A new book, “The Shareholder Value Myth,” by Cornell law professor Lynn Stout, is ruffling feathers in the field of corporate governance. Stout proclaims that the tenets of shareholder value maximization have no standing in corporate law and economics—and that there is no empirical evidence that they work.
She challenges many of the beliefs of “shareholder primacy,” which Stout says includes the mistaken claim that shareholders “own” the corporation, that they are the only residual claim on the firm’s profits, and that they hire the executives and directors to act as their agents.
Instead, Stout claims that boards have primacy and that courts have provided them latitude to use their judgment to run a business—including decisions that may reduce a company’s share price.
She says the biggest mistake has been to align executive pay with corporate performance (usually measured by stock price), which Stout says has proved to be a disaster. Managers who focus on short-term stock prices erode the long-term value of the enterprise. She blames the corporate governance movement, which pushed for this alignment, for causing harm to corporations and weakening investor returns.
The professor argues that, as companies increasingly have focused on their stock prices and given managers more stock, they have inadvertently empowered hedge funds that push companies to manage their business in the short term.
Stout calls for a return to so-called “managerialism,” where executives and directors run companies without being preoccupied with shareholder value. Shareholders under this model would have a limited and weaker role, which she says is a good thing.
Nell Minow, a leading corporate governance advocate, countered in a New York Times article that “the idea of speaking of shareholders as owners is crucial.” She believes shareholders must take active roles to prevent conflicts of interest and self-dealing. Minow also contends that the idea that shareholders have too much power is laughable, pointing to recent proxy voting against CEO pay packages that has been ignored by directors.
Ironically, Stout’s diatribe comes at a time when regulatory changes have attempted to give shareholders a stronger voice. Proxy access, say-on-pay voting, segregating broker non-votes and other improvements may be slowly having an effect.
And while the interests of a company’s shareholders may differ to some degree, leaders who communicate solid principles that espouse a long-term drive will attract high-quality investors.
Stout is right to criticize the explosion in executive pay, however wrong she is about its cause. The corporate governance movement isn’t to blame. We would argue that boards, managers and their consultants are responsible for the escalation. They have misused the pay-for-performance principles in employment contracts, coming up with equations that ensure a large paycheck regardless of corporate results.
And the notion that shareholders are not owners is anathema to an investor. Why would anyone contribute risk capital to an enterprise without a claim of ownership?
Clearly, Stout’s book is meant to stir debate. In fact, the solution to many of her complaints might indeed be to accord even greater powers to shareholders.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or email@example.com.