The misguided war against shareholder value management

Posted in Economics, Financial Markets, General Musings, Politics and Policy at 8:53 am

Lots of criticism against shareholder value management and stock-based compensation for executives has appeared in the press recently.



There’s nothing wrong with shareholder value management, which simply states that when evaluating corporate investment decisions, a company’s management should A) ignore accounting fictions that have no bearing on cash flow and B) take into account their overall cost of capital, which includes both debt and equity.

Likewise, there’s nothing wrong with aligning management’s incentives with those of the owner’s of the firm via the issue of stock options or restricted shares.

As is often the case, the problem is with the execution of the above. The root cause is short-termism itself. Stock buybacks, one time dividends, and other financial engineering practices may drive the stock price higher in the short run but it does not lead to long run value creation, which was the whole point of shareholder value management. Likewise, the way we have structured stock grants to executives is not aligning their long term interests with shareholders, it’s incentivizing them to extract as much in the way of economic rents from the companies they run in as short a time as possible. The combination of these two factors is leading to disaster. The solution is to fix the implementation, not to scrap the fundamental ideas themselves.