Does Enlightened Shareholder Value Add Value?

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School; Kobi Kastiel is Associate Professor of Law at Tel Aviv University, and Senior Fellow of the Harvard Law School Program on Corporate Governance; and Roberto Tallarita is a Lecturer on Law and Associate Director of the Program on Corporate Governance at Harvard Law School. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); Will Corporations Deliver Value to All Stakeholders? by Lucian A. Bebchuk and Roberto Tallarita; and The Perils and Questionable Promise of ESG-Based Compensation by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).

Unlike shareholder value maximization (SV), which calls on corporate leaders to maximize shareholder value, enlightened shareholder value (ESV) combines this prescription with guidance to consider stakeholder interests in the pursuit of long-term shareholder value maximization. In a forthcoming article we recently placed on SSRN, Does Enlightened Shareholder Value Add Value?, we show that replacing SV with ESV should not be expected to benefit stakeholders or society.

We begin by explaining that the appeal of ESV and the enthusiasm for it among supporters seems to be grounded in a misperception about how frequent “win-win situations” are. In the real world, corporate leaders often face significant trade-offs between shareholder and stakeholder interests, and such situations are exactly those for which the specification of corporate purpose is important.

Furthermore, we explain that, under certain standard assumptions, SV and ESV are always operationally equivalent and prescribe exactly the same corporate choices. We then relax these assumptions and consider arguments that using ESV is beneficial in order to:

  • counter the tendency of corporate leaders to be excessively focused on short-term effects;
  • educate corporate leaders to give appropriate weight to stakeholder effects;
  • provide cover to corporate leaders who wish to serve stakeholders; and/or
  • protect capitalism from a backlash and deflect pressures to adopt stakeholder-protecting regulation. We show that each of these arguments is flawed.

We conclude that replacing SV with ESV would fail to deliver any material benefits to stakeholders or society. At best, such replacement would be neutral, creating neither value nor harm. However, to the extent that the switch to ESV would introduce the illusory perception that corporate leaders can be relied upon to protect stakeholders, such a switch would be detrimental for stakeholders and society.

Below is a more detailed account of our analysis:

There are growing concerns about the effects that corporations have on “stakeholders,” including employees, suppliers, customers, local communities, and the environment. In the words of one prominent economist, “[t]he world is on fire” and “if we don’t reimagine capitalism, we will all be significantly poorer.” There is therefore a great deal of support, which we share, for developing rules and arrangements that would produce a capitalism that works for all stakeholders.

Even those who agree on the importance of this goal, however, differ substantially in their views on how to advance it. We focus in our article on one influential and widely supported approach—the view that corporations should replace their traditional SV approach with an ESV approach.

Part II discusses the ESV approach and the increasing support it has been receiving from academics, corporate leaders, and institutional investors. Unlike the “pluralistic” version of stakeholderism, which considers stakeholder welfare as an end in itself, ESV directs corporate leaders to take into account stakeholder concerns only as a means to the maximization of shareholder value.

Part III discusses the common misperception that seems to lie at the core of the support for ESV. This misperception, which we call the “win-win” illusion, misconceives the scope and frequency of win-win situations in which the same corporate actions benefit both shareholders and stakeholders.

We show that the win-win illusion is explicitly embraced by some prominent ESV manifestos, such as the 2019 Business Roundtable Statement on the Purpose of a Corporation, but it is unsubstantiated. Contrary to the perceptions of many ESV supporters, trade-offs between shareholder interests and stakeholder interests are ubiquitous, and corporate leaders routinely face difficult choices among options with very different effects for shareholders and stakeholders. This recognition, we argue, shows that even if ESV were successful in increasing the focus of corporate leaders on the relevance of stakeholder issues for shareholder value, trade-offs would remain pervasive and would severely limit the potential effects of ESV on societal problems.

Part IV examines the question whether SV and ESV are operationally equivalent, that is, whether corporate leaders operating under an ESV standard would make different decisions than corporate leaders operating under the traditional SV standard. The question is critical because supporters of SV, including Milton Friedman in a famous essay, acknowledge that treating stakeholders well may be good for shareholder value. Therefore, since SV already requires corporate leaders to make stakeholder-friendly decisions if these decisions are indeed shareholder value-maximizing, it is important to understand what a switch from SV to ESV is expected to add to the traditional framework. To this end, Part IV shows that SV and ESV direct corporate leaders to choose the same corporate action among several options (operational equivalence) and identifies four assumptions under which ESV and SV are operationally equivalent.

Part V relaxes in turn each of the four assumptions discussed in Part IV and examines whether doing so justifies the case for switching from SV to ESV.

First, we discuss whether ESV is an effective strategy to address the problem of short-termism, which allegedly affects today’s capitalism. We show that, even if concerns about short-termism were valid, ESV would not address them. To begin with, short-termism concerns arise from corporate leaders’ having short-term incentives. Addressing short-termism concerns therefore requires reforms, such as redesign of executive pay, that address the distorting effects of short-term incentives. Reminding corporate leaders about the importance of long-term effects is not an effective remedy for short-termism concerns.

Second, we discuss whether an ESV standard might be an effective way to inform or educate corporate leaders about the relevance of stakeholder factors for long-term shareholder value. But the approach of corporate rules is to provide corporate leaders with adequate incentives and rely on them to obtain the necessary information. There is little reason to expect that using an ESV language would practically affect the decisions of corporate leaders, or for reminding corporate leaders about stakeholder factors but not about other factors that are relevant for long-term value maximization.

Third, we discuss whether ESV could provide legal cover or moral support for corporate leaders to make stakeholder-friendly decisions. We show, however, that under SV, thanks to the business judgment rule, corporate leaders already have sufficient legal cover to make stakeholder-friendly decisions and justify them on the grounds that they would contribute to long-term value maximization.

Fourth and finally, we discuss whether ESV could be a way for corporate leaders to improve the image of their companies, and of capitalism in general, and to deflect pressures for regulatory interventions on business. To those interested in stakeholder protection, however, this should be a reason for opposing ESV, not for supporting it. Indeed, if ESV provided rhetorical and political cover to corporate leaders without producing any benefits for stakeholders, stakeholders could well be better off under SV.

We conclude in Part VI that replacing SV with ESV should not be expected to produce benefits for either shareholders or society, and thus should not be appealing to anyone who is concerned about corporate effects on stakeholders. Adopting ESV could at best be just inconsequential, but it could also be counterproductive by introducing illusory expectations that would impede stakeholder-favoring reforms.

Our paper is available here.

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