Maximizing shareholder value: The goal that changed corporate America
By Jia Lynn Yang,
ENDICOTT, N.Y. — This town in the hills of Upstate New York is best known as the birthplace of IBM, one of the country’s most iconic companies. But there remain only hints of that storied past.
The main street, once swarming with International Business Machines employees in their signature white shirts and dark suits, is dotted with empty storefronts. During the 1980s, there were 10,000 IBM workers in Endicott. Now, after years of layoffs and jobs shipped overseas, about 700 employees are left.
Investors in IBM’s shares, by contrast, have fared much better. IBM makes up the biggest portion of the benchmark Dow Jones industrial average and has helped drive that index to record highs. Someone who spent about $16,000 buying 1,000 shares of IBM in 1980 would now be sitting on more than $400,000 worth of stock, a 25-fold return.
It used to be a given that the interests of corporations and communities such as Endicott were closely aligned. But no more. Across the United States, as companies continue posting record profits, workers face high unemployment and stagnant wages.
Driving this change is a deep-seated belief that took hold in corporate America a few decades ago and has come to define today’s economy — that a company’s primary purpose is to maximize shareholder value.
The belief that shareholders come first is not codified by statute. Rather, it was introduced by a handful of free-market academics in the 1970s and then picked up by business leaders and the media until it became an oft-repeated mantra in the corporate world.
Together with new competition overseas, the pressure to respond to the short-term demands of Wall Street has paved the way for an economy in which companies are increasingly disconnected from the state of the nation, laying off workers in huge waves, keeping average wages low and threatening to move operations abroad in the face of regulations and taxes.
This all presents a quandary for policymakers trying to combat joblessness and raise the fortunes of lower- and middle-class Americans. Proposals by President Obama and lawmakers on Capitol Hill to change corporate tax policy, for instance, are aimed at the margins of company behavior when compared with the overwhelming drive to maximize shareholder wealth.
“The shift in what employers think of as their role not just in the community but [relative] to their workforce is quite radical, and I think it has led to the last two jobless recoveries,” said Ron Hira, an associate professor of public policy at the Rochester Institute of Technology.
The change can be seen in statements from IBM’s leaders over the years. When he was IBM’s president and chief executive, Thomas J. Watson Jr., son of the company’s founder, spoke explicitly about balancing a company’s interests with the country’s. Current chief executive Virginia Rometty has pledged to follow a plan called the “2015 Road Map” in which the primary goal is to dramatically raise the company’s earnings-per-share figure, a metric favored by Wall Street.
Job cuts have come this summer — the biggest wave in years at the company. In Essex Junction, Vt., about 450 workers were axed in June. In Dutchess County, N.Y., 700 jobs were lost. At Endicott, at least 15 workers were told to leave.
Retired software developer Linda Guyer saw the change over her 29-year career. In the beginning, “it was a wonderful place to work — maybe the way Google is today, really innovative,” said Guyer, 59, who used to work for IBM in Endicott. But after training her overseas replacements and then being pushed into early retirement, Guyer said, “you end up feeling really cynical.”
In 2009, IBM stopped breaking out how many workers it has in the United States vs. other countries. The company, based in Armonk, N.Y., probably began employing more workers in India than in this country around the same time, according to an analysis by Dave Finegold, a professor at the Rutgers School of Management and Labor Relations.
Many things have changed over the years about IBM, which has one of the oldest continuous histories of any company in the world. The firm that pioneered the floppy disk, an early version of the ATM and one of the earliest best-selling PCs now makes nearly as much money selling consulting services as it does software. Defenders argue that the company has had to reinvent itself so many times to stay alive that the values of Watson are no longer as easy to apply as they used to be.
Doug Shelton, a spokesman for IBM, said that globalization and increased competition make it hard to compare the company with its earlier days under Watson and that it still has the biggest and most talented technology workforce in the world. Shelton said that the company’s head count has expanded every year since 2002 and that it is hiring for positions across the United States.
“Change is constant in the technology industry,” Shelton said in a statement. “IBM is investing in growth areas for the future: big data, cloud computing, social business and the growing mobile computing opportunity. The company has always invested in transformational areas, and as a result, we must remix our skills so IBM can lead in these higher-value segments, in both emerging markets and in more mature economies.”
The cultural shifts in corporate America have not changed only IBM. The company is merely a representative of what has happened at most large, globalized U.S. firms. But some experts wonder whether these companies have gone too far, leaving the rest of the country behind.
“We don’t build companies to serve Wall Street,” said Margaret Blair, a professor at Vanderbilt Law School. “We build corporations to provide goods and services to a society and jobs for people.”
In the decades after World War II, as the U.S. economy boomed, the interests of companies, shareholders, society and workers appeared to be in tune. Towns such as Endicott flourished.
Even until 1981, the Business Roundtable trade group understood the need to balance these different stakeholders.
“Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy,” the group said at the time, in a document cited this year in an article in the publication Daedalus.
It continued: “The long-term viability of the corporation depends upon its responsibility to the society of which it is a part. And the well-being of society depends upon profitable and responsible business enterprises.”
But changes were already afoot in the academic world that would reshape the fundamental relationship between this country and its companies.
Lynn Stout, a professor of corporate and business law at Cornell University Law School, traces the transformation to the rise of the “Chicago school” of free-market economists.
In 1970, Nobel Prize-winning economist Milton Friedman wrote an article in the New York Times Magazine in which he famously argued that the only “social responsibility of business is to increase its profits.”
Then in 1976, economists Michael Jensen and William Meckling published a paper saying that shareholders were “principals” who hired executives and board members as “agents.” In other words, when you are an executive or corporate director, you work for the shareholders.
Stout said these legal theories appealed to the media — the idea that shareholders were king simplified the confusing debate over the purpose of a corporation.
More powerfully, it helped spawn the rise of executive pay tied to share prices — and thus the huge rise in stock-option pay. As a result, average annual executive pay has quadrupled since the early 1970s.
Part of this was a backlash to the dismal performance of the stock market during the 1970s, a decade that brought negative returns for investors. There was also the perception that companies, including IBM, had become lax in their management. Pressing executives to boost their returns created a new kind of accountability, just as the economy was becoming more globalized and more competitive.
The shift was dramatic. by 1997, the Business Roundtable had a new statement, also unearthed in the Daedalus article. It stated that the principal objective of a business enterprise “is to generate economic returns to its owners” and that if “the CEO and the directors are not focused on shareholder value, it may be less likely the corporation will realize that value.”
The mantra that executives and corporate board members have a duty to maximize shareholder value has become so ingrained that many people assume it must be codified somewhere.
But legal experts say there is no statute in state or federal law requiring corporations and executives to maximize shareholder value. Blair, the professor at Vanderbilt, said that courts in fact allow wide latitude for managers and directors when it comes to business decisions.
“Let me be clear that this pressure comes from the media, from shareholder advocates and financial institutions in whose direct interest it is for the company to get its share price to go up,” Blair said in testimony before a House hearing in 2008, “and from the self-imposed pressure created by compensation packages that provide enormous potential rewards for directors and managers if stock prices go up.”
Some who defend the use of shareholder value as a measuring stick for corporate success argue that with retirees depending on stocks, whether through pension funds or 401(k)s, rising share prices benefit more than just Wall Street.
“If you stick it to the equity holders, you’re going to stick it to the retirees,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.
Like the Business Roundtable statements that changed over time, the message from companies such as IBM shifted as well.
Watson published a seminal text in 1963 called “A Business and Its Beliefs: The Ideas that Helped Build IBM.” In it, he wrote that IBM’s philosophy could be contained in three beliefs: One, the most important, was respect for the individual employee; the second, a commitment to customer service; and third, achieving excellence.
He wrote that balancing profits between the well-being of employees and the nation’s interest is a necessary duty for companies. Watson took pride in the fact that his father avoided layoffs, even through the Great Depression.
“We acknowledge our obligation as a business institution to help improve the quality of the society we are part of,” read the text of IBM’s corporate values.
Under Watson’s watch, IBM introduced groundbreaking computers that shot his father’s company to the top of the technology world. Even into the 1980s, there was a saying that IBM’s products were so reliable, “nobody ever got fired for buying IBM.”
But by the time Louis V. Gerstner Jr. took over IBM in the early 1990s, the company was in trouble. Its main advantage in the PC business was eroding, and expenses were high compared with those of competitors.
Months into his tenure, Gerstner cut about 60,000 workers, at the time one of the biggest layoffs at a U.S. corporation.
In 1994, Gerstner outlined his own set of eight principles, a clear break from the old document. Near the top was that the company’s primary “measures of success” were shareholder value and customer satisfaction. The last one: “We are sensitive to the needs of all employees and to the communities in which we operate.”
Gerstner pulled off a turnaround considered legendary by those who study business history.
The culture at IBM was irrevocably changed, too. The chief executives who followed Gerstner have pushed the company hard to hit ambitious financial targets designed to please analysts on Wall Street. In the process, the iconic IBM charted a path that other companies have followed.
One of the most influential changes took place in 1999, when IBM overhauled its pension plan under Gerstner to help cut costs, shocking longtime employees.
Guyer, the former IBM software developer, said she still remembers the surprise of getting a letter in the mail showing her cash balance for retirement after about two decades at the company: $30,000.
“It was like, ‘Oh, my God, we’ve been totally ripped off,’ ” she said.
IBM employees later filed a class-action lawsuit over the pension changes. In 2004, the company agreed to pay $320 million to current and former employees in a settlement.
William Lazonick, an expert on industrial competitiveness at the University of Massachusetts at Lowell, said the pension-plan change was a watershed moment.
“IBM was a critical company, because everybody after that said, ‘If IBM is going in that direction, we’ll all go in that direction,’ ” Lazonick said. “By 2000, really the whole system had changed.”
The company has continued tinkering with its retirement benefits. Late last year, it changed its 401(k) contribution policy so that IBM matches employee savings just once a year rather than throughout the year. The company said it was making the change to stay competitive, but the new plan also means that employees who lose their jobs before a set date in December do not see any of the matching funds.
Since Gerstner’s time running the company, the pressure to please shareholders has only ratcheted up. Samuel J. Palmisano, chief executive from 2002 to 2011, charted new goals in 2010, calling the plan IBM’s “2015 Road Map.” The primary objective: nearly doubling earnings per share, to $20.
IBM’s current chief executive, Rometty, has picked up where Palmisano left off. The company’s 2012 annual report notes that the company’s road map “delivers long-term value and performance for all key IBM stakeholders — investors, clients, employees and society.”
But as sales flatten, questions have emerged about how the company will hit its ambitious target, aside from slashing jobs.
“This is a horrible business model,” said Lee Conrad, a coordinator for Alliance@IBM, a group that advocates for company employees. “It’s all about the EPS [earnings per share] and not about growing the business. The customers are being impacted by this when good employees are being cut. It’s just a mess.”
Guyer said everyone in the office used to have a copy of Watson’s manifesto on IBM’s principles, the one that says “respect for the individual” came first. The company had its own printing press, so it was easy to get the book.
By the time she left, she did not see the book around as much. She remembers rescuing one from a trash can once. And her copy? It is stored in her garage somewhere, a bittersweet souvenir from her corporate career.