went so far as to say that bonds would reduce the amount of volatility we see in the economy by reducing the impact of the "expectations market". Yes. Replacing equity financing with debt sounds like a reasonable solution to reducing volatility. What an absolute fraud.
- maigret 15y ago
  But ultimately stocks have to pay a dividend. I agree that a bond-only system would lead to a lot of junk bonds, but mainly because lot of stocks are also junk. In any case, some bonds belong to a balanced portfolio. Too much people have too much of stock in their portfolio (also too much real estate, but that's another topic).
sitkack 15y ago
At least is spawned a discussion here, but the lead is so full of flawed reasoning by analogy that it made me sick as a rainbow.

mhartl 15y ago

There is only one valid definition of a business purpose: to create a customer. No. The one valid definition of a business purpose is this: A business should do what the owners want it to do. Otherwise, the notion of ownership loses meaning. If the owners want to create lots of customers, they do that. If they would rather have a smaller number of highly profitable customers, they do that. If they want to create a nice side business so that they can surf in the summer and snowboard in the winter, they do that. Scottish philosopher David Hume drew an essential distinction between factual matters—is—and moral matters—ought. Asking "What should a business do?" looks like a Humean ought, but it's actually a Humean is. A business is a vehicle for achieving the ends of its owners. How then can we make sense of the maxim "a business should maximize shareholder value"? In certain kinds of businesses—especialy those owned by a large number of shareholders—the interests of the owners may generally conflict, but they can usually agree on one thing: maximize the value of the company. This describes virtually all publicly traded companies and many family businesses as well. It doesn't describe, e.g., my present business (the Ruby on Rails Tutorial), which I created as a 4-Hour Work Week–style product company to let me relax for a while, travel the world in style, and have the financial freedom to develop longer-range plans for world domination. Its purpose is definitely not to maximize shareholder value; I'm the only shareholder, so it does whatever I damn well tell it to do. Let the owners worry about what a company ought to do. Unless you're an owner, it's none of your business.

sliverstorm 15y ago
Where on earth did you get the ridiculous idea that your business can do what you want it to? [/sarcasm]
- deleted 15y ago
  [deleted]
barrkel 15y ago
Incorporation is a privilege granted by society; and property rights are never absolute. What you state is extremely individualistic, but it is unrealistic and naive for the same reason. I understand your exhortation, but it does not amount to an argument. For example, most large companies with broad shareholder bases have no owner interests that you can easily point to; the shareholder base has collective action problems, and frequently cannot meaningfully affect the company. I think you're at risk of deriving an ought from an is yourself. You take capitalist ownership structures, which exist for the hopeful progress of society at large, but you infer an ought from them, that the only thing that is fair is that ownership is absolute in control over what it owns.

Sniffnoy 15y ago

This wouldn't be so much a problem if "shareholder value" were taken to mean "the value one can get by holding a share" (i.e. profits) rather than "the value one can get by selling a share"...

yardie 15y ago
There are also dividends.

forensic 15y ago

Shareholder value is just the latest politically correct justification. Our society used to be based on concepts like honor. Honor was something you had to earn and something you could lose. To maintain your honor you had to demonstrate certain qualities: truthfulness, earnestness, fairness, politeness, genuine service toward shared superordinate goals (e.g. the country, humanity, the community). At some point, our society decided that lying is no longer dihonorable as long as you are doing it to maximize shareholder value or to sell your product. We no longer publically shame and dishonor those caught in bald-faced lies. Inordinately selfish people always justify their behaviour using socially acceptable statements. What has changed is that our society now lets them get away with it. ANY lies are now OK as long as they say "I was maximizing shareholder value." They will not be socially ostracized, will not be publicly shamed, and often will not even be criticized. People will, in fact, apologize for them. People see Wall Street crash-creators testifying at Congress answering "I do not recall" to 100% of the questions. Instead of dishonoring those liars as the liars that they obviously are... our society just does nothing. It's okay that they lied. It's just business you know. We expect our business leaders to be dishonorable. "It's not the CEOs fault that he knowingly polluted the entire river for 20 years. He was just maximizing shareholder value, discharging his fiduciary duty, we can't hold him personally responsible. It is wrong to shame him and his family, it is wrong to ostracize him from decent company, it is wrong to even criticize him publicly in the newspapers." Either this mentality changes in a hurry, or the entire country is going to go the way of Detroit.

beagle3 15y ago
> Our society used to be based on concepts like honor. Nostalgia isn't what it used to be. Society was never based on honor; it was always about worshiping those who succeeded, regardless of how bad they had been, as long as they did some good at some point. see, e.g. Rockefeller, Carnegie, Mellon & Gates in recent times, and basically all fondly remembered kings and barons in earlier times. Society adapts, in part, by giving socially acceptable deeds a normative description and concept. The socially acceptable statements lag the deeds, not lead them. > People see Wall Street crash-creators testifying at Congress answering "I do not recall" to 100% of the questions. Instead of dishonoring those liars "These liars" applies equally well to congress as to those wall street execs (with whom the former are figuratively, "in bed", and have been for the last century or so) Really, the only thing that has changed is ease of access to information. Human greed, actions and norms as reflected by social response, by and large, haven't.

dhx 15y ago

The actions flowed from the company credo which is engraved in granite at the entry to company headquarters, which makes crystal clear that customers are first, then employees, and shareholders absolutely last. Why do businesses attempt to create hierarchical order where order doesn't exist? A business with extremely happy customers, happy employees and low return on investment (including other non-monetary value) for shareholders is a failed venture. Ranking stakeholders by their importance makes it easy to create harmful (and often implicit) rules and practices that fail to address the needs of all stakeholders. Companies should instead encourage employees to think about decisions from a wide range of perspectives including customer satisfaction, employee morale and business profitability. Creating a new procedure or rule that employees must adhere to could greatly please customers. However it may create extra menial and unappealing work for employees, lowering morale to harmful levels. It could cost the company a lot of resources that would be better spent elsewhere.

1gor 15y ago

The statement 'maximizing shareholders value' is meaningless without the timeframe. The correct phrasing is to 'maximize shareholders value in the long term'. The 'long term' bit is crucial, and it is not reflected in today's management incentives. The choice that managers of public companies are facing is the well known "Consume vs. Invest". Or, in the terms of an evolutionary fitness landscape, "Exploit vs. explore". If a manager wants to maximize his next quarter's earnings, he could stop new product development, shut down customer service and equipment maintenance departments and sell, sell, sell. He could have a short short-term spike in profitability, but in the long term the company won't survive. He has exploited his current position but has failed to explore, to look to the new opportunities and threats, and to provide for the future. (Note: the manager could also buy a portfolio of high-yielding/high risk securities hoping that the crash will not happen before his next bonus is due. This is the same thing -- maximising short-term gains at the expense of the long-term prospects of the company). The manager could also overexplore, that is to overinvest in customer and product development, purchase the newest equipment and end up with a croud of excited customers and an exciting new technology/product, but no liquidity left in the bank to live to see it taking over the market. "Maximizing shareholders value" idea got a bad press, because it has become associated with the 'exploit' approach. Managers endanger the long-term prospects of the company because they can be paid well for achiving relatively short-term goals. But the working definition should be "Maximizing shareholders value in the long term" Let's make the law that the managers' options can only be excersized after 10 years. That'll do the trick.

shasta 15y ago
Yes. The article frustratingly kept identifying "maximizing shareholder value" as the problem and the naive "delight customers" as the solution. Maximizing shareholder value would be much more closely aligned with society's interests if shareholders had the information needed to distinguish real value being built from a company being strip mined.
- quanticle 15y ago
  You need a second constraint. The shareholders have to care about long-term value. Many institutional shareholders don't care and have no incentives to care about long term value. To them, firms are not long term investments - they are merely symbols moving up and down on a price chart. If your symbol moves down too often, they'll pull money out of your firm, even when those gyrations are being caused by forces completely outside your control (natural disasters, or sector-wide trends).

xianshou 15y ago

I notice Steve Jobs is consistently mentioned in the present tense...did the author write this a while ago and forget to run it by his editor, or did he simply miss all of October?

xianshou 15y ago
Also interesting: Mr. Denning self-plagiarizes the concluding three sentences of his previous article verbatim. http://www.forbes.com/sites/stevedenning/2011/11/16/why-are-fannie-freddie-ceos-paid-so-much/2/ http://www.forbes.com/sites/stevedenning/2011/11/16/why-are-... Like all great obvious, radical ideas, in the first instance it will be rejected. Then it will be ridiculed. Finally it will be self-evident and no one will be able to remember why anyone ever thought otherwise.
- stevedenning 15y ago
  Interesting? Yes hopefully. Plagiarism is "the unauthorized use or close imitation of the language and thoughts of another author and the representation of them as one's own original work." By definition, one can't plagiarize one's own writing. In the 1000+pages of stuff on the blog, it's true that some important ideas are emphasized more than once.
  - sless 15y ago
    No, it is plagiarism. It is a blatant copy of Arthur Schopenhauer, "All truth passes through three stages: First, it is ridiculed; Second, it is violently opposed; and Third, it is accepted as self-evident."
    - stevedenning 15y ago
      Thanks for the reference. I've added a note..
stevedenning 15y ago
Good point. The sentences were written before his death. I've fixed them now.

pmuhar 15y ago

Even though I know exactly what the article is about, I wish it wasnt written in relation to football/gambling terms as a lot of people are not football fans or avid gamblers, myself included.

valuegram 15y ago

While I understand the idea behind this article, it was hard to get beyond the initial metaphor, which I find highly misplaced. In sports, for the most part, the only fact that matters is a win. with the exception of rare subjective ranking systems (such as coaches polls in college football), the quality of a win doesn't matter. Of course if a coach is playing in these systems, and not doing enough to meet the expectations of the fan base, there will definitely be repercussions. In the business world, a profit of $0.01 is very different from a profit of $1.00. Of course there are numerous valuation models, but the amount of profit/revenue/etc almost always matters, as opposed to sports which use a binary valuation system (win or loss). I appreciate the overall message, and believe that the market is willing to embrace this sort of logic. Jeff Bezos is a great example of a leader focusing on long term performance and being rewarded for it.

TheFuture 15y ago

Another egghead uni prof who's spent his life getting a paycheck from the gov telling us what's wrong with capitalism that he's never participated in. If shareholders (ie owners) want short term leadership, that's what they get. No one is forcing you to sell your shares every time the stock price moves. Buy and hold.

josh33 15y ago

Each of the following words opens up the door for semantic debate: "Maximizing" - when? In the short term or long term? "Shareholder" - who? People who own actual shares or the broader definition of stakeholders who have a vested interest in the company (employees, the community around the business, owners, etc.)? "Value" - what? Dollar value? Happiness? Customer satisfaction? Employee satisfaction?

pge 15y ago

I agree with the overall viewpoint of the article, so just adding an observation on how we got here. Tying management compensation to shareholder value is a good idea; the problem is in the measurement of shareholder value. If the public markets were efficient, and market cap was an accurate reflection of value, the system would not be as broken as it is. The public markets have become a casino, where investors are often playing a game, not investing in companies they truly understand, and whose value they have analyzed. Market cap is no longer strongly correlated with company performance (revenue, net income, cash flow, customers, etc). A return to a rational market would realign incentives, and stock-based compensation would work, but that's a lot to ask...

yummyfajitas 15y ago
If the public markets were efficient, and market cap was an accurate reflection of value, the system would not be as broken as it is. If you believe the public markets are not efficient, how long will it be before you are rich?
- Andrew_Quentin 15y ago
  It is inefficient for everyone not just one person or one group. An individual therefore is not able to easily exploit the inefficiencies as they are in the same position as everyone else.
  - yummyfajitas 15y ago
    I think you are using the word "efficient" in a nonstandard way. Could you please define your terms?
GrowMap 15y ago
Has it ever occurred to you that whoever has the most money can manipulate stock prices so any investor is in not one of the insiders is a mark? It boggles my mind that so few investors realize the game is certainly rigged and they ARE going to consistently lose. Why not just go to a casino? There - at least theoretically - you know what the takeout is and can decide whether you get enough "fun" from your losses to make you think it worthwhile. Gambling is gambling and the house always wins.

Vitaly 15y ago

He misses the point. Focusing on the customer IS maximizing shareholder value. Its just its focusing on a much longer timeframe. If you want the most money this year - you play the stock market or accounting games. If you want the most money the company will earn this century... well, you focus on very very different things. And customer's loyalty is one of the top.

GrowMap 15y ago

What a marvelous discussion because it encourages the inherently self-absorbed to reveal their belief systems which nearly always include the worship of self, money, and power as their only true gods. I highly recommend they all watch the Canadian Documentary 'The Corporation' which clearly illustrates why corporations ARE like psychopaths - and generally run by people who also meet the definition. The movie is available free online. Corporations as they currently exist are inherently unethical and unsustainable because by focusing on short term gain and stock values they are destroying the real value they once had. Either social responsibility and long term goals must be injected back into corporations or they need to be boycotted by everyone with a conscience or ideally have their corporate charters revoked.

scotty79 15y ago

What is a write-down that is being referred to in this article?

mmaunder 15y ago

Another example of a company in addition to J&J and P&G that the article mentions who focuses on customers is Amazon. Bezos recently was punished via a 30% drop in Amazon stock price because he is ploughing all his net income into the Kindle Fire, even though Amazon's revenue growth is exponential and has been for a decade. Shareholders in the public market right now are focused on "value stocks" in the Buffet and Ben Graham sense and if you don't match value stock heuristics with a dividend and growing net income, you will be punished even if you're 100% focused on creating new customers.

refurb 15y ago
This is slightly off topic, but it's something I really hated about business school. Sure J&J did a great job with the Tylenol poisoning case. However, they've lost over $1B in revenue in the last year or so because they consistently failed to produce drugs that meet federal guidelines. Not to mention the "unofficial recall" where they paid people to go into stores and buy up all the J&J products so that they wouldn't have to conduct an official recall. J&J is probably the most messed up company right now.

anantzoid 15y ago

I wish I could understand this.

prewett 15y ago

A lot of what the author complains about has been around for years. Short term gains at the expense of long term growth? Yup. Executives manipulating something to make their company look good? Yup. Read "The Intelligent Investor" or "Common Stocks and Uncommon Profits", which give examples of things companies did 50 and 30 years ago.

nonsequ 15y ago

Roger L. Martin, the author of the book hawked in this article, is also a director at RIM. Maximizing shareholder value indeed! That said, Roger is correct (incidentally or not) in my book to criticize the short-term casino nature of the public equity market buyers and sellers. Too often they forget that as shareholders of a stock they are part-owners in the enterprise; rather they only desire to see the price tag on their stock certificate go up in the next minute so they can sell for a profit. That kind of thinking can poison a company. The lesson I draw from this is that it matters who your investors are. Once you've sold part of the company, you must take into account the desires of your new partners, even if they are a teeming mass of the investing public. After all, you make the choice of whom you sell to. Some corporate leaders attempt to 'manage' their way out of this by massaging earnings the way Jack Welch did. I personally think the best way to handle this is by open education. Warren Buffett writes an elegant and informative letter each year and answers questions alongside Charlie Munger for four or five hours straight at the Berkshire meeting. If your business is too volatile, too secretive, or too sensitive to be explained to the public, you probably shouldn't be doing an IPO in the first place. It occurs to me that Roger's best hope is to change the minds of RIM shareholders declaring open season on the board. It is naive of Roger Martin to think that his book and Denning's sensationalist hawking of it will do anything to soften the ire of RIM's shareholders. By the same token, it was naive of RIM's leaders not to take into account the fact that once they sold shares to the public, it became the public's company.