Why Shareholder Value Maximization Is The Dumbest Idea In The World

This article summarizes the second point that is made in Ha-Joon Chang's book that I am reviewing.  We are told that corporations should be run to maximize shareholder value.  Jack Welch, the legendary CEO of GE applauded that idea in 1981.  He later called it "the dumbest idea in the world".  Which follows are some of the reasons why it is a dumb idea.

The major problem with running corporations to maximize shareholder value is that it is not good for long term stakeholders.  Unlike other stakeholders in a corporation, shareholders prefer strategies that maximize short term profits. They encourage management to return the profits to them by paying out dividends or by using stock repurchases to increase the share price.  This is often done at the expense of long term investments that reduce the growth potential of the firm.  Most shareholders don't care about the long term since they have an easier exit strategy than employees, suppliers, customers and the community.  They can simply sell their stock when they no longer expect profits to grow.  This further encouraged managers to take excessive risks or to focus on cutting costs and paying out dividends are repurchasing stock instead of investing in the future.

The alliance between shareholders and management worked out well.  The dividends and capital gains were financed at the expense of other stakeholders. Jobs were cut, many workers were fired and rehired as non-union labor or as temporary workers.  Their suppliers were squeezed by continuous cuts in procurement prices,  or by outsourcing from low wage countries.  Governments were pressured to cut corporate taxes and to increase subsidies by the threat to relocate to other countries.  As a result there was boom in corporate profits, which were funneled to management and stockholders, inequality soared.  Moreover, since the 1980's business investment as a share of national output declined from 20.5% in the 1980's to 18.7% between 1990 and 2007.  The growth rate in per capita income also fell from 2.6% in the 1960's and 1970's to 1.6% during 1990-2009.

General Motors provide a prime example of the problems in the focus on the maximization of shareholder value.  It squandered its dominance in the auto industry and was forced in bankruptcy in 2009 by its focus on shareholder value.  It paid more attention to cost cutting and less attention to investment in new products and technologies. It also increased dividends and stock repurchases to reward shareholder.  It was overtaken by foreign competitors who developed superior products, and longer term shareholders lost their equity.

Countries outside of the US and Britain have tried to reduce the influence of short term shareholders.  In some countries governments have held a share of ownership in key companies, either directly, or indirectly through ownership by state run banks.  Sweden has a system of differential voting rights for different classes of stocks that enables long term shareholders to have more significant control over the corporation.  In Germany workers have formal representation on supervisory boards.  Japan also minimizes the control of floating shareholders by cross-shareholding among friendly companies.  What we do in the US and Britain may not be in the best interest of our corporations or the country.