Tuesday, September 11, 2012

Stout on "Increasing Shareholder Value" as Injurious

Professor Lynn Stout, Cornell Law School
Professor Lynn Stout at Cornell Law School argued last week in the Los Angeles Times, that the corporate law maxims of "profit maximization" and "increasing shareholder value" have taken on lives of their own in the past thirty years and in so doing have visited positive harm on corporations, employees, and the public at large.  In her Op-Ed "'Maximizing Shareholder Value' Is Ill-Conceived Concept," Stout essentially argues that prior to the 1980s, corporate leaders focused on promoting long-term growth for the benefit of employees, shareholders, the community at large and society as a whole.  But she posits, dating back to Milton Friedman and the rise of the Chicago School of free-market economists, the idea that shareholders "owned" corporations and that businesses existed solely to maximize shareholder profit began to take root.  Stout writes that the federal government has now embraced maximizing shareholder value as near religion today.  This embrace, per Stout, has led to calamity and disappointment:  "It's now become clear, however, that a relentless focus on share price can hurt not only employees, taxpayers and society, but shareholders too. Managers who are pressured to raise stock price quickly often resort to tricks — selling assets, cutting payroll and investment, draining cash through dividends and share repurchase programs — to bump up stock price for a year or two. But such strategies often hurt a company's long-term ability to grow and prosper."

Is it possible that the "profit maximization" maxim which has taken hold in corporate law can actually harm taxpayers, shareholders, employees and society in general?  Stout supports this by arguing that: "In 1993, Congress changed the tax code to require companies to link executive pay to 'performance' (typically stock price). The Securities and Exchange Commission over the last two decades has adopted rules to make corporate directors ever more 'accountable' to shareholders. And hedge funds have used these rules to harass companies into selling assets, cutting expenses and paying out large dividends to 'unlock shareholder value.'   How has this worked out for American investors and the American economy? Not well."

Stout continues:  "In the name of increasing shareholder value, public companies have sold key assets (Kodak's patents), outsourced jobs (Apple), cut back on customer service (Sears) and research and development (Motorola), cut safety corners (BP), showered CEOs with stock options (Citibank), lobbied Congress for corporate tax loopholes (GE) and drained cash reserves to repurchase shares until companies teetered on the brink of insolvency (much of the financial industry). Some corporations even used accounting fraud to raise share price (Enron and WorldCom). Public companies employed these strategies even though many executives and directors felt uneasy about them, sensing that a single-minded pursuit of higher share prices did not serve the interests of society, the company or shareholders themselves."

Stout concludes:  "It's time to recognize that the philosophy of 'maximize shareholder value' is just such a defunct economist's idea. Let's throw off our intellectual chains so our corporate sector can do a better job for shareholders — and the rest of us too."

Law professors and corporate practitioners would do well to re-consider what they are teaching and/or practicing when they support the "new-ish" legal principle of "profit maximization."  Surely a corporation exists to do more than simply provide profits for its shareholders.

And finally today, we wish to take a moment to reflect on and remember those who lost their lives and those who continue to grieve their losses of 9.11.01.

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