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”
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
BAD ARGUMENTS FOR SHAREHOLDER PRIMACY
4. Bad argument one: Corporation belongs to its shareholders
a. Misleading to use the language of ownership for relation of shareholders to the corporation
b. Shareholders don’t own the corporation but own a type of corporate security called stock
c. As owners of stock, shareholders rights are quite limited
d. Board of directors, not shareholders, have right to control the corporation’s assets
e. Shareholders don’t have right to help themselves to a firm’s earnings
i. Only time receive payment from corporation’s coffers is when receive a dividend declared by directors
f. 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
g. 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. The argument claims that shareholders have a right to all the money left over after corporation has met its explicit 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
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
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 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. Sum: Other stakeholders are not likely to help make the firm successfully if shareholder wealth is the only goal
b. Corporate production requires inputs from an number of groups:
i. Shareholders alone can’t make a firm
ii. Creditors, employees, managers 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. E.g., junior executives might expect that if do good work and remain loyal to firm, if firm does well, they will receive wages but also eventually raises, job security and prospect of promotion.
ii. Not realistic to make such expectations explicit (contractual)
f. It can be good for shareholders to encourage these expectations
i. Managers will be loyal
ii. Employees committed
iii. Creditors patient
iv. 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 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. Best argument for Shareholder Primacy: Agency cost argument
a. If we let directors maximize stakeholder benefits, because this is relatively hard to measure (in contrast with maximizing returns for shareholders), 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 other stakeholders
c. Might thus be better to hold directors to a standard that is easier to measure: Stock price, level of dividends
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 and lawmakers/judges do not chose shareholder primacy, but rather the entity 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