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The problem with focusing on shareholder value

Companies today put more and more focus on "shareholder value," or helping to boost the stock price. Lynn Stout of Cornell Law School says that pushes them to make bad long-term decisions about the business.

Lynn Stout, distinguished professor of Corporate and Business Law at Cornell Law School, and author of "The Shareholder Value Myth."

Image of The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public
Author: Lynn Stout
Publisher: Berrett-Koehler Publishers (2012)
Binding: Paperback, 120 pages

A big part of the consumer economy is, of course, big business. And big business, in today's world, increasingly relies on the idea of growing shareholder value.

Lynn Stout is a professor at Cornell Law School and the author of "The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public." She's quick to point out that while we might view "shareholder value" as an essential part of capitalism today, it wasn't always that way.

"This is a kind of new idea that was actually invented by professors," she says. "Historically, it's not been what capitalism is all about." The idea can be traced back to the writings of Milton Friedman in an article he wrote for the New York Times Magazine in 1970, "The Social Responsibility of Business is to Increase its Profits."

In the golden age of large public corporations, Stout says, businesses were not merely in business to make a profit, but also to fulfill other goals like building great products and providing livelihoods for employees.

But what's so wrong with companies trying to turn a profit?

Stout says this kind of singular focus on driving the stock price can lead companies to make decisions that benefit them only in the short-term -- and could be disastrous down the line.

When it comes to cost-cutting measures by companies, consumers are often the most affected. Take the example of an airline: when the company decides not to invest in repairs or infrastructure, airplane ticket buyers are the ones left waiting on the runway for maintenence to fix the plane.

"When managers are focusing on share price, it's very hard for companies to actually be innovative," Stout argues. "The second problem that short-termism imposes on consumers is that, obviously, when they're trying to cut costs...they're not going to invest in their employees; they're not going to invest in customer support, they're not going to invest in improving their products the way they should."

Worrying about the entire value of a company, and thinking long-term, doesn't just benefit the customer -- it helps the company as well.

"The life expectancy of a Fortune 500 company has declined from 75 years (back at the beginning of the century) to less than 15 years today," Stout says. "I think that's a pretty obvious symptom of what happens when you're pressuring managers to get that share price up at all costs even if it means taking on enormous risks and not planning for the future."


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About the author

David Brancaccio is the host of Marketplace Morning Report. Follow David on Twitter @DavidBrancaccio

Lynn Stout, distinguished professor of Corporate and Business Law at Cornell Law School, and author of "The Shareholder Value Myth."

Image of The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public
Author: Lynn Stout
Publisher: Berrett-Koehler Publishers (2012)
Binding: Paperback, 120 pages
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