July 25, 2006
The Problem with Shareholder Primacy
Posted by Brayden

Many thanks to Gordon for inviting me to guest blog here at Conglomerate.  I've read Conglomerate since its inception.  As a non-legal scholar, it has been a real education to me.  We'll see if I learned anything as I now jump into the fire.

One of the legal debates that interests me the most is that of shareholder primacy.  The shareholder primacy norm, as stated on paper, seems like a straightforward decision-making criterion.  Corporate directors should make decisions that benefit the shareholders (and by benefit, we mean increase shareholder value).  The norm seems to cut through the haze when directors begin discussing other ways to expend corporate resources.  The norm is often used as a justification for actions or as a restraint on efforts like charitable giving, improving worker conditions, or doing things that might be seen as "socially responsible."  Besides being straightforward, the norm is often thought of as universal and unquestioned.  Stephen Bainbridge wrote that the shareholder primacy norm "has been fully internalized by American managers."  My own experience with managers does not contradict this view (at least on the surface).  In interviewing managers during the research phase of my dissertation on corporate acquisitions, several told me that the first question they asked themselves when deciding whether to pursue an acquisition was, "how does this increase our shareholders' value?"

The problem with the shareholder primacy norm, as I see it, isn't that directors are unsure of what their goal should be.  Rather, it is often completely unclear to managers and directors what is the best way to achieve that goal.  If directors were aware of the best way to maximize shareholder value, they would probably do it.  But that's a fairly problematic assessment.  As Gordon wrote in response to Bainbridge, "the shareholder primacy norm does not speak to the content of fiduciary duties beyond determining who is the beneficiary of such duties" (1998, 284).

  and The problem is really just a restatement of Simon's bounded rationality concept.  Directors, like anyone else, are "intendedly rational but only limitedly so."  In assessing various alternatives that all seem to promote shareholder value in some unique way, directors really do not face a choice at all.  They can only be more or less effective at maximizing shareholder value.  This ultimately places the onus back on the investor who has to make the decision of which companies to invest in.  The shareholder primacy norm might be more imperative if it merely pushed directors to make decisions that benefitted shareholders rather than nonshareholder constituencies.  But as I will write about in a later post, this isn't a straightforward distinction either.  Many decisions to allocate resources in ways that benefit nonshareholder interests may also have a positive effect on shareholder value.  In fact, most executives and directors make this plea when giving charitable donations or improving worker conditions.  They argue that these actions are investments (not costs) that will lead to improved market value.  How can you argue with that?

The problem with the shareholder primacy norm is that it doesn't actually tell directors how they are to allocate resources.  That's a big problem for a norm that is supposed to assist decision-making and provide a legal justification for corporate actions.  The real function of the norm, as I see it, is a rhetorical one.  It is a protective cushion for directors that allows them to make decisions without having their intentions questioned by internal or external stakeholders.  Although the question of shareholder primacy is probably often raised in the boardroom, it's unclear that it actually controls the flow of decision-making.  Instead, if the literature on decision-making is correct (see this paper), directors base their choices on heuristics and institutionalized norms that allow directors to avoid taking undue risks while still attempting to be seen as oriented towards value-maximization. 

The norm can also be used in the opposite way.  Directors or other stakeholders may refer to the norm when trying to defeat a corporate decision that they see as too risky or that does not jive with their sensibilities.  It is in this latter way (invoking it as a political tool) that I have seen the shareholder primacy norm exerted most forcefully in the realm of public discussion. 

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"Interesting post by a guest blogger at Conglomerate:The shareholder primacy norm, as stated on paper ..." [more] (Tracked on July 25, 2006 @ 15:20)
» Brayden on Corporate Governance from ProfessorBainbridge.com ...
"Interesting post by a guest blogger at Conglomerate:The shareholder primacy norm, as stated on paper ..." [more] (Tracked on July 25, 2006 @ 18:55)
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