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.
If you liked this post, consider subscribing to the Enterprising Investor.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
Photo credits: ©CFA Institute
28 Comments
Brad and Raj,
It seems you have a different point of view on the same issues.
Brad, is saying that"the problem is not with the goal of shareholder value maximization, but with the means used to further that goal"
Raj is saying that "the idea that SVM theory is good but the practice flawed seems to me a bit like saying communism is fine in principle, it's just that it gets let down by (all) the practitioners!"
You can find Raj's comment here: http://eic.cfainstitute.org/2014/10/23/shareholder-value-maximization-t…
I'm sorry that the comments got divided across the two pages on this post, but it'd be good to post further comments here, if possible.
Thanks for joining the two discussions, Usman.
Raj, I think the big difference between the incentive pay situation and the communism situation is in external discipline. If we left it up to company executives (or investment managers) to determine their own pay, they might take everything. We recognize this problem, so the power lies with the shareholders, who discipline them partly by determining their compensation. Communism (by which I mean Marxism) fails because it doesn't even recognize the incentive problem--so in steps oppressive dictatorship. The difference is that shareholder governance can in principle solve the compensation problem so that executives take actions to maximize shareholder value (thereby maximizing the health of the company), whereas oppressive dictatorship can't solve the problem.
Forget it¡
In terms of short-termism, and rising inequality, the world’s by far dumbest idea, is the pillar of current bank regulations, namely the credit-risk-weighted capital (equity) requirements for banks.
That regulation allows banks to earn much higher risk adjusted returns on what is perceived as “absolutely safe” than on what is perceived as “risky”, and therefore distort the allocation of bank credit to the real economy.
That regulation, as a consequence, give banks no incentives to finance a naturally more risky future, and all the incentives to refinance a day by day less sturdy past.
And that regulation also blocks equal opportunities, and there is nothing that promotes inequality as much as that.
http://subprimeregulations.blogspot.com
Per Kurowski,
You have brought an interesting new angle to the discussion. But one may argue that because commercial banks funds themselves largely by deposits (principal protected), they should largely invest in assets that are also principal protected. For assuming the risk of business outcomes, pass through structures like mutual funds are better suited. You may want to read this short post on "limited purpose banking": http://blogs.stage.cfainstitute.org/investor/2011/07/12/limited-purpose…
“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 :-)
Per Kurowski,
Interesting quote!
I guess the question remains whether commercial banking is the right "ship" for financing business through equity stake. Or is that best done through pass-through structures.
James Montier presented Johnson & Johnson as a company that, unlike IBM, did not switch to shareholder value maximization (SVM).
Wrong!
In 2013, US Justice department reported that Johnson and Johnson agreed to pay more than $2.2 billion to resolve criminal and civil liability pertaining to outright corrupt practices (to maximize profit). Just because Johnson and Johnson has retained references on its website to some noble sounding mission does NOT mean that it is following that mission. This $2.2 billion settlement is evidence that Johnson and Johnson is also busy maximizing, going even beyond IBM.
I agree that SVM is a terrible idea but that comparison of IBM and Johnson and Johnson is not right. We need a more coherent and comprehensive case against SVM.
Cheik,
Thanks for visiting our blog and posting your thoughtful comment.