Michael Jensen --- http://en.wikipedia.org/wiki/Michael_Jensen

Maximizing Shareholder Value --- http://en.wikipedia.org/wiki/Shareholder_value#Maximizing_shareholder_value

Research at the University of Rochester ---  https://urresearch.rochester.edu/home.action
Jensen Comment
Note that this site includes a long listing of research in accounting, finance, and economics, much of it based on positivism and financial markets.

"Why the “Maximizing Shareholder Value” Theory of Corporate Governance is Bogus," Naked Capitalism, October 21, 2013 ---
http://www.nakedcapitalism.com/2013/10/why-the-maximizing-shareholder-value-theory-of-corporate-governance-is-bogus.html

. . .

So how did this “the last shall come first” thinking become established? You can blame it all on economists, specifically Harvard Business School’s Michael Jensen. In other words, this idea did not come out of legal analysis, changes in regulation, or court decisions. It was simply an academic theory that went mainstream. And to add insult to injury, the version of the Jensen formula that became popular was its worst possible embodiment.

A terrific 2010 paper by Frank Dobbin and Jiwook Jung, “The Misapplication of Mr. Michael Jensen: How Agency Theory Brought Down the Economy and Might Do It Again,” explains how this line of thinking went mainstream. I strongly suggest you read it in full, but I’ll give a brief recap for the time-pressed.

In the 1970s, there was a great deal of hand-wringing in America as Japanese and German manufacturers were eating American’s lunch. That led to renewed examination of how US companies were managed, with lots of theorizing about what went wrong and what the remedies might be. In 1976, Jensen and William Meckling asserted that the problem was that corporate executives served their own interests rather than those of shareholders, in other words, that there was an agency problem. Executives wanted to build empires while shareholders wanted profits to be maximized.

I strongly suspect that if Jensen and Meckling had not come out with this line of thinking, you would have gotten something similar to justify the actions of the leveraged buyout kings, who were just getting started in the 1970s and were reshaping the corporate landscape by the mid-1980s. They were doing many of the things Jensen and Meckling recommended: breaking up multi-business companies, thinning out corporate centers, and selling corporate assets (some of which were clearly excess, like corporate art and jet collection, while other sales were simply to increase leverage, like selling corporate office buildings and leasing them back). In other words, a likely reason that Jensen and Meckling’s theory gained traction was it appeared to validate a fundamental challenge to incumbent managements. (Dobbin and Jung attribute this trend, as pretty much everyone does, to Jensen because he continued to develop it. What really put it on the map was a 1990 Harvard Business Review article, “It’s Not What You Pay CEOs, but How,” that led to an explosion in the use of option-based pay and resulted in a huge increase in CEO pay relative to that of average workers.)

To forestall takeovers, many companies implemented the measures an LBO artist might take before his invading army arrived: sell off non-core divisions, borrow more, shed staff.

The problem was to the extent that the Jensen/Meckling prescription had merit, only the parts that helped company executives were adopted. Jensen didn’t just call on executives to become less ministerial and more entrepreneurial; they also called for more independent and engaged boards to oversee and discipline top managers, and more equity-driven pay, both options and other equity-linked compensation, to make management more sensitive to both upside and downside risks.

Over the next two decades, companies levered up, became more short-term oriented, and executive pay levels exploded. As Dobbin and Jung put it, “The result of the changes promoted by agency theory was that by the late 1990s, corporate America’s leaders were drag racing without the brakes.”

The paper proceeds to analyze in considerable detail how three of the major prescriptions of “agency theory” aka “executives and boards should maximize value,” namely, pay for (mythical) performance, dediversification, and greater reliance on debt all increased risk. And the authors also detail how efforts to improve oversight were ineffective.

But the paper also makes clear that this vision of how companies should be run was simply a new management fashion, as opposed to any sort of legal requirement:

Organizational institutionalists have long argued that new management practices diffuse through networks of firms like fads spread through high schools….In their models, new paradigms are socially constructed as appropriate solutions to perceived problems or crises….Expert groups that stand to gain from having their preferred strategies adopted by firms then enter the void, competing to have their model adopted….

And as Dobbin and Jung point out, the parts of the Jensen formula that got adopted were the one that had constituents. The ones that promoted looting and short-termism had obvious followings. The ones for prudent management didn’t.

And consider the implications of Jensen’s prescriptions, of pushing companies to favor shareholders, when they actually stand at the back of the line from a legal perspective. The result is that various agents (board compensation consultants, management consultants, and cronyistic boards themselves) have put incentives in place for CEOs to favor shareholders over parties that otherwise should get better treatment. So is it any surprise that companies treat employees like toilet paper, squeeze vendors, lobby hard for tax breaks and to weaken regulations, and worse, like fudge their financial reports? Jensen himself, in 2005, repudiated his earlier prescription precisely because it led to fraud. From an interview with the New York Times:

Q. So the maximum stock price is the holy grail?

A. Absolutely not. Warren Buffett says he worries as much when one of his companies becomes overvalued as undervalued. I agree. Overvalued equity is managerial heroin – it feels really great when you start out; you’re feted on television; investment bankers vie to float new issues.

But it doesn’t take long before the elation and ecstasy turn into enormous pain. The market starts demanding increased earnings and revenues, and the managers begin to say: “Holy Moley! How are we going to generate the returns?” They look for legal loopholes in the accounting, and when those don’t work, even basically honest people move around the corner to outright fraud.

If they hold a lot of stock or options themselves, it is like pouring gasoline on a fire. They fudge the numbers and hope they can sell the stock or exercise the options before anything hits the fan.

Q. Are you suggesting that executives be rewarded for driving down the price of the stock?

A. I’m saying they should be rewarded for being honest. A C.E.O. should be able to tell investors, “Listen, this company isn’t worth its $70 billion market cap; it’s really worth $30 billion, and here’s why.”

But the board would fire that executive immediately. I guess it has to be preventative – if executives would present the market with realistic numbers rather than overoptimistic expectations, the stock price would stay realistic. But I admit, we scholars don’t yet know the real answer to how to make this happen.

So having led Corporate America in the wrong direction, Jensen ‘fesses up no one knows the way out. But if executives weren’t incentivized to take such a topsy-turvey shareholder-driven view of the world, they’d weigh their obligations to other constituencies, including the community at large, along with earning shareholders a decent return. But it’s now become so institutionalized it’s hard to see how to move to a more sensible regime. For instance, analysts regularly try pressuring Costco to pay its workers less, wanting fatter margins. But the comparatively high wages are an integral part of Costco’s formula: it reduces costly staff turnover and employee pilferage. And Costco’s upscale members report they prefer to patronize a store they know treats workers better than Walmart and other discounters. If managers with an established, successful formulas still encounter pressure from the Street to strip mine their companies, imagine how hard it is for struggling companies or less secure top executives to implement strategies that will take a while to reap rewards. I’ve been getting reports from McKinsey from the better part of a decade that they simply can’t get their clients to implement new initiatives if they’ll dent quarterly returns.

This governance system is actually in crisis, but the extraordinary profit share that companies have managed to achieve by squeezing workers and the asset-goosing success of post-crisis financial policies have produced an illusion of health. But porcine maquillage only improves appearances; it doesn’t mask the stench of gangrene. Nevertheless, executives have successfully hidden the generally unhealthy state of their companies. As long as they have cheerleading analysts, complacent boards and the Fed protecting their back, they can likely continue to inflict more damage, using “maximizing shareholder value” canard as the cover for continuing rent extraction.

Read more at http://www.nakedcapitalism.com/2013/10/why-the-maximizing-shareholder-value-theory-of-corporate-governance-is-bogus.html#ehj10weqAL2vdXkh.99

So how did this “the last shall come first” thinking become established? You can blame it all on economists, specifically Harvard Business School’s Michael Jensen. In other words, this idea did not come out of legal analysis, changes in regulation, or court decisions. It was simply an academic theory that went mainstream. And to add insult to injury, the version of the Jensen formula that became popular was its worst possible embodiment.

A terrific 2010 paper by Frank Dobbin and Jiwook Jung, “The Misapplication of Mr. Michael Jensen: How Agency Theory Brought Down the Economy and Might Do It Again,” explains how this line of thinking went mainstream. I strongly suggest you read it in full, but I’ll give a brief recap for the time-pressed.

In the 1970s, there was a great deal of hand-wringing in America as Japanese and German manufacturers were eating American’s lunch. That led to renewed examination of how US companies were managed, with lots of theorizing about what went wrong and what the remedies might be. In 1976, Jensen and William Meckling asserted that the problem was that corporate executives served their own interests rather than those of shareholders, in other words, that there was an agency problem. Executives wanted to build empires while shareholders wanted profits to be maximized.

I strongly suspect that if Jensen and Meckling had not come out with this line of thinking, you would have gotten something similar to justify the actions of the leveraged buyout kings, who were just getting started in the 1970s and were reshaping the corporate landscape by the mid-1980s. They were doing many of the things Jensen and Meckling recommended: breaking up multi-business companies, thinning out corporate centers, and selling corporate assets (some of which were clearly excess, like corporate art and jet collection, while other sales were simply to increase leverage, like selling corporate office buildings and leasing them back). In other words, a likely reason that Jensen and Meckling’s theory gained traction was it appeared to validate a fundamental challenge to incumbent managements. (Dobbin and Jung attribute this trend, as pretty much everyone does, to Jensen because he continued to develop it. What really put it on the map was a 1990 Harvard Business Review article, “It’s Not What You Pay CEOs, but How,” that led to an explosion in the use of option-based pay and resulted in a huge increase in CEO pay relative to that of average workers.)

To forestall takeovers, many companies implemented the measures an LBO artist might take before his invading army arrived: sell off non-core divisions, borrow more, shed staff.

The problem was to the extent that the Jensen/Meckling prescription had merit, only the parts that helped company executives were adopted. Jensen didn’t just call on executives to become less ministerial and more entrepreneurial; they also called for more independent and engaged boards to oversee and discipline top managers, and more equity-driven pay, both options and other equity-linked compensation, to make management more sensitive to both upside and downside risks.

Over the next two decades, companies levered up, became more short-term oriented, and executive pay levels exploded. As Dobbin and Jung put it, “The result of the changes promoted by agency theory was that by the late 1990s, corporate America’s leaders were drag racing without the brakes.”

The paper proceeds to analyze in considerable detail how three of the major prescriptions of “agency theory” aka “executives and boards should maximize value,” namely, pay for (mythical) performance, dediversification, and greater reliance on debt all increased risk. And the authors also detail how efforts to improve oversight were ineffective.

But the paper also makes clear that this vision of how companies should be run was simply a new management fashion, as opposed to any sort of legal requirement:

Organizational institutionalists have long argued that new management practices diffuse through networks of firms like fads spread through high schools….In their models, new paradigms are socially constructed as appropriate solutions to perceived problems or crises….Expert groups that stand to gain from having their preferred strategies adopted by firms then enter the void, competing to have their model adopted….

And as Dobbin and Jung point out, the parts of the Jensen formula that got adopted were the one that had constituents. The ones that promoted looting and short-termism had obvious followings. The ones for prudent management didn’t.

And consider the implications of Jensen’s prescriptions, of pushing companies to favor shareholders, when they actually stand at the back of the line from a legal perspective. The result is that various agents (board compensation consultants, management consultants, and cronyistic boards themselves) have put incentives in place for CEOs to favor shareholders over parties that otherwise should get better treatment. So is it any surprise that companies treat employees like toilet paper, squeeze vendors, lobby hard for tax breaks and to weaken regulations, and worse, like fudge their financial reports? Jensen himself, in 2005, repudiated his earlier prescription precisely because it led to fraud. From an interview with the New York Times:

Q. So the maximum stock price is the holy grail?

A. Absolutely not. Warren Buffett says he worries as much when one of his companies becomes overvalued as undervalued. I agree. Overvalued equity is managerial heroin – it feels really great when you start out; you’re feted on television; investment bankers vie to float new issues.

But it doesn’t take long before the elation and ecstasy turn into enormous pain. The market starts demanding increased earnings and revenues, and the managers begin to say: “Holy Moley! How are we going to generate the returns?” They look for legal loopholes in the accounting, and when those don’t work, even basically honest people move around the corner to outright fraud.

If they hold a lot of stock or options themselves, it is like pouring gasoline on a fire. They fudge the numbers and hope they can sell the stock or exercise the options before anything hits the fan.

Q. Are you suggesting that executives be rewarded for driving down the price of the stock?

A. I’m saying they should be rewarded for being honest. A C.E.O. should be able to tell investors, “Listen, this company isn’t worth its $70 billion market cap; it’s really worth $30 billion, and here’s why.”

But the board would fire that executive immediately. I guess it has to be preventative – if executives would present the market with realistic numbers rather than overoptimistic expectations, the stock price would stay realistic. But I admit, we scholars don’t yet know the real answer to how to make this happen.

So having led Corporate America in the wrong direction, Jensen ‘fesses up no one knows the way out. But if executives weren’t incentivized to take such a topsy-turvey shareholder-driven view of the world, they’d weigh their obligations to other constituencies, including the community at large, along with earning shareholders a decent return. But it’s now become so institutionalized it’s hard to see how to move to a more sensible regime. For instance, analysts regularly try pressuring Costco to pay its workers less, wanting fatter margins. But the comparatively high wages are an integral part of Costco’s formula: it reduces costly staff turnover and employee pilferage. And Costco’s upscale members report they prefer to patronize a store they know treats workers better than Walmart and other discounters. If managers with an established, successful formulas still encounter pressure from the Street to strip mine their companies, imagine how hard it is for struggling companies or less secure top executives to implement strategies that will take a while to reap rewards. I’ve been getting reports from McKinsey from the better part of a decade that they simply can’t get their clients to implement new initiatives if they’ll dent quarterly returns.

This governance system is actually in crisis, but the extraordinary profit share that companies have managed to achieve by squeezing workers and the asset-goosing success of post-crisis financial policies have produced an illusion of health. But porcine maquillage only improves appearances; it doesn’t mask the stench of gangrene. Nevertheless, executives have successfully hidden the generally unhealthy state of their companies. As long as they have cheerleading analysts, complacent boards and the Fed protecting their back, they can likely continue to inflict more damage, using “maximizing shareholder value” canard as the cover for continuing rent extraction.

Read more at http://www.nakedcapitalism.com/2013/10/why-the-maximizing-shareholder-value-theory-of-corporate-governance-is-bogus.html#ehj10weqAL2vdXkh.99

So how did this “the last shall come first” thinking become established? You can blame it all on economists, specifically Harvard Business School’s Michael Jensen. In other words, this idea did not come out of legal analysis, changes in regulation, or court decisions. It was simply an academic theory that went mainstream. And to add insult to injury, the version of the Jensen formula that became popular was its worst possible embodiment.

A terrific 2010 paper by Frank Dobbin and Jiwook Jung, “The Misapplication of Mr. Michael Jensen: How Agency Theory Brought Down the Economy and Might Do It Again,” explains how this line of thinking went mainstream. I strongly suggest you read it in full, but I’ll give a brief recap for the time-pressed.

In the 1970s, there was a great deal of hand-wringing in America as Japanese and German manufacturers were eating American’s lunch. That led to renewed examination of how US companies were managed, with lots of theorizing about what went wrong and what the remedies might be. In 1976, Jensen and William Meckling asserted that the problem was that corporate executives served their own interests rather than those of shareholders, in other words, that there was an agency problem. Executives wanted to build empires while shareholders wanted profits to be maximized.

I strongly suspect that if Jensen and Meckling had not come out with this line of thinking, you would have gotten something similar to justify the actions of the leveraged buyout kings, who were just getting started in the 1970s and were reshaping the corporate landscape by the mid-1980s. They were doing many of the things Jensen and Meckling recommended: breaking up multi-business companies, thinning out corporate centers, and selling corporate assets (some of which were clearly excess, like corporate art and jet collection, while other sales were simply to increase leverage, like selling corporate office buildings and leasing them back). In other words, a likely reason that Jensen and Meckling’s theory gained traction was it appeared to validate a fundamental challenge to incumbent managements. (Dobbin and Jung attribute this trend, as pretty much everyone does, to Jensen because he continued to develop it. What really put it on the map was a 1990 Harvard Business Review article, “It’s Not What You Pay CEOs, but How,” that led to an explosion in the use of option-based pay and resulted in a huge increase in CEO pay relative to that of average workers.)

To forestall takeovers, many companies implemented the measures an LBO artist might take before his invading army arrived: sell off non-core divisions, borrow more, shed staff.

The problem was to the extent that the Jensen/Meckling prescription had merit, only the parts that helped company executives were adopted. Jensen didn’t just call on executives to become less ministerial and more entrepreneurial; they also called for more independent and engaged boards to oversee and discipline top managers, and more equity-driven pay, both options and other equity-linked compensation, to make management more sensitive to both upside and downside risks.

Over the next two decades, companies levered up, became more short-term oriented, and executive pay levels exploded. As Dobbin and Jung put it, “The result of the changes promoted by agency theory was that by the late 1990s, corporate America’s leaders were drag racing without the brakes.”

The paper proceeds to analyze in considerable detail how three of the major prescriptions of “agency theory” aka “executives and boards should maximize value,” namely, pay for (mythical) performance, dediversification, and greater reliance on debt all increased risk. And the authors also detail how efforts to improve oversight were ineffective.

But the paper also makes clear that this vision of how companies should be run was simply a new management fashion, as opposed to any sort of legal requirement:

Organizational institutionalists have long argued that new management practices diffuse through networks of firms like fads spread through high schools….In their models, new paradigms are socially constructed as appropriate solutions to perceived problems or crises….Expert groups that stand to gain from having their preferred strategies adopted by firms then enter the void, competing to have their model adopted….

And as Dobbin and Jung point out, the parts of the Jensen formula that got adopted were the one that had constituents. The ones that promoted looting and short-termism had obvious followings. The ones for prudent management didn’t.

And consider the implications of Jensen’s prescriptions, of pushing companies to favor shareholders, when they actually stand at the back of the line from a legal perspective. The result is that various agents (board compensation consultants, management consultants, and cronyistic boards themselves) have put incentives in place for CEOs to favor shareholders over parties that otherwise should get better treatment. So is it any surprise that companies treat employees like toilet paper, squeeze vendors, lobby hard for tax breaks and to weaken regulations, and worse, like fudge their financial reports? Jensen himself, in 2005, repudiated his earlier prescription precisely because it led to fraud. From an interview with the New York Times:

Q. So the maximum stock price is the holy grail?

A. Absolutely not. Warren Buffett says he worries as much when one of his companies becomes overvalued as undervalued. I agree. Overvalued equity is managerial heroin – it feels really great when you start out; you’re feted on television; investment bankers vie to float new issues.

But it doesn’t take long before the elation and ecstasy turn into enormous pain. The market starts demanding increased earnings and revenues, and the managers begin to say: “Holy Moley! How are we going to generate the returns?” They look for legal loopholes in the accounting, and when those don’t work, even basically honest people move around the corner to outright fraud.

If they hold a lot of stock or options themselves, it is like pouring gasoline on a fire. They fudge the numbers and hope they can sell the stock or exercise the options before anything hits the fan.

Q. Are you suggesting that executives be rewarded for driving down the price of the stock?

A. I’m saying they should be rewarded for being honest. A C.E.O. should be able to tell investors, “Listen, this company isn’t worth its $70 billion market cap; it’s really worth $30 billion, and here’s why.”

But the board would fire that executive immediately. I guess it has to be preventative – if executives would present the market with realistic numbers rather than overoptimistic expectations, the stock price would stay realistic. But I admit, we scholars don’t yet know the real answer to how to make this happen.

So having led Corporate America in the wrong direction, Jensen ‘fesses up no one knows the way out. But if executives weren’t incentivized to take such a topsy-turvey shareholder-driven view of the world, they’d weigh their obligations to other constituencies, including the community at large, along with earning shareholders a decent return. But it’s now become so institutionalized it’s hard to see how to move to a more sensible regime. For instance, analysts regularly try pressuring Costco to pay its workers less, wanting fatter margins. But the comparatively high wages are an integral part of Costco’s formula: it reduces costly staff turnover and employee pilferage. And Costco’s upscale members report they prefer to patronize a store they know treats workers better than Walmart and other discounters. If managers with an established, successful formulas still encounter pressure from the Street to strip mine their companies, imagine how hard it is for struggling companies or less secure top executives to implement strategies that will take a while to reap rewards. I’ve been getting reports from McKinsey from the better part of a decade that they simply can’t get their clients to implement new initiatives if they’ll dent quarterly returns.

This governance system is actually in crisis, but the extraordinary profit share that companies have managed to achieve by squeezing workers and the asset-goosing success of post-crisis financial policies have produced an illusion of health. But porcine maquillage only improves appearances; it doesn’t mask the stench of gangrene. Nevertheless, executives have successfully hidden the generally unhealthy state of their companies. As long as they have cheerleading analysts, complacent boards and the Fed protecting their back, they can likely continue to inflict more damage, using “maximizing shareholder value” canard as the cover for continuing rent extraction.

Read more at http://www.nakedcapitalism.com/2013/10/why-the-maximizing-shareholder-value-theory-of-corporate-governance-is-bogus.html#ehj10weqAL2vdXkh.99

So how did this “the last shall come first” thinking become established? You can blame it all on economists, specifically Harvard Business School’s Michael Jensen. In other words, this idea did not come out of legal analysis, changes in regulation, or court decisions. It was simply an academic theory that went mainstream. And to add insult to injury, the version of the Jensen formula that became popular was its worst possible embodiment.

A terrific 2010 paper by Frank Dobbin and Jiwook Jung, “The Misapplication of Mr. Michael Jensen: How Agency Theory Brought Down the Economy and Might Do It Again,” explains how this line of thinking went mainstream. I strongly suggest you read it in full, but I’ll give a brief recap for the time-pressed.

In the 1970s, there was a great deal of hand-wringing in America as Japanese and German manufacturers were eating American’s lunch. That led to renewed examination of how US companies were managed, with lots of theorizing about what went wrong and what the remedies might be. In 1976, Jensen and William Meckling asserted that the problem was that corporate executives served their own interests rather than those of shareholders, in other words, that there was an agency problem. Executives wanted to build empires while shareholders wanted profits to be maximized.

I strongly suspect that if Jensen and Meckling had not come out with this line of thinking, you would have gotten something similar to justify the actions of the leveraged buyout kings, who were just getting started in the 1970s and were reshaping the corporate landscape by the mid-1980s. They were doing many of the things Jensen and Meckling recommended: breaking up multi-business companies, thinning out corporate centers, and selling corporate assets (some of which were clearly excess, like corporate art and jet collection, while other sales were simply to increase leverage, like selling corporate office buildings and leasing them back). In other words, a likely reason that Jensen and Meckling’s theory gained traction was it appeared to validate a fundamental challenge to incumbent managements. (Dobbin and Jung attribute this trend, as pretty much everyone does, to Jensen because he continued to develop it. What really put it on the map was a 1990 Harvard Business Review article, “It’s Not What You Pay CEOs, but How,” that led to an explosion in the use of option-based pay and resulted in a huge increase in CEO pay relative to that of average workers.)

To forestall takeovers, many companies implemented the measures an LBO artist might take before his invading army arrived: sell off non-core divisions, borrow more, shed staff.

The problem was to the extent that the Jensen/Meckling prescription had merit, only the parts that helped company executives were adopted. Jensen didn’t just call on executives to become less ministerial and more entrepreneurial; they also called for more independent and engaged boards to oversee and discipline top managers, and more equity-driven pay, both options and other equity-linked compensation, to make management more sensitive to both upside and downside risks.

Over the next two decades, companies levered up, became more short-term oriented, and executive pay levels exploded. As Dobbin and Jung put it, “The result of the changes promoted by agency theory was that by the late 1990s, corporate America’s leaders were drag racing without the brakes.”

The paper proceeds to analyze in considerable detail how three of the major prescriptions of “agency theory” aka “executives and boards should maximize value,” namely, pay for (mythical) performance, dediversification, and greater reliance on debt all increased risk. And the authors also detail how efforts to improve oversight were ineffective.

But the paper also makes clear that this vision of how companies should be run was simply a new management fashion, as opposed to any sort of legal requirement:

Organizational institutionalists have long argued that new management practices diffuse through networks of firms like fads spread through high schools….In their models, new paradigms are socially constructed as appropriate solutions to perceived problems or crises….Expert groups that stand to gain from having their preferred strategies adopted by firms then enter the void, competing to have their model adopted….

And as Dobbin and Jung point out, the parts of the Jensen formula that got adopted were the one that had constituents. The ones that promoted looting and short-termism had obvious followings. The ones for prudent management didn’t.

And consider the implications of Jensen’s prescriptions, of pushing companies to favor shareholders, when they actually stand at the back of the line from a legal perspective. The result is that various agents (board compensation consultants, management consultants, and cronyistic boards themselves) have put incentives in place for CEOs to favor shareholders over parties that otherwise should get better treatment. So is it any surprise that companies treat employees like toilet paper, squeeze vendors, lobby hard for tax breaks and to weaken regulations, and worse, like fudge their financial reports? Jensen himself, in 2005, repudiated his earlier prescription precisely because it led to fraud. From an interview with the New York Times:

Q. So the maximum stock price is the holy grail?

A. Absolutely not. Warren Buffett says he worries as much when one of his companies becomes overvalued as undervalued. I agree. Overvalued equity is managerial heroin – it feels really great when you start out; you’re feted on television; investment bankers vie to float new issues.

But it doesn’t take long before the elation and ecstasy turn into enormous pain. The market starts demanding increased earnings and revenues, and the managers begin to say: “Holy Moley! How are we going to generate the returns?” They look for legal loopholes in the accounting, and when those don’t work, even basically honest people move around the corner to outright fraud.

If they hold a lot of stock or options themselves, it is like pouring gasoline on a fire. They fudge the numbers and hope they can sell the stock or exercise the options before anything hits the fan.

Q. Are you suggesting that executives be rewarded for driving down the price of the stock?

A. I’m saying they should be rewarded for being honest. A C.E.O. should be able to tell investors, “Listen, this company isn’t worth its $70 billion market cap; it’s really worth $30 billion, and here’s why.”

But the board would fire that executive immediately. I guess it has to be preventative – if executives would present the market with realistic numbers rather than overoptimistic expectations, the stock price would stay realistic. But I admit, we scholars don’t yet know the real answer to how to make this happen.

So having led Corporate America in the wrong direction, Jensen ‘fesses up no one knows the way out. But if executives weren’t incentivized to take such a topsy-turvey shareholder-driven view of the world, they’d weigh their obligations to other constituencies, including the community at large, along with earning shareholders a decent return. But it’s now become so institutionalized it’s hard to see how to move to a more sensible regime. For instance, analysts regularly try pressuring Costco to pay its workers less, wanting fatter margins. But the comparatively high wages are an integral part of Costco’s formula: it reduces costly staff turnover and employee pilferage. And Costco’s upscale members report they prefer to patronize a store they know treats workers better than Walmart and other discounters. If managers with an established, successful formulas still encounter pressure from the Street to strip mine their companies, imagine how hard it is for struggling companies or less secure top executives to implement strategies that will take a while to reap rewards. I’ve been getting reports from McKinsey from the better part of a decade that they simply can’t get their clients to implement new initiatives if they’ll dent quarterly returns.

This governance system is actually in crisis, but the extraordinary profit share that companies have managed to achieve by squeezing workers and the asset-goosing success of post-crisis financial policies have produced an illusion of health. But porcine maquillage only improves appearances; it doesn’t mask the stench of gangrene. Nevertheless, executives have successfully hidden the generally unhealthy state of their companies. As long as they have cheerleading analysts, complacent boards and the Fed protecting their back, they can likely continue to inflict more damage, using “maximizing shareholder value” canard as the cover for continuing rent extraction.

 

Read more at
http://www.nakedcapitalism.com/2013/10/why-the-maximizing-shareholder-value-theory-of-corporate-governance-is-bogus.html#ehj10weqAL2vdXkh.99

Jensen Comment
Mike Jensen was the headliner at the 2013 American Accounting Association Annual Meetings. AAA members can watch various videos by him and about him at the AAA Commons Website.

Actually Al Rappaport at Northwestern may have been more influential in spreading the word about creating shareholder value ---
Rappaport, Alfred (1998). Creating Shareholder Value: A guide for managers and investors. New York: The Free Press. pp. 13–29.

It would be interesting if Mike Jensen and/or Al Rappaport wrote rebuttals to this article.

Bob Jensen's threads on triple-bottom reporting ---
http://www.trinity.edu/rjensen/Theory02.htm#TripleBottom

Bob Jensen's threads on theory are at
http://www.trinity.edu/rjensen/Theory01.htm