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Error at the Heart of Corporate Leadership

Autor:   •  September 16, 2018  •  Essay  •  736 Words (3 Pages)  •  488 Views

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Error at the heart of Corporate leadership – Harvard Business Review

Publicly listed companies today are primarily driven by maximizing shareholder returns. This view first proposed by Milton Freidman during the 70’s and pushed by others argues that shareholders are the principals of a company they own stock in and boards & managers are their agents with the sole purpose of maximizing returns. This view (Agency theory) is challenged in the paper by highlighting five flaws

  1. It is at odds with corporate law – Shareholders are owners of stock in the company and are entitled to share in profits but are not obliged or legally liable for decisions which managers in the company make. Boards are more akin to fiduciaries who have discretion in decision making in the interest of the beneficiaries and the company.
  2. There is a misunderstanding in the role of shareholders and who they are – with the rise of big asset managers, pension and sovereign wealth funds who are major shareholders in most public companies; who in turn have a wide population of ultimate beneficiaries, a company in most cases does not know who it’s true shareholders are. The managers in these investment institutions are themselves judged by the performance of the fund and the way they select a basket of companies to generate returns from one quarter to the next. Even the shareholders on record who have voting rights can at any time sell off shares without being held accountable for the way they vote on resolutions in the long-term.
  3. No accountability for shareholders – there is no responsibility or accountability on the shareholder for any injury from the company to a third party or liable for any debt. Shareholders can invest in companies on both sides of a transaction and have no restrictions on when they transact in the company’s share or how they vote on resolutions.
  4. Narrow management’s view to satisfy shareholders – aligning manager’s decisions to that of shareholders can cause the company to deviate from functioning effectively (as was the case with Enron).
  5. Shareholders are uniform – each shareholder has a different priority and view of his/her investment and cannot be put into a single class of “owners”. The theory assumes that all shareholders want the company to maximize their return, runs counter to the investment horizon and risk appetite of each investor. The company can only satisfy a small subset of investors at any given time.

A lot of hedge funds however use agency theory to act as “owners” on behalf of their investors to buy shares in companies and bring about change in boards & management to maximize returns, using the so called “Activist playbook”.

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