Shareholder primacy: myths and realities

Bastiaan van der Linden at EDHEC Business School explains a management mindset that won’t be displaced entirely by ESG

 

Shareholder primacy is a management mindset in which strategic business decisions are made with one criterion: making money for those who own its stocks. And while this mindset has been popular among CEOs for nearly a half-century, its appeal is waning as corporate leaders take up strategies highlighting environmental, social and health movements.

 

But even as CEOs try to save the world, this doesn’t mean they have ditched shareholders and profit completely. Today, savvy CEOs are marrying shareholder primacy with business purpose to survive and even thrive during uncertain times.

 

This new dynamic is possible, in part, because business leaders realise the fallacies of long-held beliefs about shareholder primacy: 1) that it is a legal requirement; 2) that the fiduciary duty of investment professionals to their clients means that CEOs must deliver profit; and 3) that because CEOs can get the boot from shareholders, increasing the financial value of their company must be the top priority. 

 

Are we moving beyond shareholder primacy?

For decades, many believed that CEOs were legally required to maximise profit for shareholders – often referring to the case of Henry Ford and the Dodge brothers, in which a judge ruled that “a business corporation is organised and carried on primarily for the profit of the stockholders.”

 

However, a lot has changed since 1919, when the case was adjudicated. More recently, legal scholar Lynn Stout, author of The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public, made the case that shareholder primacy was the result of a misreading of corporate law and that CEOs have the legal right to serve interests other than those of investors.

 

Fiduciary duty requires investment professionals to prioritise the interests of their clients. Today most regulators accept that these interests include both financial and non-financial concerns, including, for example, clean oceans and a society that thrives thanks to good schools and medical care.

 

In 2014, the European Commission inventoried the fiduciary duties of the investment industry and concluded that advisors could serve clients’ financial and non-financial interests. In 2021, EU lawmakers went even further, requiring advisors to cover non-financial interests during discussions with their clients.

 

As for unruly shareholders firing a CEO: sure, it can happen, but this does not need to prevent CEOs from considering other interests. In many jurisdictions, terminating the contract of a CEO may require proof that they are acting against the best interests of the firm, which is not necessarily the same as the interests of the investors.

 

But if a CEO is savvy, they will use purpose in their strategy and communication to attract like-minded investors and dissuade those who have only short-term profits in mind. Recently, US researchers reviewed the transcripts of earnings calls and found that CEOs who emphasise long-term goals were more likely to attract shareholders with similar, long-term views.  

 

Balancing purpose and profit to keep shareholders happy

An excellent example of a corporate leader using purpose to keep shareholders in line is Unilever CEO Paul Polman, who made it clear in 2009 when he took the company’s reins that he would not put up with short-term profit-oriented shareholders.

 

On his first day as CEO, Polman told shareholders that Unilever would no longer publish quarterly earnings forecasts because the company was taking “a longer view.” He advised anyone who didn’t want to buy into his “long-term value-creation model” to invest their money elsewhere. After this, Unilever’s stock prices dropped, but it wasn’t long before they rebounded.

 

Polman’s move was bold. But it was also wise because he rid the company of shareholders who didn’t believe in his strategy and might have slowed its progress. This is an excellent example of a CEO using their position to create the right environment for corporate ESG to flourish and for shareholders to benefit too. Academic research shows that companies that focus myopically on short-term financial goals, often to please shareholders, perform worse in the long run.

 

Indeed, investors with a long-run view, including Larry Fink, CEO of BlackRock, typically encourage companies to take on a purpose-focused mindset to create value for their most important stakeholders, including customers, employees, suppliers, the communities in which they operate, and, of course, their shareholders.

 

Thus, paradoxically, to maximise their return, even shareholders themselves ask businesses to focus strategy and decision-making beyond profits.

 

Shareholders: a vital role to play

So, despite the trend toward business purpose and ESG goals, CEOs still need to take care of shareholders. Shareholders provide the capital to grow businesses, and they take a risk in the process. They should be rewarded for their investment and their loyalty.

 

CEOs must win over shareholders, but this isn’t the same as giving primacy to them. Volkswagen aims for “competitive profitability” to provide investors with dividends and enhance stock value. Similarly, Unilever aims to “deliver growth that is consistent, competitive, profitable and responsible.”

 

Savvy CEOs seem to alternate between mindsets because they recognise that they must serve not one stakeholder but many. Investors also see that companies must serve a broader set of stakeholders to deliver returns.

 

But even if a company is led by a CEO who wants to be 100% purpose-driven, there will inevitably be a moment when they must give primacy to shareholders, especially if activist investors are threatening mutiny or an unsolicited takeover is looming, such as when Unilever foiled an unsolicited takeover bid by Kraft Heinz.

 

Shareholder primacy and business purpose can be married into an effective strategy exactly because neither one of them is required, per se. A corporate leader may make a purpose-based strategy that serves the interests of shareholders just as well as other stakeholders without prioritising any of them but will undoubtedly still encounter situations in which shareholders must take precedence.

 

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Dr Bastiaan van der Linden is Associate Professor of Corporate Social Responsibility, EDHEC Business School

 

Main image courtesy of iStockPhoto.com