The common refrain that firms exist solely to maximise shareholder value is a tired cliché.
This solitary prescriptive path to corporate glory came into vogue and created a hum of excitement in the early 1970s. The pioneering proponent of this view, Milton Friedman; an influential economist, argued, “there is one and only one social responsibility of business; to…engage in activities designed to increase its profits.” This ‘mantra’ is now a subject of debate, on the one hand between economists and lawyers, and on the other, between executive management and shareholders.
Inquisitive brains are back in vogue, questioning the rationale for Friedman’s doctrine. The horizons of corporate leadership have opened beyond shareholder-value-thinking (SVT). The bar would be too low if SVT served as the sole measure of performance. The centre of gravity has rightfully shifted towards the creation and sustenance of the intention-fueled humanitarian principle of shared value. In progressive companies, the delicate balancing of the interests of employees, creditors and customers with wealth creation has assumed prominence. Liberal leaders with minds untrammeled by convention have embraced altruistic virtues and challenged the orthodox body politic.
Kenneth Frazier, the CEO of the fifth largest pharmaceutical company cautions, “If you get up in the morning and your sole intent is to make money for shareholders, you’ll miss…good opportunities to do a lot of good for a lot of people.’
Who are the owners of firms such as BIFM, Letshego, Choppies, commercial banks and other listed entities? If you were to google this question, a lot of reference material would pop up. Some supporting Friedman’s notion. Alongside that you’ll be dazzled by a phalanx of information questioning Friedman’s doctrine.
A listed firm is a legal person. Not owned by shareholders. In the 1925 Macaura v Northern Assurance, Lord Buckmaster ruled, “No shareholder has the right to any item of property owned by the company, for he has no legal or equitable interest therein. He is entitled a share in the profits while the company continues to carry on business and a share in the distribution of the surplus assets when the company is wound up.” This view was upheld in the 1948 Short v Treasury Commissioners where Evershed LJ stated, “Shareholders are not, in the eye of the law, part owners of the undertaking.”
On recommendation from management, the board might decide to reinvest earnings with a view to gaining competitive ground on R&D, scaling business and expanding geographic footprint. Disgruntled shareholders cannot fire executive directors. That is the sole prerogative of the board. That explains why investors in Choppies could only waggle their finger at management while howling at the moon, but couldn’t untangle themselves from the ugly imbroglio of qualified external audit reports and haemorrhaged shareholder wealth.
The theory of ownership of companies by shareholders is often based on the flawed premise that companies need shareholders’ equity to expand. While that is true for risky start-ups and unstable companies it is certainly untrue for sturdy businesses that can easily fund expansion from reserves or from debt secured from the capital markets. Management is not always bound to kneel before equity investors cap in hand.
The theory of ownership of companies by shareholders fails the principle of ownership on multiple levels, including the basic litmus test of the right to drive strategy, acquire and shed assets. Prem Sikka; University of Sheffield’s professor of accounting asserts, since shareholders don’t have the right to “dictate business strategy,” they cannot be owners.
A card often played by SVT advocates is that the management team serves as agents for shareholders. Professor Lynn Stout of Cornell Law School, a voluble opponent of SVT shreds this view to pieces; “At law, a fundamental characteristic of any principal/agent relationship is the principal’s right to control the agent’s behavior…shareholders lack the legal authority to control…executives…What shareholders own are shares, a type of contract…that gives…limited legal rights.”
What if maximising shareholder value was the only important factor in running companies? Decisions that are not in the interests of crucial stakeholders may be made. A myopic short-term view of company performance may reign supreme, favouring management and fund-hopping short-term investors but harming the interests of long-term investors.
In 2000, Coleman Andrews was credited with turning around the fortunes of SAA after achieving a whopping profit of R350m. That performance was not undergirded by superior business acumen nor an effective turnaround strategy. Andrews had stripped the airline of its assets to balloon the bottom line while significantly denting the airline’s balance sheet. Otherwise, the company’s performance would have remained in the red like in previous years, vacillating in the same loss-making space as state owned airlines of Botswana, Zimbabwe and Namibia. The same thing happened at BDC a few years ago when management went beyond parody, engaging on a spree of disposing property, under the guise of shedding underperforming assets, resulting in the shrinking of the balance sheet and the bloating of the bottom line with no guaranteed sustenance of the manufactured earnings going forward.
This short-term approach to management is a negative-sum game. It limits the company’s performance to the tenure of the CEO and tempts management to focus on hitting short-term targets with a view to securing bonuses while advertently harming long-term interests of the company. The 2010 BP oil spillage in the Gulf is a case in point. BP failed the basic tenets of project management. The quality of the well was suspect. The project suffered woeful delays. Delivery was plagued by massive cost overruns. Compromises on safety resulted in avoidable deaths and untold harm to the environment. BP’s gormless ‘saving’ of a few million dollars resulted in half of its market capitalisation wiped off, approximately US$95bn!
If you are a shareholder, rise above empty self-deception and swallow the bitter pill of knowing you’re at the bottom of the pecking order of residual claimants because you don’t own the company. Sorry for the churlish undertones but hey, c’est la vie!