Mar 02 2014

Does “Maximizing Shareholder Value” Work as a Business Objective Anymore?

Published by under business,economics,investing

In arguments over business and the economy, you often hear that the job of corporations is to “maximize shareholder value.”

People use this phrase to justify all kinds of things that are ethically ambiguous (e.g. polluting as much as possible up to the legal limit), or seen as distasteful to some (e.g. layoffs).

But, is that the right goal of a corporation? Is it even a good benchmark of a successful corporation? And, does it even work anymore?

In order to understand if “maximizing shareholder value” makes sense as a primary business objective, it’s important to understand the historical forces that led to this goal for corporations being broadly adopted. This concept has not been fixed as the sole, or even primary, goal of corporations, but instead was created in response to a specific set of circumstances.


Basically, U.S. corporations performed relatively poorly in the 1970s because of their huge size and inefficiencies (it’s difficult for lumbering giants to find and invest in good ideas). This, combined with increased competition from smaller (and therefore more efficient) Japanese firms caused U.S. firms to profit even less.

The primary operating mantra for U.S. corporations was “reinvest and retain,” meaning that corporations should use their profits to 1) reinvest in new, productive inventions, and 2) retain both their earnings and their talent to build capacity to take advantage of those productive inventions.

To our modern business eyes, this might seem foolish, but you should remember that this strategy had worked basically since the start of the industrial revolution.

So, in the 1980s, the ~100 year objective of “reinvest and retain” wasn’t working anymore. Smaller, more nimble firms were eating away at larger, slower competitors.

In addition, the 1980s saw the rise of large institutional investors – basically guys who just aggregated capital and pushed it around. These started out being guys who aggregated retirement savings for hundreds of thousands of workers, and therefore had big dollars to push into productive companies.

Large institutional investors did not care about ongoing R&D, or about retaining quality talent. And, this model was not working very well at the time. So, “maximize shareholder return” was born out of this primordial business ooze. It aligned big capital with big business in order to produce stellar returns for both.

Of course, this begs the question: does “maximize shareholder value” work as a business objective today?

I would argue that it doesn’t because:
1. Large organizations are much leaner now (after 30 years of rightsizing and justifying every head against a P&L), and feedback loops on productivity of R&D and internal investments are much more equal across all sizes of companies
2. The large institutional investors have gotten so large as to overwhelm any (and every) capital market, and therefore, every company within the market. Currency traders can crash economies. Banks control both commodities traders and commodities storage and transport facilities, allowing them to manipulate commodities markets. And 70+% of market trades are made by algorithm, introducing manipulation through HFT (yes, yes, as well as liquidity, because when you want to sell a stock, you HAVE to do it RIGHT THIS SECOND so very often).
3. We have learned to manipulate stock prices (the most common and simplest proxy for shareholder value) with a host of tricks that have nothing to do with value creation. I’m talking about things like splits and buybacks; special dividends; shifting borrowing costs and bond holdings; offshoring tax liabilities with no way of repatriation of profits sans tax (unless – or until? – large companies strongarm the federal government into a repatriation tax holiday); the creation of shell corporations; etc. These things do not add to the productive economy, but do line the wallets of bettors and financial manipulators.

I would posit that a return to “retain and reinvest” as a main objective of corporations would be good for the companies, their employees, tax rolls, the broader business climate, and society at large.

In fact, the smartest businesses that I know of are using this model to grow very, very profitable companies (albeit, probably without saying it in this way).

Look at the organizing structure and operating model of these very, very innovative, and very, very profitable companies:

Google: Two classes of shares, with minimal voting rights of money investors. No dividends. Basically, the board cannot be controlled and the huge profitability of search ads can’t escape Google’s walls to be frittered away by dumb Wall Street people. Instead, it’s tightly held by the business leaders, who reinvest in a whole host of productive innovations.

Facebook: Two classes of shares, and 57% of the voting interest held in one person – Mark Zuckerberg. He gets to take risks with money from big institutional investors without being beholden to anyone for the performance of the company. Hence, you get huge moves like the $19B acquisition of WhatsApp, even when P/E is over 100.

Berkshire Hathaway: Has never split stock. Has never paid a dividend due to tax inefficiencies of doing so. Added a second class of stock to be more affordable to newer investors, but with reduced voting rights. Buys to hold literally forever, with no plans to ever sell a company. Keeps management in place to continue growing their business units. Takes FCF from business units into a BDC structure to mount the next acquisition. This is the definition of “retain and reinvest.” 

If this is interesting, you should check out a deeper overview of the history of “maximize shareholder value” (warning: PDF).

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Sep 02 2010

Why the Future of Music is Brighter Than Ever

Many hands have been wrung about the future of music. The music industry has seen year over year of increasingly steep declines for a decade. Think about that for a minute: in 2001, the business fell by 3%. In 2002, it fell another 11%. In 2003, it recovered slightly. But the dead cat bounce was confirmed in the subsequent years. The industry has posted double digit declines in 2006, 2007, 2008, and 2009. In 1999, the industry was $14.3 billion. In 2009, it was less than half – $6.3 billion.

Can you hear the clanging death bells? Music will surely die! This fate has been proclaimed everywhere, but, of course, misses the point completely. If we learned nothing else from the housing bust, let us at least remember that more isn’t always better – sometimes it’s just more. Continue Reading »

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Aug 29 2010

What Now? Resetting the Economy for the Next 50 Years

In The Great Reset, Richard Florida asks the question that all policy makers should be asking: what happens after a Depression?

This shockingly simple question opens the door to look at history as a guide for what is to come for the U.S. economy. Florida reviews two different  economic slowdowns in American history, the Long Recession of the 1870s, and the Great Depression of the 1930s, and compares those to our most recent financial meltdown of 2007-present.

While there are a number of accounts of what went wrong, and whose fault it was that the economy tanked (Big greedy banks! The dollar-hungry, exchange-rate fixing Chinese! Government’s insatiable quest for higher levels of home ownership! Homeowners’ binge-spending, house-as-ATM profligacy!), Florida largely leaves the causes of the crisis aside. This is really for the better. Florida is a metropolitan sociologist – primarily concerned with what makes cities, and what makes them better.

But, Florida hits on a larger theme that has so far been ignored by most Great Recession books: what now? Continue Reading »

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Jun 23 2010

Moving Carries Tremendous Externalities

Published by under economics

Sorry for the delay in updates. I have been in the process of moving, which has taken me away from blogging.

Now, everything is in the new house, and many things even have a place to live!

Continue Reading »

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May 08 2010

The Demise of Web3D – The Hottest Tech Trend of 2008

Published by under economics,technology

With recent developer conferences from Facebook and Twitter, and the forthcoming Google I/O conference, it’s easy to get wrapped up in the breathless excitement of possibility. It gives tech blogs many millions of pageviews to chronicle each minor announcement as if it were a game-changer.

But, in the weeks and months that follow, the sheen inevitably wears off, and developers start determining which innovations are truly exciting, and which are just so much hype.

It’s the community that makes are breaks these companies – a point that is very apparent when we look back just two short years, at the hottest technology of 2008: Web3D.

Continue Reading »

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Apr 24 2010

Enterprise 2.0: More Important Than Facebook

Published by under economics,social media

Amongst those that talk social media, the most popular conversation is Facebook. Mark Zuckerberg is the prom king, and the entire high school commons of the blogosphere knows what’s going on with him at all times. That’s part of the reason why WebMediaBrands acquired Social Times, publisher of allfacebook.com. Check out these uniques for All Facebook – growth has tripled in Q1 in part because of increased interest in the platform:

But, there is a much more important conversation that deserves more attention: how collaboration tools are changing internal operations within organizations. These cultural changes have little to do with Facebook, but the impact will be much greater than Facebook’s impact by itself.

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Mar 27 2010

You Might Even Thank Facebook for Automatically Sharing Your Data with Other Sites

Facebook recently announced that they will give up personally identifiable information to certain “approved” sites that use Facebook Connect. Within the tech industry, this is seen as a scary invasion of privacy, but I am not sure if it is really a very big deal. This isn’t a very big step forward from a marketing perspective, and in the end, most users will be better off.

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Feb 16 2010

Whatever You Do, Don’t Buy A House Right Now

Published by under economics

Confession time: I have been looking at houses online. I salivate over the new listings every day.

We are settled into Portland enough that buying a house seemed like a reasonable option.

But, this topsy turvy market really means that the best bet is to stay on the sidelines. I won’t be buying a house any time soon. And you shouldn’t either.

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Nov 10 2009

How to Compete with FREE

Published by under book review,economics,marketing

Chris Anderson’s new book, Free: The Past and Future of a Radical Price, will scare you. And it should. If you’re in the business of selling anything, you need to think about how you might be able to give it away. Because if you don’t, someone else will. Continue Reading »

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