The Myth of Shareholder Value - Essay Example

The Myth of Shareholder value The basic argument in Bebcheck’s article is that despite the purported belief that shareholders have the power to replace directors through a democratic vote, it is not the case in practice. In order to support this contention, he has cited empirical research carried out over the past ten years which suggests that the number of challenges to incumbent directors of U.S. corporations have been very small; a practice which has fostered director complacency and could be leading to corporate performance that is below par. Thus, he argues that the present system should be reformed and shareholders should be allowed the power to vote directors out. He offers the following evidence to support his contention that making boards more accountable by improving the election procedures could contribute towards an increase in shareholder value. Firstly, proxy contests generally appear to be followed up with an increase in shareholder value. Secondly, when incumbent directors in public corporations are protected from replacement through a restriction on take over bids, this produces a concomitant managerial slack, which leads to reduced profits, sales growth and poorer operating performance. Thirdly, acquisitions and mergers made by such companies where directors are insulated from take over are also likely to be of the value decreasing kind. When anti take over measures are in place, CEO’s are less sensitive to the firm’s performance and there is a reduction in the firm’s value. Lipton and Savitt (2007) have refuted Bebcheck’s contention that reforms to the corporate electoral process are necessary. They contend that Bebcheck’s argument that the fear of replacement is necessary before directors can be motivated enough to ensure good firm performance is basically flawed, because the force driving this argument also mandates expensive proxy processes which supposedly are necessary when they may not actually be. On an overall basis, the rebuttal offered by these authors appears to stand on better ground than the original arguments proposed by Bebchuck. As they point out, the system that is currently in place has existed for many years and have given rise to a very successful U.S. economy. It could be argued that one of the reasons why Bebchuck has proposed reforms to the electoral processes is supposedly to ensure a better performance from directors so that there is better firm performance through less waste and a more efficient utilization of resources. But the process that he has recommended to improve the performance of directors by placing upon them the threat of being replaced in fact gives rise to a much more expensive proxy process. The crux of the rebuttal offered by Lipton and Savitt (2007) is that a transfer of power from the directors of the firm to the shareholders may not necessarily be a good corporate management technique. Through his reform proposals, Bebcheck is in effect, proposing that there should be a transfer of the existing balance of power into the hands of the shareholders of a corporation, because it is only when the shareholders have the power to vote the directors out that the fear of dismissal would make them perform better. They have in effect, argued that a known devil is better than an unknown one. Lipton and Savitt (2007) argue that what Bebcheck is proposing is an untried system for which the outcomes cannot be guaranteed and for which no empirical evidence exists. The system which is in place however, is one that has been proved over the years to be one that has led to a successful U.S. economy, and has been tried and tested. They systematically desiccate Bebcheck’s arguments by attacking the very core of Bebcheck’s argument, i.e., the myth of shareholder value, or that improving it would require disciplining of the directors. They contend that it is not a myth at all, because it has successfully been able to perform its designated role. Moreover, the authors also contend that Bebcheck has ignored the potentially negative consequences of his proposal. For one, it could result in a disruption of corporate management practices. Bebcheck has stated that despite reform measures, contested elections may not be that frequent and when they are, the price would be worth paying because it could improve corporate governance measures. But Lipton and Savitt (2007) have provided a better argument, because they point out that the alleged benefits Bebcheck claims are not borne out through any statistical evidence of dollars expensed and the management distractions that could occur as a consequence of the reforms he proposes. The benefits he has alleged in order to justify the costs that would be incurred are therefore unsubstantiated. According to Lipton and Savitt (2007), Bebcheck’s proposals to improve shareholder value, if implemented, would in effect empower special interest groups rather than shareholders as a whole. Their argument that those shareholder groups that have a larger representation on the board are likely to have disproportionate levels of power is valid, especially because the special interests of such groups may not necessarily be aligned with the broader interests of the corporation. Unlike directors who have a legal responsibility to act in the broader interests of the corporation as whole, special interest groups of shareholders have no such legal or moral obligation to the corporation. While Directors work to carry on the business of the corporation and make decisions in a manner that is likely to enhance corporate profits, special interest shareholders may be motivated more by their own selfish, mercenary interests to the detriment of the corporation. As these authors point out, while it may be contended that their electoral voting share may be limited, it may nevertheless be quite adequate to satisfy the thirty three percent threshold requirement under Bebcheck’s proposals for reimbursement. Hence, there is no guarantee that Bebcheck’s proposals for reform would actually increase the broader shareholder value of the corporation. It may in fact be a less efficient method to promote the corporation’s interests as compared to the existing system. In conclusion, when comparing Bebcheck’s arguments and the rebuttal that has been offered by Lipton and Savitt, the latter have offered a stronger argument. The very basis of Bebcheck’s argument that shareholder value will be enhanced and the interests of the corporation advanced despite the higher costs it may entail, have been demolished and his proposals are demonstrated to be founded on untenable myths. At the outset, most of Bebcheck’s proposals are unsubstantiated with statistical data or evidence. Secondly, his proposals are untested and attempt to change a system that has been in existence for many years and proved beneficial to the U.S. economy. The basis upon which Bebcheck contends that reforms to the voting are necessary are also unfounded, because the low incidence of proxy voting does not necessarily indicate that there is anything wrong with the existing system. In effect, Bebcheck appears to be suggesting that it’s only when directors are faced with the potential threat of dismissal that they’re likely to be effective, but he fails to justify the expenses for the reforms he proposes on the basis of this reason. Hence, the arguments against Bebcheck’s proposals are better supported. References *Lipton, Martin and Savitt, William, 2007. “The many myths of Lucian Bebchuk”, Virginia Law Review, 93: 333 Read More