Monday, August 13, 2012

The Place of Shareholder Value

It’s an old story, but nearly every public company’s key goal is “maximizing shareholder value,” or MSV. To most senior managers, it essentially means that they are effectively running the business, producing momentum in sales and profits and attracting Wall Street investment. The net result? The stock price is going up and the shareholders are getting the value they hoped for.

But focusing entirely on MSV brings its own baggage. It encourages quarterly guidance. It forces short-term thinking, encouraging decisions that benefit quarterly numbers but may not pay off in the long term. It stimulates management to use financial engineering, such as off balance sheet financing or layering earnings through acquisitions and other games. Also, even if the company is doing well, MSV could be negatively affected by industry or economic trends.

Therefore, I have always felt that the best companies focus on the total picture: products, people, customer service, integrity, etc. Then, most of the other issues, MSV included, take care of themselves. Certainly Apple and Google fall into the “big picture” category.

The topic was once again addressed in the column, “Down with Shareholder Value,” by Joe Nocera in The New York Times on Friday, where he quoted professors from Cornell, Harvard and the University of Toronto, plus the CEO of Starbucks and another executive as having taken the position that companies need to have a greater purpose than merely raising the stock price.

According to Nocera, Harvard Business School professor Jay Lorsch and Justin Fox (editorial director at the HBR Group) make a couple of key points about overdoing the focus on MSV in their article “What Good Are Shareholders?”

1. If management sees itself only as “agents” representing shareholders (the “principals”) — and dedicated mainly to keeping management in line — then executives are less likely to recognize the importance of their role as stewards of an organization with lasting value. Companies that have lasted and grown have been led by committed executives, “and not just because they are incented by their pay packages to maximize the share price.”

2. Shareholders aren’t suited to be corporate bosses, because they are too diffuse and too short-term-oriented and

Lorsch says that “he believes that the function of business in a society is not just a return to investors but to provide goods and services, provide employment, pay taxes, and so on.”

Many investors have been complaining for years about quarterly-driven short-term financial goals, an approach that can have a devastating effect on businesses’ long-term progress…all in the name of shareholder value. Many senior executives live in fear of not making their quarterly numbers.

As Nocera points out, the phrase, “maximizing shareholder value,” is deeply entrenched, and very, very compelling. No similar phrase reflects Lorsch’s point of view. Any ideas?

If we take what I call “The Total Approach,” will stock prices suffer? My bet is that management will begin to see the value of the company tied to annual performance, and the ceiling for stock prices will surely rise.

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