The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

The Principle of Shareholder Primacy and Hyper-Speculation 141
the firm, via the invisible hand of the market and the firm’s contracts, is untenable.
Admittedly, the industrial firm can only generate shareholder value if it produces
useful goods and if it honors its implicit contracts, to a certain standard, with its
employees and its customers. Nevertheless, it only realizes the common good of the
firm “somehow” and “on the back of” shareholder-value maximization, because the
new overall purpose of the firm, the maximization of shareholder value, is realized
to a growing extent by capital market speculation.
Since share prices on the stock exchange do not reflect the real value of the firm’s
productivity exactly and at all times, but are also the result of speculation in the stock
market, management has an interest in engaging in speculation and manipulation of
its own firm’s share price, and hence of its own shareholder value. This distraction
of management’s attention and intention away from the firm’s principal task, the
product, to the conditioning principle of the firm, the maximization of shareholder
value which is made the main purpose, gives rise to two detrimental effects.
Firstly, it creates perverse incentives for management to take more interest in capital
gains, road-shows etc., and thus in speculation on corporate value rather than in
production, or at least to be overly interested in speculation instead of concentrating
on the actual management task. Secondly, this leads to short-termism in corporate
governance, and a blinkered focus on shareholder value in every quarterly report.
Yet the “terror of the quarterly report” that is so characteristic of the American
economy is rather less deserving of opprobrium than the focus on the share price.
The demand that the firm should operate at a profit in every quarter is a perfectly
justified requirement because a quarter-year is a long time in a human lifespan. The
quarter-by-quarter scrutiny becomes problematic when, in every quarter, share price
growth is viewed as the task for which management is held accountable. 36
Incentives are central to every economic system, and it is one of the main arguments
for the shareholder-value principle that it creates efficient incentives for
management to maximize the total value of the firm measured in terms of shareholder
value. However, incentives can also give rise to perverse incentives, which
divert intentions to activities that are not in the firm’s interest. If shareholder value
becomes the overall purpose of the firm, the managers have strong incentives to
devote their attention and time to finding possible ways of manipulating the share
price of their firm in the capital market. The managers then allow their attention to
be drawn to decision-making factors which are not in the interest of those members
of the firm who are not shareholders. The possible perverse incentives that the
shareholder-value principle is capable of exerting over management, when viewed
as the sole purpose of the firm, are considerable.
The second effect of the perverse incentives that can stem from the shareholdervalue
principle, the short-termism of excessive attention to the day-to-day share
price on the stock exchange, is not in the firm’s long-term interest either if it inhibits
36 BRANDEIS (1914), p. 140, has already pointed to the similar problem that arises when the bank
appoints the directors of a firm and when these directors are more interested in the share price of
the firm they direct than in the firm’s product.