Introduction
Shareholder wealth maximization has been considered as the main objective of corporation. However, there has been a variety of arguments for, and against the shareholder primacy. Recently, looking at statements of directors or CEO in companies' annual report, not many companies today proclaim their commitment to increasing long term value to shareholders. The first part of this paper will briefly look at the concept of shareholder wealth maximization. The second and third part provides literature review on the supporting arguments for shareholder theory, which is the extent for the theory to stand, and arguments against shareholder theory. And the last section will discuss why many firms do not put "shareholder wealth maximization" as their top priorities in the modern economic world nowadays with some practical examples.
Concept of shareholder wealth maximization
Shareholders wealth maximization is to maximize the present value of the expected future returns to shareholders (owners of the company) which represented in market price of company's shares. The maximization for shareholder returns including the periodic dividend payment and the possible capital gains from the sale of shares means the maximization for their purchasing power. If company follows the objectives of maximizing shareholders wealth, mangers make decisions that would contribute to increase the shareholders value (i.e. dividend payment and share price).
Arguments for shareholder primacy
There are numbers of argument supporting for shareholder primacy. The three main arguments are "owners", residual claims, and agency cost arguments.
The 'owners' argument is the most long standing view. This concept regards shareholders as the owners of the firm, and firm is considered their private property. Thus, they will have the rights of residual income and residual control. This thinking was argued effectively by Adam Smith (1976). His argument is that society is best served by focusing on the returns to the owners.
The residual claims argument was found in the work of Easterbrook and Fischel (1991). They argue that the "contracts entered into by nonshareholder group such as employees, managers and creditors are explicit contracts that entitle them to fixed payments such as salaries and interest payment. In contrast, shareholders rely on an implicit contract that entitles them to whatever remains after the firm has met its explicated obligation … Thus shareholders as sole 'residual claimant' and sole 'residual risk bearers' in public firms, … and in accord with shareholders' implicit 'contractual' right, firms should be run with an eye toward maximizing shareholder wealth" (quoted in Stout, 2002, p. 1192). And if shareholders are doing well, other stakeholders are also doing well too. (Note that, stakeholders include shareholders/owners of company, and others associate with company's business such as employees, customers, suppliers, etc).
The agent cost is considered the best argument for shareholder primacy (Stout, 2002, p. 1199). In the past, and in small and family owned businesses, shareholders are also directors of firm. However, the modern corporation today, especially public enterprise is not managed by shareowners; since with large number of shareholders, it will be very difficult and chaotic if all of them together manage the firm. And there is a need for separation between management and ownership. This separation will cause conflict of interest where directors rather to act on his own interest than on the interests of shareholders. This is principal (shareholders) - agent (directors) problem. And it could lead to agency costs - costs to monitor, control, providing incentives scheme, performance measurement scheme in order to ensure directors act in line with the objective of shareholder wealth maximization. And Stout (2002, p.1200) states that this need to measure and monitor agent performance provide the foundation for the best of the standard arguments for shareholder primacy.
There have been also numbers of shareholder primacy supporting views in recent years. Hansmann and Kraakman (2000, quoted in Loderer, C. and others, Financial Management, 2010, p6) stated that the best means to this end, the pursuit of aggregate social welfare is to make corporate manager strongly accountable to shareholders' interest. The later studies of Brealey, Lyers and Allen (2006), Brighham and Ehrhardt (2007) also came to the consensus view that the fundamental objectives of firms should be maximizing the current value of their shares, and that would benefit the society.
It is worthy to note that "This belief rests, in part, on First Fundamental Welfare Theorem which states that competitive equilibrium (on which firms maximize profits and consumers maximize utility is a Pareto - efficient plan" (Loderer, C. and others, quoted in Salanie, 2000). However, this theorem based on number of unrealistic assumptions such as complete markets, price-taking behavior, perfect information, no transaction cost. Thus, "economic theory does not demonstrate that shareholder value maximization is best for society as a whole" (Loderer, C. and others, Financial management, 2010). And there has been debate for shareholders versus stakeholder theory over number of years.
Arguments against shareholder primacy - Stakeholder theory
Stakeholder theory can be classified into two main types: normative and instrumental. The former emphasizes on the moral guidelines to its stakeholders that shapes the strategy. The latter exams how stakeholder's value can be used as "means" to improve company performance and efficiency.
In 1932, Berle and Means expressed that the modern corporation shuddered the view of shareholder approach (quoted in Waldkirch, 2008, p.9). Later in 1984, Freeman with view support for stakeholder approach, argues that the achievement of firm's mission can be affected by and affect its stakeholders, and in nowadays world, firm could not be managed successfully without taking into consideration of stakeholders' interests (quoted in Waldkirch, 2008, p.7). The work of Friedmand and Miles (2002) supports further for this argument. They point out that only some stakeholders have legal claims on organization, and different stakeholder will influence companies in different ways, and some will have more influencing power than the others'. Today, through stock market, share - ownership is very fragmented, and shareholders are more like investors than the owners of the firm. In this regard, Allen (1992) argues that corporations become more like independent entities with their own purpose, their own properties and their own duties. Jensen (2000) argued that it would be difficult to achieve shareholder value without taking into consideration important groups of stakeholders i.e. customers, employees, suppliers, government and so on. This is "a form of corporate social responsibility (CSR) within an overall framework of shareholder wealth maximization" (Arnold, 2008, p8) because maximizing shareholders wealth will come at the expense of other stakeholders. For instance, corporation can increase shareholders wealth by cutting cost in operation eg. cutting jobs, finding cheaper suppliers (lower quality), thus selling lower quality products. This would put negative impact on employees, suppliers, and customers as their stakeholders and the society as a whole. Thus, management should make the decision that balances the interests of different groups of stakeholders to over come any conflict of interest or failure.
Instrumental stakeholder theory suggests corporate governance should not depart from shareholders' ownership rights, other stakeholders also have ownership rights because they are ones that run and monitor firm's operation. This can be found in Turnbull's argument (1994). He suggests that "perpetual shareholder ownership permits investors to be overpaid, which is inconstant with either economic efficiency or social equity … and claims that stakeholder participation in corporate governance can generate more accurate and unbiased information of business operation and management and thus improve governing efficiency and effectiveness" (quoted in Letza & others, 2004, p.251). Kelly and others (1997) also point out that firms with focus on their stakeholders will be more efficient, and this will also increase the efficiency of nation. Later, finding of Kay (2004) points out that company will do better if it focuses on vision and excellence first rather than on shareholders wealth maximization, and the success they achieve will also lead to maximization of shareholders value. Allen, Carletti and Marquez (2007) also proved that firms with stakeholders' orientation have higher value than firms with shareholders orientation.
Discussion and Conclusion
Shareholders are often regarded as owners and residual claims of the firms, so primacy should be given to the interests of shareholders. They are the investors of the firm with implicit contractual rights. However, shareholders do not have neither direct control on company's assets, earning and nor direct access to them. They just only have indirect influence through their board of directors and their voting right. Nowadays, the growth of institutional investors the made the views on shareholder primacy change dramatically. With large size of public corporation, the share-ownership is very fragmented by large number of investors; therefore, their influence over the board of directors will be limited. Stout (2002, p.1200) claims that the shareholder primacy is a second best solution that is good for all the stakeholders in the firm
In addition, the approach of maximizing shareholders value by maximizing company's value of share on the stock market is puzzling because of arbitrage in financial market. This leads to mispricing share's intrinsic value. If share's intrinsic value is higher the market price, it would not be best for shareholders to sell their shares, instead, they sell when the market price is higher. Thus, it is very unclear to maximize shareholders value by maximizing share value.
In today fact, not many corporations around the world have put their top priority is maximizing its share value in order to maximize wealth for shareholders. In the study of Loderer, C. and others (Financial management, 2010) on 1800 listed companies in 23 countries, they found that only 35% of large corporations focusing on the importance of shareholders, the large proportion of 43% concentrate on corporate social responsibility, even in countries with reported friendly attitude toward shareholders such as US and UK. Another typical example is Swatch Group, one of the largest firms listed in Swiss Exchange (SIX), in its 2008 annual report, the chairman said that the value of shares could not be taken as a standard to measure the real value of the company. Or CEO of Whole Foods, John Mackey, urges on the news (November 10, 2010) that "... Whole Food structures themselves around higher purposes beyond simply maximizing profit and shareholders' values". The contributions to its success are the focuses on customer needs, quality of product, ethic in production and empathetic employee management. In deed, in the US, although the wealth maximization norm found in description of the law, the "constituency statues" has recently developed which requires directors to consider the interests of stakeholders when making decision affecting companies. An example for this is the decision of Delaware judges. Delaware case law (quoted in Stout, 2000, p. 1202-1203) gives director free rein to pursue strategies that reduce shareholder wealth while benefiting other constituencies. Thus, director can use earnings to raise employees' wages rater than to declare a dividend; they can retroactively increase retirees' pension benefit, and they can donate corporate fund to charity.
Therefore, in conclusion, shareholder wealth maximization stands when public corporations were in free economy or they were private and individuals have freedom to move in or out any exchange. However, we do not live in that ideal word as "threat to freedom is the concentration of power, whether in hands of government or anyone else (Friedman & Milton, 1980, quoted in Sharplin, 2003). As seen, not many firms nowadays put "shareholder wealth maximization" as their top priorities. As the complexities of economic and finance market increases, "a firm cannot maximize value if it ignores the interest of its stakeholders enlightened value maximization can utilize much of the structure of stakeholder theory by accepting long run maximization of the value of the firm as the criterion for making the requisite tradeoff among its stakeholders" (Jensen, M., 2000). The question is that whether firm should pursuit shareholder theory or stakeholder theory. The answer is not clear because it will be different from firm to firm, nation to nation, or time to time. The corporate needs to find the approach that is most suitable for firm's sustainable growth in long run, firm's resources capabilities and flexibility, and regulation environment.
Reference:
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