Balancing claims by professional managers sounded good in theory. In practice, it often led to inconsistent and ill-defined priorities. Decision-making became unpredictable and capricious.
Closure was reached only when shifting combinations of problems, solutions, and decision-makers happened to coincide. Poorly understood problems wandered in and out of the system. That way of managing a corporation was unable to cope with the forces of globalization, deregulation and new technology that were emerging.
Greater clarity in terms of purpose was needed. Theorists began asking: is there a single goal against which progress might be measured? For it is the customer, and he alone, who through being willing to pay for a good or for a service, converts economic resources into wealth, things into goods. What the business thinks it produces is not of first importance—especially not to the future of the business and to its success.
Deregulation, globalization, the emergence of knowledge work and new technology led to a shift in the commercial center of gravity: power in the marketplace from seller to buyer.
Instead of the firm being the stable center of the commercial universe, now the customer became the center. For firms to be successful now, customers had to be not only satisfied: they had to be delighted. Once Apple, Amazon and Google showed that it was possible to deliver instant, intimate, frictionless value to customers at scale, that level of performance started to become necessary.
In effect, instant, intimate, frictionless value for customers at scale has become the new standard of corporate performance. Instead of big firms dictating to the marketplace, now customers have a crucial say in what gets bought and what doesn't. It means that firms have to be looking at, and interacting with, the world differently.
They recognized that in the emerging marketplace, they had to deliver more value to customers. Firms had to become radically innovative and nimble, just to survive. In due course, this meant embracing management practices such as Lean, Design Thinking, and Agile management.
But most public corporations in the U. Their initial champion was the Chicago economist, Milton Friedman. Executives no longer had to worry about balancing the claims of employees, customers, the firm, and society.
They could concentrate on making money for the shareholders. In , two new champions emerged. In one of the most-cited, but least-read, business articles of all time, finance professors William Meckling and Michael Jensen offered a quantitative economic rationale for maximizing shareholder value, along with generous stock-based compensation to executives who followed the theory.
The article explained how the personal interests of executives could be aligned with those of the corporation and its shareholders. Compensation in stock would turn the executives into part-owners of the firm and so protect the other part-owners—the shareholders—against the managers wasting cash on corporate jets, lavish new headquarters and other monuments to executive extravagance.
Now managers would act like owners. The message was seductive. It created a mandate for finance to take charge of the corporate boardroom, namely, those who saw the enterprise largely through the lens of the numbers—sales figures, costs, budgets and profits. Since the executives themselves now were also part-owners, the approach had a happy side-effect: they could become rich in the process.
In the s, Ronald Reagan and Margaret Thatcher gave the idea political cover: business should get back to basics. Government was the problem, not the solution. Who owns a corporation?
Shareholders do. These are the individuals, businesses, and institutions that have an ownership interest in a company after purchasing shares of that company's stock. Even if your business is a one-person shop , you are the shareholder based on your invested interest in your company. Because shareholders own the firm, they are entitled to the profits of the firm. Shareholder wealth is the appropriate goal of a business firm in a capitalist society , whereby there is private ownership of goods and services by individuals.
Those individuals own the means of production by the business to make money. The profits from the businesses in the economy accrue to the individuals. When business managers try to maximize the wealth of their firm, they are actually trying to increase the company's stock price. As the stock price increases, the value of the firm increases, as well as the shareholders' wealth.
People often think that the managers of a firm are the owners. In the case of a small business or partnership, that might be true, such as sole proprietor owner who is also the manager. In a larger business, there may be many levels of management and staff, and they do not necessarily own the firm.
Aside from their salaries and benefits, they only profit from the business if they own shares of stock in the company. As analyst Steven Pearlstein explains:. In its more corrosive application — the one that is inculcated in business schools, enforced by corporate lawyers and demanded by activist investors and Wall Street analysts — maximizing shareholder value has meant doing whatever is necessary to boost the share price this quarter and the next.
Over the years, it has been used to justify bamboozling customers, squeezing workers and suppliers, avoiding taxes and lavishing stock options on executives.
Most of what people find so distasteful about American capitalism — the ruthlessness, the greed, the inequality — has its roots in this misguided notion about what business is all about. The result? By , maximizing shareholder value has come to be seen as leading to a toxic mix of soaring short-term corporate profits, astronomic executive pay, along with stagnant median incomes, growing inequality, periodic massive financial crashes, declining corporate life expectancy, slowing productivity, declining rates of return on assets and overall, a widening distrust in business.
Now the BRT has recognized that a sole focus on profits for shareholders is no longer defensible and has seen fit to redefine business purpose.
As Pearlstein explains:. The BRT statement seems to be less a clarification of corporate purpose and more a defensive reaction to the complaints about big business, particularly by the younger generation. In response, companies will now emphasize the good things that they claim to be doing, along with making money. We will thus soon be hearing many more preachy corporate purpose statements with a capital "P", that sound good but have little or no actionable content.
From outside the corporation, it may be even more difficult to figure out what goals firms are really pursuing. In effect, if corporations really start seriously pursuing multiple-stakeholder value, with no stakeholder having priority over any other, the managers themselves may lose track of which direction they are heading. The sad truth is that we have been down this path before, with disastrous results.
In the period , managerial capitalism was understood to mean exactly that: meeting and balancing the needs of all the stakeholders. Firms can increase cash flow by quickly converting inventory and accounts receivable into cash collections. The rate of cash collection is measured by turnover ratios , and companies attempt to increase sales without the need to carry more inventory or increase the average dollar amount of receivables. A high rate of both inventory turnover and accounts-receivable turnover increases shareholder value.
If management makes decisions that increase net income each year, the company can either pay a larger cash dividend or retain earnings for use in the business. When a company can increase earnings, the ratio increases and investors view the company as more valuable. It is commonly understood that corporate directors and management have a duty to maximize shareholder value, especially for publicly traded companies.
However, legal rulings suggest that this common wisdom is, in fact, a practical myth—there is actually no legal duty to maximize profits in the management of a corporation. The idea can be traced in large part to the oversize effects of a single outdated and widely misunderstood ruling by the Michigan Supreme Court's decision in Dodge v. Ford Motor Co.
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