Shareholder Wealth

It's beat dead horses week at ThreeSources -- thanks for playing!

I suggested that the Steelers won the Super Bowl, questioned the resource allocation in the Rhode Island GOP Senate Primary, and had the temerity to say --contra the blogosphere -- that Google should maximize the value for its shareholders, even if that meant kowtowing to the ChiComs on filtering results from its search engine.

Professor Bainbridge takes my side on the last issue (no word from him on the pass interference call)

But does all of this mean that corporate fiduciary duty law should require -- or, at least, allow -- corporate directors and officers to behave in ways Kleiman deems brave or responsible when doing so would be inconsistent with shareholder wealth maximization? I think not.

In the first place, requiring directors to maximize shareholder wealth provides the board of directors with a determinate metric for making business decisions. I often use the following example to explain what I mean by that: Suppose Acme's board of directors is considering closing an obsolete plant. The board is advised that closing the plant will cost many long-time workers their job and be devastating for the local community. On the other hand, the board's advisors confirm that closing the existing plant will benefit Acme's shareholders, new employees hired to work at a more modern plant to which the work previously performed at the old plant will be transferred, and the local communities around the modern plant. Assume that the latter groups cannot gain except at the former groups' expense. By what standard should the board make the decision?

Shareholder wealth maximization provides a clear answer -- close the plant. Once the directors are allowed to deviate from shareholder wealth maximization, however, they must inevitably turn to indeterminate balancing standards. Such standards deprive directors of the critical ability to determine ex ante whether their behavior comports with the law's demands, raising the transaction costs of corporate governance.

Worse yet, absent the clear standard provided by the shareholder wealth maximization norm, the board of directors will be tempted to allow their personal self-interest to dominate their decision making. Put another way, directors who are allowed to consider everybody's interests end up being accountable to no one.

While it is swell to see a company sticking up for values that we admire, the purpose of the capital markets is to direct capital to its best (most efficient) use. without the metric of profit, we will get whatever board members think is important.

Google Posted by jk at February 8, 2006 4:34 PM