1. The Legal Case Against Shareholder Capitalism
In Steve denning’s article in Forbes last October, he explained why the idea of maximizing
shareholder value, despite being pervasive in the business world and academia, is, as even Jack
Welch 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. She
argues 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 Value
Foundation
Gautam Mahajan, President-Customer Value
Foundation
As Jesse Eisinger at ProPublica writes
As 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 all
profits, but may allocate the money in the best way they see fit. They may want to pay employees
more or invest in research. Courts allow boards of directors leeway to use their own judgments. The
law 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 strong
ground when it comes to solutions. She calls for a return to “managerialism,” where executives and
boards of directors run companies without being preoccupied with shareholder value. Companies
would be freed up to think about their customers, their employees and even start acting more
socially responsible.
Here she misses the point that the theory of shareholder capitalism has morphed into something
quite different in practice: C-Suite capitalism, in which the firm is run to a large extent for the benefit
of the C-suite and financial intermediaries, resulting in a massive financial incentives bubble, as
described in an article by Professor Mihir Desai, the Mizuho Financial Group Professor of Finance at
Harvard 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 like
throwing 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 Eisenger
writes:

2. “The era of managerial supremacy was not that successful then and would be more catastrophic
now,” says Nell Minow, a standard bearer of the corporate governance movement. “The idea of
speaking of shareholders as owners is absolutely crucial.”
She contends that the idea that shareholders wield too much power is laughable. Shareholders have
increasingly been voting against directors only to see them reappointed. Recently, shareholders at a
handful of companies have voted the majority of shares against the pay packages of chief
executives — and have been ignored.
Professor Stout’s book is concerned about reining in excessive executive compensation but
weakening 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-fact
performance. 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 pay
attention to shareholder value, customers, employees and social concerns.
Even today, most CEOs already say that “our customers are number one, and “employees are our
most important asset” and “we are committed to being good corporate citizens” and “our firm is
committed to environmental sustainability”. And yet everyone in those firms knows that when it
comes to the crunch, what really matters in these firms is the short-term profits. Even though the
management 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 Customer
Capitalism. Starting from Peter Drucker’s 1973 insight that “the only valid purpose of a firm is to
create a customer,” firms are now facing a marketplace of intense global competition where the
Internet has shifted power has shifted from seller to buyer. The result is that the true bottom line of
today’s corporations is whether it is delighting its customers by providing a continuous stream of
additional value and delivering it sooner.
A business argument, not just an appeal to altruism
The most powerful case for fundamental change from the doctrine of shareholder value comes, not
from 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, the
shareholders, the employees and everyone else.
Contact us for more help.
Gautam Mahajan
President
Customer Value Foundation
K-185 Sarai Jullena, New Delhi 110025
+91 98100 60368, 011-26831226
Email: mahajan.g@customervaluefoundation.com
Website: www.customervaluefoundation.com