Does “shareholder value” make any sense?

May 19, 2009

Justin Fox, in an excerpt from his new book, explains that “shareholder value” didn’t always mean “share price”:

The goal was to get corporate executives to pay less attention to accounting earnings and focus instead on economic earnings – which Alfred Rappaport, who taught at Northwestern University’s Kellogg School of Management, defined as anticipated cash flow discounted by the cost of capital. It was an argument for paying attention to what created value over time instead of stressing out about quarterly earnings. Which doesn’t sound dumb.

“I don’t know how many times I kept saying long term, long term, long term,” explains Rappaport, who is now 77 and living in semiretirement in Southern California, but still pens the occasional Harvard Business Review article and has a new book in the works. “To me, shareholder value was not about an immediate boost to stock price.”

This kinda assumes, however, that shareholders are in it for the long, long term too. If management’s incentives are aligned with the long-term interests of shareholders, and neither cares too much about short-term share-price fluctuations, that’s great.

But we live in a world where the overwhelming majority of stock-market investors mark their holdings to market daily, even if their time horizon is measured in years. In that world, shareholder value is the stock price, whether markets are efficient or not.

Justin says that the concept of shareholder value is not a dumb idea, as Jack Welch would have it. But in order to believe that shareholder value makes sense, you also have to believe that if you buy a stock at $100 and it drops to $50, then you haven’t lost any money so long as you haven’t actually sold the stock. And there aren’t many people who really believe that.


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