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!
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.
(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.