Carlos Tornero: Another nail in the coffin of shareholder value?

The US Business Roundtable stabs Milton Friedman in the back

All in capitalism is cyclical, not only its crises, but the guiding principles behind it.

Shareholder value maximisation, a dogma since Milton Friedman, Michael Jensen and William Meckling overturned the notion of corporate purpose in the 1970s, is now being challenged. By companies themselves.

Some 180 CEOs from the US Business Roundtable are saying what otherwise seems common sense. In a nutshell and not necessarily in their own words: it is not all about you, shareholders, there are other stakeholders who deserve attention and commitment: customers, employees, suppliers and communities among them. They, of course, need to prove that this is not just an empty statement.

Chasing shareholder value is not a legal requirement but an ideology

Sadly, it has taken a financial crisis, a climate emergency, and perhaps the subsequent emergence of ESG investing, for the penny to drop.

But it wasn’t meant to be this way. The late Lynn Stout explained it brilliantly in her book The Shareholder Value Myth.

From the 1930s until Friedman’s coup d’état on capitalism in the 1970s, the “Great Debate” over corporate purpose was not dominated by shareholder value, quite the opposite.

The contenders were Adolph Berle, from Columbia University, arguing for the unconditional benefit of shareholders.

He was up against Merrick Dodd, from Harvard University, who argued:

“The business corporation is an economic institution which has a social service as well as a profit-making function.” (See his 1932 Harvard Law Review paper: For Whom Are Corporate Managers Trustees?)

In light of Dodd’s words from almost a century ago, the annual letters of BlackRock’s Larry Fink might not seem that radical anymore — perhaps, it’s just the proof of capitalism’s cyclical nature.

But what Stout also explained to great effect was that chasing shareholder value is not a legal requirement nor a practical necessity, but an ideology and a managerial choice.

She took issue with the fact that US corporate law nowhere says that the purpose of companies is to maximize shareholder profits. On the contrary it is to “conduct and promote any lawful business or purposes”. In addition, articles of incorporation which included such shareholder value provisions were “as rare as unicorns”.

Likewise, courts would not “hold a board of directors liable for failing to maximise shareholder wealth” because the business judgement rule gives them leeway to use the assets of the companies in the pursuit of such purpose, whatever it is (provided they don’t take for themselves).

One of the myths that Stout debunked is that shareholders own corporations, and that therefore they are principals who appoint directors to boards as their agents.

Ownership of shares does not equate to ownership of corporations, because under US corporate law and possibly under any other legal systems, public corporations are independent legal entities that are owned by themselves. Shares grant the right to vote, but not even dividends are guaranteed, and that’s possibly true beyond the US.

The shareholder value myth is relevant because it has created a vicious circle of short termism. Under its tyranny, corporations would do whatever it takes to keep the stock price up and shareholders happy, from cooking the books to abusing buybacks and neglecting investment.But the shareholders here are not the ultimate beneficiaries of pensions funds or the vanishing mom and pop investor class. They are more likely to be asset managers, whose remuneration is linked to stock prices, as much as executive remuneration is.

As Stout wrote, this is like fishing with dynamite, good for the shareholder in the short term, but nefarious to the rest of the company’s stakeholders in the long run.

One of the things that Stout regretted was that shareholder value thinking infected modern discussions of corporations because it became routine for journalists, economists and observers to claim it as undisputed fact.

In that sense, it is interesting to acknowledge the Council of Institutional Investors’ response to the Business Roundtable statement.

They say it “undercuts notions of managerial accountability to shareholders”. In a seemingly defense of shareholder value primacy, the CII crucially said (emphasis added): “To achieve long-term shareholder value, it is critical to respect stakeholders, but also to have clear accountability to company owners”.

It is indeed tragic today not to have a freethinker like Stout, who died last year, to comment on the CII’s response.

Across the pond in the EU, the debate towards a more stakeholder-centric capitalism has been picked up by the European Commission in its Sustainable Action Plan.

Action number 10 of the Plan proposed the development of a “sustainable corporate governance”, although it has been overshadowed by other initiatives of the plan like the taxonomy.

In the Netherlands, De Volksbank has suggested giving voting rights to non-investor shareholders, as a new governance model aimed at creating a level playing field between stakeholders.

More recently, tax campaigner and academic Richard Murphy launched the Corporate Accountability Network, which aims at writing accounting standards that serve the interests of all company stakeholders and not just those of shareholders.

In the UK, section 172 of the Companies Act has a decisively stakeholder approach too (“to promote the success of the company for the benefit of its members as a whole”).

Kerrie Waring, CEO of the International Corporate Governance Network (ICGN), highlights the vital role that shareholders play in holding companies directly to account through voting rights, as well as the mutual responsibility between companies and investors to preserve long-term value.

Waring says that, to some extent, the statement of the US Business Roundtable aligns with section 172, regarding the fiduciary duties of directors. There is, however, one notable exception, she says.

“The UK reference makes clear that the corporate purpose is to promote the success of companies for the benefit of its members (i.e. shareholders or underlying capital providers) while having regard to other stakeholders.”

Who are considered members of the company under the UK law would be a relevant question but it is common to hear investors in Europe and in the UK proclaiming themselves owners of the companies in which they hold stock.

At an event in May I asked British economist Charles Goodhart whether investors’ ownership claim on companies is correct. His answer matched that of Stout: “It is a fantasy.”