Many Americans are confused by the concept of maximization of shareholder value. To some, it connotes enrichment of the wealthy. To others, it implies that corporate executives only care about stockholders and not their other constituencies. This essay will explore the true meaning of the term and attempt to prove that it is a legitimate objective beneficial to all interested parties.
Corporations are established to provide services and products and earn a profit from their business activities. Profitability is critical to the long-term survival of a company and security of its workers. Therefore, management, overseen by a board of directors, is responsible for taking actions that result in higher earnings. Corporations that do not manage costs, employee compensation, tax liabilities, etc. do not succeed.
Investors become impatient with management when strategies and tactics do not yield expected returns. This contingency will likely create havoc at the company and may in fact lead to executive changes.
The ultimate measurement of corporate success is net profits after taxes. The line items that determine the “bottom line” are numerous. They begin with revenues/sales. A company must sell to create profits. Management must find the least expensive sources of manpower and raw materials to bring down the highest amount to bottom line profits. Often times, this necessitates actions that populists consider un-American. Included are outsourcing overseas, headcount reductions and creative tax accounting to minimize payments to the government.
And so, it puzzles me greatly when the left becomes overly critical of logical decisions by businessmen to improve their operations. The politically incorrect response to critics is that the company exists for the benefit of its shareholders. This is technically true, but harmony between management, workers, customers and suppliers is critical to maximization of profits. So, management must always consider the global ramifications of decisions to lay off workers and move facilities.
Management that is unprepared to make tough decisions in these regards will have a short tenure. Moreover, an inability to respond to changing times that may involve increased costs of raw materials, union demands, increased regulation and so on will ultimately result in management upheaval.
Another trite concept is aligning management’s compensation with stockholders. It is an inane concept because it is axiomatic. A compensation package that rewards management when it makes bad decisions is inappropriate. This does not mean that aligning management properly is an easy task. The most pathetic situations are those perpetuated by government bureaucrats, including the president and Congress. Their theories about compensation are usually unfounded and destructive to the capitalist system.
A corporation’s stock prices increases over time when the business grows and earns more profits. If the investment community deems its growth rate low, its stock price will fall or underperform. This could be a function of not delivering what was promised or not being able to match the performance of competitors. Stock analysts follow most listed companies and will opine every quarter about the corporate performance. This will inevitably impact the price of stock, and so management carefully monitors these reports.
It is important to recognize that the overall market also affects stock prices. If investor sentiment is negative, short-term stock movements may not reflect successful business performance by individual companies.
When a company is successful in terms of growth and profits, its stock price will increase. How does this impact society? Are stocks only a convenient way for investors to gamble — a sophisticated — casino, if you will? Or, are they a legitimate investment vehicle that supports commerce.
My answer is that successful companies create wealth for stockholders who are loyal. These include management, employees (who purchase stock with 401Ks and the like) and hundreds of money managers responsible for pensions, retirement funds, not-for-profit entities, universities, etc.
Moreover, employees benefit by having jobs that pay well and provide security to their families. Communities with successful companies benefit too. They receive tax payments and increased commerce. And the list goes on.
In summary, a well-run, successful, profitable company is a windfall to many interested parties. Profits and shareholder satisfaction are critical because without them, even a good company will not be able to finance itself for the long-term.