Shareholder Value - Friedman's Dumbest Idea?

Interesting article in Forbes on the origin - and failure - of the idea that "shareholder value" is the entirety of corporate focus.

So for a time, it looked as though the magic of shareholder value was working. But once the financial tricks that were used to support it were uncovered, the underlying reality became apparent. The decline that Friedman and other sensed in 1970 turned out to be real and persistent. The rate of return on assets and on invested capital of US firms declined from 1965 to 2009 by three-quarters, as shown by the Shift Index, a study of 20,000 US firms.

The shareholder value theory thus failed even on its own narrow terms: making money. The proponents of shareholder value and stock-based executive compensation hoped that their theories would focus executives on improving the real performance of their companies and thus increasing shareholder value over time. Yet, precisely the opposite occurred. In the period of shareholder capitalism since 1976, executive compensation has exploded while corporate performance declined.

Maximizing shareholder value thus turned out to be the disease of which it purported to be the cure. Between 1960 and 1980, CEO compensation per dollar of net income earned for the 365 biggest publicly traded American companies fell by 33 percent. CEOs earned more for their shareholders for steadily less and less relative compensation. By contrast, in the decade from 1980 to 1990, CEO compensation per dollar of net earnings produced doubled. From 1990 to 2000 it quadrupled.

A related oldie but a goodie: http://www.salon.com/2011/03/29/fail...

I can only add: AMEN.

So it was not Sarbanes Oxley, the 1974 amendments to the FTA, NAFTA, Alien Abductions, and the wrath of god for our sinful lifestyles?

I do want to levy a bit at the tax code which has severely incentivized non-monetary compensation by taxing dividends and stock options in odd ways, which just became an insane cycle. It is a bit like the benefits arms race in the blue collar world-instead of giving raises which would be taxed, give out huge retirement plans, health insurance plans, disability plans.

One of the reasons that I steadfastly refuse to work for a publicly-traded company.

No, that stuff plays it's own roles. There is no one cause. But it's another thing which has gone in a direction that was not intended.

I know it's only anecdote but since we were absorbed by a shareholder corporate entity (previously we were private) the quality, speed and certainty of decisions has decreased higher up the command chain. This has put pressure and causes problems not only on the internal lower level employees and product but also the relationships with our external clients and suppliers.

I really can't see our company, third largest in the market, lasting another five years at this rate - they're only growing through acquisition instead of improving the product and growing the business and yet they're making acquisitions so fast that the business itself is not coping with all the constant upheaval.

Duoae wrote:

I know it's only anecdote but since we were absorbed by a shareholder corporate entity (previously we were private) the quality, speed and certainty of decisions has decreased higher up the command chain. This has put pressure and causes problems not only on the internal lower level employees and product but also the relationships with our external clients and suppliers.

I really can't see our company, third largest in the market, lasting another five years at this rate - they're only growing through acquisition instead of improving the product and growing the business and yet they're making acquisitions so fast that the business itself is not coping with all the constant upheaval.

I've gone through it as well.

Investing in R&D, creating new products, and improving customer service and satisfaction can't be accomplished in a quarter or even an fiscal year. And they cost money to do properly.

Making acquisitions, on the other hand, is something that can be done quickly, has an instant impact on the stock price that every executive's bonus is tied to, and lets the company write off a sh*tload of acquisition-related expenses for every deal.

And all the executives have their days eaten up either doing due diligence on acquisition targets or trying to rationalize all the new products (and their associated R&D, sales, and support teams) and don't have the time to properly manage the day-to-day operations of the existing business. Plus, since the execs don't actually know what acquisitions will happen and which won't, they don't really know what decisions to make about their existing products or services. Why build something that you might just buy in six months or a year?

Duoae wrote:

I know it's only anecdote but since we were absorbed by a shareholder corporate entity (previously we were private) the quality, speed and certainty of decisions has decreased higher up the command chain. This has put pressure and causes problems not only on the internal lower level employees and product but also the relationships with our external clients and suppliers.

This. My employer's a very small company (we're listed on a penny stock version of the TSX and are worth about $0.50/share) but since we went public through a reverse takeover last year, things from a management decision standpoint have ground to a halt. Management around here was never exactly Speedy Gonzales but because we didn't actually IPO, they had to learn on the fly how to run a public company and clearly have gotten in over their heads. We immediately had financial austerity measures slapped on us as they "realigned cash flow." This was apparently planned, though somehow no one knew about them until they happened. They were also supposed to last 3 months and we're on the 7th with no end in sight. Despite running record numbers last year, no one got the traditional profit share for last year because it was all eaten up in buying and propping up this horribly managed, failing company that we merged with. Our raises were also extremely low and morale has tanked.

It takes forever to get anything approved, no one talks to each other and as a result, decisions get made and implemented by one person before the person whose decision it was supposed to be even realises what happens. Since we hired our new IT guy, the office he was supposed to get when he returns from training with my boss in another office has changed about half a dozen times and as of right now, I don't know where he's supposed to sit. I keep asking, I keep either getting told they don't know yet or someone does know and then an hour later, I'm told to disregard. Now people are starting to get annoyed at me for having the gall to keep asking for an answer. It's bloody awful. This company was privately owned by a core group of employees for almost 30 years and in 7 months of being public, it's incredible and terrifying how much the culture here has shifted.

Adding to the dogpile - anyone heard of Amphenol? I've personally watched them do every single evil thing we blamed Bain capital for last year. Buy up successful vendors and companies, slice apart their management, then shut the American parts of the company down when hilarious targets are not met.

Mixolyde wrote:

More of the reasons that I steadfastly refuse to work for a publicly-traded company.

Mixolyde wrote:
Mixolyde wrote:

More of the reasons that I steadfastly refuse to work for a publicly-traded company.

I've forgotten what you do, but you must be pretty awesome to be able to have your pick of jobs. Not sarcasm; I'm pretty envious.

Although having had the opportunity to see what happens to a reputable game software company when they're consumed by one of these rampaging acquisition-beasts will give me more rich material for dark hilarity in the future.

H.P. Lovesauce wrote:
Mixolyde wrote:
Mixolyde wrote:

More of the reasons that I steadfastly refuse to work for a publicly-traded company.

I've forgotten what you do, but you must be pretty awesome to be able to have your pick of jobs. Not sarcasm; I'm pretty envious.

Just a fairly normal software developer. But, yes, I am pretty awesome.

So what is the solution? Is there an alternative to get us away from this toxicity?

Aren't companies subject to a financial form of Darwinism? I mean, of those companies which reject shareholder value as a guiding principle, some would see improved performance over the long term, ironically creating more value for shareholders.

DanyBoy wrote:

Aren't companies subject to a financial form of Darwinism? I mean, of those companies which reject shareholder value as a guiding principle, some would see improved performance over the long term, ironically creating more value for shareholders.

Unless.....

They are able to affect legislation disproportionately due to the fact that they have all the rights of "people" without any of the responsibilities.

Then, they could just put the taxpayers on the hook for their inevitable downturns.

DanyBoy wrote:

Aren't companies subject to a financial form of Darwinism? I mean, of those companies which reject shareholder value as a guiding principle, some would see improved performance over the long term, ironically creating more value for shareholders.

While I think this is true (pick a few high profile now defunct companies as reference) part of the explicit problem with the share holder value incentive for executives is precisely that they benefit so much in the short term that they are neither around or care about the long term so acting in their personal self interest is detached from the long term interests for the company.

There is the lobby problem, there is also the too big to fail problem. I often wonder how the financial crisis would have looked if the Anti-trust division of the DOJ had not been systematically de-funded over the years and if congress and the president had kept that in check. You see this huge disconnect in EU and US anti-trust enforcement.

And then, of course, what if the US government had broader receivership authority? Is the bitter pill of taking over and then selling off Bank of America or Wells Fargo for their misfeasance worth it in the long run? Or do we get repeats of the crashes every decade that the US saw in the 19th century?

Specifically with regard to shareholders and officers, this is not a government issue, at all. The NYSE is not a government entity. It is a public company, and was allowed to merge with the European Excahnge. NYSE guidelines with respect to shareholders and governance are subject to SEC approval, but the NYSE operates largely independent of the government. That is they are independent until the NYSE completely f*cks the dog and a new law is passed to clean up the mess.

The effect of the NYSE trickles down even to non-traded companies.

Rahmen wrote:
DanyBoy wrote:

Aren't companies subject to a financial form of Darwinism? I mean, of those companies which reject shareholder value as a guiding principle, some would see improved performance over the long term, ironically creating more value for shareholders.

While I think this is true (pick a few high profile now defunct companies as reference) part of the explicit problem with the share holder value incentive for executives is precisely that they benefit so much in the short term that they are neither around or care about the long term so acting in their personal self interest is detached from the long term interests for the company.

That, and the fact that, since the financial ecosystem rewards short term gain so handsomely and punishes long term thinking so severely, the opportunity cost for not engaging in that sort of behavior is also a selective pressure. Payroll is met on the short term.

Parallax Abstraction wrote:

It takes forever to get anything approved, no one talks to each other and as a result, decisions get made and implemented by one person before the person whose decision it was supposed to be even realizes what happens. Since we hired our new IT guy, the office he was supposed to get when he returns from training with my boss in another office has changed about half a dozen times and as of right now, I don't know where he's supposed to sit. I keep asking, I keep either getting told they don't know yet or someone does know and then an hour later, I'm told to disregard. Now people are starting to get annoyed at me for having the gall to keep asking for an answer.

This sounds frighteningly like working in the military.

How the cult of shareholder value wrecked American business [Washington Post]

DanyBoy wrote:

Aren't companies subject to a financial form of Darwinism? I mean, of those companies which reject shareholder value as a guiding principle, some would see improved performance over the long term, ironically creating more value for shareholders.

The problem is that the new generation of short term, stock value obsessed companies will be more profitable after the last generation dies off than that steady contender. Why should investment banks care about the laid off workers and destroyed productivity? It's still better to get 10% growth from five companies for two years each than 5% growth from one company for ten years.

Lots of conservatives are all about the sales tax, I'm all about sales tax for the stock market. Say 0.2% sales tax on every stock sale, unless you're selling stock you've owned for 5 or more years. We need incentive to invest, not gamble.

Yonder wrote:

Lots of conservatives are all about the sales tax, I'm all about sales tax for the stock market. Say 0.2% sales tax on every stock sale, unless you're selling stock you've owned for 5 or more years. We need incentive to invest, not gamble.

I'm not sure if you're a stock investor or not, so this might / might not be news to you.

"short term (365 days or less)" transactions are already taxed at same rate as your regular income

"long term (366+ days)" taxed at capital gains tax rate (typically far less than your regular income tax rate)

If you sell stocks you're going to get your 1099 and you will be required to report every transaction on a 8949 (two parts) and a schedule D.

So there is already a mechanism in place to tax higher for "short term" sales.

Depending on what sector you are investing, your suggestion of "5 or more years" might be unreasonable as technology, management or simple consumer tastes change, thus affecting your potential return.

Sure, you can have your blues such as IBM which may play a part in a "stable" long term investment such as a set it and forget it DRIP, but if you've got dollars into FB and consumer tastes change, you could end up having your investment go potentially under faster than you can say MySpace.

I can see and appreciate where you were coming from, but penalizing above what already is in place seems unnecessary.

Yonder's more talking about taxing the actual stock trade. That's because anywhere from 50 to 70% of all stock trades these days are done by computer algorithms that buy a stock and then sell it minutes or (micro) seconds later to make a couple of pennies. That's not the purpose of the stock market and the algorithm doesn't give a f*ck if the company makes a better mousetrap or not. It just spots an opportunity to extract more money from the side of the economy that actually does things.

OG_slinger wrote:

Yonder's more talking about taxing the actual stock trade. That's because anywhere from 50 to 70% of all stock trades these days are done by computer algorithms that buy a stock and then sell it minutes or (micro) seconds later to make a couple of pennies. That's not the purpose of the stock market and the algorithm doesn't give a f*ck if the company makes a better mousetrap or not. It just spots an opportunity to extract more money from the side of the economy that actually does things.

If you are talking about transactions of scale, unfortunately, those companies or the shells for the individuals they represent, pay very little and sometimes literally zero tax. That's a whole 'nother ugly can of worms.

Yeah, I want something in addition to the current tax on profits, which should remain, just like any other income. I am going to assume that corporations pay the same amount of taxes as people in this next example, so we can all have a hearty laugh at that.

So Company A has their super fast connection and does whatever bullsh*t they do to see that they can buy a million shares of this one stock for $80.00 a share and sell it for $80.01. They make $10k and start looking for something else to trade in the next millisecond. When they come to file taxes at the end of the year they pay, lets say 20%, leaving with a still healthy profit of $8k for that millisecond.

If you add in a sales tax under that same trade the company buys a million shares of the stock, paying a sales tax of $160k... uh oh, that trade isn't going to be profitable, better not do it. Instead of the income tax, which takes a cut of the profits (which is why it's ridiculous to think that income taxing a company will strongly affect its behavior in most cases, but that's a whole 'nother ball game), it changes what is profitable.

It's basically saying "I am buying this stock because I believe that it's going places, and I think that I can sell it for at least 0.2% more than I am buying it for right now."

It is simplistic to hang this all on shareholder value. I would think globalization and increases in competition aided by the opening of China and the end of centuries of on again off again of conflict in Europe which periodically destroyed capitol and gave the US a "peace advantage" only really interrupted by the Civil War were much greater factors.

But then again shareholder value is simplistic. It denies or minimizes that corporations exist in webs of relationships and communities. By emphasizing shareholders over others it creates a kind of systemic fragility in regards to labor and the communities in which a company exists. There is such a thing as social capitol, though it rarely exists as an asset on a balance sheet (except for the occasional entry under "Goodwill"), but it exists and having you company donate to local charities is a lot less effective than treating your employees, local suppliers, etc. like they are worth a d*mn.

The underlying idea, that the share price is a fair reflection of the value of the company is foolishness because it rests on the idea of efficient markets and thus the equal availability of information. Anyone that has worked in a company knows there are problems where they work that the management does not know about and does not want to know about, much less investors.

On the taxing issue, it would have to be international if it was going to be effective and there it meets the same problems as a cartel. There is a tremendous incentive to cheat or not participate in the first place.

An interesting potential outcome of such a tax would be to push more money into bonds, which, I assume, would not be covered by the tax. This would decrease systemic risk.

Tenebrous wrote:

On the taxing issue, it would have to be international if it was going to be effective and there it meets the same problems as a cartel. There is a tremendous incentive to cheat or not participate in the first place.

Doesn't the tax only have to be levied by the government with authority over the stock exchange? Any company from any country trading on the New York stock exchange would be affected, while any company trading in for example, Asia, wouldn't be.

It's also my understanding that companies are only traded in a single exchange. Can you trade Dell both in New York and Asia? If so that would be a problem, because everyone would just trade in the markets not being taxed.

Yes companies can be listed and traded internationally. If there is a tax one place, if they are not listed in an overseas exchange they can be listed elsewhere. A company's location has no relation to where they are listed really. There are plenty of foreign firms that are listed and traded in NY.

Can they be listed in multiple places simultaneously?

I believe so. You just have to meet the requirements for listing. I am reaching back into my memory here.

I believe the French came up with some kind of international agreement to do exactly what you are talking about in 2009 or 2010, but it went nowhere. Fast.