July 27, 2006
Enlightened Value Maximization
Posted by Brayden

In my last post, I discussed the practical problems of using the shareholder primacy norm as a decision-making criterion.  A commenter wisely suggested that the problems would be even greater if managers did not have a norm to internally regulate their behavior.  Bainbridge suggested as much in his post response.  Absent a strong norm, what keeps managers or directors from violating the trust of the investor public?

One backdoor approach is to use stakeholder theory as a guide.  Stakeholder theory asserts that directors should take into consideration all constituencies that are affected by the corporation, including employees and members of the community.  Stakeholder theory interests me because, descriptively, it probably tells us a great deal about how corporations behave, but prescriptively it's a mess.  How can you tell a director that he is to watch out for the interests of all stakeholders when much of the time those interests seem to be in direct competition? 

This is the problem that Michael Jensen tackles in his paper, "Value Maximization, Stakeholder Theory, and the Corporate Objective Function."  Jensen, a longtime proponent of value maximization, argues that "multiple objectives is no objective."  Unless managers have one clear objective (e.g. maximize market value) decision-making is likely to be incoherent and the corporation falls into disarray.  Therefore, Jensen argues that the sole objective of any corporation should be to maximize total market value - the "sum of the market values of the equity, debt,  and any other contigent claims outstanding on the firm" (pg. 12).  However, Jensen also recognizes that nonshareholder constituencies are important components to the process of accomplishing this objective.  If you don't have satisfied customers, a motivated workforce, and trusting consumers or investors, the corporation is not maximizing its total market value.

Jensen introduces, as an alternative way of thinking about this objective, the concept of "enlightened value maximization."  By this he means that the long-term market value of the firm should be seen as the scorecard, but that it should not be the primary criterion used to guide day-to-day decision-making.  Rather, corporations need their own set of internal criteria that provide motivation and a positive self-assessment of accomplishment.

We must give people enough structure to understand what maximizing value means so that they can be guided by it and therefore have a chance to actually achieve it. They must be turned on by the vision or the strategy in the sense that it taps into some human desire or passion of their own—for example, a desire to build the world’s best automobile or to create a film or play that will move people for centuries. All this can be not only consistent with value seeking, but a major contributor to it.

And this brings us up against the limits of value maximization per se. Value seeking tells an organization and its participants how their success in achieving a vision or in implementing a strategy will be assessed. But value maximizing or value seeking says nothing about how to create a superior vision or strategy. Nor does it tell employees or managers how to find or establish initiatives or ventures that create value. It only
tells them how we will measure success in their activity.

By shifting value maximization to a discussion of strategy and motivation, Jensen has moved into the world of organizational theory.  He recognizes later in the paper that what is truly needed to further this debate is a better understanding of the "drivers of performance."  Without a sound understanding of this, it becomes very difficult for investors or directors or for anyone else to hold managers accountable for their actions.  In fact, sometimes a lack of understanding of performance underlies the finicky and volatile nature of the market.  Lacking patience, investors are prone to overreact to temporary performance declines.

Enlightened value maximization also entails that corporate decision-makers (and observers) be more sensitive to the demands of nonshareholder constituencies (ironically enough).  Rather than cast about haphazardly though, enlightened value maximization calls for a more reasoned and systematic analysis of the contribution that different stakeholders have on corporate performance.  As Jensen implies in the paper, stakeholders must also be held to account for their actions and should be given priority based on their importance to performance.  Thus, in some situations, community support will be more imperative than in others.  Some corporations, then, should be more attentive to things like social responsibility than others - depending on the extent to which reputation or external legitimacy influences total market value. 

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