Skip to comments.The Dumbest Idea In The World: Maximizing Shareholder Value
Posted on 11/19/2012 12:38:59 PM PST by ksen
Imagine an NFL coach, writes Roger Martin, Dean of the Rotman School of Management at the University of Toronto, in his important new book, Fixing the Game, holding a press conference on Wednesday to announce that he predicts a win by 9 points on Sunday, and that bettors should recognize that the current spread of 6 points is too low. Or picture the teams quarterback standing up in the postgame press conference and apologizing for having only won by 3 points when the final betting spread was 9 points in his teams favor. While its laughable to imagine coaches or quarterbacks doing so, CEOs are expected to do both of these things.
Imagine also, to extrapolate Martins analogy, that the coach and his top assistants were hugely compensated, not on whether they won games, but rather by whether they covered the point spread. If they beat the point spread, they would receive massive bonuses. But if they missed covering the point spread a couple of times, the salary cap of the team could be cut and key players would have to be released, regardless of whether the team won or lost its games.
(Excerpt) Read more at forbes.com ...
Comparing “football” with commerical business transactions will not work - although the objective is still to “win,” the definition of “win” for each activity is very different.
Companies should be making profits, managing their trademarks, producing desirable products and services at prices the market will bear.
If all or most of that is happening then shareholder value will necessarily follow in the short run and over the long haul.
However, if business owners focus solely or primarily on shareholder value then they are more likely to engage in strategies that may bump up short term value at the expense of long term success.
This is the crux of the matter. Maximizing shareholder value shouldn't be seen as the same as maximizing the short-term increase in stock price. Maximizing shareholder value means maximizing the present value of future expected cash flows. Let the stock market do what it wants to do. Stock markets are by nature short-sighted and inefficient (no one can convince me of the EMH).
However, today most folks don't get the difference, so the focus is on short-term tricks, gains, etc. to boost share price, and these actions often sacrifice long-term value. CEO's of today's publicly traded companies are obsessed with what stock analysts have to say about the value of their stock, not with actually maximizing present value.
For starters, CEOs of public companies have a fiduciary responsibility to their shareholders. Shareholders invest in good faith, and CEOs are supposed to reveal their expectations for achieving success in future market conditions. Shareholders can take the CEO at their words, and stay invested, or they can take their money elsewhere.
Sports coaches are under no such responsibility. They can tell you how they expect their team to perform, but they have no obligation to fans or bettors. Coaches have an obligation only to their general managers or team presidents.
I would also say that where CEOs have an obligation to earn at least as much as their reasonable competitor, in terms of return on investment, coaches are measured by wins and losses. (I'll let others decide which is more difficult.)
SO to the original question, as a shareholder, I'm hopeful that a CEO maximizes their profits, keeps costs reasonably low, and does whatever they can to maximize my value. Otherwise, what's the point of investing?
I was thinking along the same lines as you. US companies have placed way too much emphasis on short-term profitablity to the detriment of long term financial health and stability. That did not start yesterday. Unfortunately, that is encouraged by the ability to attract capital in the markets - Wall Street. Wall Street thrives on the volatility caused by short-term thinking. . . short-term thinking also has contributed to the societal rot that we are experiencing as well. Conservatism is genarally a far superior way of thinking and behaving whether you are talking about politics or finance, IMHO
I tend to agree. This article is paving the way for their move to redefine what a “corporation” is and to stick them with new charters which impose new missions upon them which supersede shareholder value.
What are those new missions? Improving Social Justice? Creating jobs for Obama’s peeps? Who knows. Sure as heck won’t be shareholder value though.
The writer simply doesn’t understand the word “value”, and so wastes his and his readers’ time.
My reading is that the guy doesn’t understand football, coaching, point-spread, betting in general, corporate value, market capitalization, share price, profit, investing, or forecasting.
Makes anything he writes on these subjects a bit of a waste of time.
1) Something crooked this way came into the corporate world that saw CEOs walk away with 100 million in options just for doing their damn job.
2) I cringe when corporations get into social causes. There job is simply create profits for the owners. End of story.