Shareholder value. A term sometimes demonized as the culprit behind companies mistreating their stakeholders that aren’t shareholders. For clarification, a stakeholder can be customers, employees, suppliers, society as a whole etc. Don’t confuse the terms shareholder and stakeholder, even though shareholders are most definitely stakeholders as well.
What Is Shareholder Value?
Investopedia defines shareholder value as follows:
“The value delivered to the equity owners of a corporation due to management’s ability to increase sales, earnings, and free cash flow, which leads to an increase in dividends and capital gains for the shareholders.”
Ultimately, the above is needed in order for a company to remain competitive. A completely different question, however, is how companies are supposed to deliver said value. The term “shareholder value” and its maximization comes under criticism from time to time, and it usually lifts its head after big corporate scandals.
The Populist Scapegoat
In order for a firm to afford the often used, great sounding term “corporate social responsibility”, it needs to be profitable. Today, almost every single public company has their own “social responsibility” declaration somewhere in its mission statement. This is not a bad thing, and its certainly a step forward from how things used to be done. Despite this, scandals still happen, and shareholder value is once again determined to be the culprit.
When shareholder value and it’s creation comes under fire from critics, it’s an easy scapegoat: “Corporate greed for profits disregards people.” Indeed the profit motive is certainly one part of the issue, but I think we need to dig deeper.
The Corporate Church And Its Congregation
I believe firms will attract the type of shareholders it deserves. The shareholders vote the board, who in turn hire the CEO. If the corporate church preaches a gospel of virtue, it can prevent troublemakers in its congregation. If the firm declares loudly that it’s in it for the long-term, values integrity over short-term profit and treats its employees well, prospective shareholders with other intentions will stay away. Good. Besides, a virtuous business will by design create shareholder value. Thus it’s an outcome, and does not need to be the mission.
Once again, remember incentives. If bad behavior is incentivized, don’t be surprised when it happens. For the investor, look for good incentives in proxy statements. You want to see incentives that encourage long-term performance that links to pay, and values that align with your own.
Shareholder value or its maximization alone is too simplistic to blame for corporate scandals and bad behavior. Most likely, the company’s incentives were structured in a destructive way. Thus, the responsibility ultimately lies in the shareholders. In particular, institutions, which are typically the largest holders. Do they get the blame? The CEO may get fired, but who’s behind him/her?
Legislative Hurdles
Some form of legislation will always be needed. The Sarbanes-Oxley Act in particular was a long-overdue measure to tackle problems related to shareholder value creation. Still, legislation alone cannot remove all shortcomings of human nature.
As with many aspects of life, the tightening and loosening of legislation is cyclical. Loosening sets the soil for growth, but financial shenanigans are guaranteed to happen along with it. Think back to deregulation of the financial industry that led to the 2008 crash. This, in turn, creates demand for the tightening of legislation. Then, a period of regulation leads to deregulation. And the cycle continues.
Conclusion: Invest With Your Values
As an intelligent investor, you understand the role of incentives in human behavior. It’s difficult to legislate, or to centrally plan and control. What you ought to do, is invest according to your values.
If you believe that smoking is bad, and you don’t want it’s liabilities to be socialized through your taxes, don’t own a tobacco stock. If you believe that gambling causes more problems than benefits, don’t own casinos.
You wan’t to own businesses that you’re proud to hold. By definition, they usually are virtuous. Focus on businesses that have a long-term perspective, incentivize good behavior and treat employees fairly. Bad behavior and scandals won’t disappear. So in life and in business, take the high road. It’s less crowded.
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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