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2019-10-23 05:24:21

Once the issue was raised, it cannot be easily gotten rid of.

The issue? Should corporations attempt to maximize shareholder value?

The editors of the Financial Times have raised the issue once again on Tuesday in their lead editorial, “Investors Should Look Beyond the Bottom Line.”

“This newspaper has welcomed the shift among corporate leaders from a narrow focus on shareholder value to the pursuit of a broader purpose - for a hard-headed reason: when business takes a broad perspective, it can leave everyone more prosperous, including shareholders.”

“Rejecting the dogma of shareholder primacy is not a question of bleeding hearts, it is a matter of enlightened self-interest.”

Then, the editors go through a list of four or five situations in which they explain how confronting issues of climate change or employee health and benefits can, in the longer run, be a source of greater rewards than just a narrow focus on maximizing the current share price.

The key issue, to me, is the mention of the concept of the “longer run.”

The editors allude to the problem that the investment in these companies “is channeled through diversified portfolios intermediated by managed funds.

“Some executives complain that portfolio managers demand a laser-like focus on narrow financial results - demands that are built into the incentives or legal obligations funds managers face.”

That is, the pressure for portfolio managers is to produce results in the short run in order to satisfy their constituents.

So, it is not just short-sighted corporate executives that put so much emphasis upon maximizing profits in the short run. The problem is exacerbated by the fact that the investment industry is also incented to focus on short-run outcomes.

My answer to the question “should corporations attempt to maximize shareholder value?” was an unqualified yes!

But I felt that our understanding of the concept of maximizing profits needed to be clarified. I argued that executives needed to be concerned about employee welfare, about climate change, and about many issues that some would argue were social issues.

But my point was - and is - that the executives that were concerned about the culture of their business, their employees, the climate, the state of the community, would actually perform better over time in terms of financial performance and the price of their shares than those companies that just focused upon producing high short-term profits at the expense of ignoring these other issues.

Over time, I argued, by paying attention to these various constituencies, the executives would build an environment that would produce better-educated and trained workers that fully exerted their talents and abilities, that the climate would be a better place and this would contribute to better living and more productive operations and so forth. I argued that making decisions focused upon the longer run would truly allow companies to maximize shareholder value without all the negatives created by short-run thinking.

In my article, I used the example of General Electric Co. (GE), a company that certainly maximized share prize around the 1990s or so, but has resulted in a company in pretty dire straits, requiring a very expensive and very expansive restructuring.

Another way to look at the situation is presented by Nobel prize-winning Daniel Kahneman, who produced a book titled Thinking, Fast and Slow, put out in 2011 by Farrar, Straus and Giroux.

“Fast” thinking, according to Kahneman, is thinking that focuses upon quick results and is optimal in situations where there are major imminent threats. A decision must be made in response to the looming factors.

“Slow” thinking takes place when one can reflect upon a decision and prepare the best response in terms of the outcome over an extended period of time.

You get the idea.

The question then becomes: Is one maximizing profits to reach short-run requirements... or not? If one is maximizing profits to satisfy short-term demands, then one leaves out thinking much about employees and their welfare, about climate change, or any other issue that can only be addressed over a longer period of time... one in which one can engage in “slow” thinking.

This is what the editorial board of the Financial Times seems to be shooting at.

“More leaders in the corporate and investment world should articulate these arguments and embed the thinking in the incentive systems and targets of their fund managers.”

“Governments should update corporate and investment legislation to allow for a broader perspective.”

This means that governments create an environment in which corporations “being able to promote company behavior which, in the long run, creates a bigger surplus for both investors and other stakeholders to enjoy.”

The key here is: “in the long run.”

To me... and to many others... Jack Welch, CEO of General Electric from 1981 through 2001, was exciting to watch and produced some incredible and outstanding short run results during the 1990s or so. But his successors... and GE shareholders... have been paying the price ever since.

One could use the quote “There is no such thing as a free lunch” to capture this situation.

But maximizing shareholder value is a valid goal for corporate executives to pursue. We must take care, however, to understand the real concept of maximizing shareholder value and to make sure, as investors, that we value the longer-run view, the slow-thinking view, of what maximizing shareholder value really means. And let our investments support those that follow this longer-run view of maximizing shareholder value.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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