Tags: Macey | Stout | corporation | shareholder

Must Corporations Maximize Shareholder Value?

By    |   Thursday, 09 May 2013 01:48 PM

Appropriately on May Day, the American Enterprise Institute (AEI) and the Federalist Society hosted a presentation titled "Shareholder value theory: Myth or motivator?" featuring two prominent conservative experts in corporate law discussing, and energetically disagreeing about, the question of whether it is the principal duty of corporations to maximize shareholder value.

This issue has taken on renewed importance recently, as activist shareholders have sought to play a strong role in unlocking what they perceive to be hidden or neglected values in companies that they perceive are being managed ineffectively by incumbent leaders.

The contestants in the debate were Lynn Stout, a professor of corporate and business law at Cornell Law School who presented her book "The Shareholder Value Myth," and John Macey, a professor of corporate law, corporate finance and securities law of the Yale School of Management.

For me, the event was frustrating and a bit disappointing, but it served to present some ideas that will hopefully be further developed at a Cato event on May 22 when Macey will present his book "The Death of Corporate Reputation."

The participants referred to some readings that viewers might wish to consult as they think about controversies in the daily business news.

In introducing the debaters, AEI's Alex Pollock made the point that corporate governance matters are increasingly fought not among shareholders but by an array of agents. He referred to a 1932 book by Adolf Berle and Gardiner Means, "The Modern Corporation & Private Property," and suggested that the issue today is not one of principals and agents, but of a paucity of principals.

Pollock observed, "Most of the people, indeed, who stand up and claim to be stockholders, putting in questions to be addressed at annual meetings, are actually, personally speaking, not shareholders at all. In fact, they're hired managers of other people's money. In other words, agents! With all the same agency conflicts that other agents have. So I don't think it's at all true, as Lynn argues in her book, that shareholders are fictional, but I do think they are largely absent from the discussions, because the discussions are dominated by agents of various kinds on all sides." Pollock described a phenomenon he called "agency capitalism" that he asserted lies behind the issues discussed by the professors.

Perhaps the greatest service Stout provided was to identify what she called the "ideology of shareholder value." Whether or not one finds this perspective useful, I would warn readers that the daily discourse on corporate governance issues is marked by public relations spin and propaganda that the audience would be well-advised to discount by a factor of at least 99 percent.

A self-described Burkean, Stout contends that the shareholder value myth stands in the way of the application of common law principles based on experience rather than policies derived from the legislative process.

She went on to recount at length the development of the myth, referring to a paper that traces it back to the 18th and 19th centuries, when "a lot of corporations were formed, not to produce returns for investors, but to provide products and services to people in a particular area — roads, canals, bridges, banks. It's very clear that making returns for their investors was very far down the list of things the people who created the corporations were trying to accomplish."

Then, in the 20th century, the philosophy of "managerialism" came to the fore, as managers and directors saw themselves as stewards of broader interests than those of shareholders, encompassing the interests of employees, customers and the nation.

Stout blames the spread of the shareholder value myth in the latter part of the 20th century as an "ivory tower" product promoted by an article by Milton Friedman in The New York Times Magazine on Sept. 13, 1970, titled "The Social Responsibility of Business is to Increase its Profits," and a paper by William Jensen and Michael Meckling titled "The Theory of the Firm."

I found the Friedman article persuasive at the time as a counterpoint to the rise of the "corporate responsibility" movement that claimed a greater role in corporate governance for agents of citizens who asserted that they were "affected" by the actions of a corporation and are therefore entitled to greater protection than is afforded by tort law.

Readers might also want to consult a lecture presented by Jensen at AEI in 2007 that laid out the elements of shareholder value within the context of the role of hedge funds in seeking to enhance and capture that value. For me, it was instructive to consider the elements of value and to reflect on the fact that "too big to fail" banks have none of them but rely instead on subsidies they receive from government based on the ideology that "Banks Are Special."

Stout debunked the views of Friedman and Jensen on the ground that they were/are economists, not lawyers, a remark readers will recognize as a cheap shot. She then presented an elaborate legalistic argument that "history doesn't support shareholder maximization as a goal, or as the only corporate goal, state law doesn't support it, the common law doesn't support it and finally I'm going to argue that the evidence doesn't support it. We actually now have corporations that are closer to the ideal of shareholder democracy than we've ever had in American business history." For this she credits the Securities and Exchange Commission and the tax code, two creatures of federal legislation.

In rebuttal, Macey traced the concept of shareholder wealth maximization back to the Venetian accountant Pacioli in 1494, who said, "A person should not go to sleep at night until the balance sheet equation is satisfied." Therefore, he contended, shareholders are entitled to the residual value of the firm, whereas Stout contends that the corporation is itself the residual claimant.

Second, he cited state corporation laws as recognizing the exclusive rights of shareholders. For his third point, he returned to the Pacioli view and elaborated on it. For his fourth point, Macey cited a Pennsylvania case that upheld the right of corporate managers to refrain from shutting off the electricity of delinquent customers, because this is in the larger interest of the shareholders.

Finally, Macey pointed out that Delaware and other states are considering the option of an entity that can be formed to pursue objectives other than the maximization of shareholder value. Given the emphasis placed on default rules by the Obama theorist Cass Sunstein, it was remarkable that the Stout and Macey argued at length over what the default rule is where corporate bylaws are silent as to the corporate purpose.

I found the extended discussion of legal fine points provocative but unpersuasive. However, it should serve as a useful background for further discussion that will take place when Macey makes his own presentation and responds to comments by leaders of the public debate later this month.

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Appropriately on May Day, the American Enterprise Institute (AEI) and the Federalist Society hosted a presentation titled "Shareholder value theory: Myth or motivator?"
Thursday, 09 May 2013 01:48 PM
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