Shareholders first, is NOT the best investor strategy

Photo: Verne Ho on Unsplash
By Tor W. Andreassen

30 April 2021 10:29

Shareholders first, is NOT the best investor strategy

For 40 years “The Shareholder-first” doctrine has prevailed. Has it worked? What annual return on invested capital have the shareholders had in the period where they were “the chosen ones” compared to a period where they were not?

Are managers employed to first and foremost create value for shareholders? In 2021, the question may seem rhetorical. But then we forget that since the mid-1970s, shareholders have demanded and received almost all management attention.

The fact that they have not achieved a significantly higher return is ironic and deserves attention.

The basis of the shareholders-first doctrine dates to the struggle of the 1930s and the battle between two schools of thought: The economists John M. Keynes who argued for the active state, and Friedrich Hayek who argued for the active market.

In the United States, the market-liberalist school gradually took over and accelerated with Chicago economist Milton Friedman. His New York Times article from 1970: "The Social Responsibility of Business Is To Increase Its Profits" clearly stated managers’ priorities.

Seven years later, the Friedman doctrine was anchored in an article ("Theory of the Firm") that created a tsunami in academia and business and set a precedent for the next 30 years. Shareholders as principals hire the manager as agent to act on their behalf. The motivation was simple. When the owners, as managers, were replaced by professional managers, the shareholders feared that the professional managers would pay more attention to internal things, for example employees, HRM and safety, at the expense of the shareholders. The solution was to make the managers shareholders in their own company.

But has the "shareholder first" logic worked? Has it given them an extra return? More precisely, one can ask: What annual return on invested capital has the shareholders had in the period where they were given special priority compared to a period where they were not? According to an article in the Harvard Business Review, the answer is discouraging!

The author compared the annual returns of companies included in the S&P500 index for two periods: the "professional leader" period (1933 to 1976) with the "professional leader as shareholder" period (1977 to 2008). To the surprise of many, shareholders had higher annual returns in the period when they were not a priority group: 7.6 percent versus 5.9 percent.

The reason, according to the author, is that share prices are driven by expectations about the future and that it is impossible to increase shareholder value all the time. In other words, expectations cannot rise into the sky and space forever.

Norway is a small open economy in the making. We are moving towards a society that is more characterized by knowledge-based digital services ala Schibsted, Telenor, Gjensidige and than industrial enterprises ala Hydro, Elkem, Equinor, and Yara.

This quiet revolution in the business structure is not just Norwegian. For the companies in the S&P500 index, "tangible assets" such as machinery and buildings accounted for 83 percent of the balance sheet in 1970. In 2020, this had turned into 90 percent "intangible assets" such as Intellectual Property (IP), brand value, patents, and the customer base's economic value.

What I would call customer capitalism, as opposed to shareholder capitalism, is among other things characterized by three P's: People, Planet, and Profit. In this lies the fact that profit comes because of the other two Ps.

For researchers who are concerned with innovations and creating value for customers through employees and technology, it is ironic that the shareholders' first doctrine has not been to the benefit of shareholders. The moral is that shareholders' interests are best taken care of when managers pay close attention to employees, customers, the environment, and profitability.