It’s a big news day for big-business watchers, almost as if a hurricane had struck Wall Street:
- “Shareholder Value Is No Longer Everything, Top C.E.O.s Say” is the lead story in the New York Times.
- “CEO group says maximizing shareholder profits can’t be main goal” is the top story in the Washington Post.
- “Group of US corporate leaders ditches shareholder-first mantra” declares the front page of The Financial Times.
- “Move Over, Shareholders: Top CEOs Say Companies Have Obligations to Society” states the front page of the Wall Street Journal.
- “Profits and Purpose: Can Big Business Have It Both Ways?” is the slightly more nuanced phrasing on the cover of Fortune magazine.
The hubbub concerns today’s declaration by the Business Round Table (BRT) that profits for shareholder are no longer the only purpose of a corporation. This is a big deal since for the last two decades this group of some 200 powerful CEOs has stuck to the mantra, “maximize shareholder value”, and its members have for the most part faithfully implemented it.
Jamie Dimon, CEO of JPMorgan Chase & leader of the Business Round Table Photo: Giulia Marchi/Bloomberg © 2019 BLOOMBERG FINANCE LP
Maximizing Shareholder Value
The BRT has a long track record of defending business against the wider interests of society. In 1975, it helped defeat anti-trust legislation. In 1977, it helped defeat a plan for a consumer protection agency and successfully blocked labor law reform. In 1985, it successfully lobbied for a reduction in corporate taxes.
And in 1997, it issued its policy statement of “maximizing value for shareholders as the sole purpose of a corporation.” The policy statement wasn’t anything new in 1997: it merely cemented in place an idea that was already widely accepted in business, after being launched by Milton Friedman’s landmark article in 1970.
While the notion of shareholder value is valid to the extent that corporations do need to deliver value to shareholders over the long term, the shareholder value doctrine had come to mean something quite different in practice in U.S. business. As analyst Steven Pearlstein explains:
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In its more corrosive application — the one that is inculcated in business schools, enforced by corporate lawyers and demanded by activist investors and Wall Street analysts — maximizing shareholder value has meant doing whatever is necessary to boost the share price this quarter and the next. Over the years, it has been used to justify bamboozling customers, squeezing workers and suppliers, avoiding taxes and lavishing stock options on executives. Most of what people find so distasteful about American capitalism — the ruthlessness, the greed, the inequality — has its roots in this misguided notion about what business is all about.
The result? By 2019, maximizing shareholder value has come to be seen as leading to a toxic mix of soaring short-term corporate profits, astronomic executive pay, along with stagnant median incomes, growing inequality, periodic massive financial crashes, declining corporate life expectancy, slowing productivity, declining rates of return on assets and overall, a widening distrust in business.
Ditching The Dumbest Idea In The World
Now the BRT has recognized that a sole focus on profits for shareholders is no longer defensible and has seen fit to redefine business purpose. As Pearlstein explains:
In the Roundtable’s new formulation of corporate purpose, delivering value to customers, investing in employees, dealing fairly and honestly with suppliers, supporting communities and protecting the environment all have equal billing with generating long-term value for shareholders. The statement rejects the whole idea of “maximizing” one value to the exclusion of all the others. Instead, it acknowledges the need for balance and compromise in serving all of a company’s stakeholders.
It’s good news that major corporations have recognized that a sole focus on shareholders is financially, socially and economically wrong. Even Jack Welch himself—the idea’s leading exponent—in 2009 had come to call it “the dumbest idea in the world.” Shareholder value is the result, not the goal of a corporation.
The Risk Of Loss Of Clarity
It’s less good news that the purpose of a corporation is now even murkier. The BRT statement seems to be less a clarification of corporate purpose and more a defensive reaction to the complaints about big business, particularly by the younger generation. In response, companies will now emphasize the good things that they claim to be doing, along with making money.
We will thus soon be hearing many more preachy corporate purpose statements with a capital 'P', that sound good but have little or no actionable content. From outside the corporation, it may be even more difficult to figure out what goals firms are really pursuing.
Even inside the corporation, when managers are doing their utmost to show that they are “not maximizing one value to the exclusion of all others,” there is a risk that managers themselves may become unclear in their own minds which priorities they are or should be pursuing. In effect, if corporations really start seriously pursuing multiple-stakeholder value, with no stakeholder having priority over any other, the managers themselves may lose track of which direction they are heading.
The Risk Of Loss Of Direction
The sad truth is that we have been down this path before, with disastrous results. In the period 1932-1970, managerial capitalism was understood to mean exactly that: meeting and balancing the needs of all the stakeholders. As expounded in the 1932 management classic, The Modern Corporation, and Private Property by Adolf A. Berle and Gardiner C. Means, the idea was that public firms should have professional managers who would balance the claims of different stakeholders, taking into account public policy.
The result? What management theorists came to call 'garbage can organizations.' These were organizations that couldn't make up their minds. Goals wandered in and out meetings and decisions happened randomly, depending on who was present. The organization often had no clear preferences or guidelines. It frequently operated on the basis of inconsistent and ill-defined preferences, goals, and identities.
This is a principal reason why shareholder value theory emerged in the first place. In 1970, Friedman took the logical step and said that if organizations are confused, let them focus on one goal: shareholders. (It made eminent sense to focus on a single goal since mathematically you can only maximize one variable. The trouble is: Friedman chose the wrong single variable: shareholders.)
When the firm pursues only shareholder value, everyone else—customers, suppliers, society—tends to get shortchanged. It thus became apparent over several decades what should have been obvious from the start: shareholder capitalism is an unacceptable form of institutionalized selfishness.
The Better Path: Customer Capitalism
In opting for shareholder primacy, Friedman ignored a better viewpoint that was on the table: customer capitalism. In 1954, Peter Drucker had argued that “There is only one valid purpose of a corporation, to create a customer.” If the customer’s needs are met, then the shareholder’s needs will in due course also be met. When customers are delighted, the firm makes more money and can afford to pay workers more and meet the needs of other stakeholders. Moreover, customer capitalism is intrinsically moral: human beings are creating value for other human beings.
Drucker presented his radical idea without any hard evidence. That’s because, in 1954, there was practically none. Large firms primarily focused on delivering value to customers? It was a stretch of the imagination to accept that a firm like General Motors (GM) was in business for anything other than to make money itself. GM didn’t totally ignore the customer, and sometimes even recited phrases like “Our Customer Is Number One.” But when push came to shove, the customer only figured in their thinking to the extent that it fitted the internal preoccupations and plans of the firm itself. The commitment to serve the customer was a very qualified commitment and limited by the firm’s goal of making money for itself.
Then a funny thing happened. Customers struck back. In the 21st century, power in the marketplace shifted from seller to buyer. Through the Internet, globalization, and deregulation, customers suddenly had choices, reliable information about those choices and an ability to communicate with other customers. The firm-centric marketplace turned into a customer-driven marketplace. In this new world, firms that were primarily focused on delivering continuous new value for customers began making huge amounts of money. Those that weren’t, struggled.
By 2019, the evidence is in. The shift in power in the marketplace has taken effect and the Fourth Industrial Revolution is well underway. Firms that focus on continuous innovation for customers and are organized to be nimble, adaptable, and able to adjust on the fly to meet the shifting whims of a marketplace driven by end-users are flourishing, and have become the largest firms in the world. By contrast, firms focused on shareholder value and being run in the manner of the lumbering industrial giants of the 20th century, are struggling.
It is no doubt true, as Pearlstein points out, that “business leaders feel some urgency to re-engage in the public debate. By disavowing shareholder primacy and embracing a broader vision of corporate purpose, the Roundtable has now enhanced the political legitimacy of such efforts.”
The question is whether we want to return to the murky world of mid-20th Century multi-stakeholder capitalism where no one knows what the purpose of a firm really is, or advance to the 21st Century capitalism where firms are primarily focused on continuous innovation for customers while also taking into account public purpose.
And read also:
Making Sense Of Shareholder Value: The World’s Dumbest Idea
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Steve Denning
Steve Denning
My new book, 'The Age of Agile' was published by HarperCollins in 2018. I consult with organizations around the world on leadership, innovation, management and business ... Read More
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