I'm among the economic illiterate here. I'd been convinced that CEO's did have an obligation to maximize stockholder returns. It's great to know that was wrong.

“The Dumbest Idea in the World”: Corporate America's False - and Da...

... Lynn Stout's... book exposes the lie behind the destructive trend of running public companies for the sole purpose of raising the stock price.
 
 

For at least the past two decades, Americans have been duped into believing that the sole purpose of a corporation is to maximize value for its shareholders. That belief, first promoted in business schools, has been absorbed in the media, in academic circles, and in the political realm -- even progressives like Al Franken have repeated it as if it were indisputable fact. But in reality, it has no basis in the law or American precedent. The maniacal quest to raise share price is bad for everyone -- even shareholders themselves.[emphasis mine]

After  months of investigation, the  National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling concluded the Macondo blowout could be traced  to multiple decisions by BP employees and contractors to ignore standard safety procedures in the attempt to cut costs. In trying to save $1 million a day by skimping on safety procedures at the Macondo well, BP cost its shareholders alone a hundred thousand times more, nearly $100  billion.  Even if following proper safety procedures had delayed the development of the Macondo well for a full year, BP would have done much better.

This  book  argues  that the Deepwater Horizon disaster is only one example of a larger problem that  ... might  be called shareholder value thinking. [emphasis mine]

Tags: BP disaster, Deepwater Horizon Oil Spill, share price, shareholder value, stock price

Views: 157

Replies to This Discussion

Ruth,

I haven't read the book, but based on the two paragraphs you wrote, it looks like they just made a bad calculation.  I agree that the BP spill hurt the environment, the shareholders and I'm sure many other things, but what they did was a calculated risk to save money which backfired badly. 

I remember when I worked in retail, there are OSHA safety standards that require the replacement of extension cords after six months of use in a retail establishment.  Regardless of wear and tear, just replace them because they might be worn. If a company were to replace those as regularly as they were supposed to, they might make no profit, and if they don't they may cause a fire and someone or everyone dies.

I understand completely the need for the standards, because without them, companies will do anything to save a buck.  Rivers catching fire because they were so polluted in the 1970's from industrial waste comes to mind.

I guarantee you that every business that you frequent, from the morning coffee place to giants like G.E. are always looking to cut something that is an extra expense so they can either take more money home for themselves, buy more equipment, or higher more people.  Only the government can do things without looking at what might be wasteful spending because they don't make a profit and use our money.  Real business' have to find ways to cut costs because the point of being in business is to make a profit.  Whether it is for shareholders or just to get extra presents for your kids birthday if it is a small store. 

Profit is how we all get paid, and profit is made by companies cutting expenses.  Sometimes those expenses are cut through innovation and sometimes through cheating and stupidity, but the corners being cut create the paychecks.  Even the tax dollars that government workers are paid with come from the profits made by cutting expenses to make a profit.

Basically, unless you live in a world without money, where all items have zero value and are given away for free I don't understand how trying to make a profit for shareholders or yourself is bad.  Maybe the way some people go about getting the profit is bad, but the idea of getting profit for shareholders is sound.

Oh dear! "I don't understand how trying to make a profit for shareholders or yourself is bad."

That is not the point at all. Profits keep the machinery of commerce oiled. There is nothing bad about profit, per se. But there are other considerations to keep in mind. 

We have an incredibly lovely winery in Spokane, an old mansion on top of a volcanic bluff overlooking the city and river. It was full of antiques from the days of mining, lumbering and milling wealth that made the city a very prosperous one. A frayed electric cord in the office cause a fire that destroyed irreplaceable things. Thankfully, the structure was rebuilt, but nothing can replace those old Victorian pieces of a grander time in Spokane. 

Arbor Crest Wine Cellars

Arbor Crest Fire

And of course there are the effects on owners and employees who loved and treasured the place, lost time and money in rebuilding the structure, and loss of the many scheduled events. Profit is a necessary part but not the only one. 

 

I found another shorter summary written by the book's author, Lynn Stout is, Distinguished Professor of Corporate and Business Law at Cornell.

Some highlights:
"[T]here is a notable lack of persuasive empirical evidence demonstrating that individual corporations run according to the principles of shareholder value maximization perform better over time than those that are not."

CEO's hyper-focused goals to increase quarterly profits and raise share prices "sell key assets, fire loyal employees, and ruthlessly squeeze the workforce that remains; cut back on product support, customer assistance, and research and development; delay replacing outworn, outmoded, and unsafe equipment." Those practices actually harm many shareholders who invest for long term gains and stability. Also, shareholders live real lives where they also suffer because of the harm to the economy and the environment caused by corporate short-sightedness.

She also notes that the legal duties of the Board of Directors and top executives make them responsible to the corporation, not the shareholders. She wants to turn away from a focus on shareholders and hopes for reform through better decisions by the directors, taking into account many factors in setting policy besides short term gains.
http://blogs.law.harvard.edu/corpgov/2012/06/26/the-shareholder-val...

However, my concern is that the evidence shows that CEO's influence the selection of new directors to get a majority that will rubber-stamp the CEO's plans. Being a director can be pretty lucrative at >$200,000 for very limited hours. Reforming that seems daunting as the system stands now.

A major critique of Stout's approach is that, in effect, it would squelch ongoing efforts to democratize corporate governance by empowering shareholders to nominate people to sit on the Board, and to increase the legal authority of shareholders to sue executives and board members on behalf of the corporation because they were negligent in their duties to the corporation and did things to line their own pockets instead of doing what was best for the corporation.
Comment 1, gs.law.harvard.edu/corpgov/2012/06/26/the-shareholder-value-myth/
and more fully at http://corpgov.proxyexchange.org/2012/06/review the-shareholdervalue-myth/

However, I think that a problem with this critique is that it doesn't fit the facts either because most shareholders are apathetic. Activist shareholders may not represent the corporation or shareholders as a whole. But see the above critic of Stout, James McRitchie's substantial progress toward educating and empowering shareholders at http://www.shareowners.org/profile/JamesMcRitchie, http://www.shareowners.org/ and at http://corpgov.net/

Nevertheless, I think both approaches have merit, as does alternet's involvement in Corporations for the 99%, which seeks reform by going back to the view that corporate leaders should consider the effects of their actions on all stakeholders including employees and the community.

BTW, Ruth, you aren't economically illiterate if you believe what most business leaders believe at least partly because that is what they were taught in business school. ;)

Diane,

That summary explanation from the author makes sense and shows me what the book means and why Joan posted it.  Thank you both, now I might get the book where the cover didn't do it for me.

 

Thanks, I'm glad it helped. I went looking for more info because I didn't entirely get it either. I'm going to buy the book too.

If you're interested enough to buy the book you may also find the approach of Stout's critic worth thinking about in tandem with her book. He agrees with her about the problem, but thinks a different solution is better, i.e. bottom up reform via shareholder organizing rather than the top down reform via the Board of Directors that Stout advocates. He has been working on this since 1995. http://corpgov.net/ and http://www.shareowners.org/

P.S. When they talk about proxy this and proxy that its kind of hard to get what they're talking about if you haven't been in on their discussion since the start. "Proxy" is short for shareholders suing the officers and/or directors. The only way they have a legal right to do that is by suing on behalf of the corporation because the top folks have only a duties of care and of loyalty to the corporation, not the shareholders. Legally, they sue as "proxy" for the corporation. Corporate law is mainly made by states and varies among states. Not all states allow shareholders to sue as proxies for the corporation. These folks are trying to get more states to allow proxy suits.

(Tangent alert) Why that matters is that your lawsuit will get booted out of court unless you can claim somebody trampled on YOUR legally protected rights because they didn't live up to their duty to you, eg. they were negligent and you were harmed or they broke their contract with you and you suffered harm as a result. This is called "standing" to sue.

The only exception is if the law allows for you to sue on behalf of another, like a parent on behalf of their minor child. A very unfortunate precedent was set when the environmental movement was getting started in the 60's - 70's. Someone sued on behalf of redwood trees, but the Supreme Court said that trees don't have any legal rights, so suing on their behalf wasn't allowed. What a different world this would be if trees were legal persons entitled to full Constitutional rights like corporations per the SCOTUS decided in Citizens United. I don't look to this SCOTUS (Supreme Court of the United States) as holding out any hope that legal rights will be extended to trees, waterways, oceans in US waters, animals whose habitats have been destroyed or any other parts of our commons being abused by Exxon and the rest of them. Sigh.

(Being a retired lawyer helps me cut through some of the legalese.)
Prop 8 and the legal right to sue, analogy to proxy suits by shareholders, continued. In the Prop. 8 case, the CA Supreme court ruled that the people who fought and won their battle at the ballot box to stop same-sex marriage were legally allowed to APPEAL, on behalf of California, a federal court decision declaring prop 8 violated the Constitutional rights of the same sex unmarried couples in CA who challenged prop 8 in federal court.
That was a big deal because CA laws before that said that the state's Attorney General and Governor were the only ones with a right to sue or appeal on behalf of California. The CA Supreme Court said that because those legally designated representatives chose not to appeal the federal decision. This opens an interesting pathway for citizen groups who initiate ballot propositions to extend their reach into shaping the law in CA. Coming full circle, the people at shareholders.org and corpgov.net hope to reshape corporate laws away from the short term mania and fraudulent sale of derivatives on the stock market that led us to the 2008 collapse.

(Tangent alert) I think maybe that given the insane CA constitution, the CA Supreme Court had to allow the appeal even though it was part of overturning their recent decision that denying same-sex couples to marry violated their legal rights under the California Constitution. Would that the US Supreme Court showed the same judicial restraint instead of deciding cases based really on their own political beliefs and values. Talk about judicial activism! Wasn't it conservatives like them who complained loudly about the judicial activism of the courts?

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