Debating “The Shareholder Value Myth”
posted by Kelli Alces
Many thanks to Larry and the Concurring Opinions folks for inviting me to blog this month. This is my first time blogging and I’m glad to finally try it out.
On Wednesday, I attended an event promoting Lynn Stout’s book The Shareholder Value Myth, sponsored by the Federalist Society and the American Enterprise Institute. The event was structured as a debate of Stout’s thesis with Jonathan Macey (who wrote this review of the book) taking the opposing position. In her book, Stout argued that the widely accepted norm that corporations are owned by shareholders and exist to maximize shareholder wealth is a destructive myth. Instead, Stout claimed, corporations own themselves and in running corporations, managers can and should pursue any lawful purpose.
It is a real credit to Lynn that there was such a lively, thought-provoking debate about the topic. That corporate managers have an obligation to work on behalf of shareholders to maximize shareholder wealth may be the most basic tenet of corporate law and policy. Options theory aside, many think of shareholders as the “owners” of the corporation and even those who question whether shareholders technically own the corporation do not doubt that the corporation should be operated in such a way as to maximize shareholder value. This unwritten “norm” has dominated corporate law, policy, scholarship, and, indeed, management for a long time (for precisely how long, Stout and Macey disagreed). It is extremely impressive that Stout has been able to provoke a debate about the viability of this fundamental norm.
Wednesday’s debate was the second time I’d seen Stout present at a Federalist Society event. Both times, she began her presentation by arguing that hers was the truly conservative position. It seems an unlikely claim that surprises the audience given what her conclusions are, but I think it highlights what Stout does so well – she reaches her audience with their priors in mind in order to really draw them into her ideas where they might be tempted to dismiss her arguments out of hand. Her presentation was not about good corporate behavior or environmentalism, themes she touched upon in the book, but rather about how debunking the shareholder value myth would allow corporate law to favor state law over federal regulation, to prefer common law rules to statutory regulation, to enhance private ordering, and to honor the lessons of history.
Stout claimed that academics created the shareholder value myth based on a mistaken belief that shareholders are the firm’s owners. Stout argued that corporations own themselves because corporations, through their managers, decide how to allocate profits. She rejected the notion that shareholders are a corporation’s residual claimant. Because, according to Stout, shareholders have no more of a readily exercisable claim to the firm’s assets than any other corporate constituent, their interests should not be pursued above all others when determining what is best for the corporation. The corporation’s interests may include a broader range of outcomes than simply shareholder wealth maximization.
Macey disagreed with Stout’s premise that shareholders are not the residual claimants. He pointed out that the understanding of absolute priority that leads us to call shareholders residual claimants is not just applicable to dying companies, but defines how we value shares in living companies. He also noted that shareholders are the only corporate constituency with the ability to vote on corporate decisions and elect the board. The law gives shareholders special powers because of their position as residual claimants.
In every other form of property ownership I’m aware of, the owner of the equity interest is considered the owner of the property. Even if one does not accept that shareholders are owners of corporations (I agree that it might be theoretically useful at times not to use the term “owner” to define their interest and role in the firm), they do not fail to be “owners” simply because they are not able to unilaterally dispose of corporate property. Ownership interests are often encumbered by the rights of others, as shareholders’ interests in corporate assets are encumbered by the rights of corporate creditors and the interests of other shareholders in delegating control over the assets to managers. Indeed, managers may make decisions to spend corporate assets in various ways that will affect the amount of equity attributable to the “residual claim.” The fact that shareholders agree to take their shares subject to certain restrictions does not mean that they do not have a claim to the value corporation’s equity in certain circumstances. This claim against the firm’s equity (however limited or hypothetical) forms the basis of considerable and real value shareholders are able to trade on and profit from and thereby enjoy personally.
It seems to me that the residual claim is a common, helpful way of understanding the value of the equity interest in a firm, even when the firm’s equity has no value. Indeed, when there is no equity in the firm and only some creditors can be repaid, we say that the junior-most claimants who could be paid from corporate assets are the residual claimants and, in bankruptcy, we give those creditors of the insolvent company many of the rights we would afford shareholders. The rights over the firm’s management and assets that we associate with ownership of a business follow the residual claim, whether it belongs to shareholders or not. So, even where a corporation may not be maximizing shareholder value because shareholder value no longer remains, management should be working to maximize the value of the residual claim, to create as much value as possible from the use of the firm’s assets. One need not be able to cash out her proportional share of the residual claim on demand in order for an understanding of the residual claim to be a valuable guide to managerial decision making.
The interesting question, and one Stout confronted head on, is how to maximize the value of the firm’s assets. Stout is adamant that managers cannot maximize the value of the firm by focusing solely on maximizing shareholder value as measured by current stock price. Will the firm work to increase the value of its assets in the short term or will it seek long term growth and viability? What outcomes really are in the best interests of the corporation? How do managers balance the competing rights and interests of various constituents in doing what they believe is “best” for the corporation? I will return to these issues in a future post.
Stout has written a book that is accessible to many audiences while seriously questioning deeply held assumptions about corporate law and policy. In corporate law scholarship, that is a rare combination. Work that forces us to question the premises of our thinking and policy-making is extremely valuable and Stout does an impressive and thought-provoking job in The Shareholder Value Myth.