Thursday, 5 January 2012

Shareholder maximisation & risk

The section below, from Colin Crouch's rather ace book The Strange Non-Death of Neo-Liberalism, is rather interesting. The picture is familiar - companies under pressure from shareholders to hit certain targets will sacrifice investment etc (sometimes even if they think it will provide a long-term benefit). What I hadn't considered before (maybe I was being fick) was how this in a sense twists the idea of shareholder rights being a compensation for risk. If shareholders were long-term oriented it shouldn't happen - they ought to want companies to invest even if it means missing a few quarterly targets. But shareholders - or at least those that assume that role given the delegation of authority by asset owners - don't think like that. That's probably in (large?) part because they too face short-term pressure.

There is a further important consequence of the combination of shareholder maximisation and highly active, short-term markets. In theory, shareholders’ earnings, their dividends, based on profits, are the residuum in a firm’s trading activities, the last claim that is made on a firm after all claims from bond-holders, employees, creditors, investment needs and other requirements have been met. This is the risk-bearing activity at the heart of capitalism that enables firms to be innovative and that justifies shareholder maximisation: if the shareholders must wait until all other contractual claims on a firm have been met then they need to be able to have the final say over how the firm is managed. Also, their rewards from successful transactions must be high, as these must compensate them for the losses that will come from risks that go wrong.

This principle remains valid if a firm goes bankrupt; shareholders have the last claims on any assets. But during routine operations of a viable company it has been heavily compromised by the emergence of profit expectations within today’s highly volatile stock markets. Ideas spread as to what short-term return on profits ought to be available in the market; remember shares are being bought and sold with an eye primarily on the secondary markets. There will therefore be a flight from shares of firms not meeting the prevailing idea of a good return. Such firms become vulnerable to hostile takeover, something which senior managers are keen to avoid, as it often leads to them losing their jobs. Managers are therefore under strong pressure to meet or exceed a target level of return to shareholders. If necessary, investment plans, customer service and employee compensation will have to be held back to meet this target. Once this occurs, distributed profits are no longer a residuum but are an early call on a firm’s earnings. They are ceasing to be rewards for commercial risk, but are being protected from all risks other than those stemming from a collapse of secondary markets (where, we now know, government will protect them anyway).

No comments: