The ShareHolder Value Myth Chapters 5 and 6

Carly Krieger

Limits to Market Efficiency and Maximizing Shareholder Value

• Maximizing shareholder value is harmful for companies in the long term

• Stock prices to not reflect true value • Private information about products is not fully reflected

in stock price until the bad news is publicized• (Think Toxic Fish Example) • http://nymag.com

/news/features/scandals/martha-stewart-2012-4/• Behavioral finance- examines how human emotions and

irrationalities can distort prices and drive trading

Team Production

• Team Production theory • Developed by Lynn Stout and Margaret Blair• Both participators in investment project are needed

for the success of the project• Some projects require not only team production

from financial investors but also team production with stakeholders.– Railroad example: a railroad requires more then just the

tracks and cars, it requires engineers, conductors from the community

Shareholder Primacy Ideology Vs Team Production Theory

• Shareholder value thinking discourages team production • Surveys show that as U.S. firms have accepted shareholder

primacy, their employee loyalty has decreased• The two theories conflict, team production theory says businesses

cannot thrive and function in accordance with shareholder primacy ideology

• Conflict exists in shareholders desire to attempt to unbind themselves from projects in the attempts to capitalize on their investments and exploit their partners/ other shareholder/stakeholders endowments

• More U.S. public corporations are going “private” • What benefits are there to this?

BP and Shareholder Primacy• The U.K. has less structured, more shareholder friendly laws than the U.S.• Shareholders can vote on dividends and have the power in a extenuating

circumstance, to remove board directors• These laws do not guarantee U.K. corporations to lock in shareholder capital• After the Deepwater Horizon oil spill, BP was going to cut back by delaying paying

its dividends which angered British pentioners• BP quickly resumed paying dividends and instead cut spending by selling $30 billion

in assets • This quick change over shows that shareholder primacy does not protect

stakeholder’s ability to lock in corporate capital• Do you agree with BP’s decision? Does BP use shareholder primacy or team

production? Split into 4 Groups and come up with alternative actions BP could have had after this crisis.

• *Things to consider: what is more important for a company, loyalty to stakeholders? Or locking in corporate capital?

The Rise of Short Term Investors • Many powerful shareholders today are short term

shareholders • NYSE Annual share turnover in 1960- 12% (8 year holding

period)• NYSE Annual share turnover in 2010- 300% (4 month holding

period) • Change occurred due to advances in Information technology,

deregulation • Brokers used to be used to buy stocks- now funds specialize

in computerized “flash trading” strategies in which shares are bought and held for seconds before being resold

The Long-term vs Short-term Conflict

• Short-term investors (Hedge fund activists) want to raise share price now

• Long Term investors want directors to invest in the companies future, don’t want the stock price to reflect an untrue value

• While the two want different things, they do not compete directly with each other

• Hedge Fund Activists have the upperhand

Accounting Fraud

• Raises share price without improving real performance

• Hides large quantities of money in debt• Enron, Worldcom• Many institutional investors became rich from

Enron because Enron “unlocked” shareholder value (68)

Other Ways of Raising Share Price • Another way to create shareholder value is to split up

companies by selling off assets or divisions and allowing investors to invest only in the line of business they prefer (69)

• Kraft Foods did just this when they took over British Chocolate manufacturer Cadbury in 2010. A year and a half later Kraft decided to split itself into 2 companies.

• One would sell sugary snacks and chocolate, the other would sell cold cuts and Kraft mac n Cheese

• In arrangements like these, short term investors benefit while long term investors do not

Corporate Musical Chairs: Why do Hedge funds have the upper hand?

• SEC does not require hedge funds to report their activity

• Difficult to find data on hedge fund performance

• Stock based compensation plans have made executives wealthier in the last 20 years

Shareholder Value Expectations

• Roger Martin points out that investors use their assessments of a companies market activities to form expectations regarding how the company will perform in the future to estimate the stock price of the company (71)

• Do you think this an accurate assessment

Chapter 6: Keeping Promises to Build Successful Companies

• Share holders “tie their hands” when they buy public corporation stocks

• Investor’s money goes straight to the corporation when they stock in the primary market

• In return for investing their money, the shareholder receives a contract with the corporation

• Share holder may never get money back• Share holder’s contribution is “locked in” to the

corporate entity

Why do Investors Tie Their Hands?

• Advantages: investors are protected from each other’s possible financial losses

• Partial value of company would be destroyed if investors could withdraw investments

• Makes company look more attractive and stable. Would not have this stability if different investors were withdrawing and becoming involved all the time

• Protects each investor from the betrayal of the other – “opportunism”

Avoiding Opportunism • A company as a factory: no single shareholder can threaten

to withdraw their money thus ruining the business• If investors could withdraw their money whenever they

wanted, no creditor would ever feel confident lending a company money

• Bondholders would be able to withdraw their money, preventing the firm from using borrowed money to make long term investments

• Corporate Asset Shielding – “corporation’s ability to protect its assets from the claims of shareholders and shareholders creditor’s” (79) Hansmann and Kraakman

Why is a Board of Directors Necessary?

• Investors have the expectation that the board of directors will have stable control of the public company. If they cannot keep the company on it’s feet they will lose their board positions

• Directors are trusted to not steal corporate assets • Board power allows directors to mediate between

shareholders and stakeholders who have different interests