Should Shareholders Call the Shots?

Not according to one intrepid academic

Someone with credibility has finally come along to challenge the seemingly well-settled notion that shareholders should ultimately control corporate governance.

Lynn Stout, a visiting law professor at Cornell, has just published The Shareholder Value Myth which the International Herald Tribune described as a “slim and elegant polemic” arguing that ‘shareholder democracy’ has no basis in law.
Her premise is that the only time shareholders have legal rights is during takeovers and bankruptcies. Nowhere else in the law is there any explicit support for shareholders running companies because they are the “owners”.

There’s no question that the populist arguments against her position are pretty compelling right now, but Professor Stout counters that preoccupation with ‘shareholder value’ is what gave us the dodgy business culture we have today. She attributes our current ethical lapses and indifferent corporate performance to the short-termism associated with a focus on stock price.

I happen to be of the pragmatic school that doubts whether the average shareholder, especially of mutual funds, cares at all about the inner workings of the companies whose stocks he owns or has a better sense of how a particular company should operate than its own managers. I, for one, throw my proxies away.

It makes perfect sense to me that investors who contribute capital directly to a company – like venture capital or private equity funds – should have a proportionate say in how their companies are run. I also understand why a shareholder who accumulates a substantial position in a company (especially for the purpose of acquiring majority or total control) is entitled to some say in matters of governance. But I fail to see how a shareholder who bought an incidental number of shares in the marketplace should have any influence over company affairs. If the investor likes what’s going on at the company, he can maintain or increase his position; if not, he can vote with his feet.

Under current law, directors run companies and decide what businesses to be in and, through their appointed managers, how to conduct them. According to Professor Stout, residual shareholder rights in bankruptcy and shareholder takeover protections are simply prophylactics against the unfair treatment of shareholders, and special shareholder consideration should not therefore be extended to solvent companies not under attack.

Professor Stout’s polemic clearly flies in the face of the ‘shareholder spring’ we are currently experiencing in which activist hedge funds are enjoying unusual success and institutional investors are pressing for more rational executive pay packages. She calls for a return to the more complex “stakeholder model” in which company management takes into consideration the diverse interests and values of employees, customers, creditors and the local community as well as shareholders. Stout says we shouldn’t be focused on “a very narrow subset [of stakeholders] that is particularly short-sighted, opportunistic, indifferent to external costs, and lacking in conscience.”

Ironically, the strategy of ‘maximizing shareholder value’ is attributed to Jack Welch of GE back in the 1970’s. In a recent interview on the future of capitalism, however, Welch reversed himself and called ‘shareholder value’ “the dumbest idea in the world.” To him, and to me, “shareholder value is an outcome, not a strategy.”