Professor of Strategy and Entrepreneurship
London Business School

“Shareholder value orientation” – now, where did that come from?!

Well, it came from the US. And, alright then, a bit from the UK.

For the (blissfully) ignorant among us, what is it? It is the view that the purpose of a public corporation is to maximize the value of the company for shareholders. Traditionally, we find this orientation in Anglo-American societies. The view that the public corporation is more a social institution which has to consider the interests of various stakeholders, including shareholders but also employees, customers, the local community, etc. is the traditional soft stuff found in other parts of Europe and Asia (although, over the last decade or two “shareholder value orientation” has been spreading like a forest fire – pardon the analogy – gaining geographic terrain even in previously unlikely homes such as Germany, France and so on).

Whenever I ask a group of executives or MBA students in my classroom “to whom is the primary responsibility of a company?” nine out of ten people will wholeheartedly shout “shareholders!”, with usually a small, minority contingent on the backburner – with a suspected long-term Marketing indoctrination – arguing that “the company should adopt a customer-focus” and always place customers first (because that’s the best thing to do in order to gain shareholder value I guess…).

But why is that? Why do we immediately assume that the primary beneficiaries of organisations should be shareholders? I even find that quite a few people get a bit annoyed if not angry by even raising that question – like it is some God-given truth, which can’t be opened for debate and is even quite embarrassing to think (let alone talk) about.

Don’t get me wrong, I am not saying that companies shouldn’t do it but surely it is not a “law of nature” or so that a company is ultimately (only) responsible to its shareholders. It’s a choice. And like with many choices in business, that means that it is something worth thinking about every now and then; whether it is really the choice you want to make.

My former colleague (the great) Sumantra Ghoshal – who unfortunately died some years ago – would even argue (if inebriated) that shareholders are not owners at all, at least not of the company. He would argue something like the following (and a posthumous pardon to Sumantra if I remember his argument slightly incorrectly; he would often not be the only inebriated party in the conversation…): He’d say, if you own a dog, and the dog jumps into your neighbour’s house and wrecks the place, you are responsible for all the damage. However, if you own shares in an oil company and one of its oil-tankers shipwrecks and causes a billion dollar in damages to the environment, you’re only responsible for the extent of the monetary value of your shares; that’s the maximum you can lose.

Although Sumantra of course realised the legal reality of the situation, his argument was that therefore a shareholder’s ownership rights are just as limited as his responsibilities. As a shareholder, you’re an investor, which gives you the rights to for instance dividends, but it doesn’t make you the “owner” of the place in our traditional sense of the word.

Moreover, he would continue to argue that as an employee you often give a lot more: your intellectual capital, loyalty, ideas, firm-specific skills and investments, etc. And companies would do well to solicit such “gifts”. And if as an employee you give a lot more (than just money), and a lot more of yourself, perhaps you’re also entitled to more, in terms of the company’s loyalties and priorities.
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6 Comments for ““Shareholder value orientation” – now, where did that come from?!”

  • Pravin Halady (SEMBA 2006) says:

    I found this post very interesting. Regarding the shareholder/owner question, there are some examples where shareholders have earned superior, sometimes outstanding economic returns yet managed to retain a sense of belonging and loyalty among employees. An example where it works really well is Berkshire Hathaway’s portfolio companies.

    Warren Buffet explains his philosophy regarding CEOs in his 2007 letter to shareholders (snippet below):
    “In our efforts (to continue earning superior returns), we will be aided enormously by the managers who have joined Berkshire. This is an unusual group in several ways. First, most of them have no financial need to work. Many sold us their businesses for large sums and run them because they love doing so, not because they need the money. Naturally they wish to be paid fairly, but money alone is not the reason they work hard and productively. A second, somewhat related, point about these managers is that they have exactly the job they want for the rest of their working years. At almost any other company, key managers below the top aspire to keep climbing the pyramid. For them, the subsidiary or division they manage today is a way station – or so they hope. Indeed, if they are in their present positions five years from now, they may well feel like failures.
    Conversely, our CEOs’ scorecards for success are not whether they obtain my job but instead are the long-term performances of their businesses. Their decisions flow from a here-today, here-forever mindset. I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage.”

  • Freek says:

    Pravin: Thanks for the quote and example. It would always be Sumantra’s point as well; that, in the long run, interests are aligned and that, as a company, you would do well to acknowledge this and act upon it. I guess there is a bit of wishful thinking involved as wel…

  • V says:

    I am a senior executive working for an airline. I wouldn’t challenge the “shareholders’ value orientation”, as it is indeed common sense (if not sacred cow) to me. But when it comes to the time for budgeting staff salaries, I always put the staff’s interests as my top priority and push the envelope as such, and feel very right in doing so.

  • Joe Feig says:

    The concepts of maximizing shareholder value, the customer comes first, and employee performance should be commensurately rewarded including extraordinary rewards on a recurring basis are mutually exclusive. They are in fact interrelated. How management of a company, be they owner-managers or “professional managers”, (BTW, I believe all must have an ownership stake), executes their responsibilities to optimize all of these objectives, is the challenge of being an effective manager and the measure of one.

    Joe Feig
    Part-owner of a family women’s contemporary clothing designer/mfr
    and Managing Director of a small Investment Bank/Consulting Company

  • Joe Feig says:

    My comment needed editing. Point was the three concepts are NOT mutually exclusive.

    Sorry about that.

    Joe Feig

  • Christian Bieck says:

    I like your colleagues way of thinking. The shareholder value paradigm always seemed a little strange to me. I agree that investors should get a return on their investment, but in the end, the shareholder only invests money. The employess invest their human capital, the city/community/… invests its ressources, natural and other, etc. Stakeholder value theory took all of that into account – while shareholder value theory IMO leads to bad business results by focussing on the short term.

    My favorite example of a well-run, publicly owned company that openly ignores the shareholder value paradigm is Porsche. I read an interview with the CEO, W. Wiedeking, where he lists shareholders as #5 or so on the list of people to care for… ;-)

    On the other hand, I don’t find it quite believable that the customer is #1, either. Maybe in industries where a long term relationship is established they share the top, but in the the end a sustainable operation will require a good balancing of ALL stakeholders.

    And the shareholder paradigm will in few years be just as unknown as it was 20 years ago… ;-)

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