Creating shareholder wealth is seen almost as a holy grail for business to achieve. If you can maximise the wealth of your shareholders, you are attaining one of, if not THE most important strategies of the business. It can be difficult to argue against. Albeit over two centuries ago, Smith’s idea of the ‘invisible hand’ guiding the marketplace in such a way that efficiencies are rewarded with investment can still be seen as relevant in modern times. This success can then be seen to benefit the society as a whole.
Just look at BP- before the Gulf of Mexico oil spill, it was estimated that for every £8 paid into UK pension funds, £1 can be attributed to BP. A perfect example of looking after the shareholders and also creating a positive outlook for millions in the UK, surely?
Looking at the picture after the oil spill however and we see a potential problem with focussing too much on shareholders. BP halved their dividend paid from the figure before the disaster. This will have a significant impact on both shareholders, and in extension, almost every member of the UK public that holds a pension. In non-monetary terms, the environmental impact of the coastline has devastated livelihoods and sea life, and killed 11 people.
Is it too harsh to hold BP so culpable for this? It could be chalked down to misfortune, maybe it was completely unavoidable. Looking at BP’s track record; namely the Texas City disaster, the history of budget cuts forcing cutbacks on safety and training cannot, and should not be ignored. These budget cuts will have undoubtedly resulted in improved profit margins and will most likely have had a positive impact on the shareholder, and yet now BP are in a situation where a relentless pursuance of maximising shareholder wealth has come back to bite shareholders where it hurts the most- their wallets. With an estimated £40bn loss for shareholders in dividends over the next 10 years, every shareholder and almost every UK citizen with a pension will see a huge loss. Maximising shareholder wealth? Perhaps not...
The use of performance indicators as tools to measure shareholder wealth can also be brought into question. Domino’s Pizza are considered to be one of the best performers on the stock exchange since the economic downturn. This can be seen by an ever improving EPS figure. Are these the be all and end all indicators to highlight good business performance though?
Writer and producer of The Wire, David Simon has an interesting take the use of statistics when reporting, “as soon as you invent that statistical category, 50 people in that institution will be at work trying to figure out a way to make it look as if progress is actually occurring when actually no progress is”. A perfect example of this in the real world is the use of a share buyback shame- something Domino’s and several other FTSE companies frequently take part in. By spending surplus cash to buy shares and take them out of circulation, businesses are able to artificially increase the earnings of each individual share without actually improving the share price.
The emphasis of improving shareholder wealth is stressed to managers so much that they are put under immense pressure to meet these figures. When it comes to self preservation, why wouldn’t management do anything they could to make the figures appear more attractive than they actually are?
Should shareholder wealth be held in such high regard even with the clear and obvious flaws? Maybe not, but with the power shareholders wield, nothing is going to change any time soon.
Personally I love the Wire, and all the shows that David Simon has been involved in, and thats a great quote that you have there.
ReplyDeleteCertainly if you watch The Wire, the main conflict is how organisational pressures make people act in ways they sometimes disagree with season 4 on the School system is a particular high point)
With BP I suppose the question is, was it the organisation pressures? or individual failures? Certainly when you look at the news stories coming out of the US it points in both directions.
whats so wrong with what Domino's did btw? A share buy-back scheme will increase the share price and therefore shareholder wealth. Why are you so against it?
I wouldn't say I'm particularly against the idea of a share buyback scheme. It's more an attempt on my part to highlight that management are able to manipulate the statistics that are seen as indicators of performance. If your objective is to increase shareholder wealth, share buyback schemes are fantastic.
ReplyDeleteI'm more against the idea of shareholders being held up as the most important stakeholder. It would be nice to see more companies acknowledge that they have a responsibility to all of their stakeholders. You could argue from the perspective of Friedman that shareholders are the owners of the company, which is a perfectly reasonable perspective. I just feel that without consumers, suppliers, employees, etc, there would be no means to reward shareholders investments, and a lot of companies seem to have forgotten this.
Maybe I’m being a little too anti-capitalist in that respect though... Why would any business trading on the stock exchange look to improve the wellbeing of stakeholders they have already completed their agreed ‘contracts’ with at the expense of profit?
As for The Wire, I would easily rate it above any series, or television show I have ever watched. I think the most tragic part of it is that it is so true to the real world. Obviously we don’t all live in the city of Baltimore dealing with drug organizations and corrupt politicians, but that apparent line between right and wrong is so blurred and so often crossed on either side.
It seems to relate to business for me as well- I spent my placement year in the NHS and I saw far too often a reluctance to do the ‘right’ thing for fear of being punished with extra work or responsibility (giving a f**k when it’s not your turn, if you will).
Your experiences in the NHS gel with what I've heard from a number of people who work in that environment. From how organisational targets work though (particularly in places like the NHS, but also in any large organisation like BP) it's easy to see how you could lose sight of the bigger picture. The pressure to meet key performance indicators makes safety for BP into a cost decision, or instead of developing relationships with a supplier, you instead, to hit your monthly target, just switch out suppliers to the lowest cost.
ReplyDeleteParticularly in The Wire I thought this was captured so well in the smoothing of the crime figures in the police depicted by the show. What was interesting though was when you looked at why. The Mayor was under pressure from the public, the Mayer put pressure on the Police Commissoner, The Commisioner put pressure on his Majors and the Majors put pressure on their staff.
Whats worse is, no-one wanted to hear that the way they approached crime was wrong, and those that didn't toe the party line (McNulty, Lester and even Bunny) were soon crushed.
You can see how this could work in organisations easily, and how sometimes it actually takes a huge external shock like the BP oil spill to completely change the mentality and direction.
Horrible to think isn't it, that in many institutions (business and otherwise) good people, thinking good thoughts for the right reasons, simply get ground underfoot because their opinions are inconvienient truths.
With reference to the self preservation comment to be an excuse to why managers do what ever possible to acheive goals like maximising shareholder wealth, shouldn't a persons morals and knowledge kick in before they make decisions like cutting safety budgets in the case of BP? Since after all, these managers are meant to from an academic background and should therefore understand the ramifications of such actions?
ReplyDeleteI would like to think that morals and pure common sense are the first things that management would think about before making decisions. I'm not sure if it happens enough though.
ReplyDeleteAs mentioned above, managers can seem to drown in KPIs and such an amount of pressure from shareholders to constantly improve. Maybe they lose sight of what is really important?
As human beings, I think it’s natural to have self-preservation as a key motivator. If, as a manager, you were told to reduce the budget or lose your job, would you comply, knowing that it could have a detrimental effect on performance or safety? I would like to think I would at least argue the case, but if you have the pressure of a multi £billion corporation breathing down your neck demanding improvements, it could override your morals.
I would say rather them than me, but I imagine I’ll end up in a similar situation at some point in my career working towards CEO of a global corporation...