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.
