What is maximizing shareholder value, anyway?
Then, in October, James Montier did a presentation about how maximizing shareholder value is a bad idea, and, in fact, has damaged shareholders. 100% agree with his arguments and conclusions, but I don’t see how the practices he derides (the focus on quarterly results and irrationally paid CEOs) are related to the words “maximizing shareholder value.” Turns out I needed to better understand the definition of “Maximizing Shareholder Value” that he is using:
Over the years, academic research papers on the subject, such as those by Jensen and Meckling (1976) and Jensen and Murphy (1990), have made it inseparable from the alignment of incentives. That is, top management of companies should be offered financial incentives (e.g., stock ownership and call options) to align its interest with maximizing stock price.
Cliff Asness is looking at it from a different angle. He also is not tied to the definition cited by Montier. That is, he is interested in maximizing shareholder value rather than the academic Maximizing Shareholder Value. But while I think about stocks in the long term, as owning a piece of a company, Asness approaches it from the more immediate “what is the stock worth TODAY” point of view. And he’s right. The only way to measure shareholder value is by the dollar value of the company, which is found in the stock price. Right now. Not half a lifetime from now. He also makes the point that there is really no other way for a company to be run (emphasis mine):
Basically, if capital markets price things well (with few ex ante errors, or put differently, the market is close to “efficient”) then maximizing shareholder value is a very good idea. Believing that markets make common and giant predictable errors is the only legitimate beef one can have with maximizing shareholder value, and it’s absolutely fair to debate this tenet.
But instead of confining the debate to this central point, or even realizing that this is the central point, critics attack shareholder value for many ancillary reasons. For instance, they laugh off the concept as vacuous, the absence of a strategy. They attack share‑based and particularly options‑based compensation. They attack markets and managers for being too “short-term.” They attack the titular idea as inducing the “expectations game,” something they hold in great contempt. Finally, they attack — and at least this salvo is on the core concept — the idea that the firm should be run for its owners, instead of for a diffuse and sometimes amorphous set of stakeholders. Some critics have valid and important points about these things. However, as I will explain, with little exception, they are not actually criticizing the shareholder value idea at all.
It’s a little ironic that one of the arguments the haters make is that shareholders themselves are a diffuse and amorphous set of stakeholders. But it certainly should be much simpler to figure out ways to represent shareholders with well defined claims, than to try to figure out how to include the interests of all these other parties. That is, more than they are already included by legal structures and contracts, etc.
The OECD published this paper on the topic in 1999. It’s a lot more thorough than anything cited above. But it confirms that in the US, the corporate model of governance is and (legally) should be focused on maximizing shareholder value (not Maximizing Shareholder Value).
So then Asness is correct, and the better question becomes, does the market price of a company reflect its total value? I think that prices reflect today’s realities extrapolated out into the future. That includes political realities. A few examples of these that have huge impacts on individual and sector stock prices include existing regulatory structures (think about energy and health care), corporate personhood, the status of QE or any other Fed action, the government guarantees for certain large financial institutions, and the status of the rule of law. So if you think that companies or sectors are mispriced relative to their real value, or to one another, then maybe you need to look at the underlying assumptions that the market is taking into account.
I would also add:
“The market can remain irrational longer than you can remain solvent.” – Gary Shilling/John Maynard Keynes.