Should Management Be Primarily Responsible to Shareholders?

SUMMING UP Opinions among James Heskett's readers are divided over a critical corporate governance question: Should management put the shorter-term interests of shareholders over the longer-term needs of the company?
by James Heskett

Summing Up

How Do We Encourage CEOs to Manage for Sustainability?

Important forces encourage short-term perspectives among managers as well as investors today. These include governance biases, tax policies, faster turnover among leaders, and rapidly evolving forces in the competitive environment. But the ascendancy of agency theory—the idea that shareholders are owners of the corporation and managers their agents in a quest to maximize shareholder value—need not be one of them. Agency theory will not be a problem if we bend it to the task of encouraging sustainability of organizations and relationships between those who regulate them, serve them, and invest in them.

That’s a lot of substance among responses to this month’s column. As Ulrich Nettesheim put it, “It is an excellent time to be reexamining how we currently practice capitalism and whether or not it is serving mankind’s longer-term interests sufficiently well.”

Not everyone spoke as one on the issue. Rob Jones, for example, commented that, “Theories abound, but owner still means owner… Social and moral obligations make for fascinating discussion, but taking short-term gain to the long term detriment of a corporation isn’t illegal… business entities don’t incorporate to make people happy or to make people better. They incorporate to make people money. Everything else good that happens beyond that is icing on the stakeholders’ cake.”

Others differed. Michael Dermody commented, “The problem with agency (theory) (is that it) … creates undue risk of moral hazard, simply because boards and senior management are often significant shareholders. If it is true that the average tenure of a CEO today is 3 years, how could any sane CEO not seek to maximize share value by the time of their exit?” Even those defending the “father of agency theory,” Milton Friedman, reconciled his views with managing for long-term sustainability rather than maximum short-term shareholder value. Jacob Navon said, for example, “I think this whole debate is introducing spurious distinctions and definitions… Friedman … did not seem to define ‘maximizing shareholder value’ over a particular time horizon. Lesser minds have taken it to mean that the phrase inherently focuses on the short-term.”

David B. introduced a point that drew a lot of comment when he said that, “Every relevant interested party, with the exception of the shareholder, is looking for sustainability.” Rob Kautz provided us with a reminder that sustainability should be a concern of shareholders as well. In his words, “Empirical financial analyses have shown that consistent returns over three years or more result in a higher than average PE (price-earnings ratio) when controlled for industry and stage in the business cycle.” Bob Vanourek, citing results of a study by the McKinsey Global Institute, said that long-term oriented firms in its sample “outperformed the short-termers in revenue growth, profitability , job creation, and more.” Kautz continued: “Long term success is valued too highly to be interrupted by a hostile takeover,” thus fostering sustainability.

If sustainability is such an important issue, how do we encourage it? A number of suggestions were put forward. Fizzinni proposed such things as efforts to encourage employee ownership as well as changing the tax laws to render tax-free those capital gains earned on stock held for ten years or more. Shann Turnbull suggested the need for education in “new organizational forms” such as “Network Governance” that are currently “mostly ignored by business schools.” Jacob Navon succinctly put it this way: “What happened to the lessons I was taught on campus about running the business as a ‘going concern’?” How do we encourage CEOs to manage for sustainability? What do you think?

On September 13, 1970, an opinion piece appeared in The New York Times Magazine that has become the most read, misread, and referenced article ever written by a Nobel Laureate economist. And it’s still being argued today.

In “A Friedman Doctrine--The Social Responsibility of Business Is to Increase its Profits,” Milton Friedman argued that the best way for managers to contribute to the social good was by maintaining a single-minded focus on profit, acting as agents for shareholders who put their capital at risk investing in their companies. It triggered an immediate controversy.

Of greater importance than the issue posed in the article’s title was the proposition that followed: Because shareholders are owners of a corporation, professional managers and directors are their agents, primarily responsible for carrying out their wishes and creating value for them. This idea was further developed in a 1976 article by Michael Jensen and William Meckling, who posited that for managers this meant maximizing the value created for shareholders.

Agency theory ascends

It isn’t much of an exaggeration to say that the “Friedman Doctrine” triggered a half-century of dominance for “agency theory” in corporate governance. Adherence to the concept has led to such things as an increase in performance-based pay (to align managers’ interests with those of shareholders), a reduction in the defenses against hostile takeovers (that typically increase short-term value for owners of the acquired company), increased merger and acquisition activity, increased shareholder activism regarding issues such as executive pay and staggered board membership (designed to preserve continuity in governance, but criticized by shareholders as a means of preserving the status quo), and, in the minds of its advocates, greater management accountability.

Agency theory has been associated with management decisions designed to increase short-term profitability (desired by short-term investors who make up an increasing share of the total) over long-term health of the corporation. This includes imprudent downsizing of organizations, spending reduction for long-term R&D, and extreme cases of leveraging a company’s balance sheet to provide immediate rewards to investors.

Don’t nod off at this point. Agency theory is much more than just a dry concept; it has had a profound impact on the way corporations have been managed for nearly 50 years. One reason the theory has predominated is that it is simple and straightforward. Shareholder value is easy to measure. Agency theory simplifies the mission for managers; they need only serve one primary master. Theorists have been hard-put to come up with notions as easy to understand and implement.

Now, Friedman’s ideas are being critically reexamined. The late London Business School Professor Sumantra Ghoshal questioned whether shareholders are even “owners” in the common sense of that term. As he put it, “If the value creation is achieved by combining the resources of both employees and shareholders, why should value distribution favor only the latter?”

Allegiance to the corporation

The re-evaluation continues in a current Harvard Business Review article. Harvard Business School Professors Joseph Bower and Lynn Paine propose that the primary allegiance of managers and their boards should be to the health of the corporation, not the maximization of shareholder value. The rationale for this includes the arguments that managers can be held legally accountable while shareholders “have no legal duty to protect or serve the companies whose shares they own,” managers and directors are better positioned to take the long-term health of the corporation into account in formulating strategies and allocating resources, and the interests of future shareholders and other stakeholders would have to be given more deference. The authors point out that they are “capitalists to the core… But the health of the economic system depends on getting the role of shareholders right.”

Agency theory is so deeply entrenched in corporate governance today that significant change of any kind would be challenging. How would accountability centered on the long-term health of the corporation be implemented? Would it foster pay based on longer-term performance, the introduction of non-financial goals in judging performance, or greater voice for employees? Or would it return us to a world of poison pill protection against takeovers, less say over corporate matters for shareholders, and slower-acting boards in the face of poor management performance? Would recently-emboldened shareholders even permit such a change?

Whether or not it is possible or even advisable to seek an alternative to agency theory and the kind of accountability it fosters, the fact is that alternatives are receiving increased scrutiny. Do you buy into agency theory? Should the primary responsibility of managers and directors be maximizing returns to shareholders? What do YOU think?


Joseph L. Bower and Lynn S. Paine, The Error at the Heart of Corporate Leadership: Most CEOs and Boards Believe Their Main Duty Is to Maximize Shareholder Value. It’s Not., Harvard Business Review, May-June, 2017, pp. 50-60.

Milton Friedman, A Friedman Doctrine—The Social Responsibility of Business Is To Increase Its Profits, The New York Times Magazine, September 13, 1970, p. 17.

Sumantra Ghoshal, Bad Management Theories Are Destroying Good Management Practices, Academy of Management Learning & Education, 2005, pp. 75-91.

Michael C. Jensen and William H. Meckling, A Theory of the Firm: Governance, Residual Claims and Organizational Forms, Journal of Financial Economics, Vol. 3, No. 4, 1976.

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