Shareholder value: world's dumbest idea

The idea that companies exist solely to produce shareholder value can be traced to a 1970 editorial by Milton Friedman. Writing in Forbes, Steve Denning calls this The World’s Dumbest Idea, and gives pretty comprehensive evidence to support that notion: "As often happens with bad ideas that make some people a lot of money, shareholder… READ THE REST

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Bob: Did I do something illegal?

Gilbert Huph: [begrudgingly] No.

Bob: Are you saying we shouldn’t help our customers?

Gilbert Huph: [pacing back and forth] The law requires that I answer no.

Bob: We’re supposed to help people!

Gilbert Huph: We’re supposed to help our people! Starting with our stockholders, Bob! Who’s helping them out, Huh?

The Incredibles


I think there are a lot more dumber (dumbmerer-er?) ideas out there than this one, but shareholder value is an incredibly tenacious and destructive dumb idea.

There seems to be a basic logic to making CEOs take their compensation in stock, since they’d presumably have an incentive to run the firm wisely. But they have every incentive to warp the rules to their advantage. If you’re in just the right position you can make out like a bandit, leaving ordinary stockholders and employees screwed.

Golden parachutes need a remote destruct device.


That’s the thing- the idea of maximizing share valuation isn’t dumb enough to draw ridicule, or dumb enough to fail strictly on its own merit (or lack). It’s appealing enough that the supporters can dismiss the rest as naysayers or haters.

Feh, not the example I’d use. Both Mr. Incredible and Huph then look like tools, just for different reasons. For that matter, pretty much everyone in that movie has at least some turn as a tool.

It also has the advantage of extreme simplicity. Ethics is hard, until you reduce it to one dimension. Kind of like how the Laffer Curve is so much easier to explain than Keynes. That doesn’t make it right, but it sure does make it popular.

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Dr. Deming addressed this fallacy a few decades ago - it takes executives quite a long time to learn. The aim proposed here for any organization is for everybody to gain – stockholders, employees, suppliers, customers, community, the environment – over the long term." page 51 of the The New Economics.

Many companies manage more based on this idea than the foolish idea of “shareholder value.” But there are quite a few executives that seek to use “shareholder value” as an excuse for bad practices they chose to support.

The idea that companies exist solely to produce shareholder value can be traced to a 1970 editorial by Milton Friedman.

Not really. The classic example cited for the shareholder primacy norm dates to 1919, when the Michigan Supreme Court held that it was illegal for Ford Motor Company to pay its workers guaranteed wages and benefits, when the money spent on the proposed entitlements could instead be used to pay a dividend to shareholders (in this case, the Dodge brothers, who were minority shareholders of Ford). “a business corporation is organized and carried on primarily for the the profit of the stockholders. The powers of the directors are to be employed to that end.” Dodge v. Ford, 204 Mich. 459, 170 N.W. 668. (Mich. 1919) (wikipedia summary).

Many have argued against using Dodge v. Ford for this precedent. The above quote was merely dicta, probably overreaching dicta at that, and Ford at the time was not a publicly-traded corporation, but a closely-held company.

Nevertheless, the case is frequently cited as establishing shareholder primacy, and is clear evidence that the idea is is closer to 100 years old than it is to 40.

I’ve no doubt that Friedman picked it up and ran with it, as served his interests.


The logical reason why shareholder value is paramount is due to the structure of the financial statements, in which shareholder value directly increases corporate net-worth (or more accurately, net assets) while Labor detracts from net worth, since labor is an expense (as opposed to capital investment). Furthermore, the customers are not paramount because pleasing customers is an expensive gamble, as so many failed marketing campaigns attest. Perhaps the FASB, the accounting standard-setting body in the US, should consider requiring companies to treat employee welfare & training as assets, which would positively reflect their balance sheets.

The idea behind stock used to be medium- to long-term investment – buying a share of the company and taking a share of its profits as dividends and of its growth in the market (which would be reflected in relatively slow stock price increase).

These days, people have instead been sold on the market at a pure gambling game, and want to get the money instantly. Which all too easily leads to an emphasis on stock price at the expense of actually looking after the best interests of the business.

Not healthy for the businesses, or for the economy. Or for the investors, unless they’re lucky enough to get out before the business falls over, or have a long enough horizon and sufficient diversification to accept the higher risk.

I really hope we’ve got another few decades before the next shoe drops, and that it doesn’t drop into the gears.


To be fair, Milton Friedman also suggested closing down the FDA, as the free market would determine what drugs were safe or not. So while the terrible idea of Shareholder value was actually enacted, some of his other ideas were even dumber.


Huh? Sure, the money from an IPO goes into a company’s coffers but all the buying and selling on the secondary market (you know, the NYSE, etc.) does not put any more money into the company…it merely creates pressure for the company to perform publicly in a way that convinces buyers to pay more for those stocks.

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Perhaps the dumbest aspect to the entire idea is the idea - supported by court cases like Dodge v Ford - that shareholder value is maximixed by maximizing the current quarter’s or current year’s bottom line. Prior to the advent of shareholder suits for delinquency of fiduciary duty - as opposed to outright fraud or embezzlement - the courts were wont to take the position that a company’s management knew what was best for it in the long term. If Ford’s approach of generous compensation to highly skilled assembly-line workers were not suited to the shareholders’ preferences, they could either vote out the board of directors, or vote with their feet and invest their money in a company run according to their wishes, but not try to get a court to second-guess the decisions of management.

Nowadays, shareholders can all but get a court to order a company to engage in unethical behaviour. The argument that over the long run, that will diminish the company’s value by destroying its goodwill appears not to stand up. This is perhaps the single greates perverse incentive in the corporate world.


I’d have to agree with wryfi here in regards to Milton Friedman. Taking the account of corporations in existence ever since the Dutch in the 1600s, Dutch East India Company, I do think this really awful concept predates Friedman. I would even dare to say, even further then Ford. Take a look at bubbles that burst historically, ie. South Sea Company (1700s), Railway mania (1800s), etc,. All over value at the extremes, hard to say maximizing shareholder value didn’t take into an account.

I think it would be better just to look at the previous article titled: The Dumbest Idea In The World: Maximizing Shareholder Value.

The most risible part is when an economist inveighs against “analytical looseness and lack of rigor.”


That’s what I found most exasperating about The Incredibles. That and the preceding scene were a brilliant illustration of the sort of courageous subversion of unjust authority that is within the reach of ordinary people. From that scene, we go on to Mr. Incredible’s midlife crisis, which links up with his childrens’ escapist fantasies – and they end up as superheroes again, with the story explicitly denying the value of ordinary people and their potential.

I’m left wondering if there was some intended theme cut short or lost: that stories about superheroes, and endless adventure stories, end up just making us feel bad, devaluing the things we could do, and sometimes actually do, to make things better.

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At first I thought you were going to reference the Ford Pinto case… which is a great illustration of why short term shareholder value prioritization leads to unethical behavior which must be countered by public action.

Simply put, Ford was proven to have decided to not fix a defect that was immolating their customers, because the repairs would cut into their profits more than would the wrongful death damages from lawsuits.

The only ways for the civilization to rebalance that calculation to counter such bad results are punishments such as punitive damages, which are specifically designed to be large enough to cause enough pain to the company to overcome the profit motive on the other side.

“Tort Reform” as a rallying cry of the tea baggers and various other republican cohorts is precisely the attempt to remove this counterbalance and revert corporate profit calculation to the same schema used by Ford in the Pinto case, and the tobacco companies prior to the 1980s, which guarantees unethical behavior, and ensures that ethical corporations must lose when competing with unethical ones.


I assume that the existence of the secondary market is what makes the IPO market successful. If people thought that the company felt it was acceptable to ignore their interests as soon as they got their money in the IPO, how many people would invest in the IPO?

One only need see the ire directed at Facebook by much of the tech industry for pricing their IPO in a fashion that benefited the company, but not the shareholders. Many feel that FB’s actions have damaged all other companies seeking capital for years, as Silicon Valley IPO’s may now be viewed with suspicion.

(Of course, the conspiratorially minded have noted that if there’s no IPO market to speak of, various technology firms requiring real capital will have no choice but to sell to the current leaders like… Facebook)

I think Mr. Friedman, like a lot of Libertarians, likes simplicity. There should be a handful of axioms from which all morality can be derived, allowing all actions to evaluated by a nice simple single-dimensional metric.

The fact that a well-run company has dozens of different obligations from financial to ethical, many often running counter to each other makes it hard to rigorously state “this is the way a company should be run.” As soon as you allow judgement into the mix, complexity and ambiguity overwhelm the beautiful, elegant simplicity and certainty that I have found many Libertarians crave.

Shareholder value is, in my opinion, a classical example of that desire for simplicity.

(I will say that I am not as convinced that it has made a major difference in corporate governance. Neither private companies nor companies of old seem less devoted to the ills ascribed to “shareholder value”. Likewise, good companies seem to exist at about the same ratio in both private and public companies.)

I don’t know that I would call myself a libertarian, but I like simplicity, too. In fact, I’d go so far as to say that one of the dumbest traits of the modern liberal is to throw the baby out with the bathwater, as it were, and just label anything that has to do with simplifying things and removing the clusterfuck that is our modern governmental mess as being a libertarian idea. It’s not, though in today’s polarized age everything gets assigned as being the exclusive property of camp A or B.

I hate Friedman and his disciples’ ideas, and all the bullshit that came out of it, as clearly argued in the Shock Doctrine. I am not in any way defending this guy- I just want to point out that simply suggesting that over-regluating is not a great idea doesn’t make you a right-wing, tea-party libertarian. It actually makes a lot of fucking sense in a lot of situations. Like with everything, blanket philosophical statements rarely apply to all situations.

What I find interesting and encouraging is that this article is being published in Forbes- hardly a liberal / left-wing periodical. Maybe there is some light at the end of the tunnel.