In 2009 GE’s iconic CEO Jack Welch denounced shareholder value as a business objective in aninterview* in which he bluntly stated “on the face of it, shareholder value is the dumbest idea in the world”. Shareholder value initially posted impressive results in the 90’s but something was amiss and Ibelieve that aligning the increase of shareholder value as the sole objective of a business has resulted in real damage to investment in the American economy and innovation.
This revelation by Jack Welch came as surprise because he was the icon of shareholder value during the1990’s. At GE I attended countless finance meetings and training sessions where the objective of shareholder value was hammered home. So if according to Welch shareholder value is a dumb idea how was the concept able to captivate corporate business culture? In his book, Fixing the Game, Roger Martin traces the genesis of shareholder value theory to a paper published in the 1976 Journal of Financial Economics entitled “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” The concept was simple, offer business management equity as incentive compensation so their actions will be more closely aligned with, and reward, shareholders. This concept had intuitive logic and a somewhat altruistic appeal – pay for performance.
But a concept will remain a concept unless it receives promotion. In business there is a sideline legion of academics, consultants, human behaviorists and compensation experts ready to pounce on the next big thing – and get paid for it. If you print an idea enough times and get paid for talking about it at enough places the theory will take on its own momentum and eventually becomes knowledge. These agents of promotion created a Kool-Aid mix of shareholder value theory with equity participation and handed it out to HR departments, board members, stock analysts and of course corporate management. Equity- for-performance became the tip of the spear for shareholder value theory.
Shareholder value turned corporate strategy into a blunt instrument that resulted in cost cutting, financial engineering, wasteful mergers, production out-sourcing, debt fueled stock buy-backs, plant closing, use of non-GAAP measures, evaporating product/service quality, reduced innovation and R&D, etc. The real damage took place behind closed doors when equity-grants jumped over to include corporate directors. This compromise of corporate governance caused boards to lose objectivity and directly contributed to the corporate nuttiness that still continues today. What was left behind was the customer and employee, and ironically eventually investors, as corporate leadership cut expense budgets, searched for synergies and stopped investing.
* Forbes – FEB 5, 2015 Salesforce CEO Slams ‘The World’s Dumbest Idea’: Maximizing Shareholder Value