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Summary of Week 05 Lecture The shareholder value myth Coursera class by prof. Rolf Strom
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Shareholder value: Elements and History

Elements The Shareholder value paradigm is a model of understanding a firm that suggests a company's fundamental goal is to drive value to its shareholders What we have asked so far Is growth reasonable as the only metric for success? Is innovation the only cure? How do narratives abut our results? Is monitoring the only control? History Origins and evolution: How did the shareholder value theory emerge? (Orthodox Theory) Introductory story - Quotation by Charlie Wilson: "What is good for GM is good for America" (1957)
Is it reasonable to extrapolate that what is good for the country is good for all the firms in it?

- The theory is first stated in 1970 with an article in the NYT by freedman saying that the objective for the firm is to make as much profit as possible - 1976: Janson & Maclean base their arguments in watching big corporations: The firm executives were more interested in their own futures than in the future of the firm.
Reduce costs Monitoring becomes awkward when identifying who monitors the CEO Efficient market hypotheses: the markets are informationally efficient, so in average you can't always maximize your product.

The market uses the price of the share to control itself. Then the executives will be focused on the share value (in theory)
Regulatory and market changes - In the 1970's the mutual funds were not very popular, but by the end of the decade, their popularity grew a lot.
In the early 70's banks started to be free to regulate the interests they offer, There were some institutional relations with the firm, but that was mostly debt

- In the 80's people started to borrow money to buy companies, divide them and make a profit by selling the parts. - So the firms started to protect themselves by using the shareholder system Shareholder centric strategy - 1990: Article "Core competency of the corporation"
Introduced an idea that we today keep as an orthodox way on how we think about management.

Principal idea: Firms should think about themselves as a Core Competency. The job of the company is to focus on its own competency Three key criteria about the competency 1. Not easy to-imitate 2. Can be reused, 3. Must add value to the consumers and customers Vertical integration can be discarded. Just concentrate on what you do best,
Example of a firm that embraced this idea: Sarah Lee

They sell cakes The core competency of Sarah Lee was THE BRAND There were long term consequences, but in the 90's the model boosted the company in the short term.
- A question rises: where do you expect to find the more efficient use of capital: The firm or its shares?
In the 90's the capital apparently went from the firm to the Shareholders.

Prepared by Ariadna 73

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Summary of Week 05 Lecture The shareholder value myth Coursera class by prof. Rolf Strom
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Instead of giving the money back to the firm to grow, Put it back in the hands of citizens and they will make efficient use of it. By late 1990's and last decade, firms have moved to stop investing in improvement and just generate profit for the shareholder

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An alternative view of the origins (Heterodox Theory) Why things occur when they occur? Why this theory was developed in the 1950's? - There was a salary cap: If you made more than certain amount of money, the government would take it all. - But if your income came from stock options, the taxes were really low. So the firms started to pay them high executives with stock options - Then the economy started to expand.
Executives started to be paid in stocks so they could have high salaries and not pay high taxes Then the share price started to reach a plateau, and the executive income was affected.

Who were this executives of the 50's? - Mostly white males - Mostly well fed, smoking cigars, drinking whiskey - Mostly old The teacher's theory: The shareholder value theory would then be a demographic accident.

Is shareholder value a good idea?

What in the purpose of the firm? Some say, the purpose is to make profit. The teacher doesn't like this The owner of the firm is the firm itself Then the purpose would be to secure its own profitability Who are the shareholders? The firms are LLC, so the shareholders are not liable and not owners There is no obligation from the firm to the shareholder. 10% of the world population own the largest chunk of shares 90% are basically non -relevant The Shareholder theory has benefited a tiny percentage of the population. And the benefits has been enormous and have contributed to inequality If the firm wants to renew its relations with the shareholders, it needs to focus on meeting the expectations of the market. Short- termism becomes the logic that in-forms the firm. For example: quarterly expectations The need to secure short term results is in conflict with trying to do good long-term things

Conclusion
Examining CEO pay (250 times the lay-man compensation): It is the consequence of the Shareholder paradigm The pay of the CEO Is that big with the tacit permission of the shareholder. It is a simple market equation: For the shareholders, it is cheap to pay the CEO millions if he keeps the value of the share The number of CEO's is insignificant and giving them millions won't break the bank All the shareholders want to secure the long term profitability, but the firms are managed for a few who only want short term profitability How did we get to this? Is this the model of capitalism that the emergent economies want? Is this model good for the firm itself? There are NOT easy questions What kind of Capitalism do we want?

Prepared by Ariadna 73

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