Book Review: The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corportations, and the Public

This article was written by guest author, Michael C. Macchiarola, Distinguished Lecturer at City University of New York.*

As our inelegant Presidential contest examines unceremoniously the very foundations of free enterprise, and questions the appropriate roles and responsibilities of its participants and of government more generally, Professor Lynn Stout’s The Shareholder Value Myth offers a critique of its own, laying blame for many of the corporate world’s recent failures at the feet of the overzealous corporation and its unapologetic pursuit of shareholder value. Stout’s book represents a natural progression – or corporate law corollary – to the financial world’s growing mistrust of the Efficient Market Hypothesis in the wake of our recent crisis.[1] And, I must confess, at the outset, that I approached this book and its philosophy with a healthy dose of skepticism. For, just as efficient markets could not explain the world as neatly as many first advanced, a shareholder primacy ideology certainly could not be the boogeyman that the very title of this book suggested. My suspicions were only heightened when the very first page of the book’s preface seemed to tag Enron’s shareholder-centric policies, of all things, for that company’s shameful demise.[2]

The Enron assertion, however, is indicative of the work’s bipolarity. On the one hand, The Shareholder Value Myth offers a major contribution to our understanding of corporate purpose. In a well written and breezy style, the book confronts and debunks many of the myths, biases and ambiguities that have crept into our language and conception of corporate law. The book format allows the author to synthesize a series of topics that she has spent a celebrated career exploring with the depth and rigor of a first-rate scholar.[3] At the same time, however, The Shareholder Value Myth struggles to distinguish correlation from causation and, at times, suffers its own brand of inexactness that, too often, offers sweeping generalizations liable to frustrate an aporetic reader.

Professor Stout’s overarching philosophy comes in three parts and, to her credit, stands much of today’s conventional wisdom on its head. First, despite what many have been taught as doctrine, Stout argues persuasively that “U.S. corporate law does not, and never has, required directors of public corporations to maximize shareholder value.”[4] Second, again in the face of the routine understanding and conditioning of many, Stout maintains that the shareholders of today’s public corporations are “neither owners, nor principals, nor residual claimants.”[5] Finally, Stout contends that “empirical evidence does not provide clear support for the proposition that shareholder primacy rules produce superior results.”[6] Whether by happenstance or otherwise, these assertions progress from strongest to weakest. And, the author concedes that the answers to some of what she confronts are elusive, as understanding the corporation remains as much an art as a science.[7] Each assertion, however, is worthy of further examination in this review,  and, such an assessment follows.

“How Shareholder Primacy Gets Corporate Law Wrong” represents the book’s strongest chapter, contesting the “widespread perception” that the stewards of the corporation have a legal duty to maximize shareholder wealth.[8] Building on her recent scholarship, Stout traces the birth of this “fable” to the “oversized effects of a single outdated and widely misunderstood judicial opinion.”[9] Dodge v. Ford Motor Company was a 1919 decision of the Michigan Supreme Court. The opinion’s status as a meaningful legal precedent on the issue of corporate purpose is tenuous at best. Yet, its facts “are familiar to virtually every student who has taken a course in corporate law.”[10] As Stout has observed in the past, “[t]he case is old, it hails from a state court that plays only a marginal role in the corporate law arena, and it involves a conflict between controlling and minority shareholders” more than an issue of corporate purpose generally.[11] The chapter explains quite well that any idea that corporate law, as a positive matter, affirmatively requires companies to maximize shareholder wealth turns out to be spurious. In fact, none of the three sources of corporate law (internal corporate law, state statutes and judicial opinions) expressly require shareholder primacy as most typically describe it. To the contrary, through the routine application of the business judgment rule, courts regularly provide prophylactic protection for the informed and non-conflicted decisions of corporate boards.[12]

Left underdeveloped in this chapter, however, is the more nuanced notion that the duty of directors is owed less to the shareholders than to the corporation itself. Such an outlook provides that directors’ efforts should be aimed at promoting the corporation’s existence and long-term success. In the much cited decision of Unocal Corporation v. Mesa Petroleum Company, for example, the Delaware Court of Chancery described a corporate board’s “fundamental duty and obligation” as “to protect the corporate enterprise, which includes stockholders.”[13] The court’s very words suggest that the interests of a corporate enterprise include a constituency beyond just the shareholder.[14] The notion of shareholder primacy might fit more neatly into such a construction than the author considers, however, with the fortunes of the shareholder operating as a convenient, yet inexact, proxy for the success of the overall corporate enterprise. Ultimately, such an idea is entirely consistent with the financial theory that values a corporation’s shares according to the present value of the perpetual stream of dividends to which they entitle their holder.[15] After all, dividends are paid to shareholders. Much as a bond can be stripped of its coupons, the corporation’s long-term prospects can be broken into a series of expected dividend payments to be paid in perpetuity. And, while shareholders certainly invest with different expectations, levels of patience and investment time horizons, those who oversee the corporation are entrusted with protecting the enterprise’s overall success. Like it or not, shareholders’ fortunes are tied to the achievement of the corporation during the time they hold shares. Few would argue, for example, with the author’s contention that many in the C-suite at Enron were obsessed with the company’s share price. But such a short-sighted obsession was likely to implode in the long run and, therefore, should not be confused as consistent with any reasonable person’s version of a responsible shareholder-centric model.

After successfully debunking the myth that shareholder maximization is a positive requirement of a corporate board, the book’s next chapter, entitled “How Shareholder Primacy Gets Corporate Economics Wrong,” takes aim at three mistaken assumptions that have undergirded the popular, yet wrongheaded, principal-agent model of a corporation. In a refreshingly efficient manner, Stout refutes the oft-repeated ideas that shareholders enjoy special status as (i) owners, (ii) principals, or (iii) residual claimants of the corporation.[16]  Again, as Stout observes, to the extent that a special status is observed, it is more a clumsy result of convenience than any reliable reality. And, the shareholder primacy methodology, for all of its faultiness, might simply be seen as a palatable solution to the agency cost problem highlighted by Jensen and Meckerling. Besides, “a manager told to serve two masters (a little for the equity holders, a little for the community) has been freed of both and is answerable to neither.”[17] Moreover, flawed as it may be, there is no denying that the shareholder primacy model offers a valuable signaling mechanism and some predictability to all of the corporation’s constituents, however defined.

Unsurprisingly, the evidence in support of the contention that shareholder primacy rules fail to produce better results for public corporations is incomplete at best. As a result, those who question this assertion are left to prove the counter-factual and make the case that somehow, without an ideology of shareholder primacy, the recent record of American corporations would have been even worse. Yet, in indicting shareholder primacy thinking as “unrealistic” and “dysfunctional,” Professor Stout holds no punches.[18] Asserting that the ideology “reduces investors to the lowest common denominator,” she comments that:

“It favors the desires of the pathologically impatient investor over the long-sighted; favors the opportunistic and untrustworthy over those who want to be able to keep ex ante commitments to stakeholders and each other; favors the irrationally self-destructive over those more sensitive to their own interest as diversified universal owners; and favors the psychopathically selfish over the prosocial concerned about other people, future generations, and the planet.”[19]

Stout bemoans the fact that the “gospel of shareholder value” and its accompanying rhetoric have made for a convenient dogma, ready to offer up the misbehaving corporate agent as an “obvious suspect for every headline-grabbing corporate failure and scandal.”[20] At times, however, her book is just as guilty – finding a convenient malefactor all its own. In fact, throughout the book, the reader is confronted with a whole host of issues for which shareholder primacy is left to shoulder the blame. And, too often, this is done when other, more plausible explanations are readily available. For example, “[t]he population of publicly held U.S. corporations is shrinking rapidly” the book offers, in an effort “to escape the pressures of shareholder-primacy thinking.”[21] The costs and burdens of Sarbanes-Oxley, the possibility of a cyclical macroeconomic slump and the dramatic speculation-encouraging effects of decimalization are hardly investigated as causes of the dearth of IPOs.[22] Never mind that globalization and technological improvements have made the competition for listings more competitive than ever. In another example, we are told that “[i]n 1984, equity-based compensation accounted for zero percent of the median executive’s compensation at S&P 500 firms; by 2011, this figure had risen to 66 percent.”[23] Such a statement is offered to support Stout’s damning point that “managers in U.S. companies had stronger personal incentives to run public corporations according to the ideals of shareholder value thinking.”[24] The growth of equity-based compensation is not surprising, however, when one considers (i) the incredible innovation and development of financial derivatives, (ii) the birth of the Internet and the technology revolution, and (iii) the accompanying bull market for equities over that time period. Other choices also strike a discerning reader as petty, curious or politically motivated. One of today’s favorite targets, Goldman Sachs, for example, is cited for taking “risks that nearly toppled the financial system,” yet Lehman Brothers and Bear Stearns pass with nary a mention.[25]

The book’s most disappointing part is its last section, where the author’s voice moves beyond constructive critique and flirts with endorsing the corporate loathing that has become all the rage today. In any shape, the so-called “pro-social shareholder” construct that the author offers is destined for disappointment.  Socially responsible investing, for example, fails to account for the idiosyncratic tastes and ethical values of individual market participants and is unlikely to amount to more than a utopian mirage. In fact, “[a]bsent large-scale coordination – which seems both impractical and uncomfortably threatening to liberty – an individual fund can affect ‘ethical purity’ on its investment process only to its own economic disadvantage.”[26]

In providing a thought-provoking and engaging examination of some of the more basic tenets that have become gospel in the area of corporate law, Stout supplies plenty of food for thought. But, in skirting the issue of what might replace the conventional shareholder-primacy ideology, the work fails to abide by the old axiom that “if you are going to criticize, you should propose.” Nonetheless, the book has effectively highlighted some of the deficiencies and biases embedded in such a view. Perhaps more importantly, it goes a long way to awaking those who might lazily and reflexively continue to offer that “the only shareholder whose interests count is the shareholder who is short-sighted, opportunistic, undiversified, and without a conscience.”[27] This book makes clear that it is imperative that executives running America’s public companies maintain a more holistic understanding of their enterprise. Energy and effort is required to respond to the company’s shareholder base, and understand its various stakeholders and constituencies (shareholder and otherwise). Moreover, public companies must remain vigilant in assessing the dynamic nature of today’s markets and their imperfect and chaotic regulation. For all of the book’s achievements, however, it remains more a diagnosis than a prescription. And it fails to fully appreciate the significantly wide chasm between causation and correlation. Simply because the ideology of shareholder primacy has not proven as self-sustaining as we might have originally hoped or believed, does not mean that there exists a preferable alternative. And, simply because the recent past remains inglorious for U.S. corporations does not establish unequivocally that the focus on shareholder primacy was the culprit. A series of concomitant events should not immovably spawn a theory. For, as the seasoned corporate lawyer can attest, “past performance is not necessarily indicative of future results.”

In the end, any prescribed alternative to the maximization of shareholder value is likely to prove more frustrating than Stout anticipates. And, any such ideology seems destined too to be dogged by many of the coordination problems that have beset the non-homogeneous shareholders of today’s companies. Absent a reliable guidepost – as flawed, frustrating or displeasing as it might be – corporate results are likely to be even more subjective and chaotic. In the end then, this review hopes to bespeak caution – warning all that we should be careful in discarding the good in pursuit of the perfect.

* I thank Nicholas Meza, Mark Molique and their colleagues at the Arizona State Law Journal Blog. Their special efforts to bring efficiency to the world of legal scholarship are a welcomed development. As always, I thank Frank J. Macchiarola for his thoughtful comments and his overall inspiration.

[1] The Efficient Market Hypothesis asserts that financial markets are “informationally efficient” and, as a result, an investor cannot consistently achieve excess returns given the information available at the time that an investment is made. See Eugene F. Fama, Random Walks in Stock Market Prices, Fin. Analysts J., Jan./Feb. 1995, reprinted from Sept./Oct. 1965, at 76 (“[a]n ‘efficient’ market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants.”).

[2] Lynn Stout, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public (2012) at v. (describing Enron as “a firm obsessed with raising its share price and a supposed paragon of ‘good corporate governance’” that “collapsed in fraud and scandal in 2000.”).

[3] See, e.g. Lynn A. Stout, The Legal Origin of the 2008 Credit Crisis, 1 Harvard Bus. L. Rev. 1 (2011); Lynn A. Stout, The Mythical Benefits of Shareholder Control, 93 Va. L. Rev. 789 (2007); Lynn A. Stout, The Shareholder As Ulysses: Some Empirical Evidence on Why Investors In Public Corporations Tolerate Board Governance, 152 U. Pa. L. Rev. 667 (2003).

[4] Stout, supra note 2 at 58.

[5] Stout, supra note 2 at 58.

[6] Stout, supra note 2 at 58.

[7] See, e.g. Stout, supra note [ ] at 57 (offering that “[b]ecause there are so many variables at work when we look at major trends instead of individual companies or nations, statistical regressions of the type so popular among those who do empirical research on corporations may be of little use.”).

[8] Stout, supra note 2 at 25.

[9] Stout, supra note 2 at 25. For her original critique, see Lynn A. Stout, Why We Should Stop Teaching Dodge v. Ford, 3 Va. Law & Bus. Rev. 163 (2008) (“Much of the credit, or perhaps more accurately the blame, for this state of affairs can be laid at the door of a single judicial opinion: the 1919 Michigan Supreme Court decision in Dodge v. Ford Motor Company.”).

[10] Stout, Why We Should Stop Teaching Dodge v. Ford, supra note [ ] at 164.

[11] See Stout, Why We Should Stop Teaching Dodge v. Ford, supra note [ ] at 168.

[12] Stout, supra note 2 at 31 (observing that “[t]he business judgment rule thus allows directors in public corporations that plan to stay public to enjoy a remarkably wide range of autonomy in deciding what to do with the corporation’s earnings and assets.”). Professor Stout herself has written in praise of the business judgment rule and its application, see Lynn A. Stout, In Praise of Procedure: An Economic and Behavioral Defense of Van Gorkom and the Business Judgment Rule, 96 Nw. U. L. Rev. 765 (2002).

[13] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).

[14] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d at 955 (suggesting that directors consider “the impact on ‘constituencies’ other than shareholders”).  See also Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. Dec. 30, 1991) (suggesting that the duties of directors expand in scope when a corporation is in the “zone of insolvency”).

[15] See Richard A. Brealey, Stewart C. Myers and Franklin Allen, Principles of Corporate Finance (9th ed., 2007) at 88 (observing that the present value of a stock is a discount of the future cash dividends by the return that can be earned in the capital market on securities of comparable risk).

[16] See Jesse Eisinger, Challenging the Long-Held Belief in ‘Shareholder Value’, N.Y. Times DealBook (Jun. 27, 2012) (commenting that “[i]t’s almost as if the legal world has been keeping a giant secret from the economists, business schools, investors and journalists.”).

[17] Frank H. Easterbrook and Daniel R. Fischel, The Economic Structure of Corporate Law (1991) at 38. See also Michael C. Jensen, Value Maximization, Stakeholder Theory, and the Corporate Objective Function, 12 Bus. Ethics Qtrly 238 (Apr. 2002) (noting that “[a]ny organization must have a single-valued objective as a precursor to purposeful or rational behavior” and further observing that it is “logically impossible to maximize in more than one dimension at the same time.”).

[18] Stout, supra note 2 at 107.

[19] Stout, supra note 2 at 107. Cf. Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power (2004) (describing corporations as “dangerous psychopathic” entities).

[20] Stout, supra note 2 at 19-20.

[21] Stout, supra note 2 at 5.

[22] In fairness, the author does give Sarbanes-Oxley a passing mention, see, e.g. Stout, supra note [ ] at 54. Decimalization, on the other hand, is not mentioned at all. And, it remains an understudied topic. For a discussion of the effects of decimalization see Michael Macchiarola, Has Decimalization Been a Success?, (Apr. 7, 2011) avail. at

[23] Stout, supra note 2 at 20.

[24] Stout, supra note 2 at 21.

[25] Stout, supra note 2 at 104.

[26] Michael C. Macchiarola, Book Review: Human Rights, Corporate Complicity and Disinvestment, 22 LAW & POL. BOOK REV. 344, 346 (2012).

[27] Stout, supra note 2 at 10.

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