Failure of Shareholder Value - Essay Example

Failure of Shareholder Value Shareholder Value Failure In the recent past, the primary idea behind corporate management has been to do anything possible to maximize shareholder value. In fact, setting demanding return targets for capital employed has resulted in the failure of FTSE 100 and S&P500 to meet the shareholder goals. The failure of companies to focus on the long-term business goals in favour of short-term shareholder value often slows economic growth and increases inequality in the meeting stakeholder interests. In addition, it triggered rampant scams, wild fluctuations in growth, poor investment in research and development as well as employee training. These challenges alongside weakening corporate reputation have complicated the realization of shareholder value for most companies. Background of the issue Despite its perceived role in stimulating business growth, shareholder value remains contentious in out-of-business quarters (Kristie, 2012). Whereas the corporate executives’ penchant for maximizing the share price lacks any historical or legal basis, the refusal of shareholder value in a business organization may as well spell the end of the company’s operations. Regardless of the reasoning, Cole, Sturgess and Brown (2013) have argued that there is no empirical evidence linking corporate focus on shareholder value to an improvement of the status of the economy and or the society. Shareholder value is said to have begun in second half of the 20th century as an imperative control for managerial excesses, but over the history it has turned into a skewed, self-interested doctrine preferred by economists, finance managers and over-paid corporate managers. According to Roth (2013) the supremacy of shareholder value has not yet been codified in law as the most important priority of the corporate world. In most markets, business organizations can be established for any legitimate purpose. In fact, there is no corporate charter that supports the need to maximize profits or share value (Stout, 2012). Equally missing in law is the need for executives and company directors to be indebted to shareholders under special conditions. The executives owe a fiduciary responsibility to the business organization, which is an amalgamation of different stakeholders (Ho, 2010). The only exception is that shareholders are legally entitled to the corporation’s residual value upon the organization’s fulfilment of its other duties. Notably, company directors still have sweeping powers over the residual value, provided they are not channelling the moneys to their own pockets. It is factual that the power to select members of a company’s board of directors rests with the shareholders (Roth, 2013). But upon their resumption of duty, the directors are relatively autonomous when it comes to meeting the business interests and those of the shareholders (Kristie, 2012). Statistics The real paradox surrounding this mad-rush to maximizing shareholder price is that it is yet to be felt by shareholders. According to Ho (2010), from 1930s to 1970s before the doctrine of shareholder value became prominent, Western countries controlled business operations under managerial capitalism, in which, executives showed a great determination to balance shareholder interests with those of other stakeholders in the business including workers, consumers and the society. During that period, the entire tangible compound annual profit on the stocks of the S&P 500 was 7.6 percent. But after the development of the shareholder value in 1976 through to the current world, shareholder value has yielded a drop in the returns of the same companies by at least 1.2 percent (Ho, 2010). Roth (2013) has noted that several events have taken place during the corporate eras that could have impacted on the shareholder value and interests. One possible reason behind the differences is that fewer gains created by business organizations under the managerial capitalism regime and the industry in general were being channelled to top executives or important workers. Another possible reason could be that under the current regime of shareholder value, greater business gains are going into the pockets of top managers who are believed to be creating real shareholder value. Cole, Sturgess and Brown (2013) noted that the ratio of pay checks for corporate chief executives to the profits of an organization has increased tremendously over the past four decades. The sharp rise in executive compensation can be attributed to a stock-based reimbursement program, which has been the tradition for most of the companies since 1980s (Stout, 2012). Shareholder participation Despite the need for optimization of shareholder value for the success of the whole organization, corporate professionals are split as to which stakeholder holds a subsidiary role in the whole mix. Some people have pointed in the direction of hedge funds involved in the trade of millions of shares every passing minute for purposes of earning hedge-fund-like gains, others have argued in favour of mutual funds usually known for retaining the stock for a few years (Kristie, 2012). Yet others have rooted for retired employees who have held it for several decades. Corporations might attempt to find solutions to the question of shrinking shareholder returns by empowering shareholders with regard to how the business operations are managed (Stout, 2012). But it becomes clear that even as companies proclaim their commitment to fulfilling the shareholder interests, corporate managers and directors have never paused for a second in their effort to limit and prevent shareholder participation in corporate governance. According to Ho (2010), this obvious hypocrisy is evident in concerted efforts to deny shareholders the opportunity to have an input on executive compensation or being entitled to nominate directors who would cut on the excesses of the autonomous directors. For most business organizations, maximizing shareholder interest has also justified deceiving customers; pressing suppliers and workers harder; preventing taxes; and abandoning social responsibility causes (Stout, 2012). For all companies whose primary agenda is maximizing profits, such practices may be logical. But in the likely scenario that competition prompts all players in the industry to adopt a similar behaviour, as it happens in fledged markets the long-term interests of the society and the real businesses will be severely impaired. For instance, a British company outsourcing production from overseas companies can be well-intentioned to maximize shareholder value (Cole, Sturgess, and Brown, 2013). But when other companies in Britain follow suit, so many British workers will lose jobs and or be forced to bear salary reductions that will eventually limit their buying power to an extent that they will no longer be able to purchase even the low-priced commodities produced overseas. The organizations may also realize that the state no longer has enough revenue from taxes to facilitate training programs for would-be workers or carry out targeted investment in the infrastructure that support sustainable production and supply of goods to the market (Stout, 2012). In light of these ‘unfair’ corporate practices aimed at maximizing shareholder value, business organizations that engage in such practices receive a beating in the long-term in the form of more expenditure in production and delivery of goods; costly ads, CSR, and public relations programs which are aimed at winning over the hearts of the consumers and positioning company products in the market, especially for companies that are accused of unethical corporate practices Kristie, 2012). According to Roth (2013), economists refer to such unexpected spill-over effects in the quest for shareholder value as negative externalities. When corporations experience such conditions, they approach governments to help with providing solutions, which normally comes in the form of short-term bailouts. Nonetheless, one of the greatest symbols of shareholder capitalism is the penchant to avoid taxes and conformity to regulations (Kristie, 2012). In light of this, corporate executives normally oppose virtually anything that seeks to cut down on their profits and shareholder price to the extent that some take their firms through costly compensation claims and government fines for unethical corporate practices (Roth, 2013). As a result, the corporate obsession with prioritizing shareholders interest and the expectation of the society to follow suit has boomeranged on the shareholder’s value in the sense that their gains have been shrinking due to the unsustainable demands on return targets for capital (Ho, 2010). And, although, innovation and productivity of employees are based on maximization of shareholder value, FTSE 100 and S&P500 companies have become blinder to the extent that they encourage their employees to toil more and generate impressive short-term shareholder value. Such a mentality only serves to demoralize the workforce and complicate the achievement of the goals (Stout, 2012). Stout (2012) associates poor shareholder value to shrinking corporate budgets for the more sustainable programs such as R&D and employee training which have lasting positive impacts on the business. Ho (2010) notes that many businesses have replaced sustainable strategies with more short-term shareholder value options such as poaching or recycling employees from other companies who are believed to be qualified in certain fields and paying them heavily in order to keep them. The end result has been finding quick-fixes to problems that require lasting solutions and loss of innovation and productivity of the workforce. In addition, the knowledge of FTSE 100 and S&P500 company workers in the recent past to the effect that their use of ingenuity or greater efficiency on the job is set to benefit the shareholders and senior executives only serves to dampen their spirits and shrink the shareholder value. Prioritizing customer Interest The society is not normally happy with the priority of companies being the shareholder value. Owing to the fact that the stakeholder translates into customers and prospects, their dissatisfaction with their relegation in a high stakes game where the return targets for capital is the main agenda is evident in hostile markets for companies whose behaviour they regard as ‘inappropriate’ (Stout, 2012). By contrast, Apple has scored highest in terms of returns on capital investment despite placing the shareholder interests lower in the list of their priorities. Apple’s late Chief Executive, Steve Jobs, proved that shareholder value can be considered among the least priorities of a company, but still performs well. On the contrary, Stout (2012) notes that corporations that prioritize shareholder value hold that they are meticulous in their delineation of stock value from shareholder value. The companies’ managing directors are usually quick to recognize the fact that no business organization could maximize its shareholder value in the long-term without attracting competent employees, producing quality commodities and influencing the formation of an effective government. States work with business organizations to implement effective policies that improve the wellbeing of members of the society. This concept implies shareholder value will in the long-term be similar to those of other stakeholders within society, but that is not normally the case considering that by focusing on short-term goals in highest shareholder value, businesses normally forfeit long-term goals (Roth, 2013). By contrast, if optimizing the value for shareholders demands meeting the interests of customers, the workforce and the society in general, then the same reasoning could mean maximizing customer interests would, eventually, require granting other stakeholders such as shareholders, employees and communities of their interests. According to Cole, Sturgess and Brown (2013), that is precisely the ideology that Apple seeks to advance: the concept of creating and retaining a consumer. In the short-term, however, creating and retaining customers by relegating the shareholder value is normally impractical. Conclusion Generally, FTSE 100 and S&P 500 companies seek to benefit from return targets for capital investments instead of pursuing long-term goals. This has led to the failure of the strategy during the past four decades. Most executives have perfected the idea of chafing under the trimestral revenues thrust upon them by asset managers. They are in a fix, however. On the one hand, corporate executives are afraid of and hate impatient investors who can demand takeovers anytime. On the other hand, they are unhappy about their poor image in the eyes of the public, but they cannot do much within the short-term investment period within which they must deliver. These issues have conspired to precipitate a failure of shareholder value for FTSE 100 and S&P 500 companies over the recent past.   References Cole, S., Sturgess, B., and Brown, M. (2013). Using Reputation to Grow Corporate Value. World Economics, 14(3), pp.43-64. Ho, V.H. 2010. "Enlightened Shareholder Value": Corporate Governance beyond the Shareholder-Stakeholder Divide. Journal of Corporation Law, 36(1), pp.59-112. Kristie, J. 2012. The year in governance: and what a year it was. While the S&P 500 index finished the year unchanged, the same cannot be said of the year in corporate governance. A 2011 month-by-month timeline of the key markers in the ever-demanding and continually evolving practice of board leadership. Directors & Boards. Summer, 36(4), p.12. Lourenço et al. 2014. The Value Relevance of Reputation for Sustainability Leadership. Journal of Business Ethics, 119(1), pp.17-28. Roth, M. 2013. Independent directors, shareholder empowerment and long-termism: the transatlantic perspective. Fordham Journal of Corporate & Financial Law, 18(4), pp.751-820. Stout, L.A. 2012. The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public. New York: Berrett-Koehler Publishers. Read More