We doubt that the strong economic performance of the United States since the mid-1980s would have taken place without the discipline of shareholder capitalism and an increasingly sharp eye by many participants in its economy on creating shareholder value.
The U.S. corporate focus on shareholder value tends to limit investment in outdated strategies—even encourage divestment—well before any competing governance model would. Schumpeter’s ”creative destruction” is fostered by a bottom-line focus. Moreover, it is hard to claim (as many have at times, albeit often managers of poorly performing companies) that the capital markets are shortsighted compared with other corporate governors—the high number and value of technology and internet companies going public in recent years attests to this. Foolish maybe, but shortsighted? Certainly not.
But what about actual economic performance? Economists widely agree that the dominant measure of an economy’s success is GDP per capita. The United States—the world’s most capitalist, shareholder friendly economy—has a lead of more than 20 percent over other major countries. Up to 1975 other countries were catching up, but this convergence has since stopped. If anything, the lead of the United States has been widening. From 1994 to 1997, the McKinsey Global Institute carried out a series of research projects to analyze the differences in GDP per capita between the United States and other countries. The research, which focused on the United States, Germany, and Japan, attributed the U.S. advantage to much higher factor productivity, especially capital productivity. How can the United States be outperforming other countries with a savings rate that is often deplored as wholly inadequate? The answer is what happens to those savings. In the United States they are invested in more productive (i.e., economically profitable or value creating) projects than in either Germany or Japan. Financial returns in the corporate sector in the United States between 1974 and 1993 were dramatically higher than in Germany or Japan.
This is not to say that the shareholder value system is always perceived as fair. Job losses from restructuring disrupt lives. At the same time, one can argue that an economy’s ability to create jobs, or its lack thereof, is the better measure of fairness. On that score, the track record of the United States compared with the other countries speaks for itself. Two centuries ago, Adam Smith postulated that the most productive and innovative companies would create the highest returns to shareholders and attract better workers, who would be more productive and increase returns further—a virtuous cycle. On the other hand, companies that destroy value would create a vicious cycle and eventually wither away. In today’s terms, we believe that a company that focuses on building shareholder value is served well by being a good corporate citizen. Why? Simply because such a company will create more value for its shareholders. Consider the employee stakeholders. A company that tries to fatten its profits by providing a shabby work environment, underpaying employees, and skimping on benefits will have trouble attracting and retaining high quality employees. With today’s increased labor mobility and more educated workforce, this kind of a company will be less profitable. While it may feel good to treat people well, it’s also good business.
The empirical record also strongly supports the conclusion that shareholder wealth creation does not come at the expense of other stakeholders. We analyzed the relationship among labor productivity, increases in shareholder wealth, and employment growth across a range of industries in the United States, Japan, and Germany. Our conclusions are that companies with higher labor productivity are more likely to create more value than those with lower productivity, and that these gains do not come at the expense of employees in general. Companies that are able to create more value also create more jobs.
Overall, EG Corporation’s financial performance had been mediocre for the last five years. Earnings growth had not kept pace with inflation, and return on equity had been hovering around 10 percent. Part of the problem was that EG had been hit with unfavorable ”extraordinary items” that had depressed bottom line results. Beyond this, though, the company had failed to deliver on overall commitments for growth and operating earnings in its businesses for the last few years. From an investor’s standpoint, the company’s stock price had lagged the market for the last several years. Analysts bemoaned the company’s lackluster performance, especially in view of its strong brand position in Consumerco. They were disenchanted with the slow progress in building profits in other parts of the company. Some security analysts had gone so far as to speculate that EG would make a good breakup play. EG Corporation’s board and senior management were frustrated by their inability to convince the market that EG should be more highly valued.