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John Engle
John Engle
Articles (408) 

Beware Companies That Do Not Believe in Maximizing Shareholder Value

The Business Roundtable says companies must serve all stakeholders; value investors should be skeptical

August 25, 2019 | About:

Maximizing shareholder value has been the defining feature of public company management principles for decades. Obviously, this so called value-based management model is not always implemented by companies in practice, but it has been seen as the aspirational goal lauded by academics and business leaders alike.

Despite decades of preeminence, value-based management is now under threat. Indeed, its latest formidable opponent, somewhat astonishingly, is the Business Roundtable.

The rise of value-based management

Value-based management theory has been around for a long time, but it achieved preeminence in the 1980s thanks to activist investors and buyout firms pushing managers of public companies to put shareholders first, instead of feathering their own nests. In 1997, the Business Roundtable, a group of top executives from across a host of industries, gave its official imprimatur to the principle, and it has gradually become the most widely taught, understood and accepted model of business management.

This view of the shareholder-as-owner is perhaps still best exemplified by the management style and philosophy of Warren Buffett (Trades, Portfolio), who has deployed it to great effect across Berkshire Hathaway (BRK.A)(BRK.B)'s sprawling business empire. The doyen of value investing writes his shareholder letters in the voice of a manager speaking to owners, since that is what the Oracle of Omaha has always considered Berkshire’s investors to be.

Big Business repudiates value-based management

After decades of dominance, it appears the era of value-based management may be at an end, at least if the top brass at the Business Roundtable get their way. On Aug. 19, the group issued a statement penned by its current head, JPMorgan (NYSE:JPM) CEO Jamie Dimon:

“While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders. Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity.”

Dimon’s statement was signed by 181 Business Roundtable members, including such heavyweights as Jeff Bezos of Amazon.com Inc. (NASDAQ:AMZN) and Goldman Sachs (NYSE:GS) boss David M. Solomon. In essence, the Business Roundtable has declared that maximizing shareholder value should no longer be seen as the sole purpose of a company. Instead, they must consider all stakeholders: investors, employees and society as a whole.

Everything is political

Dimon has been a leading figure among business leaders who in recent years have argued that companies can no longer be apolitical value-creating machines. Instead, customers, citizens and even employees now demand that businesses take stands on a host of issues. The JPMorgan chief has said as much in a letter to shareholders:

“In the past, boards and advisers to boards advised company CEOs to keep their head down and stay out of the line of fire. Now the opposite may be true. If companies and CEOs do not get involved in public-policy issues, making progress on all these problems may be more difficult.”

Dimon has been pushing other top executives to follow his lead in taking stands on sensitive topics once thought to be outside the realm of business. Evidently, his admonitions have begun to have their intended effect.

A response to critics

Criticism of companies seemingly aiming to enrich themselves and their shareholders at the expense of employees and communities has been growing in recent years. As Bloomberg recently reported, the Business Roundtable’s rejection of the value-based management model makes a degree of sense in the context of the present political zeitgeist:

“The concept has been criticized for leading to a fixation on short-term results and helping fuel the rapid increase in executive pay. Last year, public companies in the U.S. began disclosing the difference between their CEOs’ compensation and that of their median workers. At S&P 500 firms, the average ratio is about 280-to-1, according to data compiled by Bloomberg.”

Evidently, the Business Roundtable thinks that the only way to address these issues is to change the model itself. However, the group’s statement is heavy on ambition, but rather light on implementation.

Missing the point

A major problem with the Business Roundtable’s newfound disregard for value-based management is that it comes in response to criticism that is fundamentally off the mark.

Attacks on executive compensation, quarterly earnings and short-term thinking can be justified, but they hardly fit into the principles espoused by value-based management. Indeed, the whole idea is to limit management’s ability to enrich itself at the expense of shareholders.

Taking political stands or making wooly statements about considering all stakeholders hardly addresses the root of that criticism. Rather, it is a problem with executive compensation. If anything, a greater attention to maximizing long-term shareholder value would do away with some of these supposed problems.

Verdict

This move by some of the world’s top executives may, if actually implemented, mark a critical turning point in the behavior of public companies. The very idea that a company must address all stakeholders, apparently at the expense of its actual owners (i.e., the shareholders) is suspect. Indeed, it is far more likely that a company that can justify its actions on grounds other than shareholder value creation (especially if those justifications are wooly, abstract and difficult to measure) will use such justifications as pretense for inefficient uses of capital.

Overall, value-oriented investors should look askance at managers who claim to answer to a higher power, or serve a greater master, than their shareholders. Such managerial behavior is far more likely to create opportunities for abuse. While not likely to affect company behavior all that much in the relative short-term, investors should remain vigilant.

Companies that serve all stakeholders are, definitionally, companies that do not serve their shareholders to their best ability. That alone may one day justify avoiding such stocks as investments.

Disclosure: No positions.

About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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