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August 2018

The Myth of Maximizing Shareholder Value

Aug 14, 2018 10:00 AM
Bruce Hunter

February of 2017 Kraft Heinz bid $143 billion for Unilever PLC . The cultural differences between the two entities couldn’t have been more different. On the one side was Unilever. CEO Paul Polman and its Board had shifted course dramatically in 2009 to favor a longer-term view on corporate growth and development which included refusing to post guidance or quarterly results. Warren Buffett and 3G, the primary owners of Kraft Heinz, were focused on action to drive up share prices. Savage cost reduction was the primary and well documented operating procedure . After only two days following the rejection of the offer by Unilever’s board and recognizing significant other headwinds, Kraft Heinz smartly pulled the deal off the table.

stark contrast between the approaches of the two companies was particularly interesting to me as a spectator because of my former employment at Kraft. During a 25 year career I saw the company morph from a fiercely independent and proud entity (General Foods) to a conglomerate which had been financially engineered in the name of maximizing shareholder value. General Foods, Kraft, Nabisco and Cadbury had been merged. company then split to form Mondelez and Kraft with the latter subsequently merged with Heinz to form the most recent corporate iteration Kraft Heinz. A lot of splicing and dicing which no doubt created a lot of money for a select few but which saw a tremendous amount of employee displacement and little to no improvement in performance. Which brings us back to the myth of maximizing shareholder value.

The mantra and focus on maximizing shareholder value has gradually replaced the stakeholder model (which sought to balance the interest of workers, shareholders and the larger community) in the mid 1980’s. This shareholder ideology is now so pervasive that it’s hard to believe that so few years ago it was non-existent. The original theory of a focus on share price as a key corporate metric traces to Milton Friedman in the early 70’s and followed on in a paper by Michael Jenson of Harvard in 1976. In the mid 80’s it was supported by than Jack Welch (first nicknamed Neutron Jack while re-engineering GE by doing away with a quarter of its workforce). The concept was also popularized and then vilified by Michael Milken of junk bond fame. Still, the ideology didn’t die. It grew stronger.

Most studies now conclude that there is no evidence to support that the ideology of maximizing shareholder value has been effective. The opposite is true. Studies point to this ideology as a prime culprit in the decline of U.S. public corporations and the current sad state of the U.S. middle class. From 1997 to 2008 public companies listed on U.S. exchanges dropped by half.

focus on shareholder value and share price as a primary executive compensation metric has created a monster. Bill Lazonick, President of the Academic Industry Research Center, offers some additional startling facts from research involving the top 500 companies listed on the S & P conducted from 2001 to 2010. During that time a full 94% of the profit generated went to fund dividends and stock buy-backs in order to influence stock price. Put another way, only 6% was re-invested in the operations of the companies. No wonder that the backbone of the US industrial base and the middle class has been eroded so substantially.

U.S. companies are going through a process of financialization, a new term for me discovered in the research for this article. It describes a process which increases the focus on the bottom line to drive profit and thus share prices higher. Capital Extraction was another term used to describe the tactics directed to improving share value. Reduction of sustaining expenses, selling off company assets, employee reductions, dividend and stock buy-backs are all examples of tools used by CEOs to influence stock price. Unfortunately the empirical evidence suggests that these actions create longer-term diminution of stock price and company value. It turns out that short term gain really does create longer term pain.

It’s probably not a great leap to lead one to the conclusion that the current U.S. political situation and populist uprising are directly tied to the development and feeding of the share value ideology. What’s concerning is there is evidence that it is expanding to encompass many of developed and developing countries. Japan, India, the UK and China are catching up. For those of you entrusted with your company’s strategic direction or leadership, it’s time to replace your shareholder value metric or suffer the longer term consequences.

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