The Basic Corporate Error Of Maximizing Shareholder Returns

Chief executives typically look to improve the fortunes of a company and returns to shareholders. Many take to heart the argument Milton Friedman made in a 1970 New York Times op-ed that the “social responsibility of business is to increase its profits.” That has been further interpreted as meaning the responsibility to maximize return on investment to shareholders.

The presumption has become the foundation of many arguments of what businesses should do, the degree of legal constraints that ought to be taken removed from their behavior,

This is both legally incorrect and strategically troubling and mistaken.

The Legal Fallacy Of Shareholder Primacy

Experts in corporate governance have, across many years, tried to find a legal basis for the prescription. It has yet to appear. In the 2014 Supreme Court decision in “Burwell, Secretary of Health and Huma Services, et. al. v. Hobby Lobby Stores,” the Court addressed whether a for-profit corporation could give money to religious causes. “While it is certainly true that a central objective of for-profit corporations is to make money, modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not do so,” Justice Samuel Alito wrote for the Court.

Corporate law and governance also recognize that a company’s board and executives have duties to the company

Are shareholders legally important in a corporate structure? Absolutely. They have rights and corporate law ensures them. The corporation has duties. Harvard Business School Professor Nien-hê Hsieh explains the concept of fiduciary duties to shareholders in an online course. “Rather than require specific outcomes–such as achieving maximum share price–fiduciary duties are largely about conduct, process, and motivation,” she wrote.

A company has the responsibility to provide relevant information about corporate performance, to act in good faith, to act with diligence and prudence. Corporate managers and boards are charged with strategy and operations for the company’s benefit, shareholder’s benefit being an offshoot just as profit is a result of intelligent business operation that makes customers happy.

The Broader Responsibilities Of Corporations

In basic calculus, math students learn that you cannot maximize for more than one variable at a time. That doesn’t mean one factor cannot benefit while another does as well. However, the definition of maximization means that one thing requires precedence over others. Something has to come first; everything becomes subject to that desire.

The tenet of shareholder interest maximization would require managers and boards to do things that were detrimental to the success of the company. They would need to consider shortchanging workers, business partners, and customers. Every decision would be based on how to extract more value from every source — actions that would ultimately turn every broader concept of stakeholder into enemies. Many of the best potential employees, partners, and customers would go elsewhere, a terrible outcome for a business.

The Great Irony Of Shareholder Value

The maximization tenet also assumes that every shareholder has identical interests. This is far from true. It is perfectly possible for a company to have shareholders that vary widely in their investment strategies, like a Warren Buffett looking to hold shares for a long time and see the company develop, and a Carl Icahn who would be comfortable splitting a company up into parts and selling them off to get a quicker return.

That’s the irony of maximizing shareholder value, because it’s impossible. Shareholders have different outlooks, want their investments to do different things, expect increased value through different ways.

Why spend time defending and using something that makes no logical or legal sense?