How Enlightened is Enlightened Shareholder Value?

There has been growing support for replacing the traditional corporate purpose with so-called “enlightened shareholder value,” which would guide firms to consider stakeholder interests when pursuing long-term shareholder value maximization. But such a move would not benefit stakeholders and might in fact be counterproductive. 

There is a growing concern for the external effects that companies create for their “stakeholders,” including employees, suppliers, customers, local communities, and the environment. Some observers believe that corporate choices are significant drivers of societal problems such as labor market dislocations, rising inequality, increased market concentration, and climate change. 

Although we share some of these concerns, we are wary of the increasing popularity of some of the proposed solutions. In a forthcoming article, “Does Enlightened Shareholder Value Add Value?,” we identify the problems with one of these solutions: the proposal, supported by prominent academics, actively considered in the ongoing US project for the Restatement of Corporate Governance Law, and already adopted by the United Kingdom corporate code, to replace the traditional corporate purpose of maximizing long-term shareholder value (SV) with what is commonly known as enlightened shareholder value (ESV).

ESV combines the traditional SV prescription with guidance to consider stakeholder interests in the pursuit of long-term shareholder value maximization. In our article, we show that replacing SV with ESV would not benefit—and could even harm—stakeholders and society.  

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. However, the appeal of this view and the enthusiasm it generates among supporters seem to be grounded in a misperception about how frequent “win-win situations” are. Although the win-win view is embraced by some prominent ESV manifestos and supporters, we explain that it is seriously flawed. 

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. Indeed, such situations are exactly those for which the specification of corporate purpose is important. Thus, 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.

Furthermore, and importantly, we explain that, under certain standard assumptions, SV and ESV are always operationally equivalent and prescribe exactly the same corporate choices. The question is critical because supporters of SV, including Milton Friedman in his famous 1970 New York Times 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.

Even when we relax the standard assumptions, we show that moving to ESV should not be expected to benefit stakeholders or society. In particular, we consider four arguments that using ESV would be beneficial in order to:

1. Counter the tendency of corporate leaders to be excessively focused on short-term effects; 
2. Educate corporate leaders to give appropriate weight to stakeholder effects;
3. Provide cover to corporate leaders who wish to serve stakeholders; and/or
4. Protect capitalism from a backlash and deflect pressures to adopt stakeholder-protecting regulation. 

None of these arguments, we explain, holds up. 

First, if concerns about short-termism were valid, ESV would not address them. Short-termism concerns arise from corporate leaders’ having short-term incentives. Addressing short-termism concerns therefore requires reforms, such as a redesign of executive pay, that can 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. 

Second, there is little reason to expect that using an ESV language would practically affect the decisions of corporate leaders. The approach of corporate rules is to provide corporate leaders with adequate incentives. If corporate leaders are not friendly with stakeholders, it’s unlikely that a formal change in the formulation of their duties will alter this behavior.

Third, under the business judgment rule, corporate leaders already have sufficient legal cover to make stakeholder-friendly decisions, if they want to, and to justify them on the grounds that they would contribute to long-term value maximization. 

The fourth argument, that ESV could protect capitalism from popular backlash and regulation, might indeed be true. But to those interested in stakeholder protection, 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. 

Our conclusion is 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. Thus, at best, adopting ESV could be just inconsequential. However, we show that moving to ESV could also be counterproductive by introducing illusory expectations that the move would serve stakeholders and thereby impeding stakeholder-favoring reforms. 

Our paper is available here, and comments would be most welcome.  

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