Maximizing Shareholder Value — A Legitimate Goal of Business Strategy or the Dumbest Idea in the World?

How Qantas Got Into A Tailspin

….if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

Warren Buffett in his 2007 letter to Berkshire Hathaway shareholders

From Managerial Capitalism to Shareholder Primacy

For most of the 20th century firms were managed according to a philosophy called ‘managerial capitalism’. In this philosophy boards of directors and managers called the shots and made decisions not only for the benefit of shareholders but also for Customers, suppliers, employees, and the community. During this era, shareholders were widely dispersed and played a passive role.

But this started to change in 1970 when Milton Friedman, an Economist, published an essay in the New York Times forcefully arguing that there was only one proper purpose for a business — to maximize profits for its owners (who Freidman assumed to be its shareholders) while conforming to the basic rules of society.

Friedman’s proposition got a strong boost in 1976 when Michael Jensen and Dean Meckling published their famous article on Agency Theory. In a nutshell, Agency Theory argues that directors and managers are inherently self-interested, and that controls and incentives need to be put in place to ensure they maximize owners’ (shareholders) wealth. This was the start of equity-based compensation for executives.

By the early 1980s, the notion that corporations should be managed solely for the benefit of their shareholders was up and running. In 1990 Jensen wrote another article that gave equity-based compensation a further push, arguing that CEOs should be paid with significant amounts of shares so that their interests would be aligned with shareholders. Equity based compensation subsequently exploded in its application, if not in beneficial effects over the next 30 years.

By the time the year 2000 came around there was widespread support in the Anglo-American business world for what became known as Shareholder Primacy, the notion that public corporations are owned by their shareholders, that Shareholder Value should take precedence over the interests of all other corporate stakeholders such as society and the environment in general, specific communities, suppliers, employees and even the organization itself, and that the primary responsibility of boards and management (even the ‘purpose’) of publicly listed corporations is to maximize a corporation’s share price for the benefit of current shareholders.

Maximizing Shareholder Value is a Choice, not a Legal Obligation

Maximizing Shareholder Value (MSV) involves a single-minded focus on short-term profits as the perceived driver of share price, on doing whatever it takes to boost profits this quarter, and to repeat the cycle next quarter, and the next, and the next…….. A related perspective involves maximizing Total Shareholder Return which factors in gains or losses in share price plus dividends, again in the short term.

But this is a doctrine that has attracted escalating criticism since the early 2000s when the accounting scandals associated with Enron, WorldCom, Tyco, Global Crossing and others began to emerge. Serious questions have been increasingly raised about the legal basis for Shareholder Primacy, especially the idea that shareholders are the ‘owners’ of corporations.

While this ownership question is still under debate it has become clear in recent years that Maximizing Shareholder Value is a managerial choice, not a legal obligation. And it’s a choice that can involve accountability problems and dubious, if not illegal, managerial behavior.

McKinsey politely describes this dubious behavior as using ‘accounting or financial gimmicks’ while The Economist calls it ‘shenanigans’. Steve Denning, writing in Forbes 2016, cuts to the chase by calling it ‘institutionalized selfishness’ whereby some managers, boards of directors, shareholders and institutional investors look after their own interests at the expense of all other stakeholders.

Some examples of this behavior include ‘managing’ (manipulating might be a better term) short term earnings to meet analysts’ expectations and/or to look better than they actually are by cutting R & D and other long-term growth investments; squeezing workers and suppliers; avoiding taxes; relying on exorbitant but short-term equity based pay incentives for executives; share buybacks at the expense of reinvesting in the business; using share options to lock employees in; ‘greenwashing’; pursuing risky acquisitions, joint ventures or projects that lead to a ‘sugar hit’ in the share price but fail to create long term value…..and the playbook goes on!

Back in 2009, Jack Welch, a former CEO of GE from 1981 to 2001 and former champion of MSV during that period made, rather ironically, an important observation:

On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy…………your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal………Short-term profits should be allied with an increase in the long term-term value of a company….

In the following decade there were many articles and publications condemning MSV. If you want to read a few of these, Google Steve Denning in Forbes.

A Shift in Thinking to Sustained Value Creation for All Stakeholders

By 2019 a quantum shift in thinking had occurred. That year the Business Round Table (BRT), the peak body for corporate CEOs in the U.S. which had endorsed MSV as the sole purpose of public companies for the previous 22 years, released a new statement on the purpose of a corporation saying that:

……….companies should serve not only their shareholders, but also deliver value to their customers, invest in employees, deal fairly with suppliers and support the communities in which they operate.

Interestingly, the five commitments made by the BRT had delivering value to customers at the very top and generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate at the bottom.

The Davos Manifesto 2020 was very similar:

The purpose of a company is to engage all its stakeholders in shared and sustained value creation. In creating such value, a company serves not only its shareholders, but all its stakeholders — employees, customers, suppliers, local communities and society at large.

So, how do this quantum shift in thinking inform the question posed in the headline to this story?

Business Strategy and Shareholder Value

My perspective has long been that Shareholder Value, measured by share price, is not a legitimate nor even a sensible goal of Business Strategy. In Strategy Conversations in Practice (SCIP), I deliberately exclude share price as a dimension of Organization Value Creation. Why?

First, share price is an outcome of the Business Model choices a firm makes, the Strategy Conversations it goes through in continuously innovating this Business Model, and its performance in creating sustainable Customer and Organization Value, all in the context of its competitive, industry and macro environments including government policies, technology changes, regulatory and competitive changes to name just a few.

Second, share price is a subjective valuation. It’s part science, part art, and part ‘smoke and mirrors’ on the part of corporations themselves and the financial institutions that value them. In the words of Warren Buffett in his 2023 letter to Berkshire Hathaway shareholders:

It’s crucial to understand that stocks often trade at truly foolish prices, both high and low. “Efficient” markets exist only in textbooks. In truth, marketable stocks and bonds are baffling, their behavior usually understandable only in retrospect.

There is no empirical evidence to support the argument that Shareholder Primacy generates superior business results in the longer term. Trying to ‘predict’ share price goals based on Business Strategy is an exercise in making ‘fortune tellers’ look good.

Third, MSV, whether measured by share price gains or TSR, is an exercise in extracting value from corporations to benefit only one group of stakeholders — current shareholders — at the expense of all other stakeholders. It’s contrary to the concept of Strategy as the pattern realized in the choices an organization makes in creating sustainable value for its Customers, for itself and for its stakeholders.

Finally, Maximizing Shareholder Value is an invitation for shenanigans as history has already shown. If you want a more entertaining perspective on this point, watch Damien Lewis as Bobby Axelrod in Billions. I know it’s meant to be fiction but how much is true?? How many parallels have there been in the corporate world? One of my favourite quotes from Bobby is:

What Have I Done Wrong? Really? Except Make Money And Succeed

The good news is that we’re seeing increasing momentum in the swing away from the doctrine of Shareholder Primacy and MSV to a broader stakeholder perspective, one that recognizes the importance of sustainable value creation for Customers, for the organization itself and for all stakeholders, with reasonable returns for shareholders as a guardrail. The bad news is that many firms have been slow in accepting this swing.

Qantas in a Tailspin

Qantas, the Australian flag carrier, the Flying Kangaroo, the Spirit of Australia, is one example. Qantas has the good fortune to operate in a cosy oligopoly. Qantas announced, on 24th August, an underlying profit before tax of $A2.5 bill for the year ending June 2023 — a record financial result — and Total Shareholder Return for the year of 39%.

Sounds great on the surface, especially since Qantas had been the most complained about company in Australia for each of the two years prior. The complaints covered almost all elements of the ‘customer experience’ — ticket prices, flight delays, lost baggage, long queues in terminals, problems in redeeming $570 million in flights credits from the Covid era, lack of availability of flights for frequent flyer redemptions, unanswered phone calls…….

But, on the 31st of August, the Australian Consumer and Competition Commission (ACCC) launched action in the Federal Court alleging that Qantas had engaged in false, misleading or deceptive conduct between May and July 2022 by continuing to sell seats on more than 8000 ‘ghost flights’ that had already been cancelled. According to the ACCC, many of these cancellations were made for reasons that were within Qantas’s control.

On 5th September, Alan Joyce, the controversial Qantas CEO since 2008 who was due to retire in November, announced his immediate resignation. That move sparked intensive inquiry and hundreds of articles in the business press. Roger Montgomery, writing in The Australian on 8th September summed up the situation clearly. It’s the Maximizing Shareholder Value question.

While whispers revolve around Joyce’s sudden retirement and its implications on the board’s autonomy, a more pressing issue demands attention. Specifically, did the board, under the shadow of short-term profitability objectives, potentiallycompromise the airline’s long-term brand and value?……..Did the board possibly prioritise immediate profits, those that might coincide with the retirement of a CEO, over Qantas’ enduring reputation and value?

Trust in Qantas has plummeted to an all-time low. Robert Gottliebsen, a highly respected business journalist, has labelled the current situation in Qantas as one of the worst failures of corporate governance in Australia. The significance of this claim is underscored by Qantas’ 61% share of the domestic travel market. Qantas is not just another airline with poor Customer performance and overpaid executives. A healthy Qantas is crucial to the Australian economy. But Maximizing Shareholder Value is not a sign of a healthy Qantas.

Qantas has been Maximizing Shareholder Value for a long time

There are four inter-related signs of the dominance of MSV thinking in Qantas’s history over the last 15 years.

First, Qantas engaged in nine share buybacks over the period from 2008 to 2023. Roger Montgomery estimated the disbursement to participating shareholders as approximately $A2.2 billion ($A1 billion of which was in the 2022/23 year alone) with another $1.6 billion in dividends to shareholders. Montgomery noted that Qantas reported a net loss of $116 million over the period and speculated that the $3.8 billion to shareholders was funded by an increase of $A1 billion in debt since 2008 plus $A2.7 billion in taxpayer money provided to Qantas during the Covid years.

Second, Qantas began cancelling and deferring orders for new aircraft in 2011. In 2014 the average age of the Qantas fleet was 7.7 years. In 2023 it is 16.4 years. Qantas is facing an estimated cost of $A6 billion to rejuvenate its fleet over the next three years. Many people have questioned the wisdom of the share buybacks and argue that, in recent years, Qantas should have been raising share capital instead to assist in funding the new aircraft and to reduce the risk associated with relying on $A5 billion in Customers’ pre-payments for flights (including those that were cancelled and not yet refunded) for working capital.

Third, Qantas has treated its Customers very poorly. The firm has openly admitted this. Vanessa Hudson, who took over the CEO’s role on 6th September from Alan Joyce, issued a public apology on 22nd September. However, it’s stunning to hear a newly appointed CEO, one who was the CFO for four years prior and had been with Qantas since 1994, apologize for poor service and then ask Customers to judge her on her actions going forward. It’s almost as if she wasn’t part of the previous senior executive team that got Qantas into the tailspin in the first place.

Fourth, there is Alan Joyce’s compensation package. Joyce sold $17.1million in shares into the buyback in June 2023, with the board’s permission and before the 22/23 results were announced. Joyce’s total pay outcome for 22/23 was $21.4million (Annual Report). After a very strong institutional investor pushback and a lot of adverse press coverage, $14.4million of this is now subject to ‘claw back’ by the board but the final decision is still pending. Ironically, it’s been suggested by more than one financial journalist that Joyce’s pay over his 15 years tenure was more than Qantas’ total profit for the same period!!

Qantas insiders will undoubtedly talk about a long list of other matters that contributed to the current tailspin, most of which fit into the MSV playbook. They include drip feeding capacity increases to allow higher pricing; attempts to reduce operating costs through ongoing conflicts with unions and illegal terminations; failed joint ventures in Asia; the price war with Virgin; inappropriate influence over Federal Government decisions on international competitors’ access to Australia; the failed attempt to cancel, effective 31st December 2023, $570 million in consumer flight credits outstanding from the Covid era and others.

But when you manage a corporation to maximize value for current shareholders you make short term choices for the wrong reasons. The goal of Business Strategy is to create sustainable value for Customers, which enables the corporation itself and its stakeholders to share in that value. Shareholder value in itself may not be the ‘dumbest idea in the world’ but the doctrine of Maximizing Shareholder Value certainly is.

Summary: Shareholder Value, measured by share price, is not a legitimate nor even a sensible goal of Business Strategy. It’s an outcome of Business Strategy, subjectively arrived at through a combination of art, science and smoke and mirrors. Shareholder Primacy, the notion that public corporations are owned by their shareholders and that Shareholder Value should take precedence over the interests of all other corporate stakeholders, is a flawed doctrine. Maximizing Shareholder Value is a managerial choice, not a legal obligation. And it’s a choice that can involve accountability problems and dubious, if not illegal, managerial behavior. The goal of Business Strategy is for a firm to create sustainable value for its Customers, and to share in that value for itself and all its stakeholders — employees, suppliers, communities, environments, and society in general.

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