Shareholder value: world's dumbest idea

The idea that companies exist solely to produce shareholder value can be traced to a 1970 editorial by Milton Friedman. Writing in Forbes, Steve Denning calls this The World's Dumbest Idea, and gives pretty comprehensive evidence to support that notion: "As often happens with bad ideas that make some people a lot of money, shareholder value caught on and became the conventional wisdom."

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  1. Bob: Did I do something illegal?

    Gilbert Huph: [begrudgingly] No.

    Bob: Are you saying we shouldn't help our customers?

    Gilbert Huph: [pacing back and forth] The law requires that I answer no.

    Bob: We're supposed to help people!

    Gilbert Huph: We're supposed to help our people! Starting with our stockholders, Bob! Who's helping them out, Huh?

    -- The Incredibles

  2. I think there are a lot more dumber (dumbmerer-er?) ideas out there than this one, but shareholder value is an incredibly tenacious and destructive dumb idea.

    There seems to be a basic logic to making CEOs take their compensation in stock, since they'd presumably have an incentive to run the firm wisely. But they have every incentive to warp the rules to their advantage. If you're in just the right position you can make out like a bandit, leaving ordinary stockholders and employees screwed.

    Golden parachutes need a remote destruct device.

  3. wryfi says:

    The idea that companies exist solely to produce shareholder value can be traced to a 1970 editorial by Milton Friedman.

    Not really. The classic example cited for the shareholder primacy norm dates to 1919, when the Michigan Supreme Court held that it was illegal for Ford Motor Company to pay its workers guaranteed wages and benefits, when the money spent on the proposed entitlements could instead be used to pay a dividend to shareholders (in this case, the Dodge brothers, who were minority shareholders of Ford). "a business corporation is organized and carried on primarily for the the profit of the stockholders. The powers of the directors are to be employed to that end." Dodge v. Ford, 204 Mich. 459, 170 N.W. 668. (Mich. 1919) (wikipedia summary).

    Many have argued against using Dodge v. Ford for this precedent. The above quote was merely dicta, probably overreaching dicta at that, and Ford at the time was not a publicly-traded corporation, but a closely-held company.

    Nevertheless, the case is frequently cited as establishing shareholder primacy, and is clear evidence that the idea is is closer to 100 years old than it is to 40.

    I've no doubt that Friedman picked it up and ran with it, as served his interests.

  4. To be fair, Milton Friedman also suggested closing down the FDA, as the free market would determine what drugs were safe or not. So while the terrible idea of Shareholder value was actually enacted, some of his other ideas were even dumber.

  5. Perhaps the dumbest aspect to the entire idea is the idea - supported by court cases like Dodge v Ford - that shareholder value is maximixed by maximizing the current quarter's or current year's bottom line. Prior to the advent of shareholder suits for delinquency of fiduciary duty - as opposed to outright fraud or embezzlement - the courts were wont to take the position that a company's management knew what was best for it in the long term. If Ford's approach of generous compensation to highly skilled assembly-line workers were not suited to the shareholders' preferences, they could either vote out the board of directors, or vote with their feet and invest their money in a company run according to their wishes, but not try to get a court to second-guess the decisions of management.

    Nowadays, shareholders can all but get a court to order a company to engage in unethical behaviour. The argument that over the long run, that will diminish the company's value by destroying its goodwill appears not to stand up. This is perhaps the single greates perverse incentive in the corporate world.

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