The data behind the case against shareholder value maximization as the proper objective of the company are not entirely persuasive, but they are telling. To examine the data, let?s compare the periods before and after the beginning of the shareholder value era.
The decades that preceded the shareholder value era were notable in that they marked the rise of the professional manager. Until the 1930s, American commerce was dominated by CEO-owners like the Rockefellers, Mellons, Carnegies, and Morgans. But during the middle of the twentieth century, firms increasingly came to be run by the hired help, a new class of professional CEOs.
It was this shift that in 1976 Jensen and Meckling found so troublesome. In particular, they argued that owners were getting short shrift from these professional managers, who enhanced their own financial well-being at the expense of the shareholders in a way that an owner manager would not have done. The result, they maintained, was that shareholders were earning a suboptimally low return on their investment because professional managers were wasting resources by padding their own bank accounts.
Were these managers extracting unreasonable sums from their companies in the period just before the rise of shareholder value theory? Interestingly, despite the intuitive appeal of this nest-feathering hypothesis, the data do not suggest that they were. One way to calibrate CEO compensation is to determine the total compensation dollars earned per dollar of net income earned by the company. The higher the resulting amount, the greater the ?take? of management (represented here by the CEO) versus shareholders. Between 1960 and 1980, CEO compensation per dollar of net income earned for the 365 biggest publicly traded American companies fell by 33 percent. CEOs earned more for their shareholders for steadily less and less relative compensation.
These CEOs may well have been squandering company resources in other ways, but they certainly weren?t utilizing their positions to extract resources out of the company and pour them into their own compensation.
But this all changed in 1980, just as Jack Welch took over GE and Roberto Goizueta became CEO of Coca-Cola. After falling steadily by one-third over the prior two decades, CEO compensation per dollar of net earnings produced doubled in the decade from 1980 to 1990.
And if that wasn?t enough, CEO compensation per dollar of net earnings produced quadrupled between 1990 and 2000?up eightfold in the two decades after shareholders supposedly wrested back the upper hand from management.
On the basis of this data, it could be fairly argued that shareholders had it pretty good before the age of shareholder value capitalism, and that the advent of the shareholder value era was a boon for executives rather than for shareholders. However, if shareholders also did much better in the 1980?2000 period, the growth in CEO compensation may have been perfectly reasonable. Perhaps both boats were lifted, as the prevailing theory suggests.
Unfortunately, as pointed out in chapter 1, nothing of this sort happened. Returns to shareholders were better in the period before the shift to shareholder value capitalism than after. From the beginning of the shift to professional management, which can be marked from the publication of a seminal book by Adolf A Berle and Gardiner C Means called The Modern Corporation and Private Property in 1933, to the publication of Jensen and Meckling?s article in 1976, total real compound annual return on the S&P 500 was 7.5 percent. Since 1976, the total real return on the S&P 500 was 6.5 percent (compound annual).
It is hard to argue that the age of shareholder value maximization worked out well for shareholders, but it is also difficult to make the case that shareholders have done definitively worse. While the difference between 7.5 percent and 6.5 percent is meaningful, especially when compounded over more than three decades, the rates of return change depending on what years and indices are measured. For instance, parity for the shareholder value age and the period before it can be achieved if the start and end dates are sufficiently manipulated.
What cannot be delivered with any degree of credibility, however, is evidence that shareholders have done better after 1976 than they did before. The data just aren?t there. Looking at narrower, company-level data, one might ask: how do companies that explicitly put shareholder value theory at the heart of the strategy do relative to those who do not? As we saw earlier in this chapter, J&J clearly puts shareholders fourth in its list of priorities, well behind customers, and tells shareholders it is interested in earning only a ?fair? return for them. Despite that, J&J actually beat Jack Welch at creating shareholder value, growing it at 14.5 percent compound annually versus 12.3 percent for GE over Welch?s two decades as CEO. Compared with another shareholder value-creation legend, Roberto Goizueta, who ran Coca-Cola from 1980 until his death in 1997, J&J did just fine too. It created value at a 15.0 percent clip versus Coca-Cola?s 15.1 percent during Goizueta?s 17-year tenure. Procter & Gamble, with its own clear focus on customers first, outperformed Welch 15.2 percent to 12.3 percent and, at 14.6 percent, almost equaled Goizueta?s numbers.
Apple Corporation provides another interesting exemplar. By happenstance, Apple was founded in 1976, the very beginning of the shareholder value era. The company had a brilliant first five years, including its 1980 IPO, which was the biggest since that of the Ford Motor Company in 1956. But by 1983, prevailing wisdom dictated that the aggressive young entrepreneurs who had founded the company needed the wisdom, marketing acumen, and financial discipline of a professional manager; thus, Apple?s board brought in as CEO John Sculley, the world-class marketer who had created the Pepsi Challenge while at PepsiCo. Almost immediately, there was friction between Sculley and cofounder Steve Jobs, who was subsequently sent packing. Though Sculley was able to keep market expectations high for a number of years, he struggled to produce returns in the real market. By 1993, with Apple facing declining margins, diminishing sales and an eroding stock price, Sculley was out. And in 1997, prodigal son Jobs returned as CEO.
When Jobs returned, he had to deal with a market capitalization that had fallen to $2.1 billion, less than a quarter of its high in 1992 and almost back to the level of its IPO. Yet, within the space of thirteen years, Jobs accomplished the unthinkable. On May 26, 2010, Apple overtook Microsoft to become the most valuable technology company in the world and the second-most valuable company?of any kind?after Exxon Mobil. It was a stunning reversal of the position of the two rivals in 1997, when Microsoft was worth forty times as much as Apple. Based on Apple?s market capitalization of $222 billion on May 26, 2010, Jobs had provided his 1997 shareholders with a hundred-times return on their investment, or a 43 percent compound annual growth in shareholder value over thirteen years.
A key feature of Jobs? approach as CEO has been to make clear to the shareholders where they stand: they will do well if Apple serves its customers well, and they should otherwise stay out of his face. If we are to deduce anything from his actions, his view seems to be that shareholders had no right to even be informed, let alone given details or reassurances, even when he suffered a life-threatening ailment. Shareholders objected strongly to being treated with such apparent disdain, but Jobs made no gesture in their direction other than to tell them, through the media, that his health was his business and no one else?s.
Clearly, there are several ways to put shareholders behind customers on the priority list. It can be done frankly but respectfully as it is at J&J; it can be done with subtlety as it is at P&G, or it can be with seeming impudence as it is at Apple. Regardless of the approach, each company puts customers ahead of shareholders, yet each still manages to deliver strong, if not outstanding, returns to its shareholders. And each stands apart, an outlier from the mass of its competitors, all of whom embrace the prevailing theory of shareholder value maximization.
Reprinted by permission of Harvard Business Review Press. Excerpted from Fixing the Game: How Runaway Expectations Broke the Economy. Copyright 2011 Roger L Martin. All Rights Reserved.
