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Has corporate America renounced shareholder wealth maximization?

Aug. 19, 2019 marks a turning point in the history of American capitalism. On that day, the influential Business Roundtable (BRT), an association of close to 200 CEOs of major US corporations, abandoned its longstanding advocacy of shareholder wealth maximization as the main purpose of business corporations and formally adopted a new “Statement of Purpose of the Corporation (SPC).”

In its recent proclamation, the BRT committed corporate America to creating value for ALL stakeholders by adopting a five-fold mission: to deliver value to customers, to invest in employees, to deal fairly and ethically with suppliers, to support the communities in which we work, and to generate long-term value for shareholders.

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Interestingly, this vision statement listed the economic interests of shareholders last among its major corporate stakeholders, implicitly conveying the message that the interest of all other stakeholders took precedence over those of corporate owners.

Order of priority

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This order of priority runs counter to the longstanding tradition of shareholder primacy, which gives the highest importance to the economic interest of corporate shareholders over all other stakeholders in the business—its customers, its workers, its suppliers and distributors, and the community of which it is an integral part.

Equally interesting is the use of the qualifier “long-term” for shareholder value.

Shareholder primacy goes hand in hand with yet another established tradition in the corporate world—the single-minded pursuit of immediate profit, commonly referred to as “short-termism.” By common practice, corporate shareholders invest their money in the business enterprise for the purpose of realizing immediate returns. They often exert pressure on their appointed corporate managers through a variety of financial incentives to pursue business strategies intended to yield immediate profits to the business. Corporate managers willingly accede to these demands because it is in their own economic interest to do so.

As a result, business strategies seldom aim for long-run profitability and consequently fail to capture potential economic value over the extended economic life of the enterprise.

The near obsessive preoccupation with achieving immediate profit targets—“making the quarter,” in common business parlance—leads to a zero-sum situation in which the incomes of the owners of the firm are enhanced at the expense of the economic interests of the other groups that contribute to the process of value creation and who have equal stakes in the enterprise.

Corporate managers, serving as agents of shareholders (their principals in the Agency Theory of the firm) may increase profits in any of a number of ways. Consider the textbook definition short-run profit (P)= revenue (R )-Cost (C).

Positive effects

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R may be enhanced through a variety of techniques of price manipulation, depending on demand conditions, primarily by raising prices well above per unit cost. C may be reduced by scrimping on product quality and customer care, withholding incentive pay and performance bonuses from workers, cutting down on training and development, imposing onerous contracts on business partners and so on.

The positive effects of all these strategies on short-run profit are achieved at the expense of economic value withdrawn from other stakeholders.

Here’s our pitch. Corporate managers should instead aim for long-run shareholder wealth maximization, and treat all outlays enumerated above as investments to enhance future productivity rather than as costs to be minimized. In this way, the business enterprise will be able to produce higher economic value in the future and enhance the residual value that goes to shareholders.

Our inescapable conclusion is that creating value for all other stakeholders now is the best the means of maximizing shareholder wealth in the future.

Momentous event

In looking at that momentous event than took place on Aug. 19, we can speculate that the signatories to the SPC were not proposing to abandon shareholder wealth maximization, long regarded as the main force that drives modern capitalism, nor to discredit Milton Friedman’s thesis that the profit motive and the free reign of market forces together insure that the well-being of society is best served.

Amazon’s Jeff Bezos, Apple’s Tim Cook, Bank of America’s Brian Moynihan, BGC’s Joe Davis and IBM’s Ginni Rometty, to mention but a few of the over 150 signatories to the SPC, are simply too smart to propose the abandonment of the profit motive.

Rather, they were subtly and ingeniously proposing that corporations should put a stop to their value destroying short-run strategies, and aim instead for long-run shareholder wealth maximization.

For all the talk about its impending demise, shareholder wealth maximization is alive and well.

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