Praise for The Shareholder Value Myth “This book threatens to trigger an avalanche of new thinking about corporations. Written by one of the most respected theorists in corpo- rate governance, it takes aim at the smug ‘profi t-only’ complacency found in business schools and boardrooms. Anyone who reads it will be forced to think—and think again.” —Thomas Donaldson, Mark O. Winkelman Professor, The Wharton School, University of Pennsylvania “The only antidote to prevailing bad theory is calm, careful, plainspoken, and relentless argumentation that peels away the distracting layers of abstract mumbo jumbo to expose the lunacy of the underlying theory for all to see. Lynn Stout does the world a great favor in exposing shareholder value theory for what it is: fl awed and damaging theory. Comprehensive yet brief, profound yet enjoyable, this is a must-read for anyone who cares about the future of democratic capitalism.” —Roger Martin, Dean, Rotman School of Management, University of Toronto, and author of Fixing the Game “It is widely believed that corporations exist solely to maximize profi ts. It is also widely believed that this corporate purpose is prescribed by law. Lynn Stout shows that these infl uential beliefs are both wrong and very likely destructive.” —Ralph Gomory, Research Professor, New York University; President Emeritus, Alfred P. Sloan Foundation; and former Senior Vice President for Science and Technology, IBM Corporation “Professor Stout is a leader of a growing group of corporate executives, economists, lawyers, and thoughtful investors who have embraced the concept that corporations should, and indeed must, be managed in the interests of all their constituents. This book is a very read- able explanation of the adverse impact that ignoring the interests of all constituents and short-termism have had on not just employees, customers, suppliers, communities, and the economy as a whole but the very shareholders themselves.” —Martin Lipton, Senior Partner, Wachtell, Lipton, Rosen & Katz “Lynn Stout raises a critical question about American capitalism: what is the purpose of the public corporation? For too many years there has been an uncontested assertion that all that matters is creating shareholder wealth. This is an underlying cause of many of the ills facing American society, and this is therefore a critically important book!” —Jay Lorsch, Louis Kirstein Professor of Human Relations, Harvard Business School, and author of Back to the Drawing Board (with Colin B. Carter) and Pawns or Potentates “Lynn Stout presents a thoroughly researched and articulated case against shareholder value exclusivity. It serves the grand purpose of illuminating the debate in the hope of fi nding a reasoned result.” —Ira Millstein, Director, Columbia Law School and Columbia Business School Program on Global, Economic, and Regulatory Interdependence, and Theodore Nierenberg Adjunct Professor of Corporate Governance, Yale School of Management “Lynn Stout’s engaging book deals a knockout blow to the mantra of ‘shareholder value’ that has come to dominate corporate boardrooms in the last two decades. While she makes her case in a readable and entertaining way, her message is very serious: the obsession that the business community has with maximizing shareholder value is mak- ing US corporations weaker, not stronger.” —Dr. Margaret M. Blair, Professor of Law, Milton R. Underwood Chair in Free Enterprise, Vanderbilt University Law School “Lynn Stout kicks another brick off of the mantle of short-termism, showing again why choosing to myopically focus on short-term value not only can destroy longer-term performance but also is legally in- consistent with leading corporate governance principles, incentives, and actions that aspire to more sustainable value creation—over the long term and for all stakeholders, including shareholders.” —Dean Krehmeyer, Executive Director, Business Roundtable Institute for Corporate Ethics THE SHAREHOLDER VALUE MYTH How Putting Shareholders First Harms Investors, Corporations, and the Public LYNN STOUT The Shareholder Value Myth Copyright © 2012 by Lynn Stout All rights reserved. No part of this publication may be reproduced, distrib- uted, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior writ- ten permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission requests, write to the publisher, addressed “Attention: Permissions Coordinator,” at the address below. Berrett-Koehler Publishers, Inc. 235 Montgomery Street, Suite 650 San Francisco, California 94104-2916 Tel: (415) 288-0260, Fax: (415) 362-2512 www.bkconnection.com Ordering information for print editions Quantity sales.Special discounts are available on quantity purchases by cor- porations, associations, and others. For details, contact the “Special Sales Department” at the Berrett-Koehler address above. Individual sales.Berrett-Koehler publications are available through most bookstores. They can also be ordered directly from Berrett-Koehler: Tel: (800) 929-2929; Fax: (802) 864-7626; www.bkconnection.com Orders for college textbook/course adoption use.Please contact Berrett- Koehler: Tel:(800) 929-2929; Fax: (802) 864-7626. Orders by U.S. trade bookstores and wholesalers.Please contact Ingram Publisher Services, Tel: (800) 509-4887; Fax: (800) 838-1149; E-mail: customer .service@ingram publisher services .com; or visit www .ingram publisher services .com/ Ordering for details about electronic ordering. Berrett-Koehler and the BK logo are registered trademarks of Berrett-Koehler Publishers,Inc. First Edition Paperback print edition ISBN 978-1-60509-813-5 PDF e-book ISBN 978-1-60509-815-9 IDPF e-book ISBN 978-1-60509-816-6 2012-1 Cover design: Nicole Hayward Project management: Lisa Crowder, Adept Content Solutions, Urbana, IL Full-service book production: Adept Content Solutions, Urbana, IL Contents Preface v INTRODUCTION: “THE DUMBEST IDEA IN THE WORLD” 1 PART I: DEBUNKING THE SHAREHOLDER VALUE MYTH 13 Chapter One The Rise of Shareholder Value Thinking 15 Chapter Two How Shareholder Primacy Gets Corporate Law Wrong 24 Chapter Three How Shareholder Primacy Gets Corporate Economics Wrong 33 Chapter Four How Shareholder Primacy Gets the Empirical Evidence Wrong 47 PART II: WHAT DO SHAREHOLDERS REALLY VALUE? 61 Chapter Five Short-Term Speculators versus Long-Term Investors 63 Chapter Six Keeping Promises to Build Successful Companies 74 Chapter Seven Hedge Funds versus Universal Investors 86 Chapter Eight Making Room for Shareholder Conscience 95 CONCLUSION: “SLAVES OF SOME DEFUNCT ECONOMIST” 103 Notes 117 Index 129 About the Author 133 iii This page intentionally left blank Preface Back when I was a law school student in the early 1980s, my professors taught me that shareholders “own” corporations and that the purpose of corporations is to “maximize share- holder value.” I was just out of college at the time and not very familiar with the business world, so this made sense enough to me. When I first began lecturing and writing in business law myself, I incorporated the shareholder value thinking that I had been taught into my own teaching and scholarship. It soon became apparent to me there was a problem with this approach. The more I read business law cases, the more obvious it became that U.S. corporate law does not, in fact, require corporations to maximize either share price or share- holder wealth. My first reaction was puzzlement and frus- tration. Shareholder value thinking was almost uniformly accepted by experts in law, finance, and management. Why then, I asked myself, wasn’t it required by the actual rules of corporate law? In 1995, I spent some time as a guest scholar at the Brookings Institution in Washington, D.C. While there I was lucky enough to get to know Margaret Blair, an economist also interested in corporations. Blair offered a novel answer to my question: maybe corporate law was right and the experts were wrong. Maybe there were good reasons why corporate directors were not required to maximize shareholder value. That conversation with Blair began my nearly two decades of investigation into the question of corporate purpose. My sense that something was wrong with shareholder value thinking was only heightened when Enron, a firm obsessed with rais- ing its share price and a supposed paragon of “good corporate governance,” collapsed in fraud and scandal in 2000. v vi Preface Writing both alone and with Blair, I published articles on the question of corporate purpose and sought out the work of other academics willing to question the theoretical and empirical validity of “shareholder primacy.” Meanwhile, I was becoming involved in the business world myself as an advisor to and a director of profit and nonprofit organizations. I took every opportunity to ask the business executives, corporate lawyers, and individual and institutional investors I dealt with how they thought corporations really worked. The more I listened to their answers, the more I grew to suspect that “maximize shareholder value” is an incoherent and counter- productive business objective. Put bluntly, conventional shareholder value thinking is a mistake for most firms—and a big mistake at that. Shareholder value thinking causes corporate managers to focus myopi- cally on short-term earnings reports at the expense of long- term performance; discourages investment and innovation; harms employees, customers, and communities; and causes companies to indulge in reckless, sociopathic, and socially ir- responsible behaviors. It threatens the welfare of consumers, employees, communities, and investors alike. This book explains why. It is written to be of use for law and business experts, but it is also written to be understood by ex- ecutives, investors, and informed laypersons—indeed anyone who wants to understand why corporations do what they do, and how we can help corporations do better. Although it would be near-impossible for me to thank ev- eryone who generously gave me ideas, suggestions, or support as I wrote this book, I would like to acknowledge the special contributions and inspiration provided by Ralph Gomory and Gail Pesyna at the Sloan Foundation; Judy Samuelson at the Aspen Institute; and Steve Piersanti and the wonderful staff at Berrett-Koehler. This is their book as well. Lynn Stout February 2012 I N T R O D U C T I O N “The Dumbest Idea in the World” The Deepwater Horizon was an oil drilling rig, a massive float- ing structure that cost more than a third of a billion dollars to build and measured the length of a football field from bottom to top. On the night of April 20, 2010, the Deepwater Horizon was working in the Gulf of Mexico, finishing an exploratory well named Macondo for the corporation BP. Suddenly the rig was rocked by a loud explosion. Within minutes the Deepwater Horizon was transformed into a column of fire that burned for nearly two days before collapsing into the depths of the Gulf of Mexico. Meanwhile, the Macondo well began vomit- ing tens of thousands of barrels of oil daily from beneath the sea floor into the Gulf waters. By the time the well was capped in September 2010, the Macondo well blowout was estimated to have caused the largest offshore oil spill in history.1 The Deepwater Horizon disaster was tragedy on an epic scale, not only for the rig and the eleven people who died on it, but also for the corporation BP. By June of 2010, BP had suspended paying its regular dividends, and BP common stock (trading around $60 before the spill) had plunged to less than $30 per share. The result was a decline in BP’s total stock market value amounting to nearly $100 billion. BP’s shareholders were not the only ones to suffer. The value of BP bonds tanked as BP’s credit rating was cut from a prestigious AA to the near-junk status BBB. Other oil companies working in the Gulf were idled, along with BP, due to a government- 1