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Maximizing Shareholder Value?

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Maximizing shareholder value—a mantra made popular in 1976 by the most-cited academic business article of all time, Jensen and Meckling’s “Theory of the Firm”—is just too vague and uninspiring to move employees to action. People need something tangible and actionable to focus on—something that will result in maximizing shareholder value. Tell an employee to increase shareholder value, and he’ll struggle. Tell him to increase customer value, and he can think of a dozen things to do, many of them actionable, measurable, and beneficial to your bottom line.

Here are five reasons why it’s time to focus instead on understanding and meeting the needs of your customers:

Shareholders care more about how healthy your company looks than how healthy it is. According to the authors of the 2008 Harvard Business Review article “Innovation Killers,” “Over 90 percent of the shares of publicly traded companies in the United States are held in the portfolios of mutual funds, pension funds, and hedge funds. The average holding period for stocks in these portfolios is less than 10 months.”

It’s time to stop thinking of the typical shareholder as a grandma in Peoria holding shares of stock for 20 years.

That hedge fund manager you were trying so hard to please last year has already dumped your stock. Shareholders have very little interest in the long-term health of your company, only in the appearance of long-term health. It might be more accurate to refer to today’s shareholders as “sharehandlers.”

Asking an executive to maximize shareholder value can be a very bad idea. If a stock’s P/E ratio is 20-to-1, then only 5 percent of a firm’s value is driven by this year’s earnings. To put it another way, 95 percent of shareholder value is driven by shareholders’ expectations of the future…which can be manipulated. Most of those shareholders are not actually going to be around to see whether the company meets its long-term earnings goals. So the executive with stock options has great incentive to manage investor expectations.

Maximizing shareholder value doesn’t work anyway. We should not be shocked to find this failed logic has led to failed results. Roger Martin (“The Age of Customer Capitalism,”Harvard Business Review, Jan. 2010) researched and compared the pre-maximize era (pre-1976) with the post-maximize era (post-1976). Here’s what he found: The compound annual real shareholder return actually dropped from 7.6 percent to 5.9 percent. The new goal of maximizing shareholder value did nothing to…maximize shareholder value.

Jack Welch, the ‘poster child’ for maximizing shareholder value, was highly successful over his tenure. But GE shareholder value plummeted after his retirement, most likely because investors were trading on the appearance of health—not the actual long-term health—of GE. And that appearance changed dramatically with Mr. Welch’s retirement. It’s been 10 years since he retired, and GE’s market capitalization is still only one-third of what it was when he left. It may be a long time before his successor(s) can ‘manage expectations’ to the peak he reached.

Only tangible goals, pursued day after day, ultimately get results. Like achieving personal satisfaction, in and of itself maximizing shareholder value can be a difficult thing to figure out how to achieve. But when you instead focus on something tangible like improving customer satisfaction, you can begin to see how that goal will result in maximized shareholder value. The more happy customers you have, the happier your shareholders will be. The more miles you run leading up to the marathon, the more likely you’ll put in a satisfying performance on the day of the race. The organization behaving as though its goal is to understand and meet the needs of its customers will outperform competitors fixated on shareholder value.”

Employees need a higher calling to be inspired. According to Napoleon, “Small plans do not inflame the hearts of men.” If you’re the CEO and you think your employees are passionate about this quarter’s earnings per share, you’re out of touch. You might be excited about it because you have large stock options, but that’s not the kind of passion that’s going to rub off on your employees. In fact, many employees will question your motivation to reach the goal when they know you’ll benefit disproportionately—sometimes wildly disproportionately—from the achievement of that goal.

Employees will quickly forget last quarter’s earnings, but years from now they’ll be telling their grandkids how they were on a new product team that turned their industry upside down.

Meeting customer needs requires understanding them—and from that understanding can flow a river of profits.  Two points of clarification: First, “customers” includes both existing and new customers (sometimes in new markets). Second, “meeting needs” must include both value creation and value capture. Value creation is a new offering that provides value beyond the customer’s next best alternative. Value capture is returning some of this customer value to the supplier through appropriate pricing. Done correctly, meeting customer needs will not reduce your profits; it will increase them.

When you see a gulf that large between good and poor practitioners, it should scream ‘opportunity!’

The executive’s dilemma, of course, is to find a way to survive the short term while building the long term. After all, those short-term “sharehandlers” will continue to form expectations, and the board of directors will continue to watch these expectations impact stock price. Take a two-pronged approach of finding new ways to influence investors while rapidly seeking to understand the customer needs that have, so far, gone unmet.

Not everyone is willing to expend the blood, sweat, and tears it takes to create a new reality inside their company and make a mark in the marketplace. Just imagine what will happen if you’re able to make this shift before your competitors. The edge you’ll gain will be tremendous—and so will the rewards.

About Dan Adams

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Dan Adams is President of Advanced Industrial Marketing, Inc. and new author of New Product Blueprinting: The Handbook for B2B Organic Growth. Adams was head of strategic planning for a billion-dollar company and has extensive experience in Fortune 500 marketing, business development, and leadership positions. An award-winning speaker, he is a guest lecturer at Wharton’s Executive MBA program and trains in every region of the world.

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