Value Creation and Corporate Governance
Shareholder value maximization has been severely criticized in recent years, but it is not clear what, if anything, is to take its place. In a new working paper I review three models of corporate value creation—shareholder value, stakeholder value and company purpose achievement—and their implications for corporate governance.
Shareholder value—associated with Milton Friedman and Alfred Rapport—is no doubt still the most influential approach, but stakeholder and purpose views are gaining ground. The choice of value creation measure has powerful implications for ownership and corporate governance because it concerns the essential raison d’être of the corporate form. Changing views of value creation are therefore likely to lead to changes in corporate governance.
The shareholder model is narrowly focused on the wealth of a particular stakeholder group. It appeals to the baser instincts of selfishness at the risk of conflict with ethical principles and the broader interests of society. But it provides powerful incentives, a clear focus, and the ability to attract equity finance willing to take risk. It can work reasonably well if the other stakeholders are able to take care of themselves and if regulation can protect the broader interests of society and nature. However, it has been heavily criticized in recent years and suffers from myopia due to excessively high assumed opportunity costs of capital (discount rates).
The stakeholder model—associated among others with Richard Freeman—takes into consideration the interests of society, but provides little incentive, focus and accountability. It runs the risk of decision deadlocks and insufficient finance. In practice, a single dominant stakeholder group—investors, managers, employees, customers, suppliers, or government—therefore takes charge, and the interests of other stakeholders are taken into consideration (if at all) by governance arrangements and contracting, much as they are in the shareholder model.
The purpose model—associated among others with Colin Mayer—lets the shareholders of the company choose a socially useful purpose which will typically be to satisfy a social need (a customer demand) by supplying goods and services in a responsible way. In other words, companies exist to serve a social need which they fill by providing society with goods and services. This—rather than making profits or paying wages—is their essential function. The purpose guides the company’s strategy, values, and governance structure, which will normally be directed at business expansion being in accordance with the socially useful purpose. However, there remains a risk that a given purpose will become less socially useful over time, and it is also possible that the narrow-minded focus on the purpose will neglect the broader interest of society by, for example, minimizing taxes or exploiting suppliers. The purpose will therefore need to be revised over time which entails the risk that it will be opportunistically adapted to share value maximization.
For now, the purpose model looks like the most promising candidate. It is a relatively new conception which addresses some of the central weaknesses of the shareholder value and stakeholder models. It therefore deserves special attention. On the one hand, it provides companies with a clear focus, which the multi-constituency stakeholder model lacks. It is consistent with (constrained) profit maximization which comes from fulfilling the purpose, ie with the idea of companies maximizing profits by striving for their purpose. The better they do it, the more value they create for society. Moreover, the purpose may be broadened to include fair treatment of stakeholders—like employees, suppliers or government organizations—who help serve the purpose.
It is worth noting however that bad behaviour or scandals will not automatically disappear just because companies adopt a corporate purpose other than shareholder value maximization. Agency problems will persist as long as the key actors—shareholders, executives, directors, or employees—are more concerned about their own welfare than the stated purpose of the company. What we can hope for is something more modest, namely that a company purpose statement will increase the incentives and opportunities to engage in activities that create value for society as a whole.
Moreover, the tension between the interest of individual companies and the broader interests of society is likely to remain. A company which produces coal will still have a hard time realizing that it is time to close down.
Steen Thomsen is the Novo Nordisk Foundation Professor at the Center for Corporate Governance, Copenhagen Business School.
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