Sunday, August 14, 2011

What Do Shareholders Really Want?

In a 2010 article in the Harvard Business Review, Roger Martin asks the question “have shareholders actually been better off since they displaced managers as the centre of the business universe? The simple answer is no. From 1933 to the end of 1976, when they were allegedly playing second fiddle to professional management, shareholders of the S&P 500 earned compound annual returns of 7.6%. From 1977 to the end of 2008, they did considerably worse – earning real returns of 5.9% a year. If you modify the start and end dates of the two periods, you can produce performance numbers that are at parity, but there’s no sign that shareholders benefited more when their interests were put first and foremost,” (p.60).

One may be asking why Martin is looking at these specific years and that is because modern capitalism can be broken down into two major areas, the first, managerial capitalism, began in 1932 and was defined by the radical notion that firms ought to have professional management. This period is noted for the famous work by Adolf Berle and Gardiner Means who published their paper entitled “The Modern Corporation and Private Property”, which stated that management should be divorced from ownership.

Then in 1976, the second era of modern capitalism started, when managerial capitalism was strongly criticised by Michael Jensen and William Meckling in their paper entitled “Theory of the Firm: Managerial Behaviour, Agency Costs and ownership Structure. This paper, which Martin highlights has become the most-cited academic paper of all time, argued that “owners were getting short changed from professional managers, who enhanced their own financial well-being rather than that of the shareholders. Stating that managers were squandering corporate and social resources to feather their own nests,” (p.60).

There seems to be a lot of criticism about ‘fat cat’ organisations and their ‘greedy shareholders’ – but how true are these comments in reality. Many institutional shareholders are responsible for pension funds and similar investment vehicles. These portfolio’s aren’t short-term in nature, in fact far from it, these institutional investors are looking for long-term sustainable results – and short-term gains followed by a big loss doesn’t instil confidence in these investors.

Also similar to customer theory, many individual shareholders have unrealistic expectations in respect of investment returns – some are looking for a quick profit for themselves with little concern for the long term interests of the organisation. Wanting to get in and get out with a quick profit – where in this instance the focus of the investor is purely self-interest.

So why is it that companies that don’t focus on maximising shareholder value deliver such impressive returns? Because, says Martin, their CEO’s are free to concentrate on building the real business, rather than managing shareholder expectations. Martin’s article highlights how, back in 1997, just after the IPO, Research in Motion (RIM), makers of the Blackberry, made a rule that any manager who talked about the share price at work had to buy a doughnut for every person in the company. In 2001, the COO mentioned RIM’s surging stock price and was subsequently actioned with buying 800 doughnuts for the employees - apparently he had to make special arrangements to have that many made and delivered. Either way there hasn’t been a recorded infraction of the rule since then, (Martin, R, 2010, p.64).

What organisations want are shareholders who seek an investment that is in the interests of both parties and not the shareholder that has only their self-interest at heart, especially if it’s short term self-interest. These short-term focused investors will never optimise sustainable organisational performance, which is more likely to give greater returns over the long haul and will have little interest in strategies that optimise anything beyond this years returns. A short-sighted view that is likely to lead to long term disaster.

As Martin concludes “managers like profits as much as shareholders do, because the more profits the firm makes, the more money is available to pay managers. In other words, the need for a healthy share price is a natural constraint on any objective you set. Making it the prime objective, however, creates the temptation to trade long-term gains in operations-driven value for temporary gains in expectation-driven value,” (p.65).


Martin, R. (2010). The Age of Customer Capitalism. The Harvard Business Review. Vol. 88, Issue 1, p.58-65.

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