The Legal Case Against Shareholder CapitalismIn Steve denning’s article in Forbes last October, he explained why the idea ...
“The era of managerial supremacy was not that successful then and would be more catastrophicnow,” says Nell Minow, a stand...
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The Legal Case Against Shareholder Capitalism


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  • It is indeed an interesting article. However, The Balanced Scorecard Approach may be the remedy here. The holistic view of an enterprise has to be taken. The business belongs to shareholders, in multiple forms (individuals, government, FIIs, Banks, NBFCs, et al). The value is to be provided to the customer for maximisation (optimisation may be a better word) of wealth to the shareholders. However, the interests of the stakeholders (most importantly society, government, mother earth) has to be carefully guarded).

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The Legal Case Against Shareholder Capitalism

  1. 1. The Legal Case Against Shareholder CapitalismIn Steve denning’s article in Forbes last October, he explained why the idea of maximizingshareholder value, despite being pervasive in the business world and academia, is, as even JackWelch admits, “the dumbest idea in the world”. It has led to the very opposite of what was intended.It has systematically destroyed actual shareholder value and morphed into something quite different:C-suite Capitalism, in which companies are being run principally for the benefit of the C-Suite,creating in the process a massive financial incentives bubble.Now a law professor, Lynn Stout, has weighed in with her book, The Shareholder Value Myth. Sheargues that shareholder value is not only dumb and counter-productive: it’s legally unsound.Read on to see why. If you need help with Creating Value and Leadership, contact Customer ValueFoundationGautam Mahajan, President-Customer ValueFoundationAs Jesse Eisinger at ProPublica writesAs Ms. Stout explains, what the law actually says is that shareholders are more like contractors,similar to debt-holders, employees and suppliers. Directors are not obligated to give them any and allprofits, but may allocate the money in the best way they see fit. They may want to pay employeesmore or invest in research. Courts allow boards of directors leeway to use their own judgments. Thelaw gives shareholders special consideration only during takeovers and in bankruptcy. In bankruptcy,shareholders become the “residual claimants” who get what’s left over.A return to ‘managerialism’Professor Stout’s book has a good description of the legal basis of the problem but is on less strongground when it comes to solutions. She calls for a return to “managerialism,” where executives andboards of directors run companies without being preoccupied with shareholder value. Companieswould be freed up to think about their customers, their employees and even start acting moresocially responsible.Here she misses the point that the theory of shareholder capitalism has morphed into somethingquite different in practice: C-Suite capitalism, in which the firm is run to a large extent for the benefitof the C-suite and financial intermediaries, resulting in a massive financial incentives bubble, asdescribed in an article by Professor Mihir Desai, the Mizuho Financial Group Professor of Finance atHarvard Business School in the April issue of Harvard Business Review.Merely freeing the C-suite from any need to give special consideration to shareholders would be likethrowing kerosene on a raging fire. It would simply blow the financial incentives bubble even bigger.If anything, the voice of shareholders needs to be strengthened, not weakened. As Jesse Eisengerwrites:
  2. 2. “The era of managerial supremacy was not that successful then and would be more catastrophicnow,” says Nell Minow, a standard bearer of the corporate governance movement. “The idea ofspeaking of shareholders as owners is absolutely crucial.”She contends that the idea that shareholders wield too much power is laughable. Shareholders haveincreasingly been voting against directors only to see them reappointed. Recently, shareholders at ahandful of companies have voted the majority of shares against the pay packages of chiefexecutives — and have been ignored.Professor Stout’s book is concerned about reining in excessive executive compensation butweakening shareholder influence is hardly the way to go about it.The book argues that the C-suite should get salaries and then bonuses for after-the-factperformance. But this begs answer the question: what is performance? The concept of“managerialism,” is a vague concoction of interests, where executives and boards of directors payattention to shareholder value, customers, employees and social concerns.Even today, most CEOs already say that “our customers are number one, and “employees are ourmost important asset” and “we are committed to being good corporate citizens” and “our firm iscommitted to environmental sustainability”. And yet everyone in those firms knows that when itcomes to the crunch, what really matters in these firms is the short-term profits. Even though themanagement talks about multiple goals, it actually has a de facto single bottom line.Professor Stout’s book misses the fundamental point that we have passed into an era of CustomerCapitalism. Starting from Peter Drucker’s 1973 insight that “the only valid purpose of a firm is tocreate a customer,” firms are now facing a marketplace of intense global competition where theInternet has shifted power has shifted from seller to buyer. The result is that the true bottom line oftoday’s corporations is whether it is delighting its customers by providing a continuous stream ofadditional value and delivering it sooner.A business argument, not just an appeal to altruismThe most powerful case for fundamental change from the doctrine of shareholder value comes, notfrom appeals to altruism, which are unlikely to have much impact, but rather from the business case:the shift from shareholder capitalism to customer capitalism makes a lot more money for the firm, theshareholders, the employees and everyone else.Contact us for more help.Gautam MahajanPresidentCustomer Value FoundationK-185 Sarai Jullena, New Delhi 110025+91 98100 60368, 011-26831226Email: mahajan.g@customervaluefoundation.comWebsite: