Washington Post Article on the Shift to Maximizing Shareholder Value

By Cydney Posner

Looking forward to Labor Day, you might be interested in this piece from the Washington Post, "Maximizing shareholder value: The goal that changed corporate America."  Using the iconic IBM as a vehicle, the article rekindles the debate about the primary purpose of corporations and the impact of the shift in corporate focus to maximizing shareholder value and away from a broader spectrum of interests that includes employees, community and society at large. (See my articles of 10/5/12, 7/2/12 and 10/11/11.)

The article begins by noting the depopulation of a small town in New York that once was home to 10,000 IBM employees and now is home to only 700. In contrast, investors in IBM shares have received a 25-fold return over the same period. The decades after World War II saw a booming economy where "the interests of companies, shareholders, society and workers appeared to be in tune." The author traces the rising disjunction between interests of the corporation and those of the community to "a deep-seated belief that took hold in corporate America a few decades ago and has come to define today's economy — that a company's primary purpose is to maximize shareholder value." The concept is not statutory; "[r]ather, it was introduced by a handful of free-market academics in the 1970s and then picked up by business leaders and the media until it became an oft-repeated mantra in the corporate world." It is the "pressure to respond to the short-term demands of Wall Street," together with new competition overseas, that has driven the wedge between companies and the communities in which they operate, the author contends. That position is supported by an associate professor of public policy, who opines that "'[t]he shift in what employers think of as their role not just in the community but [relative] to their workforce is quite radical, and I think it has led to the last two jobless recoveries.' "

The author points out that this change is reflected in statements from IBM's leaders: when the son of IBM's founder was CEO, he wrote "that balancing profits between the well-being of employees and the nation's interest is a necessary duty for companies" and acknowledged the company's "obligation as a business institution to help improve the quality of the society we are part of…." The first and most important component of the company's philosophy at that time was respect for the individual employee, and the CEO was proud "that his father avoided layoffs, even through <br>the Great Depression." In the 1990s, though, the company's competitive advantages were eroding., The CEO achieved a legendary turnaround, but part of the price, the author contends, was a 60,000-employee layoff and a shift in emphasis to earnings per share. Defenders argue "that the company has had to reinvent itself so many times to stay alive that the values of [the founder and his son] are no longer as easy to apply as they used to be." The current CEO "has pledged to follow a plan called the ‘2015 Road Map' in which the primary goal is to dramatically raise the company's earnings-per-share figure, a metric favored by Wall Street." In 1981, even the Business Roundtable recognized the responsibility of corporations to the society of which they are a part. By 1997, pronouncements from the Business Roundtable maintained "that the principal objective of a business enterprise ‘is to generate economic returns to its owners….'"

Professor Lynn Stout attributes the transformation to the rise of the Chicago school of economists, including statements by economist Milton Friedman famously arguing that the only "social responsibility of business is to increase its profits." Subsequently, two other economists published a paper characterizing shareholders as "'principals' who hired executives and board members as ‘agents.' In other words, when you are an executive or corporate director, you work for the shareholders. Stout said these legal theories appealed to the media — the idea that shareholders were king simplified the confusing debate over the purpose of a corporation. More powerfully, it helped spawn the rise of executive pay tied to share prices — and thus the huge rise in stock-option pay. As a result, average annual executive pay has quadrupled since the early 1970s." The author attributes part of the dramatic shift in focus to share prices to a backlash against "the dismal performance of the stock market during the 1970s, a decade that brought negative returns for investors. There was also the perception that companies, including IBM, had become lax in their management. Pressing executives to boost their returns created a new kind of accountability, just as the economy was becoming more globalized and more competitive." A Vanderbilt professor testified before Congress in 2008 that "this pressure comes from the media, from shareholder advocates and financial institutions in whose direct interest it is for the company to get its share price to go up…. and from the self-imposed pressure created by compensation packages that provide enormous potential rewards for directors and managers if stock prices go up."

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