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Shareholder value can be a misguided concept

21 March 2024

Creating shareholder value is often described as driving increased returns for its investors. Christopher Barrow of Metropolitan Safe Deposits argues that this interpretation of corporate success can lead to fundamentally flawed board decisions.

Strategic decisions are made to boost growth and profitability in the best interests of the shareholders. This proposition is being increasingly challenged. There are many reasons why businesses should go beyond the pursuit of what is often described as ‘maximum shareholder value’.

Firstly, what do we mean by shareholder value? A common definition is the value delivered to the equity owners of a company as a result of the management’s ability to increase revenues and profits, which leads to an increase in dividends and potential capital gains for shareholders. In a perfect world, it should incentivise shareholders to reinvest part of its profits to grow the business, as opposed to paying out all retained profits as dividends or using them to buy back shares.

However, shareholder value has become a hot topic, since the creation of wealth for shareholders has not always translated into a fair distribution to the company’s employees and customers or, for that matter, the local community. Not only is the pursuit of maximum shareholder value increasingly regarded as unfair, but it can also distract company management, sometimes with disastrous consequences.

Those who follow equity markets will be familiar with Jack Welch, the legendary former CEO of GE and often regarded as the father of the shareholder value movement. He told the FT in an interview in 2009: “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy…. Your main constituencies are your employees, your customers and your products.” Ironically, it was Jack Welch who planted the seeds of GE’s own demise as a result of his focus on short-term performance and financial engineering of an overly complex business.

A more recent example of the failure of a great company that did not heed his advice is Boeing, the embattled aerospace manufacturer. There has been much written about the causes of Boeing’s decline. Many analysts trace back the company’s problems to the appointment of Harry Stonecipher, the architect of the Boeing/McDonnell Douglas merger, to CEO in 2003. He deliberately transformed Boeing from a company run by engineers to an enterprise overseen by finance professionals. His famous quote “Boeing is a great engineering firm, but people invest in a company because they want to make money” says it all….

GE and Boeing (mismanagement of an overstretched GE and the disastrous change of culture at Boeing) are just two specific examples of once great businesses that focused solely on creating shareholder value. Philosophically and ethically, not only should companies act in the best interests of employees, customers and shareholders, but the owners should also want their companies to act in a socially responsible way. This is sometimes referred to as ‘shareholder welfare’, such as acting responsibly and sustainably towards the environment and providing a social function of providing goods and services to the community.

Senior management of public companies and even private companies are too often looking over their shoulders at the short-term expectations of markets or private equity investors. There is nothing wrong, per se, with management being motivated by (reasonable) financial incentives based on higher profits and share prices. However, they should not confuse ‘cause and effect’. Instead of obsessing about short-term results, companies should develop long-term strategic goals. Many companies sacrifice long-term value creation strategies for short-term financial gains. Naturally, it is important to achieve short-term results, but not at the expense of sacrificing future cash flows from the company’s growth prospects, capabilities and relationships.

Strategic leaders with a long-term vision, an ability to manage day-to-day business, and (increasingly important) an empathetic attitude towards employees, are best equipped to create shareholder value for investors. Company boards are, quite rightly, under pressure to follow a more responsible form of corporate capitalism by adopting a broader and more sympathetic sense of purpose and a longer-term perspective.

A company’s objective could be described as ‘shareholder welfare maximisation’ and not market value maximisation. Put another way, CEOs should be encouraged to think strategically, empathetically and manage their companies for the benefit of all stakeholders, not just their shareholders. The simple reality is that well-run companies that look after all their stakeholders are most likely to maximise long-term returns for shareholders – a win-win!