Wednesday, 25 April 2007

Share price as a performance indicator

I've just been alerted to this paper which does a pretty good demolition job on the idea of using share price as an indicator of corporate performance. I've got a huge amount of sympathy with this. We all want the companies in which we have investments to do well because a) that helps pay our pensions and b) that means there are jobs. However how can one single indicator like the share price, which is buffetted around on the sea of investor views and fears, really tell us much about what is really going on in companies? In addition what happens to those companies if directors think that their principal objective, and what they are highly incentivised to achieve, is arising share price?

Here's what John Plender had to say on the subject in his interesting book Going off the Rails:

The bizarre irony here is that the shareholder value movement has ended up replicating the errors of socialist planners in the old Soviet Union who imposed targets on industrial managers that were frequently met by fiddling the figures or doing damage to some other aspect of the business. By fixing on a single managerial incentive – the share price – the Anglo-American system has encouraged management to maximize short-term profits at the expense of longer term growth. When managers found that they could not generate enough short-term profit to satisfy investors and stock market analysts in the bubble period, they resorted to takeovers as a means of keeping one step ahead of the baying hounds of the financial community. And when takeovers became more difficult to pull off in the depressed stock market conditions that followed the bubble, they took to window-dressing the figures either within the rules or fraudulently as at WorldCom.

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