What's wrong with the primacy of shareholders?

A lot, according to Lynn Stout, a law professor at the University of California at Los Angeles. Not only has the assertion of shareholder primacy in the US since the 1970s been presented a lopsided view of the corporation, it hasn't described very well what actually happens in companies in practice. Moreover, she contends, "governance experts who tout the 'U.S. model' abroad may, in fact, be exporting damaged goods." She sees a growing body of evidence, in practice and theory, suggesting that putting shareholder interests first is bad for shareholders.

Stout's pedigree as a scholar is considerable. With Margaret Blair, she authored a paper in 1999 that saw boards not as the representative of shareholders but instead as a mediating hierarchy between the conflicting and contesting calls on corporate resources. Board adjudicate those claims. Her work cannot, however, be pigeonholed as falling under stakeholder theory or corporate social responsibility, either, though it incorporates aspects of their conclusions without accepting all the premises.

In her new working paper, she contends that contrary to common assumptions, US corporate law and practice does not require directors to maximise shareholder wealth. Boards have a wide range of discretion, constrained only at the margin by market forces, to sacrifice shareholder wealth in order to benefit other constituencies. "Although recent 'reforms' designed to promote greater shareholder power have begun to limit this discretion, U.S. corporate governance remains director-centric," she asserts. Theory, too, points in directions away from the conclusions of agency theory. She outlines five other theoretical perspectives and explores why each gives us reason to believe that shareholder primacy rules in public companies have a perverse effect: such rules disadvantage shareholders.

Among her observations is one we've long shared: that shareholder value is a flawed concept when shareholders have such different time horizons. She concludes that the thinking that goes into shareholder primacy in its conventional form is "on the brink of intellectual collapse". What comes next will be a lot more subtle. This is a charmingly readable paper, as well as one that will challenge your thinking.

Source document: The working paper "New Thinking on 'Shareholder Primacy'," by Lynn Stout of UCLA, is a 28-page pdf file.