The Tyranny of Shareholder Returns

Giff Constable Uncategorized

When Hillary Clinton recently took aim at hit-and-run activist investors, hedge-funder Donald Drapkin retorted that “Management forgets that shareholders own the company.”

This is legally true, but conceptually problematic. Short term investors really own an abstract object, which I’ll call a chit. They think the chit will go up or down, and they either invest or short accordingly. They don’t really care about the company, the employees, the customers, the management. They just want their chit to move in the direction they want it to move. Then, after reaching their target performance, they move on.

This actually works fine as long as investor and company incentives are aligned long-term, but it completely breaks down when investors take a short-term view *and* are given meaningful influence. This is when you get financial engineering, rather than value creation.

One of the primary reasons that Apple is the most successful company in the world today is that Steve Jobs was willing to ignore wall street and invest in the long term. And contrary to arguments from the investor community, Google and Facebook did exactly the right thing in ensuring founder control rather than shareholder control.

There are a lot of established companies that are being disrupted today, and one of the biggest blockers they have to re-inventing themselves is being willing and able to ignore Wall Street, take risks, and play the long game. This isn’t the only blocker, but it is a doozy.

Shareholder returns is a terrible way to build a company. Shareholder returns should be the result of creating value for customers, employees and society, not the primary driver. When shareholder returns drives the bus, the result isn’t value but rather volatility in the form of bubbles and crashes.

Wall Street offers a lot of value to our economy. We need things like liquidity at the stock and company level. We need growth capital. We need hedging instruments. The problem, and it is only a problem when the power balance gets out of whack, is that Wall Street itself really only cares about making money. They just want the chits to move the way they want. They don’t *really* care about the people behind the chits. This isn’t the end of the world, but they use the good things to cover for all the bad.

What many people misunderstand is that it’s not about immorality. The 2008 financial crisis wasn’t the creation of evil people, but rather amoral people who thought they were just doing their jobs of making money, and by doing their jobs surely they must be contributing to the workings of the economy, because that’s what Wall Street does, right?

As a society and an economy, we need to rethink the role shareholders play and how this has driven short-term thinking that is making our businesses, and frankly our government, quite disfunctional.