If you agree with the economist John Maynard Keynes that “ideas shape the course of history,” then you ought to agree that the history of modern business and finance has been shaped by one influential idea: that the job of a company’s management is to maximize shareholder value. But according to James Montier, a distinguished investment professional and behavioral finance writer, shareholder value maximization is “a bad idea.” He believes it has not added any value for shareholders and has contributed to such major economic and social problems as short-termism and rising inequality.
Montier made his case against shareholder value maximization when delivering the closing keynote address at the 2014 European Investment Conference in London. In his characteristic iconoclastic style with a generous use of ironic humor, Montier labeled shareholder value maximization the way Jack Welch, the former CEO of GE, had once described it in 2009, as “the dumbest idea in the world.”
An Academic Opinion without Much Evidence
Montier said that the idea of shareholder value maximization didn’t come from businesses but rather originated as an opinion in academia and was unsupported by much evidence. It is most directly traced to an op-ed written by economist Milton Friedman in 1970. . . .
Read more on the European Investment Conference blog.
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28 Comments
Okay. Thanks, Usman.
Brad,
Didn't you miss the whole discussion on incentives? How they are tied to the idea of shareholder value maximization and how they have failed the shareholders?
Sarah
I didn't miss it, Sarah: if incentives are badly designed, causing executives to take actions that maximize executive compensation but not shareholder value, then incentives are a problem; but if incentives cause executives to take actions that maximize shareholder value, then they're a solution.
Or possibly I've mis-interpreted your question?
James Montier has got it right. This shareholder value maximization is a dumb academic idea. Is it anything other than self-delusion to believe that paying CEO's millions of $ in incentives is adding value for shareholders? The point is "maximizing" shareholder value has led to "maximizing" financial incentives for management, it is causing the US economy all kinds of problems. Check out the story on Forbes, The Highest-Paid CEOs Are The Worst Performers.
Thank you Timothy for visiting a blog and sharing your views.
I think you are focusing on incentives, which, as I understand was also a central point made by James Montier.
Hello Timothy
As we enter the season of annual performance reviews your comment is timely.
The only point I would add to it is that CEO compensation can/should be controlled by shareholders.
To the extent that shareholders do not exercise this right it is difficult to lay blame on the CEO.
Not all CEOs are bad eggs, by and large they are well compensated for the work they do, the responsibility they bear, and the flak they take.
Their compensation should be commensurate with the value they add to shareholders - if this is one million or one billion so be it - but the shareholders should decide.
Have a nice weekend
Savio
Savio,
I think it is quite difficult to determine how much economic value is added/deleted by a CEO, isolating it from all the other factors at play.
Yes, very difficult. That's part of the reason that it's often difficult to determine why a given company has done badly: maybe the board of directors believes the CEO has done well, and compensates him or her accordingly, but the (unknown) truth is that he or she has made poor decisions.
Brad,
As I understand, the problematic incentives that James Montier was referring to were largely call options and stock ownership. According to James, research in behavioral finance shows that large incentives do not work as expected, therefore, maximizing shareholder value through such incentives doesn't work.
Yes, incentive compensation with option-like payoff structures are often a problem because they make the executive's interests very different from those of the shareholders. It's the same thing with performance-based compensation for private equity investment managers (e.g., buyouts, venture capital, private real estate, hedge funds).
With restricted stock ownership the interests of the executives and the shareholders are perfectly aligned. You point out that there may still be problems if the compensation is simply too large; that's something I don't know about.
The important point for this discussion, in my opinion, is that the problem is not with the goal of shareholder value maximization, but with the means used to further that goal. Basically, badly designed incentives can interfere with it.
Thanks.