What is the origin of shareholder value theory?
Businesses should show corporate social responsibility by improving conditions for their shareholders. According to O’Connell et al. (2020), “Shareholder theory value states that “the primary objective of management is to maximize shareholder value; This objective ranks in front of the interests of other corporate stakeholders, such as employees, suppliers, customers and society” (p.1). Shareholder theory claims that the shareholders should be considered as the legitimate owners of the assets of a business, and the managers should grow these assets for the shareholders. O’Connell et al. (2020) also stated that the shareholders theory, the shareholders assets can be divided into share price and dividends, and the managers role is to ensure that the value of the share price and dividend increases. The shareholder theory fails to consider that the managers only role is not overseeing the financial performances of the organization. According to Zumenta et al. (2021), previously, there was an open debate suggested by the shareholder theory about whose interests should come first—shorter-term profit maximization, or longer-term total value maximization for wider society. An example of such a situation is that “as early as 1932, Berle and Means argued that corporations have a variety of purposes and interests including encouraging entrepreneurship, innovation and building communities; This wider view is gaining more traction in recent decades as evidenced by an increased interest in ethical investment funds” (O’Connell et al., 2020, p.1). By doing this, it shows that the manager’s also have the role of ensuring that the businesses are socially responsible. “It would seem, therefore, that shareholder value creation is important, however, needs to be balanced with other stakeholders’ interests; This is referred to as an enlightened approach to shareholder value maximization” (O’Connell et al., 2020, p.1). Business structure and economic environment and financialization are some of the factors that led to the shareholder value theory.
One of the factors that led to shareholder value theory is business structure and the economic environment. According to O’Connell et al. (2020), the origin of the shareholder value theory can be traced from the late 18 century during the industrial revolution when the amount of capital required to finance the uprising innovative manufacturing businesses led to the change in business structures. All the business structures were changed from the traditional small and family-run business and the large public businesses with many shareholders and professional managers; This change was referred to as managerialism, and it led to the use of more advanced technology and the use of strategic planning. (O’Connell et al., 2020). By focusing on managerialism, there was a growth in the sector of shareholder value maximization. According to Shepherd (2018), the influence of managerialism became increasingly prevalent in the organizational environment. O’Connell et al. (2020) stated that in 1970 was a challenging time for corporates as there was a decrease in the level of competition due to the introduction of foreign businesses, which led to the decline of their share prices. “The widespread reduction in the value of corporate stocks led to a focus by business leaders, policy makers, regulators and politicians throughout 1980s and 1990s on the role of the board and their duty and relationship to shareholders” (O’Connell et al., 2020 p.2). An appropriate explanation for the poor performance of corporates was that humans are inherently self-serving. Board directors were making decisions that benefitted them and not the shareholders, and therefore, the shareholder value theory was developed to solve this by wide spread promotion of shareholders gaining wealth. “Directors were not opposed to this approach as they believed that by focusing on wealth maximization, they could avoid their corporate being the target of a take-over bid; This reason was particularly pertinent in the 1980s as a wave of merger activity was sweeping through major stock markets” (O’Connell et al., 2020, p.2). Thus, one of the factors that led to shareholder value theory is business structure and the economic environment.
Another factor that led to the shareholder value theory is financialization. Financialization is an action that leads to the rise of shareholder value. According to Aalbers (2019), financialization refers to “the increasing dominance of financial actors, markets, practices, measurements, and narratives, at various scales, resulting in a structural transformation of economies, firms (including financial institutions), states, and households” (p.3). O’Connell et al. (2020) stated that in the 1980s, banks invested in corporate shares. One of the reasons for this is that “financial institutions pursue wealth maximization as their primary investment objective; This increased attention from well-informed investors and led to pressure on directors to deliver high returns on their tangible assets” (O’Connell et al., 2020). Corporates faced the risk being taken-over and broken up if high returns and profits were not generated. By doing this, the priorities of corporates shifted. O’Connell et al. (2020) stated that the priorities of corporates shifted to divesture, outsourcing cost-cutting and off-shoring as managers. The managers did whatever was necessary to meet the earnings expectations of the market, and one of the ways they managed to do this was the use of technology which led to “easier access to information on corporates, increased interest from a wider range of investors and hence greater liquidity in the stock market by shareholders” (O’Connell et al., 2020). Thus, another factor that led to the shareholder value theory is financialization.
In conclusion, shareholders are the most important stakeholders in a business. Business structure and economic environment, and financialization are some of the main factors that led to the shareholder value theory. Shareholder theory claims that the shareholders should be considered as the legitimate owners of the assets of a business, and the managers should grow these assets for the shareholders. Corporate leaders should allow the shareholders participate in making business decisions by giving them the opportunity to propose and vote on the policies of the corporation.
Aalbers, M. (2019). Financialization.
O’Connell, M., & Ward, A. M. (2020). Shareholder theory/shareholder value. Encyclopedia of sustainable management, 1-7.
Shepherd, S. (2018). Managerialism: an ideal type. Studies in Higher Education, 43(9), 1668-1678.
Zumente, I., & Bistrova, J. (2021). ESG importance for long-term shareholder value creation: Literature vs. practice. Journal of Open Innovation: Technology, Market, and Complexity, 7(2), 127.