![]() ![]() ![]() Wealthy shareholder Gordon Gekko (played by Michael Douglas) addresses other stockholders at a shareholder meeting of the fictional firm Teldar Paper: “And you can’t assume that firms maximize profits.”ĬEOs feathering their own nests: For those who recall the 1980s, the 1987 blockbuster film “Wall Street” captured that in a famous scene. “You can’t ignore the self-interest of everybody that’s involved,” Jensen said. In “Theory of the Firm,” he and co-author William Meckling argued that corporate shareholders were shortchanged by corporate managers seeking perks. Jensen went on to co-author the often-cited business paper. “We saw enormous amounts of waste going on,” said economist Michael Jensen, a former University of Chicago student of Friedman’s now retired in Sarasota, Florida. In their eyes, the model was inefficient - and unfair to shareholders. “We just didn’t see the seams starting to come apart until the late ’60s and early ’70s.”įriedman and his University of Chicago free-market colleagues argued that corporations were taking on too many “social responsibilities”: providing jobs, helping to fight pollution and reducing discrimination in society. “Many companies had gotten fat and lazy during the ‘golden age of American business,’” Wartzman said. The downturn exposed American companies as uncompetitive in an increasingly global environment. Throughout the decade of the ’70s, the old postwar business model was crumbling under pressure from inflation and weak growth. But most famously it was stagflation.’” This was a new idea that began to take root. ![]() “Some called it slumpflation,” said Rick Wartzman of the Drucker Institute and author of “The End of Loyalty.” “’Inflump’ was another one that circulated. Profits for whom? For shareholders, Friedman wrote. “There is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits.” At the University of Chicago, economist Milton Friedman (who would later win the Nobel Prize) wrote this in the New York Times Magazine in 1970: That’s the job of a corporation.īut companies have not always seen themselves as serving stockholders first. A more responsible business is now considered to be one that allows increased expenses in the areas just noted in order to be a better partner to employees, customers, and local authorities.We’re revisiting a story originally published in June 2016.ĬEOs say it all the time: They have a responsibility to “maximize shareholder value.” Fund managers say it too: CEOs have a responsibility to maximize profits for shareholders. These issues have led to an increasing outcry against an excessively tight focus on shareholder value. This additional level of leverage can increase earnings per share, but puts an organization at risk of not being able to pay back loans if there is an economic decline. Yet another possible outcome is an increased use of debt instead of equity. Further, they might engage in tax management ploys to pay less than the company’s fair share of taxes.Īnother offshoot of a tight focus on shareholder value is an increased risk of financial reporting fraud, as managers are more likely to be tempted to falsely report optimistic results in order to further increase the share price. Management might also engage in environmentally unfriendly activities, such as dumping hazardous waste irresponsibly. Another possibility is outsourcing to low-wage locations, which may drive work away from the home country. They might force down compensation levels, leading to an increased amount of employee turnover. For example, management might drive down costs to an excessive extent, which can result in shoddy products. Problems with Shareholder ValueĪn excessive focus on shareholder value can lead to adverse outcomes in a number of areas, because management wants to reduce costs. Shareholder value is a core concept of business management, which drives the need to continually increase cash flow over the long term. Increased sales and profits can increase the share price, while increased free cash flow is used to either pay dividends to investors or further expand the business, which in turn may increase the market value of their shares. Shareholder value can be generated by increasing sales, profits, and/or the amount of free cash flow. Shareholder value is the increased worth generated by a business for its shareholders. ![]()
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