Shareholder Value

The idea of maximizing shareholder value has caught the imagination of the corporate world. On the face of it, it makes sense. The true owners of a company are its shareholders. Shareholders invest in a company in the expectation of increasing returns over time. As such, they have a stake in the long run success of the organization. By maximizing shareholder returns, a company is simply giving its real owners a return that they expect and should receive. By this reasoning, any other objective would hurt the shareholders and is therefore inefficient.

There is one major problem with this argument. Value is built over time i.e. in the long run. Shareholders typically hold shares for a limited period. So most shareholders have a short term view of the company. This results in a fundamental mismatch in timing horizons. The effect is that shareholders (specially the larger ones) can pressure company management to produce immediate returns in the short run. Unfortunately, such actions often come at the expense of the long run. The result is that over time, lost value and become increasingly vulnerable to external shocks.

This vulnerability is reflected in the decreasing lifespans of companies. The repercussions of a failing company go well beyond its shareholders and employees. A very large number of people are negatively affected. One company's failure can easily set of a chain reaction. For example, suppliers to the company can also start to fail setting off chain reactions of their own. Even competitors can be negatively affected since companies within an industry have very similar supply chains. Any weakening of one supply chain can reflect onto others.

We also have to keep in mind that companies are always embedded in communities. They do not exist in a vacuum. Much of the salaries that are given to employees are spent in the local community. If these jobs vanish, the external community falls onto hard times with its attendant social problems. So focussing on shareholder value alone is doing a great disservice not just to the organization but also to its supply chain and to the larger communities in which the organization operates in.

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Are Markets Perfect?

The Free Market: A False Idol After All? (Photo credit: elycefeliz)

Current economic thinking essentially states that any demand will be met by a supply because people are rational who are constantly striving to maximize their "happiness". Ofcourse, happiness needs to be defined more closely. So acquisition of material goods is deemed to be a proxy for "happiness". The more goods and services someone acquires, consumes or accumulates, that person is considered to be "happier" relative to someone else who is unable to do the same. By this reckoning, rationality indicates that any demand will be met since by doing so, all parties concerned will be "better off" or "happier".

That is the theory. What about practice? Currently business organizations provide many of the goods and services that we depend on. These are profit making entities whose primary, if not sole mandate, is to make a profit for their shareholders. So any demand should be met. But it isn't. Why not? One of the biggest flaws in the current capitalist paradigm is that it overserves some goods and services and underserves others. The free market system is very powerful. If all costs are properly factored in, then it serves as an excellent allocator of resources most of the time. Most of the time, not all of the time. Why is this so?

If markets are perfect, then no segment of a population should be left unserved. If this happens, then markets are flawed and some corrective mechanism needs to be applied.

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Infinite Growth?

Can any economy grow indefinitely? If it can, should it do so? What is the point of economic growth? For over 200 years, we have lived in a system that takes infinite growth for granted. This has been coupled with a growth in basic science and associated technologies. As a result, there is a firm conviction amongst many (perhaps most) that all problems can be resolved by better and new kinds of technologies. Thus the conclusion is drawn that there are no limits to growth.

In my mind, this is a false conclusion. In a universe of ultimately finite resources, there are going to be limits to infinite growth. The picture is further complicated by the effect that increasing wealth has on demographic growth. In country after country, as the economy has taken off, there has been a baby boom followed by a baby bust. Sometimes governments have intervened in order to limit population growth but even without such intervention, fertility rates have fallen with increasing development. The reason is simple: wealthier parents generally choose to limit the number of their offspring since there is a reasonable chance that their children will outlive them. So they choose to concentrate greater amount of resources on a smaller number of children.

I believe that there are ultimately hard limits to growth. No economy can grow infinitely. The time taken to reach such limits however is dependent on the type of economic growth. Western Europe and later North America developed a peculiarly wasteful form of economic growth. Products are built not to last but to fail. This is exacerbated by carefully and cleverly creating demand for the latest, greatest even if current models function perfectly well. This results in overflowing landfills and enormous garbage dumps in the seas. It also leads to stresses on eco-systems which all too often lead to their collapse. After 200 years of largely unbridled capitalism, we seem to be reaching a point of looming economic collapse simply primarily because of wasteful resource usage.

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The Unending Quest For Productivity

What is productivity? Why is it important? What is the benefit of ever increasing productivity? Is there a natural limit to productivity gains? Modern economies are built around a platform of unending productivity. Much has been written and continues to be written about productivity. The basic assumption of our society (and by society I mean the world) is that ever increasing productivity is unquestionably good.

A basic definition of productivity as given in Wikipedia is total output per one unit of total input. This definition also helps to give an answer to the question of why productivity is important. The more we can produce per given amount of input, the more productive we are and so our production processes are more efficient. This also helps to address a benefit of ever increasing productivity. Greater efficiency in production processes helps to reduce waste and should provide superior quality and service.

Viewed from this lens, productivity per-se is good and greater productivity is even better. Hence it makes sense to try and constantly increase productivity. This is an economic argument that is accepted almost without question. This same argument also easily flows into the private sphere. Thus apart from taking about work productivity, there is constant discussion about improving personal productivity. An entire industry has grown up on how to improve personal productivity. Books, blogs, talks, seminars, there is a huge amount of information and advice available . Anyone wanting to explore this area is quickly overwhelmed. The key assumption behind all this is that only economic activities are worthwhile.

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