History
The first modern articulation that shareholder wealth creation is the paramount interest of the management of a company was published in Fortune magazine in 1962 in an article by the management of a US textile company, Indian Head Mills, whose history can be traced back to the 1820s. The article stated that:"The objective of our company is to increase the intrinsic value of our common stock. We are not in business to grow bigger for the sake of size, not to become more diversified, not to make the most or best of anything, not to provide jobs, have the most modern plants, the happiest customers, lead in new product development, or to achieve any other status which has no relation to the economic use of capital. Any or all of these may be, from time to time, a means to our objective, but means and ends must never be confused. We are in business solely to improve the inherent value of the common stockholders' equity in the company.[3]"
Economist Milton Friedman introduced the Friedman doctrine in a 1970 essay for The New York Times, entitled "A Friedman Doctrine: The Social Responsibility of Business Is to Increase Its Profits".[4] In it, he argued that a company has no social responsibility to the public or society; its only responsibility is to its shareholders.[5] The Friedman doctrine was amplified after the publication of an influential 1976 business paper by finance professors Michael C. Jensen and William Meckling, "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure", which provided a quantitative economic rationale for maximizing shareholder value.[6]
On August 12, 1981, Jack Welch made a speech at The Pierre Hotel in New York City called "Growing Fast in a Slow-Growth Economy", which is often acknowledged as the "dawn of the shareholder-value movement".[7] Welch did not mention the term "shareholder value", but outlined his beliefs in selling underperforming businesses and cutting costs to increase profits faster than global economic growth.[8] In the United Kingdom in 1983, Brian Pitman became CEO of Lloyds Bank and sought to clarify the governing objective for the company.[9] The following year, he set return on equity as the key measure of financial performance and set a target for every business within the bank to achieve a return that exceeded its cost of equity.[10]
The management consulting firms Stern Stewart,[11] Marakon Associates,[12][13] and Alcar pioneered value-based management (VBM), also known as managing for value (MFV), in the 1980s based on the academic work of Joel Stern, Dr. Bill Alberts, and Professor Alfred Rappaport.[14] In "Creating Shareholder Value: The New Standard for Business Performance", published in 1986, Rappaport argued that "the ultimate test of corporate strategy, indeed the only reliable measure, is whether it creates economic value for shareholders".[2] Other consulting firms including McKinsey and BCG developed VBM approaches.[15]
In March 2009, Welch criticized parts of the application of this concept, saying he never meant to suggest boosting a company's share price should be the main goal of executives.[8] He said managers and investors should not set share price increases as their overarching goal. He added that short-term profits should be allied with an increase in the long-term value of a company.[8] "On the face of it, shareholder value is the dumbest idea in the world," he said. "Shareholder value is a result, not a strategy . . . Your main constituencies are your employees, your customers and your products."[8] Welch later elaborated on this, clarifying that "my point is, increasing the value of your company in both the short and long term is an outcome of the implementation of successful strategies."[17]
Interpretation
During the 1970s, there was an economic crisis caused by stagflation. The stock market had been flat for nearly 12 years and inflation levels had reached double-digits. The Japanese had taken the top spot as the dominant force in auto and high technology manufacturing, a title historically held by American companies.[18] This, coupled with the economic changes noted by Mark Mizruchi and Howard Kimeldorf, brought about the question as to how to fix the current model of management. Though there were contending solutions to resolve these problems (e.g.Theodore Levitt's focus on customer value creation and R. Edward Feeman's stakeholder management framework),[19] the winner was the Agency Theory developed by Jensen and Meckling.
Mizruchi and Kimeldorf offer an explanation of the rise in prominence of institutional investors and securities analysts as a function of the changing political economy throughout the late 20th century. The crux of their argument is based upon one main idea. The rise in prominence of institutional investors can be credited to three significant forces, namely organized labor, the state and the banks. The roles of these three forces shifted, or were abdicated, in an effort to keep corporate abuse in check. However, "without the internal discipline provided by the banks and external discipline provided by the state and labor, the corporate world has been left to the professionals who have the ability to manipulate the vital information about corporate performance on which investors depend".
