The Debate: Should Business Schools Teach Shareholder Value Maximization?

The Debate: Should Business Schools Teach Shareholder Value Maximization? main image

In the first of our debate series, Theo Vermaelen of INSEAD and Jerry Davis of the Ross School of Business go head-to-head on whether shareholder value maximization should be the main goal of corporations – and by extension, whether business schools should teach it. You can have your say below the line.

Yes – Theo Vermaelen, INSEAD


In a recent Harvard Business Review article Robert Reich argues that business schools should stop teaching that managers should maximize shareholder value. His argument is that this objective increases income inequality. Specifically, companies cut labor costs to make more money for the benefit of shareholders, so the shareholders get richer but the poor are worse off.

Income inequality is usually a concern for politicians. So we teach that companies should maximize shareholder value, but at the end of the day politicians redistribute the gains to address issues such as income inequality. For example, in a January 2014 article the Tax Foundation noted that the top 1% of US tax papers pays more Federal taxes than the bottom 90%. This inequality has increased over time: in 1980 the bottom 90% paid 50.72% of income taxes. Apparently this growth in inequality is a result of expanding tax credits which went from US$20 billion in 1990 to US$176 billion in 2010. So, inequality has gone up recently, but not in the sense meant by Mr Reich.


Robert Reich, as all the opponents of shareholder value maximization, wants us to teach maximizing stakeholder value, not shareholder value. Maximizing stakeholder value means trading off interests of various stakeholders against each other. How do I make this tradeoff? Politicians make tradeoffs like this all the time but there are differences between a CEO and a politician. A politician has to compete every four years or so but a CEO has to continuously compete in the global market place. It may well be that in the short run he or she will make excess profits, but in the long run competition means that the return on invested capital will converge to the cost of capital. So, increasing salaries, when your competitors are not, will reduce your competitiveness and is not sustainable in the long run. The high paid worker may well lose his job faster, and/or the company will hire fewer workers than would otherwise have been the case. To my great amazement the (socialist) French minister of economic affairs Emmanuel Macron supports my view: on October 9 he complained that French companies prefer to increase salaries rather than to hire new people, making French industry uncompetitive and responsible for high unemployment

There is also another major difference between a CEO and a politician. A politician can force his shareholders (the tax payers) to put up more money through the coercive power of the state or use this power to convince bond holders that it is safe to lend to the State. A CEO has to convince shareholders to invest money in the company. A company that states that its goal is not to maximize shareholder value will have a difficult time to attract equity capital. Or if it manages to do so, it will create an arbitrage opportunity for shareholder activists and potential bidders to take a stake in the company and replace the management. Politicians can’t lose their jobs through hostile bids, at least not until the next electoral cycle.

And finally, the CEO is appointed by the board who are appointed by the shareholders. So unlike a politician he or she is not elected by all the stakeholders in the company. It seems then normal that board members push the CEO to maximize the wealth of the shareholders who gave them the board seat. Letting CEOs pursue alternative goals is not only a violation of fiduciary duties but also an unethical breach of implicit contract with the shareholders.

Dr Theo Vermaelen is a professor of finance at INSEAD. He is the coeditor of the Journal of Empirical Finance and has taught at London Business School, UCLA Anderson, and the University Of Chicago Booth School Of Business.

No – Jerry Davis, Ross School of Business

Ross School of Business

Since the shareholder value revolution of the 1980s, many business schools have taught the doctrine that corporations exist to maximize shareholder value, which was operationally defined in terms of share price. This may have served a useful purpose during the days of the bloated conglomerate, when it provided a rationale for splitting oversized companies into market-focused businesses. Today, however, the theology of shareholder value is increasingly irrelevant and even harmful. Like belief in Santa Claus, faith in share price can be safely retired.

1. It is limiting

There are dozens of alternative forms of organization that do not rely on public equity markets for their financing, even in financial services. Fidelity is privately owned, primarily by the Johnson family. The American Funds group is largely employee owned. Vanguard Group and State Farm are mutuals owned by their customers. Financial giant TIAA-CREF and the 8000 credit unions in the US are nonprofit organizations (and of course most investment banks were partnerships for decades before they went public). Business schools should be teaching students how to make discriminating choices based on the tradeoffs involved in alternative forms of financing, not privileging only one format for business.

2. It is backward looking

The US has half as many public corporations today as in 1997, and the number has declined every year but one since then, as de-listings greatly outnumber IPOs. Moreover, the most visible IPOs in recent years have adopted governance structures that ensure the control of the founding group via superior voting rights (Groupon, Zynga, LinkedIn, and Facebook). History suggests that such voting structures will not serve investors well in the long run.

3. It is provincial

Most countries in the world do not have a stock market, and share price-oriented corporations are of limited importance in many of the world’s other top economies. Germany has about as many public corporations as Pakistan, and its laws require labor representation on the board of directors; its export economy is heavily dependent on medium-sized private enterprises. Japan continues to practice a form of ‘stakeholder capitalism’, reflected in its shareholder-indifferent governance practices (with Sony as a notable exception). China is a nominally communist country with substantial state control of the economy. Teaching students an exclusive focus on ‘shareholder value’ does students a disservice in a global economy in which shareholder value is viewed largely as an American obsession, like the NFL or Taylor Swift.

4. It is operationally irrelevant for most MBA graduates

The decisions and actions taken by MBA students have only limited relevance to the question of the purpose of the public corporation until late in their career, if ever.

5. Recruiters are indifferent to it

For top MBA programs, many of the most sought-after recruiters (e.g. most consulting firms) are not public corporations; they do not have public shareholders. Moreover, interviews with recruiters found that none mentioned ‘shareholder value’ as being relevant to what they sought in MBA graduates. They want students who can think rigorously and do things; their views on shareholder value are about as relevant as Hank Paulson’s views on Christian Science were to his duties as CEO of Goldman Sachs and treasury secretary.

6. It is lazy

Perhaps focusing on shareholder value was bold in the 1980s, when the US still had dozens of shareholder-hostile conglomerates experiencing a ‘valuation gap’. A focus on shareholder value may have been a useful rhetorical tool for bust-ups and other restructurings, and it had novelty value in the business school classroom. Now it is simply a way to waste time on an idle discussion with no practical implications, of the sort that atheists and believers have on the internet every day.  

Dr Jerry Davis is the Wilbur K Pierpont Collegiate Professor of Management at the University of Michigan’s Ross School of Business. He is the author of Managed by the Markets: How Finance Reshaped America which was awarded the 2010 George R Terry Award for Outstanding Contribution to the Advancement for Management Knowledge.

What do you think? Have your say below the line.

Written by Mike Grill

Mike's remit covers content, SEO and blogger outreach. Outside of his work for TopMBA.com, he is an assistant coach for MLU outfit, the Portland Stags.

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I don't know about anyone else, but I went into this thinking "yes, of course b-schools should teach shareholder maximization." If the purpose of corporations isn't to make a profit, then what is it? But I'm beginning to rethink that position now, thanks to Prof. Davis. He makes a pretty compelling argument.
I was asked to comment on Robert Reich's statement, but now I can't resist the temptation to respond to Jerry Davis. The first two comments show that Professor Davis seems to be confused about what we teach in finance courses. Maximizing shareholder value is not the same as increasing the stock price. You don't need a stock price to maximize shareholder value. The basic measure of shareholder value is the present value of expected free cash flows and any company, publicly traded or not, has cash flows and risk. For example, when evaluating an investment decision, we teach students that they should calculate net present value (NPV). NPV is the present value of of all expected cash flows discounted at the cost of capital. The cost of capital is the weighted average of the cost of equity and debt. The cost of equity measures the opportunity cost of investing in the projects. i.e. the return that shareholders can expect if they invest in financial markets in assets with the same risk. In theory the NPV measures the change in shareholder value if you accept the project. So if you have you have project A with an NPV of $ 200 milion and project B with an NPV of $ 100 million, we recommend that you take A. The reason is that if you go for B you create an incentive for shareholders to replace you and switch to project A. This analysis can be made for any company with shareholders, regardless whether the company is listed on the stock market or not. Now it is true that there are companies where the management does not care too much about maximizing shareholder value, especially outside the U.S. or the Anglo-Saxon world and want to maximize stakeholder value. The problem with this governance model is that it is not obvious how to measure stakeholder value or how to trade-off the interests of different stakeholders. Take the extreme example of a non-profit organisation, such as a private business school. In a non-profit organisation, shareholders don't demand any financial returns. We can then recalculate the NPV by assuming the cost of equity is zero, so the discount rate falls. However, a true non-profit organisation should make decisions so that the NPV is zero. So, if the business school realizes that its activities generate a positive NPV, it can bring the NPV to zero by e.g. increasing salaries and bonuses to professors or lowering their teaching load, lowering tuiton fees or give scholarships to students, investing in new facilities, increasing compensation to the administrative staff and so on. The number of ways to get to zero NPV is infinite. Hence the Dean of the business school has then to trade-off the interests of various stakeholders and its inevitable that the stakeholders with the largest power ( normally the faculty) will get most of the surplus. So a Dean, like any stakeholder value maximizer, is more or less behaving like a politician. But a business school should train managers to survive in a globally competitive economy. We don't train politicians. I don't know about the recruiters at the Ross School of Business but at INSEAD recruiters appreciate MBAs with analytical skills who can put all the relevant value drivers in a spread sheet and calculate the consequences for shareholder value. Even firms who want to pursue other objectives ( say a family firm who wants to preserve control because of the private benefits from control such as the ability to put family members on the board etc) may be interested in calculating the opportunity cost of not maximizing shareholder value. For example suppose project A above requires issuing equity and as a result the family loses control and therefore prefers project B. The but then family should have a debate on whether these private benefits from control are worth $ 100 million.
Thank you to Theo for the opportunity to clarify things. The phrase “teach shareholder value maximization” can be ambiguous, which is why I said “operationally defined in terms of share price” in the very first sentence. It is true that in finance classes shareholder value refers to an unobserved construct: the present value of expected free cash flows. Business schools are obliged to teach NPV and discounted cash flow analysis, as these are part of the basic tool kit of any business education; few would claim otherwise, and my students all leave well-equipped to make such calculations. The mischief arises from two places, which are often conflated: the normative belief that corporations “exist to create shareholder value,” and the empirical belief that share price is the best measure of shareholder value for listed companies. The first is not an empirical claim, but more of a kind of theology. It asserts that social welfare is best served by profit-maximizing firms (cf. Milton Friedman’s infamous op-ed) and/or that law and custom require managers to prioritize shareholder value over other ends. Theo says, “Letting CEOs pursue alternative goals is not only a violation of fiduciary duties but also an unethical breach of implicit contract with the shareholders.” But the claim that corporations SHOULD maximize shareholder value on these grounds is theology; business schools should not teach theology, or inaccurate understandings of the law. The second source of mischief is more practical, because it suggests that rather than maximizing an unobserved construct (the finance class version of shareholder value), managers can (and should) aim to increase market capitalization, which is highly observable. The overwhelming majority of interested parties, for better or worse, do not distinguish between the value of shares on the market and “shareholder value.” Several of the mechanisms Theo alludes to in his first post (activist shareholders, the market for corporate control, shareholder-elected boards) only make sense for listed companies. As I noted, listed companies are a small and shrinking segment of the population of enterprises. Partnerships, B Corporations, L3Cs, nonprofits, mutuals, and co-operatives provide a sampling of alternatives which routinely pursue goals beyond shareholder value, and they do not seem paralyzed by the tradeoffs involved. Even many listed enterprises have created governance devices that render activist shareholders, hostile takeovers, and the board largely impotent (e.g., Google and Facebook, where the founders control an absolute majority of the votes and thereby have control of the board). Prioritizing share price may have made sense at certain times and places, but it is time for business schools to move on. The world is full of alternatives.
Great issue. From a logical standpoint, shareholder value is an effect and as Louis Gerstner CEO of IBM once said “I came to see, in my time at IBM, that culture isn’t just one aspect of the game—it is the game.” The truth is that values and behavior drive culture, culture drives employee engagement, employee engagement drives customer satisfaction, and customer satisfaction drives shareholder value. When workplace culture (its values and behaviors) violates our own values, poor performance is the result and shareholder value suffers greatly. Our values are what we all use to decide what to do and how we react to what we experience. When we work for a company whose culture closely aligns with our own values, we become emotionally driven to throw everything we have at our work – all our creativity, innovation and productivity as well as all of our energy, knowledge, experience, and intelligence. So, yes, how to maximize shareholder value should be taught but it is not really about FV or such. It is about how to create a culture that leads employees to be emotionally driven to unleash their full potential on their work. The how tos are simple and based on the science of people, why they react the way they do to what management does and does not do. Best regards, Ben Simonton