UPDATED: "Shareholder value" is wrongly interpreted

by technopolitical Fri Dec 22nd, 2006 at 03:15:50 AM EST

Update [2006-12-23 2:44:13 by technopolitical]: New title above, whining below, diary boxed [now unboxed].

OK, that does it: under mild provocation, I'm mildly annoyed. The comments are wide-ranging and perceptive, but (at comments=32) are almost perfectly non-responsive to the idea presented in the diary. I'll try again later, perhaps with a better abstract.

Update [2006-12-23 18:20:13 by technopolitical] Much better -- Thanks!

Formerly:

Share Value isn't Shareholder Value

Orthodox market ideology rests on a mistaken understanding of the principle -- its own principle -- that corporations should maximise shareholder value. A correct understanding of this principle undermines the reasoning that requires corporations to behave in a manner that has some have termed "psychopathic".

I will argue this through a series of what I intend to be utterly uncontroversial statements. I assume that ideas this simple are not new, but I cannot recall encountering them previously, and I welcome criticism of this effort to set them out in a systematic way. Version 0.3:

(1) To quote Wikipedia, "In most countries, including the United States, boards of directors and company managers have a fiduciary responsibility to run the company in the interests of its shareholders." (Stock: Shareholder rights)
(2) Running a corporation in the interests of its shareholders, commonly described as "maximising shareholder value", and this is generally taken to mean (at least to a good approximation) maximising the value of the shares.
(3) A corporation sometimes can increase its share value through actions that cause a greater decrease in the aggregate share value of other corporations. For example, a corporation may obtain a broad patent and use it in a way that inhibits innovation across an entire field. [Better example?]
(4) A corporation sometimes can increase the aggregate share value of other corporations a great deal through actions that cause a small decrease in its own share value. For example, a corporation may offer free licenses to a patent of little relevance to its own business. [Better example?]
(5) Most shareholders hold well-diversified portfolios, often index funds. Few invest solely or even predominantly in the shares of any one corporation.
(6) For a corporation to serve the financial interests of shareholders holding well-diversified portfolios, "maximising shareholder value" entails maximising the (suitably weighted) share values of the corporations in their portfolios. (This isn't exactly correct, since investors value not just the "share value", but its effect on portfolio-level risk, etc., but it is a good approximation and can serve as shorthand.)

(7) Accordingly, in situations of types (3) and (4), the current interpretation of "maximising shareholder value" as "maximising the value of the corporation's shares" can create a perverse fiduciary responsibility on the part of managers and directors to take actions that decrease the value of a typical shareholder's share holdings.
(8) Shareholders value things other than their shares. For example, they may prefer market choices, low taxes, and a stable climate.
(9) Corporations sometimes can increase their share value by actions that create negative externalities of greater magnitude. For example, they may narrow market choices in an area by monopolising production, reduce labour costs by wage cuts that make workers more dependent on tax-funded government services, or lower production costs by choosing processes with high, climate-damaging carbon emissions. Any of these actions may impose large costs on society for small gains in corporate value.

(10) Accordingly, in situations of type (9), the obligation to maximise a corporation's share value can create a perverse fiduciary responsibility on the part of managers and directors take actions that are against a typical shareholder's actual interests, which include more than just portfolio value.

Points (7) and (10) show that maximising share value is sometimes at odds with maximising shareholder value, and hence show that the usual interpretation of the fiduciary responsibilities of boards of directors and corporate managers is misguided. How might this be remedied, at least in part?

In a formal, economic sense, one solution would be to internalise all externalities, so that profit aligns with some reasonable measure of overall value. This has been pursued with substantial but limited success. The question is how to further reduce the problems that this remedy seeks to address.

One approach (the hard reform option) would be to adjust the interpretation of shareholder value to take account of the discrepancies noted above, while maintaining the same obligation to maximise that value. This encounters multiple difficulties:

(a) Different shareholders will hold different portfolios, and they will experience non-financial externalities to different degrees. Thus, there can be no metric as simple as share value.
(b) Weighing external benefits is difficult both in a practical sense and in an institutional sense, because they cannot be measured by standard accounting and auditing procedures.
(c) Decisions that create benefits outside a corporation could create conflicts of interest (and opportunities for fraud) among internal decision makers, who may be in a position to capture unduly large portions of these benefits.
(d) Because external benefits aren't internal and monetary, it is hard to convert them into benefits (hence incentives) for the decision makers in the corporation.

A second approach (the soft reform option) would impose no obligation to maximise shareholder value in the extended sense outlined above, but would instead merely remove any obligation to take actions that would decrease it. That is, the creation of large external benefits at a small cost would sometimes be a defence against shareholder lawsuits claiming a violation of fiduciary responsibilities. This suffers from problems (a)-(c) above, but to a lesser extent because the newly-legitimised decisions are purely optional, and decision makers would be free to act on them only when the case for their value is overwhelming. As for (d), weak incentives are acceptable, because inaction is acceptable.

To summarise: With the soft reform option, a director or manager taking a decision that is overwhelmingly beneficial to shareholders would be protected from lawsuits (and principled scorn), even if the effect on the corporation's share value is negative.

In comparison to the metric of single-corporation share price, the metric of total benefit to shareholders is better aligned with total benefit to society. Accordingly, the new range of decisions that the soft reform option would allow will include many of the sort ordinarily called "good".

At the margin, merely recognising that share value isn't shareholder value would legitimise (and delegitimise) corporate decisions in a favourable way, and would shake a pillar of market orthodoxy. Fabius and his army can take it forward from there.

Any useful ideas and words I offer here may be (should be) used freely and without attribution.
I promise that I won't be doing much with them.

Poll

Votes: 4
Results	\|	Other Polls

UPDATED: "Shareholder value" is wrongly interpreted | 63 comments (63 topical, 0 editorial, 0 hidden)

Re: Share Value isn't Shareholder Value (4.00 / 2)

This has been bothering me, so I thought I'd share it.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Fri Dec 22nd, 2006 at 03:16:57 AM EST

Re: Share Value isn't Shareholder Value (none / 0)

I agree totally with your article, and I must have considered subconciously it beforehand as I pretty much figure out it all from your heading.

Thanks for writing it up so clearly!

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Dec 22nd, 2006 at 03:02:19 PM EST
[ Parent ]

What is missing (4.00 / 2)

is the original function of shares - to provide dividends to the holders of the shares.

http://en.wikipedia.org/wiki/Dividends

Dividends are, crudely, the amount of company value (usually, but not necessarily, profit) that the board decides to pay equally to each equivalent share after a period of trading (usually one year, but rules vary by country).

The basic rule is that for all equivalent shares, the dividend is shared equally. That is what you own, when you own shares - the right to receive dividends and the right to vote on the election of the officials who administer the 'pool'.

You also may buy or sell those shareholder rights. And there is the problem.

What was originally a bet that required waiting until the horses had run to find out if you had backed a winner, has become a crazy melée of punters desperately trying to sell each other their betting tickets while the race is still being run. These transactions do not add anything to the pool.

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 04:18:22 AM EST

Re: What is missing (none / 1)

When dividends are paid, the share price is depressed in proportion to the size of the dividend, so the shareholder breaks even. If the dividend is paid in cash, the shareholder can buy shares with it, and if it's paid in shares the shareholder can sell them for cash. Or the shareholder can obtain a dividend even if the company doesn't give it out by, say, selling a few percent of his/her holding each year. It all boils down to the same thing.

It might be worth revisiting Keynes. The key word is liquidity...

Investments which are 'fixed' for the community are thus made 'liquid' for the individual.
...
Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced. This is the inevitable result of investment markets organised with a view to so-called 'liquidity'. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of an investment institutions to concentrate their resources upon the holding of 'liquid' securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance whichh envelop the future. The actual, private object of the most skilled investment of to-day is 'to beat the gun'. as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.
...
These tendencies are a scarcely avoidable outcome of our having successfully organised 'liquid' investment markets. It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges. That the sins of the London Stock Exchange are less than those of Wall Street may be due, not so much to differences in national character, as to the fact that to the average Englishman Throgmonton Street is, compared with Wall Street to the average American, inaccessible and very expensive. The jobber's 'turn', the high brokerage charges and the heavy transfer tax payable to the Exchaquer, which attend dealings on the London Stock Exchange, sufficiently diminish the liquidity of the market (although the practice of fortnightly accounts operates the other way) to rule out a large proportion of the transactions characteristic of Wall Street.[4] The introduction of a substantial overnment transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.
The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets ovten facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is 'liquid' (though this cannot be true of all investors collectively) callms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are availale to the individual. This is the dilemma. So long as it is open to the individual to employ his wealth in hoarding or lending money, the alternative of purchasing actual capital assets cannot be rendered sufficiently attractive (especially to the man who does not manage the capital assets and know very little about them), except by organising markets wherein these assets can be easily realised for money.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Fri Dec 22nd, 2006 at 06:45:15 AM EST
[ Parent ]

An excellent post! (none / 0)

"to pass the bad, or depreciating, half-crown to the other fellow"
+
"make the purchase of an investment permanent" ie less liquid
=
dilemma

For which I'd like to know the answer...

Ignoring the practicalities of changing well-established markets, what instrument could society use to promote corporate enterprise and reduce individual or grouped speculation?

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 08:05:14 AM EST
[ Parent ]

Re: An excellent post! (4.00 / 2)

Well, they could do what the entire Canadian market has done ie Companies can bung that part of their gross revenues which is in excess of "costs" into a legal wrapper and sell them off to investors in the form of "units".

So that investors get their hands on revenues BEFORE the management does. It makes the investment far less speculative.

Bugger trust law of course - a wrapper based upon French jurisprudence is better (Three Guesses what that could be), except the French haven't woken up to it, eh Jerome?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 22nd, 2006 at 09:31:14 AM EST
[ Parent ]

Re: What is missing (none / 1)

When dividends are paid, the share price is depressed in proportion to the size of the dividend, so the shareholder breaks even. If the dividend is paid in cash, the shareholder can buy shares with it, and if it's paid in shares the shareholder can sell them for cash. Or the shareholder can obtain a dividend even if the company doesn't give it out by, say, selling a few percent of his/her holding each year. It all boils down to the same thing.

I agree with your comment, but would present one small correction. For the investor who doesn't want to withdraw cash from his investment in a company--say he really believes in the company and wants to leave all his money in for 10 years--he is forced to take a dividend. And while you are correct that he can buy stock with the dividend, he is first taxed on the dividend payment. The dividend tax rate is historically low for the US today, 15%, but if it's a $1000 dividend, he would only have $850 after tax to reinvest. This investor would be theoretically better off if the money was left in the company.

by wchurchill on Fri Dec 22nd, 2006 at 05:19:59 PM EST
[ Parent ]

Re: What is missing (none / 0)

If the dividend tax rate is higher than the tax on sold shares, then it is beneficial for the investor to sell the shares themself if he wants a "dividend", and conversely. Now, the question is, if a dividend is paid in shares, doesn't the investor pay tax on that? That would make a dividend paid in shares optimal for the investor. It makes no difference to the company.

I seem to recall that un Spain there would be no tax on stock sales if the shares had been held for a period of several years. That gave the long-term investor an advantage consistent with their greater social utility. I don't know what the situation is currently.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Fri Dec 22nd, 2006 at 05:35:55 PM EST
[ Parent ]

Re: What is missing (none / 0)

That would be another solution - to apply tax based on timed holdings. I.E - the less tax is paid the longer you own the shares. And not too difficult to implement. A kind of tax on liquidity.

After 5 years, for instance, no tax would be payable.

This was the company taxation law in Finland for start-ups, until recently. If you started a company and owned shares (which then required a minimum 100% capital of around 8000 €) you would pay capital gains tax if you sold within 5 years - I forget how much - but after 5 years it was all tax free.

This lead to an increase in entrepreneurship that still echoes today in Finland. 5 years happened, at the time, to be the period it would normally take to build up a viable operation with a proof-of-concept that then required further capital for exploitation. The extra capital needed meant sell-out of part or all.

But this adheres to the Peter Principle which states, crudely, that there are some people who start companies. some who grow them, and yet others who run them on the upper plateau. And very rarely can one find these talents in a single management culture.

The Finnish tax described above was seed money. It said "You risk 8000, but you could win millions". And the subtext was "You are not the right people to build it anyway"

To me, this is what governments should do: firstly, there is an ongoing actuarial analysis of present trends, extrapolated to future trends. Then instruments have to be found that dick with those trends, if they are considered to be ultimately detrimental to the 'social good'.

The 'social good' is the only thing that governments should concern themselves with. That is why they 'represent' us.

All law is to do with habituation. The sum total of what all the members in a society accept as 'normal' is behavioural. It is not good for everybody, but it is good for the majority of members. 'Strange Fruit' on the trees of the US South 50 year ago have produced a behavioural change that would never have happened without media. Strange behaviours in a society have to be explained and then accepted or rejected - that is the role of the media: the 4th Estate.

We behave very differently as individuals, but we are rather predictable in our general attitudes because we rarely have a good choice (perfect match) in our representation. Our individual lives are analogue, but our choices are discrete - rough with the smooth.

So what I am arguing for <ducks> is a reassessment of democracy. Does 'one person, one vote' still cut it when most of the voters are traumatiised into behavioural acquiesence by the MMS?

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 08:24:04 PM EST
[ Parent ]

Re: What is missing (none / 1)

interesting point. If you have held the shares more than 12 months the gains would be long term, taxed at 15%, which is the same as the long term gain tax. However, if you held them less than 12 months, the tax is your ordinary income tax, which is as high as 35%--talking Federal tax only.
Dividends paid in shares are taxed just like cash, so there's no real advantage to a share dividend, and therefore you don't see many of them.

by wchurchill on Fri Dec 22nd, 2006 at 09:19:44 PM EST
[ Parent ]

Re: What is missing (none / 1)

we may be getting lost in the back and forth here,,,but I think you are pointing out, that if dividends are not paid by the company, the investor can decide upon his own when to take the "dividend", ie:cash out of his investment, but simply selling shares. and in the US, this receives the lower tax rate of capital gains, on the gain. and I think that is a correct theoretical view.

Not to complicate this, but just fyi, there is a view among some investors that if managment has to pay a "cash" dividend, they are more accountable. both in the sense of every quarter paying cash of some amount, and second, there is some gamesmanship that can be played in the world of accounting with income (versus cash--potential chicanery)--but those games tend to go away when it comes to writing someone a check. these comments get into a somewhat arcane world of accounting, and apologies, though I think you understand them, as they are pretty esoteric.

by wchurchill on Sat Dec 23rd, 2006 at 02:46:49 AM EST
[ Parent ]

Re: What is missing (none / 0)

This explains why dividends seem to be falling out of favour. With electronic trading and online brokerage, even by retail banks, it is so easy to withdraw cash from your investment that a dividend is generally bad for the investor.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 06:13:28 AM EST
[ Parent ]

Re: What is missing (none / 0)

A common misconception. A shareholder gains zero when a firm releases a dividend.

If you read french, I wrote Les dividendes enrichissent-ils les actionnaires ?.

BTW, does anyone know the tax treatment of share buybacks?

by Laurent GUERBY on Fri Dec 22nd, 2006 at 10:47:40 AM EST
[ Parent ]

Re: What is missing (none / 0)

Explain why a shareholder gains zero.

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 10:52:13 AM EST
[ Parent ]

Re: What is missing (none / 1)

That's what my french blog entry does :)

In short:

Because everyone can buy a share just at the end of the day before the dividend "ex-date" and sell it at the beginning of the next trading day while having gained the right to receive the full dividend.

So if the share closes at $100 and gives you a $5 dividend, if the share open at $100 every bozo on earth could earn $5 by buying then selling without taking any risk. So in practice, the share opens at $95.

For the shareholder: before $100 in one share, after $95 in one share and $5 in cash. Zero gain.

If you don't believe me, look at my french blog example: when microsoft paid a total $30 billion in dividends on the week-end after friday 12 november 2004. Shareholders gained next to nothing.

by Laurent GUERBY on Fri Dec 22nd, 2006 at 11:10:12 AM EST
[ Parent ]

Re: What is missing (none / 0)

You've given me a 4 without understanding my comment. LOL

When dividends are paid, the share price is depressed in proportion to the size of the dividend, so the shareholder breaks even. If the dividend is paid in cash, the shareholder can buy shares with it, and if it's paid in shares the shareholder can sell them for cash. Or the shareholder can obtain a dividend even if the company doesn't give it out by, say, selling a few percent of his/her holding each year. It all boils down to the same thing.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Fri Dec 22nd, 2006 at 11:32:34 AM EST
[ Parent ]

Re: What is missing (none / 0)

Not at all. I 4 you just for breathing...

I'm trying to find out how the process of periodic reward for investment has been subverted by speculation/liquidity (the dilemma).

And whether there are remedies. I'm thinking of the LLP model again.

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 12:10:54 PM EST
[ Parent ]

Re: What is missing (none / 0)

In the US it's a non-taxable event.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Fri Dec 22nd, 2006 at 11:54:29 AM EST
[ Parent ]

Re: What is missing (none / 0)

That makes a difference, because you do pay taxes when you buy or sell stock.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Fri Dec 22nd, 2006 at 11:58:04 AM EST
[ Parent ]

Re: What is missing (none / 0)

BTW, does anyone know the tax treatment of share buybacks?

In the US, there is no tax impact for the buyer of the shares at the time of the purchase--tax impact comes when those shares are sold at a later date. So for the company that buys back shares, it is not a taxable event.

For the person who sells those shares, he of course has a taxable event, and will recognize long or short term capital gain, or capital loss,,,,,,depending on how long he has held the shares, and how the shares have performed in that period.

by wchurchill on Fri Dec 22nd, 2006 at 05:26:37 PM EST
[ Parent ]

Tax and share buyback (none / 0)

Let's say a company with a market cap around 100 millions USD manages to make this year around 6 millions USD in "profit". Let's say at the end of the year there are one million shares, each one valued at 106 USD.

Option A: company declares the 6 millions profit, pays about 2 millions in taxes (assuming rate = 33%) and pays 4 millions to shareholders in dividends. (In most countries, this 4 million will also be taxed as income to shareholders.)

Option B: company buys 6 millions USD / 100 (average price) ~= 60 000 of its own shares and cancels them. Assuming the company will be able to turn in the same 6 millions USD profit next year and assuming a constant earning per share, the new 940 000 shares should be valued at 106.38 USD.

If I understand correctly what you and ATinNM are telling me zero taxes are paid by company in option B.

The shareholder in option A will pay near or no capital gain if he sells his share (initially bought at the beginning of the year) after the dividend, and in option B he will pay capital gain tax.

From the state point of view, seems to be close, a more accurate model (real taxation rates, interest rates, company valuation model taking into account profit taxes) would be needed.

Any reference?

by Laurent GUERBY on Sat Dec 23rd, 2006 at 05:27:00 AM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

In option B...

does the company sell the shares at $100 or at $106? Wouldn't it be selling 56600 shares at $106 rather than 60000 shares at $100? That would leave 943400 shares valued at $106. In your calculation the share buyback results in a +$0.38 bump to the share price, which seems inconsistent.
aren't the assumptions about performance in the next year supposed to be factored in the share price already? [constant earnings per share is indeed a necessary assumption]

In any case, it seems share buybacks are "better" than dividends because the shareholders do not have to implicitly pay any tax on the company's profit: they get $6M as opposed to $4M.

If corporations pay tax only on profit, does this mean that they can use share buybacks to pay no tax at all?

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 06:06:14 AM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

My model is not good enough for this level of accuracy (as I said) and is indeed not consistent.

Since you can't buy groceries with your shares, the shareholder wil have to sell, when he sells he will pay capital gain tax (or income tax), which can be more than company profit taxes.

If you bought at 100 and sold at 106, you make 6 in additional income which is taxed. If you hold on your share longer, you need to take into account risk-free interest rate, etc...

I don't know if retirement funds are taxed on capital gain, if not, we now know why they vote for share buybacks.

by Laurent GUERBY on Sat Dec 23rd, 2006 at 06:36:45 AM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

Retirement funds can be legally organized, in the US, in so many ways a general answer is impossible.

But, if your ready for this one, the US goverment, in its wisdom, allows corporations to put their own stock in their internal retirement plan. So when they buy back shares they also increase the estimated net worth of that fund as well.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sat Dec 23rd, 2006 at 12:36:09 PM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

The risk-free interest rate doesn't exist...

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 05:14:52 PM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

Well, let's call it the best approximation of it and forget about the approximation :).

by Laurent GUERBY on Sat Dec 23rd, 2006 at 06:12:57 PM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

I have a serious point to make with that, and that is that the assumption that there is a single lowest interest rate at which it is possible to both lend and borrow is simply not true. Well, it might be true for banks (i.e., market makers), for instance in London they can all borrow from each other at LIBOR, but other market participants don't have access to that, and can borrow and lend at different rates.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 06:17:41 PM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

The risk free rate is when someone lends to the state, and in France at least you can buy various "BTAN", "OAT" that gives you this rate (with a tiny spread, France being one of the best borrower of the eurozone and also near zero bank margins), the government recently announced measures to ease the access to state debt for consumers.

By definition lending to any other entity will get a higher rate.

And of course banks take their margin for most products, I believe I would get interest of EURIBOR 3 or 6 monthes minus 15 basis point if I block money for the duration at my bank.

by Laurent GUERBY on Sun Dec 24th, 2006 at 04:48:31 AM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

And only the state gets the risk-free rate when they borrow, banks get interbank rates (LIBOR, EURIBOR...) and people get the shaft.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sun Dec 24th, 2006 at 04:52:13 AM EST
[ Parent ]

Missing an Important Point (none / 0)

In the US - Your Tax Laws May Vary - OK?

In option B neither the Corporation nor the investor has to pay taxes on the $.38 increase in share value. Focusing on the latter, no money has been "constructively received" by the shareholder thus there is no tax event.

In your example, the $.38 can be viewed, by the investor, as the monetarized value of a tax-free compounding rate which increases the Internal Rate of Return of the investment. (Does that make any sense?)

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sat Dec 23rd, 2006 at 12:26:56 PM EST
[ Parent ]

Re: Missing an Important Point (none / 1)

$0.38 means nothing here, it is far below the errors and approximations I made.

by Laurent GUERBY on Sat Dec 23rd, 2006 at 06:14:04 PM EST
[ Parent ]

Re: Tax and share buyback (none / 1)

No and I apologize if my previous answer was confusing. In both option A and B the company will pay the taxes. So the company pays $2 million in both cases.

the difference comes with the shareholders. When the shareholder receives the dividend at the end of the year, he/she pays taxes at the dividend rate, now 15% in the US. The difference really comes for those shareholders who are long term investors, and don't want the annual dividend payments. If no dividend is paid, and the money is left in the company, and the company continues profit growth as you suggest, the individuals money grows without any of it being taxed. Then say at the end of 10 years he sells, he then pays a 15% capital gains tax--but all of "his earnings" in the company have grown without him paying the 15% tax on the annual dividend. So the 10 year holder not paying dividends, gets the full compounding effect on his portion of the earnings.

If he invested in an identical company that paid the dividend every year, he would pay the personal tax on the dividend each year, and thus lose the opportunity to compound his gains on the portion paid in taxes.

This is less of an issue in the US than it was in the past. So for example, 6 years ago the top federal income tax for individuals for ordinary income was about 40%, and that rate also applied to dividends. So this meant earnings were taxed at (using your example) 33% by the corporation,,,and then the dividend was paid after the corporate tax was taken out,,,,,and the dividend was taxed again at the 40% level. So just to play that out, if my portion of the corporate earnings was $10,000, the company was going to pay $3,333 in taxes to the government. Then if the company was paying all after tax earnings out as dividends, I would get the remaining $6,667 paid to me as a dividend, and I would pay another $2,667 to the Federal Government. So of my $10,000 portion of the earnings, I would be taxed twice and pay $6000 in total to the government, and receive only $4000--a combined tax rate of 60%. And in New York or California, state tax would take at least another $667.

This "double taxation" effect on dividends caused companies to reduce their dividend payouts as a % of after tax earnings from something like 3.5% in the '70's to 1.2% in the early 2000 (from memory, but it was dramatic). The view of companies was that it was better for the shareholder if the money was left in the company, not double taxed as a dividend, and then the shareholder could sell shares when he needed money, and the capital gains tax rate was lower than the ordinary income tax rate, so the shareholder did better. Now at lower and equal dividend and capital gains tax rates of 15%, this is less of an issue, and companies are gradually starting to pay more in dividends.

by wchurchill on Sun Dec 24th, 2006 at 01:57:43 AM EST
[ Parent ]

Re: Tax and share buyback (none / 1)

Thanks for those precisions.

Here is what I know about taxation in France for 2006 income and profits:

Company profit taxation is at 33.33%.

Marginal effective income tax rate is at 40% (kicks in after 66 679 euros of income).

When you receive a dividend, up to 1 525 euros per person, you can remove 40% of the amount, the rest is counted as income.

Some fixed interest products (including state debt) has a marginal rate of 27% (if you choose "prélèvement libératoire" as most "rich" people do, otherwise it is taxed as income - interesting for low revenue).

French "Plan d'Epagne en Action" (financial vehicle where you can put pretty much whatever you want: shares, indices, ...) capital gain is taxed at 11% after 5 years, but there is a investment cap at 132 000 euros per person (current value can be above).

The big french saving product is "assurance vie", after 8 years capital gains are taxed at 7.5% for the part above 4600 euros per person per year (if I understand correctly, I have no such product).

Unsurprisingly "assurance vie" is the most popular financial product in France, and I guess managers of such funds encourage share buybacks.

by Laurent GUERBY on Sun Dec 24th, 2006 at 05:46:54 AM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

thanks, this was very interesting. I'll take some time later and go back and work with the articles in French--dificile pour moi, mais une bonne methode a apprendre (forgive my French).

it does look like for truely long term investing, l'assurance vie would be good, particularly if the investment was in well diversified funds, such as index funds. Investing in individual companies would be problematic, because their fortunes may turn downward and you have to sell early. but investors that have invested over truely long periods of time in the S&P 500, for example, have done pretty well,,,,so 10,000 EU may double every 7 years, and at the end of 21 years be worth 80,000--taxed at only 7.5% would leave one with 74,750. or better yet, invest 10,000 this way at 30 years old, and cash in at 65--theoretically it doubles 5 times to 320,000, minus the 7.5%. that is "theoretically" of course.

I didn't realize the top french ordinary income tax rate was 40%, if I understand you right. the US is 35%, but not much difference. I think the french rate takes effect at a lower income, however.

thanks again, i enjoyed the comments and links.

by wchurchill on Sun Dec 24th, 2006 at 11:26:40 AM EST
[ Parent ]

Re: Tax and share buyback (none / 0)

One problem with the french tax code is that it's full of holes, there are more than 600 tax holes. There are some top income people who pay zero income tax.

The legislator passed a law to cap the amount of exemption at some number, but constitutional court rejected the article as "too complex" (it was the same as a cap of taxes on income at 60% which was not censored by the same court - a real scandal).

So take the frenhc marginal tax rate with a grain of salt.

by Laurent GUERBY on Sun Dec 24th, 2006 at 12:34:46 PM EST
[ Parent ]

Re: What is missing (none / 0)

The basic rule is that for all equivalent shares, the dividend is shared equally. That is what you own, when you own shares - the right to receive dividends and the right to vote on the election of the officials who administer the 'pool'.

Shares also give you an equal share of voting rights... except that some companies have two lines of shares, one with and one without voting rights.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Fri Dec 22nd, 2006 at 11:44:01 AM EST
[ Parent ]

Tax Policy (4.00 / 2)

Dividends are taxed at time of payment whereas an increase in share price is non-taxable until the share(s) are sold.
Increasing share price is, thus, privileged over dividends.

Ending this privilege can be accomplished by (1) stop taxing dividends, (2) tax increase in share prices quarterly.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Fri Dec 22nd, 2006 at 11:52:05 AM EST
[ Parent ]

Re: Tax Policy (none / 0)

At last an answer to my question!

Tänx

which is the Finnish slang way of phonetically reproducing the standard Finnish pronunciation of the English word)

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 12:14:24 PM EST
[ Parent ]

Re: Tax Policy (none / 0)

I exist only to serve. ;-)

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Fri Dec 22nd, 2006 at 12:27:55 PM EST
[ Parent ]

Re: Tax Policy (none / 1)

I've heard the same said in a slighty different form by underpaid waiters...

You can't be me, I'm taken

by Sven Triloqvist on Fri Dec 22nd, 2006 at 12:30:19 PM EST
[ Parent ]

Interesting insight (4.00 / 2)

Of course, this goes aganst the current grain of financial markets, which want companies to specialize as much as possible (i.e. have as narrow remits as possible that they pursue as ferociously as possible) so that they, the financial players, can decide to build the kind of diversification that they want (or that they can sell back at high price to those companies that have given up stability for the pursuit of specialised profit).

In effect, you are calling for the renewal of the concept of conglomerates, which have better resilience and stability and better encompass externalities.

Or did i get your point wrong?

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Dec 22nd, 2006 at 05:45:09 AM EST

Re: Interesting insight (4.00 / 2)

Yes, you do seem to miss my point (though at the comments=19 mark, the other remarks on the thread don't even aim at it).

What I reject is the fundamental concept that corporations maximise shareholder value by maximising the value of the corporation's shares. The reason is that investors (predictably) have other interests, e.g., in other corporations' share values. Accordingly, for a corporation's shareholders, on average, the value of an action is not its value to the corporation.

What I find attractive is redefining the responsibility of corporate decision makers to allow them to increase shareholder value as measured by more realistic, extended standards -- even if this reduces the value of the corporation's shares.

This is radically different from internalising externalities by conglomeration, or by emissions trading, or by any other means. It is instead (with caveats) legitimising the creation of large positive externalities (and the avoidance of large negative ones), despite (lesser) internal costs.

This thesis rejects Milton Friedman's famous statement that "there is one and only one social responsibility of business -- to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game", and does so on the very grounds often used to support it. This feature could give it ideological traction.

(Please excuse my excessive use of emphasis.)

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Fri Dec 22nd, 2006 at 01:45:34 PM EST
[ Parent ]

Re: Interesting insight (none / 0)

There is another aspect to this, and that is that the "Shareholder Value" manifests itself in the form of the bank-created IOU's/"Claims over Value" we use as our Money.

Such "Deficit-based" Money is one form of what Marx called "Fictitious Capital" and the other was - wait for it - Shares in Joint Stock Limited Liability Corporations.

ie Fictitious Capital essentially consists of two different legal claims over Value - "Debt" and "Equity".

Deficit-based Money is exponentially hungry - since the loans which gave rise to it have to be repaid PLUS INTEREST. The Black Hole of deficit-money sucks "Shareholder Value" out of all of the productive stakeholders (aka externalities) through the finely evolved structure of the Corporation, which, like a Submarine, is a beautiful piece of engineering, but with a malign purpose.

I simply advocate a simple new "Open" form of Corporation which may operate and thrive without Rentier monkeys on its shoulder.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 22nd, 2006 at 05:11:59 PM EST
[ Parent ]

Re: Interesting insight (4.00 / 2)

My comment was n°3 - don't blame me if the debate was sidetracked.

The thing is - a company is only responsive to those that own shares in THAT company - and they may own nothing else. If you start worrying about shares of other companies that may be affected by the actions of that company, you get into impossible to solve conflicts of interests.

Not all shareholders have the same portfolio, nor the same time horizons. If what that company does has differnet impacts on different other companies, how do you decide between these effects (including that on the shares of the company itself) which is most worthy.

I do think that the solution I mentioned (conglomerates, and internalisation of these wider externalities) are relevant in that context.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Dec 23rd, 2006 at 05:06:56 AM EST
[ Parent ]

Re: Interesting insight (none / 0)

Indeed, you were a strong force for tracking rather than side-tracking (though the side-track is quite good), and conglomeration does have effects in the same direction as what I discuss. Your comment is about part of the reason why my whine says the thread, as a whole, was almost perfectly nonresponsive to the idea.

Not all shareholders have the same portfolio, nor the same time horizons. If what that company does has different impacts on different other companies, how do you decide between these effects (including that on the shares of the company itself) which is most worthy.

Yes, this is related to the point I raised in (a) above, "Different shareholders will hold different portfolios, and they will experience non-financial externalities to different degrees. Thus, there can be no metric as simple as share value." I think that this is a powerful objection to the hard reform option (shifting the definition of fiduciary responsibility).

Regarding differences among shareholders' portfolios, this objection is weakened somewhat (but remains powerful) if one is willing to adopt a model of the average shareholder; which might be something like "a fully diversified portfolio", whatever that means. This stance would bias decisions toward over-weighting broad benefits -- a bias relative to perfect adherence to the principle, but far from pathological from a social-welfare perspective.

I am not sure how the time-horizon issue affects the total-shareholder-value principle differently from the partial-shareholder-value principle. (Ha! An advance in tactical terminology -- total-value : partial-value :: Bolshevik : Menshevik :: Mahayana : Hinayana)

If you start worrying about shares of other companies that may be affected by the actions of that company, you get into impossible to solve conflicts of interests.

If this means conflicts of interest for decision makers in the conventional sense, then it arises with both the partial- and whole-value principles. In either case, an individual may have incentives to make improper decisions. The whole-value principle would, however, provide effective excuses for decisions that are in fact driven by conflicts of interest, along the lines of my point (c) above.
--------------

In the soft reform option, increasing total shareholder value would merely be a defence against accusations of wrongdoing through deliberate sacrifice of partial shareholder value. Here, the objections you raise seem substantially weaker, particularly if the burden of evidence regarding this is placed on the defence. Presumably, a prudent decision maker would take actions of this kind only when the external benefits are clear and enormous.

The hidden agenda in all this is to drive a wedge into a crack on the intellectual structure of what I have called orthodox market ideology, of the Friedman sort.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sat Dec 23rd, 2006 at 06:01:50 PM EST
[ Parent ]

Re: Share Value isn't Shareholder Value (none / 1)

The problem isn't that management is supposed to look out for the interests of the stockholders, it is that the stockholders no longer are willing to wait for their gains.

A company which plots a course of slow steady growth through infrastructure investing, R&D and other long-range efforts, will find itself hammered by Wall Street. This will lead to complaints about the management, and in many cases their replacement by those more willing to play Wall Street's game.

What Wall Street (that means us though mutual funds and retirement accounts) wants is 8-12% growth per year. We also want to see the rate of growth increase each year. A company like Coca Cola which grows at (perhaps) 2% per year due to expanding markets (that is more people) is held in low regard. This used be the type of company that was recommended to widows and orphans. The stock went up a couple of percent each year and paid a nice dividend of, say, 3-4%.

Every trick in the book is now used to manipulate the firms performance. This includes "off book" entities, shifting operating expenses to special charges, stock buybacks and even outright lying. Such manipulation (and the emergence of financial instruments based solely on gambling such as the QQQ shares of NASDAQ) usually are the prelude to a financial collapse.

The latest wrinkle is for public companies to be taken private by hedge funds and other closed investment firms. What goes on behind closed books remains a mystery. After some time the firms will re-emerge as a new public offering with no review of their business practices.

Just today the NY Times has an article about several firms which have failed to release financial records on time and are still being traded on the NYSE. Only mindless gamblers would buy such a pig in the poke. This shows the terminal stage of greed.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Fri Dec 22nd, 2006 at 12:54:34 PM EST

Re: Share Value isn't Shareholder Value (none / 0)

A company which plots a course of slow steady growth through infrastructure investing, R&D and other long-range efforts, will find itself hammered by Wall Street. This will lead to complaints about the management, and in many cases their replacement by those more willing to play Wall Street's game.

This I find interesting and might be worth exploring. How is this hammering done? I guess low prices on the stocks is one thing, but if a mayority of the stock (or the votes if it is not the same) is owned by longterm investors who selected this management in the first place, what do they care about low prices on the stocks. Just makes it easier to expand your holdings while awaiting the big payoff.

Is it low credit grades making it hard to pass bad times?

Is it bad reviews of the managers? Peer-pressure is a powerful thing.

Or are there simply no longterm investors as fund managers can skim more the more they play aorund?

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Dec 22nd, 2006 at 02:59:53 PM EST
[ Parent ]

Re: Share Value isn't Shareholder Value (none / 0)

"The problem isn't that management is supposed to look out for the interests of the stockholders..."

I'm suggesting that they sometimes be excused for looking out for the interests of (at least) their own stockholders, presuming that their portfolios include other stocks.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sat Dec 23rd, 2006 at 06:53:05 PM EST
[ Parent ]

Re: Share Value isn't Shareholder Value (none / 0)

Your article is focusing on maximizing shareholder value, and I agree that is an important goal of corporations. But it is not the only goals of today's corporations. Corporations have goals such as providing high quality innovative products to their customers, amongst many other goals. So I disagree with your premise, and the premise of the authors of the Economist article,

Orthodox market ideology rests on a mistaken understanding of the principle -- its own principle -- that corporations should maximise shareholder value. A correct understanding of this principle undermines the reasoning that requires corporations to behave in a manner that has some have termed "psychopathic".

Companies are very capable of balancing and executing on multiple goals--they can walk and chew gum at the same time. The company you and the Economist article describe might indeed by a psychopath, and just as there are human psychopaths (that become totally fixated on one object in life), there are certainly examples of business psychopaths. But just as it would be inaccurate to label the human race as psychopathic because of the actions of a few, it is similarly inaccurate to libel the business community with the same logic.

As an example, following is the mission statement of Medtronic, the worldwide market leader in Cardiac Rhythm Disease Management. First, a very short history for those unfamiliar with the company:

Medtronic was founded in 1949 by Earl E. Bakken and the late Palmer J. Hermundslie.
Since developing the first wearable external cardiac pacemaker in 1957 and manufacturing the first reliable long-term implantable pacing system in 1960, Medtronic has been the world's leading producer of pacing technology. Today, Medtronic is the world's leading medical technology company, providing lifelong solutions for people with chronic disease. Headquartered in Minneapolis, Minnesota, our operations are primarily focused on providing therapeutic, diagnostic, and monitoring systems for cardiovascular, neurological, diabetes, spinal, and ear, nose and throat markets.

Next, the company's mission statement, which sets the tone for the way the company is run:

The Medtronic Mission
In 1960, Earl Bakken, with the help of the company's board of directors, produced a formal statement of Medtronic's objectives. Nearly a half-century later, the Mission Statement continues to serve as both the ethical and practical framework for Medtronic's operations. It reads as follows:
To contribute to human welfare by application of biomedical engineering in the research, design, manufacture, and sale of instruments or appliances that alleviate pain, restore health, and extend life.
To direct our growth in the areas of biomedical engineering where we display maximum strength and ability; to gather people and facilities that tend to augment these areas; to continuously build on these areas through education and knowledge assimilation; to avoid participation in areas where we cannot make unique and worthy contributions.
To strive without reserve for the greatest possible reliability and quality in our products; to be the unsurpassed standard of comparison; and to be recognized as a company of dedication, honesty, integrity, and service.
To make a fair profit on current operations to meet our obligations, sustain our growth, and reach our goals.
To recognize the personal worth of employees by providing an employment framework that allows personal satisfaction in work accomplished, security, advancement opportunity, and means to share in the company's success.
To maintain good citizenship as a company.

I wouldn't be surprised if some of us have friends and relatives who are living high quality lives due to some of these Medtronic products.

Thank God there are a lot more Medtronics out there than Erons.

by wchurchill on Fri Dec 22nd, 2006 at 05:04:00 PM EST

Re: Share Value isn't Shareholder Value (none / 0)

In an earlier draft, I included a discussion of why Friedman's position is far more reasonable than it might seem. For example, corporation that maximises long-term profit has powerful incentives to innovate, to produce quality products, to be an attractive place to work, and so on. In the orthodox framework, however, these are (or rather, should be) subsidiary goals -- not independent, but serving the primary goal of maximising share value.

That said, a focus on maximising share value per se is, in the world of real human beings, likely to lead to short-term thinking that produces inferior long-term results. Treating the subsidiary goals as primary may, in fact, better serve the primary goal than would directly pursuing it. (The psychopath model breaks down in part because corporations often pursue a more enlightened form of self-interest than the model would indicate.)

What I suggest would fully legitimise, in hard-core Friedmanesque terms, more corporate behaviour of the sort that you praise. It would recognise that these "subsidiary goals" have value external to the corporation that should, in some measure, be considered part of shareholder value.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Fri Dec 22nd, 2006 at 07:09:30 PM EST
[ Parent ]

Re: Share Value isn't Shareholder Value (none / 0)

That said, a focus on maximising share value per se is, in the world of real human beings, likely to lead to short-term thinking that produces inferior long-term results.

I know this is popular thinking, but I, and I think many others in business, disagree with it. There is a book written by a couple of Stanford professors 10 years or so ago, called, I think, "Good to Great". They had a great line, which was a question and answer: "Should we manage for the short term or the long term?" the answer is "yes". To think that you can't do both, is like saying you can't walk and chew gum at the same time. Of course there are tradeoffs, and at times it's easy to forego the long term for a short term quarter, or year. But if you're a CEO that wants to be around for 10--20 years, obviously you have to do both. And there are many companies that accomplish this.

I believe the thinking that I espoused above is now very standard in business, at least US business. But like so many other things the press writes about, it's the scandals at Enron, etc. etc. that make the headlines--not the consistent progress at Medtronic, GE, etc, etc.

by wchurchill on Fri Dec 22nd, 2006 at 09:31:17 PM EST
[ Parent ]

Re: Share Value isn't Shareholder Value (none / 1)

The natural difference between "news" and the rest of human activity does indeed create a systematic bias in how we see the world. For example, there have been many more failed start-up companies because failure and mediocrity are so much less newsworthy than is blazing success.

Good management must indeed balance many tasks, including those with short- and long-term goals. I'm only claiming that there is not only an inherent trade-off between goals (as you note), but also a psychological tendency for easily measured, short-term, monetary goals to crowd out long-term investment in (for example) people and knowledge. An attitude that directly values the latter serves, I think, as a counterweight to this tendency.

This is a squishy point, and I was moved to state it in order to expand my agreement with your earlier point, as I understood it. Disparage my effort at ET civility if you must... Bite the hand... Examine the equine teeth... ;^)

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sat Dec 23rd, 2006 at 06:47:59 PM EST
[ Parent ]

Re: UPDATED: Comments on stocks, dividends, etc. (none / 1)

Focusing on your actual proposition.....

At the heart of it is the distinction between Value and Price - as in Oscar Wilde's definition of a Cynic as knowing "the Price of Everything and the Value of Nothing".

So maybe Shareholder Value concerns Price and Share Value is actual increase in assets over Time (Marx's Surplus Value?). Dividends are a side issue, being merely a matter of distribution of this Surpus Value.

We must also look at the way Price may lose touch with the Reality of "Value Generation".

ie the multiple of expected earnings reflected in the Price.

In a "Bubble" the Price no longer reflects the underlying Reality of Value Generation, because individuals' expectations relate to future Price (ie the "Greater Fool" out there), rather than that of future Value.

It never ceases to make me smile when I hear that "£x billion of shareholder value" was lost when the market price falls.

The Reality of the business - the Share Value - remains exactly what it was before the fall: only Shareholders perceptions have changed.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Dec 23rd, 2006 at 03:43:40 AM EST

Re: UPDATED: Comments on stocks, dividends, etc. (none / 1)

I think your argument hinges on the validity of

(6) For shareholders with well-diversified portfolios, "maximising shareholder value" entails maximising the (suitably weighted) share values of the corporations in their portfolios.

I don't think it is.

For any portfolio the return is a (suitably) weighted average of the returns of the constituent assets, irrespective of diversification.

Now, diversified portfolios arise precisely because maximizing return is not the only criterion by which investors make their investment decisions. So, in the specific case of investors with diversified portfolios, it is not only maximising the portfolio return that they're interested in.

The focus on share value (and return) comes from

(2) Running a corporation in the interests of its shareholders, commonly described as "maximising shareholder value", and this is generally taken to mean maximising the value of the shares.

The value of a stock to an investor may or may not come from its return. For those few with large stakes in it it appears to at first sight, but if their holdings are too large to liquidate quickly, they are "married" to the company for a longer period of time than the average investor, and so have an interest not just in maximising the immediate return to their investment, but in ensuring the continued health of the company for some period of time. For the large majority of investors with small holdings, those are presumably for diversification purposes, and for these minimising risk is as important as maximising return.

So it would appear that the identification of shareholder value with stock price is the weak link of the whole argument, and indeed I would say it's just a specious argument by ideologues bent on justifying notorious excesses by pseudoscientific use of economic arguments.

Where does this argument actually come from? Thomas Friedman?

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 01:33:16 PM EST

Re: UPDATED: Comments on stocks, dividends, etc. (none / 0)

Indeed. I've updated the diary to read

(2) Running a corporation in the interests of its shareholders, commonly described as "maximising shareholder value", and this is generally taken to mean (at least to a good approximation) maximising the value of the shares.
....
(6) For a corporation to serve the financial interests of shareholders holding well-diversified portfolios, "maximising shareholder value" entails maximising the (suitably weighted) share values of the corporations in their portfolios. (This isn't exactly correct, since investors value not just the "share value", but its effect on portfolio-level risk, etc., but it is a good approximation and can serve as shorthand.)

Regarding the origin of this interpretation of "shareholder value", I don't know, but the definitions in Wikipedia: Shareholder value suggest that it is widespread. Isn't it a good approximation for typical investors, provided that the price reflects the actual value of the company, rather than a confused or fraudulent valuation? (That is, absent the considerations I discuss.)

Note that my purpose is not to praise stock-value = stockholder-value, but to bury or at least dirty it.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sat Dec 23rd, 2006 at 07:16:55 PM EST
[ Parent ]

Re: UPDATED: Comments on stocks, dividends, etc. (none / 0)

PN: the value of the shares is the value at a particular point in time. What people are interested in is the return rate, that is, the value of the shares with reference to at least two time points: when the shares were bought and now. So if "Shareholder value = share value" is to make any sense, "share value = share return".

The "best" way to increase the return rate of a company is a speculative bubble around it. As long as the investor gets off the bubble before it pops, he can get fantastic returns, and the returns are the larger the closer to the popping one gets. Sort of like playing blackjack with the timing of the bubble ;-)

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sun Dec 24th, 2006 at 04:43:07 AM EST
[ Parent ]

Re: UPDATED: Comments on stocks, dividends, etc. (none / 1)

The motivation for this diary seems to be the risk that "good management" might find itself subject to a lawsuit by the shareholders on the basis of the "fiduciary responsibility to maximise shareholder value".

That is, the creation of large external benefits at a small cost would sometimes be a defence against shareholder lawsuits claiming a violation of fiduciary responsibilities. ...
To summarise: With the soft reform option, a director or manager taking a decision that is overwhelmingly beneficial to shareholders would be protected from lawsuits (and principled scorn), even if the effect on the corporation's share value is negative.

I was a little puzzled by this so I went googling, and uncovered the following:

Institutional Shareholder Services: Europeans Take a More Active Role in U.S. Cases (December 04, 2006)

More European investors are realizing that it makes sense to participate in U.S. securities class-action cases by serving as lead plaintiffs, or by filing claims for their share of billions of dollars in settlements.
...
... the Parmalat Finanziara class action. ...
... a securities lawsuit against Royal Dutch Shell. The lawsuit, which is pending in federal court in New Jersey, was filed separately from the consolidated class action that was brought earlier ... the Nortel Networks litigation...
European and other international investors also have joined in derivative lawsuits that seek corporate governance changes. In October 2005, U.K. and Dutch pension funds were part of an international coalition of institutions that sued News Corp. in Delaware court over the company's decision to extend its "poison pill" defense without seeking shareholder approval. After surviving a motion to dismiss, the investors reached a settlement with the media company in April.
In addition, AP7, a Swedish pension fund, is serving as a lead plaintiff in a derivative lawsuit by Viacom investors that seeks to recover compensation paid to top executives, according to Keith Johnson, a Wisconsin-based lawyer who advises foreign pension funds.

What is going on here? are these good or bad lawsuits? Your wikipedia link to Shareholder rights contains the following quotation right after the bit you quote:

In most countries, including the United States, boards of directors and company managers have a fiduciary responsibility to run the company in the interests of its stockholders. Nonetheless, as Martin Whitman writes:

"...it can safely be stated that there does not exist any publicly traded company where management works exclusively in the best interests of OPMI [Outside Passive Minority Investor] stockholders. Instead, there are both "communities of interest" and "conflicts of interest" between stockholders (principal) and management (agent). This conflict is referred to as the principal/agent problem. It would be naive to think that any management would forego management compensation, and management entrenchment, just because some of these management privileges might be perceived as giving rise to a conflict of interest with OPMIs." [Whitman, 2004, 5]

But that was written 2 years ago. This is 2006, and we seem to be weeing the principal/agent problem being brought to court. More from the same article quoted above:

Willis said the interest by European institutions has increased after those investors realized that serving as a lead plaintiff may be necessary to ensure they are treated fairly in U.S. settlements involving European companies. A lead plaintiff plays a key role in defining the class, determining the settlement distribution ratio, negotiating any governance improvements, and deciding whether a proposed accord is sufficient, Willis said. In addition to Parmalat and Shell, a number of major European firms have faced U.S. class-action cases. In 2004, a record 29 foreign issuers were hit with securities class actions in U.S. courts, according to a report by PricewaterhouseCoopers.

I clearly have not been paying attention...

... the $120 million Deutsche Telekom settlement, where the class was defined narrowly to include only those shareholders who bought their shares on American exchanges. ... The excluded European investors had to file a multitude of separate claims in Germany. ...
... the Elan, DaimlerChrysler, and Lernout & Hauspie settlements, ... The larger group of investors who bought their shares through Easdaq (Nasdaq's former European technology market) since have filed a separate class action in the United States ...
As the Parmalat case illustrates, American courts "have been quite willing to appoint Europeans either as co-lead plaintiffs or sole lead plaintiffs in U.S. class actions," as long as the Europeans can show that a U.S. court has jurisdiction over their claims ...
... a U.S. shareholder lawsuit against BP's board over problems at the company's Prudhoe Bay oilfield in Alaska ...
...
While no U.K. courts have held that pension fund trustees have a legal obligation to file claims, fund trustees do have an obligation to derive value for their fund, and filing settlement claims is an "obvious way to derive value after a loss has been incurred," Owens said during a SCAS Web cast in September.
"There are many hundreds, perhaps thousands, of institutions right across the U.K. and Europe already putting procedures in place to ensure that this particular part of their investment protection is covered," Owens said. Otherwise, they may face "difficult questions [from beneficiaries] if nothing at all has been done."

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sat Dec 23rd, 2006 at 02:47:39 PM EST

Re: UPDATED: Comments on stocks, dividends, etc. (none / 0)

Most US exports may be suffering, but the export of US law is working very well, or perhaps I should say, very effectively.

You missed the latest news, though -- pension fund trustees now not only "have a legal obligation to file claims", but a legal obligation to file any and all claims for which the expected settlement value is greater than the expected litigation cost, presuming that the most effective means of twisting the facts and law are employed against the weakest targets. Failure to do so will of course make them subject to similar litigation.... Ooops, I was mistaken. That isn't news, it merely seems like the next logical step.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sat Dec 23rd, 2006 at 06:15:13 PM EST
[ Parent ]

Addressing your point, (none / 0)

at least a little better, hopefully.

(5) Most shareholders hold well-diversified portfolios, often index funds. Few invest solely or even predominantly in the shares of any one corporation.

Sometimes the issues can be explored by looking at how things would work in a specific example, or a more narrow group. I think most, certainly many, shareholders diversify as you suggest. However, there is a not insignificant group that become highly invested in a single company, and another group that thinks they are good at "stock picking', and do not diversify. I'm thinking of senior management of the company, founders of the company, and employees of the company, particularly as the employees rise through the ranks. It is pretty common for senior managers to end up with a huge percentage of their net worth invested in their company--particularly since many companies break their compensation packages to employees into cash, stock options, restricted stock, kinds of programs. I've normally had 80%+ of my financial net worth (excluding home) invested in the stock of the company I worked for. Investors usually like to see management heavily invested in the company.

Also some investors get very excited about a company's opportunities, follow the company closely, and despite recommendations of financiaql advisors will go over 10% of their portfolio in a company. Obviously they can lose, but some of the world's fortunes are made when people "bet the farm" on something they believe in. Berkshire Hathaway comes to mind as an example of shareholders keeping their money there. IBM in the '70's, Google today,,,,these are companies where "the secretaries" can be millionaires.

It seems this approach would take a lot of that away, and maybe lose some of that 60+ hour a week drive on the part of management and employees.

by wchurchill on Sun Dec 24th, 2006 at 02:24:34 AM EST

Re: Addressing your point, (none / 0)

An additional argument against point (5) is that the number of shareholders doesn't matter, but the size of their holdings. A few shareholders at the top own the company, and then at the bottom there is a mass of small shareholders who, together, only own a small percentage of the shares of the company. So when it comes to making decisions, it's those shareholders with a chance of influencing who has a controlling interest that have the power to influence the company's management. And those few shareholders with large holdings can have idiosyncratic reasons for those holdings.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sun Dec 24th, 2006 at 04:37:43 AM EST
[ Parent ]

Re: Addressing your point, (none / 0)

it's those shareholders with a chance of influencing who has a controlling interest that have the power to influence the company's management.

This is an argument that the soft reform option would seldom be exercised (e.g., only when positive externalities are huge); and this, in turn, argues against wchurchill's concern that it might substantially disrupt incentives.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sun Dec 24th, 2006 at 03:48:07 PM EST
[ Parent ]

Re: UPDATED: Shareholder value is wrongly interp (none / 0)

Ultimately, it behooves the investors to be informed about the companies they invest in, and if they don't like what the company is doing, vote with their feet and divest. I am going to go and take a good look at the "securities class-actions" and "derivative lawsuits" that are mentioned in my parallel comment and see what these lawsuits are really about. I doubt they are over marginal variations of the rate of return.

And small investors who object to the practices of institutional investors such as index funds should not put their money into index funds in the first place. Hell, if all you want to track an index just buy index futures. Don't give your money to someone else so they get to charge you a fee, and have shareholder rights at a bunch of companies.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Carrie (migeru at eurotrib dot com) on Sun Dec 24th, 2006 at 05:06:16 AM EST

Re: UPDATED: Shareholder value is wrongly interp (none / 1)

Yes, and I tend to prefer mechanisms based on moving-foot voting rather than raised-hand voting. When people vote with their feet, they get what they choose, and hence have reason to invest serious thought in the choice. When they vote with their hands, they tend to be relatively thoughtless,because their vote is almost guaranteed to make no difference. Worse, their thoughtless choices (en mass) impose the results on the unwilling -- which, when policies are implemented, is apt to include themselves.

(BTW, regarding shareholder lawsuits, where does the settlement money come from?)

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Sun Dec 24th, 2006 at 03:54:52 PM EST
[ Parent ]

UPDATED: "Shareholder value" is wrongly interpreted | 63 comments (63 topical, 0 editorial, 0 hidden)

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UPDATED: "Shareholder value" is wrongly interpreted

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