Lynn Stout, “Bad and Not-So-Bad Arguments for Shareholder Primacy”


1.       Shareholder primacy (“The property view”)

          a.       “The corporation exists only to make money for its shareholders”
Ambiguity: Which shareholders (present? future?)? At what level of risk?

2.       “Stakeholder view” (or the “entity view”)

          a.       The corporation exists to serve its stakeholders (all those who have a stake in the corporate activities, including, but not limited to, shareholders)

3.       Other stakeholders and possible goals of corporations besides making money for shareholders

          a.       Employees: More secure jobs for employees

          b.       Customers: Better quality products for consumers

          c.       Community: Greater contribution to welfare of the community

          d.       Creditors: Minimizing risks of those to whom owe money

          e.       Suppliers: Being a reliable customer


4.       Bad argument one: Corporation belongs to its shareholders

                    i.        Therefore its only goal should be to make money for them

          b.       Misleading to use the language of ownership for relation of shareholders to the corporation

                    i.        Ownership might include right to control and to dispose of what one owns and shareholders to not have the right to control corporate decisions or the right to sell the corporation

          c.       Shareholders don’t own the corporation but own a type of corporate security called stock

                    i.        As owners of stock, shareholders rights are quite limited

          d.       Board of directors, not shareholders, have right to control the corporation’s assets

                    i.        Shareholders don’t have right to help themselves to a firm’s earnings

                    ii.       Only time receive payment from corporation’s coffers is when receive a dividend declared by directors

          e.       Shareholders influence over firm’s earnings are indirect via their influence on board of directors

                    i.        Given widely dispersed share ownership, shareholder influence on board is often so diluted as to be negligible

          f.       Further, debt holders have as much claim to the corporations cash flow as do shareholders.


5.       Bad argument two: Shareholders are “sole residual claimants”

          a.       As such, shareholders have a right to all the money left over after corporation has met its explicitly contracted financial obligations (e.g., dept to creditors, wages to employees/managers)

          b.       Stout argues that only during bankruptcy is this true

          c.       While an ongoing profitable business, it is again the right of the directors to decide what to do with the firm’s earnings (beyond explicit financial obligations)

                    i.        They can pay a dividend to shareholders

                    ii.       They can raise managers/employees salaries

                    iii.      Start an on-site childcare center

                    iv.      Improve customer service

                    v.       Beef up retirees pensions

                    vi.      Make donations to charity

                    vii.     Plow the profits back into the business so it can expand

          d.       As a legal matter, shareholders are entitled to receive nothing from the firm unless and until the directors decide they should receive something.

          e.       Many groups other than shareholders are residual claimants (or residual risk bearers) in sense of expect to enjoy benefits (or burdens) beyond what they are explicitly contractually entitled to

                    i.        When firm is doing well

                              (1)     Employees receive raises and enjoy greater job security

                              (2)     Managers get use of a company jet

                              (3)     Bondholders enjoy increased protection from corporate insolvency

                    ii.       When firm doing poorly, all suffer along with shareholders

                              (1)     Employees face “reductions in force”

                              (2)     Managers told to fly coach

                              (3)     Debt-holders face increased risk


6.       Team production argument against shareholder primacy

          a.       Other stakeholders are not likely to help make the firm successfully if shareholder wealth is the only goal

                    i.        So shareholders will lose if stakeholder’s interests are ignored

          b.       Corporate production requires inputs from an number of groups

                    i.        Shareholders alone can’t make a firm successful

                    ii.       Creditors, employees, manager, and even local government must often make contributions in order for enterprise to succeed

          c.       Why do they contribute?

          d.       In part expect to be compensated according to explicit contracts

                    i.        E.g., employees work for wages

          e.       But they also rely on implicit contracts (expectations)

                    i.        All these groups expect to be treated considerately and will benefit if the firm does well

                    ii.       E.g., Junior executives might expect that if do good work and remain loyal to firm, if firm does well, they will receive wages (explicitly contracted for), but also eventually raises, job security and prospect of promotion.

                    iii.      Not realistic to make such expectations explicit (contractual)

          f.       It can be good for shareholders to encourage these expectations among stakeholders

                    i.        Managers will be loyal

                    ii.       Employees committed

                    iii.      Creditors patient

                    iv.      Customers loyal

                    v.       Governments supportive

          g.       If directors focus solely and directly on shareholder wealth, stakeholders are unlikely to be willing contribute to the firm and make the “firm-specific investments that can be essential to a company’s success”

                    i.        Consider that one way to maximize shareholder wealth is to take wealth from the other corporate constituencies

                    ii.       E.g., by firing employees and managers and shutting down operations (built and maintained in part with tax breaks and financing from governments) and distributing the proceeds to current shareholders


          h.       Stout suggests the ideal rule for corporate directors is not to maximize solely the shareholder’s wealth, but the total sum of benefits enjoyed by all groups that participate in the firm


7.       “Not so bad” argument for shareholder primacy: Agency cost argument

          a.       If we encourage directors maximize stakeholder benefits, because this is relatively hard to measure (in contrast with maximizing returns for shareholders measured by stock price and dividends), the directors may use the extra discretion to look out for their own (director’s own) interests instead of those of the firm

          b.       And this would be bad for all stakeholders

          c.       Might thus be better to hold directors to a standard that is easier to measure–stock price, level of dividends–that is, by how well it maximizes shareholder wealth

                    i.        Thus limiting the “agency costs” (the costs associated with executives pursuing their own self interest at the expense of the corporation’s)

          d.       Stout argues that how serious a worry this is can only be determined by empirical inquiry


8.       In the real world, people choose the stakeholder model, not shareholder primacy

          a.       Although the rhetoric is less clear, people in business (including shareholders) and lawmakers/judges do not chose shareholder primacy (property model), but rather the entity model (stakeholder model)

          b.       They let the directors make choices for the other stakeholders at the expense of shareholders

          c.       Over 30 states have passed “constituency” laws that expressly permit corporate directors to sacrifice shareholder interests in order to serve other stakeholders

          d.       No corporate charters say shareholder wealth maximization is a corporate goal