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Monday, October 15, 2012

Strategic CSR - Shareholder value

It is well-established in both corporate law and business norms that, as the owners of the firm, the goals of the business should be aligned with the interests of its shareholders. Or, at least, popular perception is that this is the case. The article in the url below reviews a recent book that challenges this perception of shareholder primacy:

To Lynn A. Stout, however, it amounts to nothing more than a ‘shareholder dictatorship.’ Ms. Stout, a professor at Cornell Law School, has written a slim and elegant polemic … to explain the idea’s two problems: It’s worked out horribly and, as a matter of law, it’s not true.

The main argument of the book is uncontroversial—that the focus on shareholders as owners (and particularly attempts to solve the agency problem via stock options—Issues: Executive Compensation, p172) has caused executives to fixate on share price, which results in short-term decision-making. What is unique and important, however, is Stout’s reporting of this focus as a misinterpretation of corporate law:

… the idea that shareholders “own” their companies isn’t actually so set in the law, Ms. Stout argues. It’s almost as if the legal world has been keeping a giant secret from the economists, business schools, investors and journalists. Instead, … what the law actually says is that shareholders are more like contractors, similar to debtholders, employees and suppliers. Directors are not obligated to give them any and all profits, but may allocate the money in the best way they see fit. They may want to pay employees more or invest in research. Courts allow boards leeway to use their own judgments. The law gives shareholders special consideration only during takeovers and in bankruptcy. In bankruptcy, shareholders become the “residual claimants” who get what’s left over.

As Stout indicates, this logic results in a perversion of the goals guiding the firm:

A solvent company has completely different purposes from those of insolvent ones. We don’t decide what to do with living horses because we turn dead horses into glue, she says.

There is an apparent contradiction in Stout’s argument, however, as, while detailing the overly-strong influence investors have today on corporate policy, she also:

… contends that the idea that shareholders wield too much power is laughable. Shareholders have increasingly been voting against directors only to see them reappointed. Recently, shareholders at a handful of companies have voted the majority of shares against the pay packages of chief executives — and have been ignored.

The unhealthy influence of investors (who, today, are more like gamblers than owners), however, is a problem that seems difficult to refute:

The average holding period of a stock was eight years in 1960; today, it’s four months.

Nevertheless, such influence has the distinct advantage of acting as an important oversight function over executive independence. While distorting the firm’s goals in favor of the investor, this oversight influence also guards against executive incompetence and fraud. As such, weakening investor power, without strengthening the oversight function or abilities of other stakeholders, is unlikely to generate a positive outcome. Clearly, shareholders hold a disproportionate negative influence on executive decisions at present. The solution is to re-orient the firm towards more of a broad stakeholder perspective. But, as we point out in Strategic CSR, the responsibility on firms to act socially responsible is two-way. It will only work if all stakeholders act to hold the firm accountable for its actions.

Take care

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Challenging the Long-held Believe in ‘Shareholder Value’
By Jesse Eisinger
June 28, 2012
The New York Times
Late Edition – Final