4
The Tyranny of Shareholder Value
Wealth is evidently not the good we are seeking; for it is merely useful and for the sake of something else.
—Aristotle, The Nicomachean Ethics
In December 2019, my children and I got together for the holiday season, as we do every year. The year, and the decade, were coming to a close. Both my son and my daughter were stepping into their thirties and starting their own families; a few months earlier, I had turned 60 and stepped down as CEO at Best Buy. It was a moment of reflection for all of us.
The news also weighed heavily on our minds: catastrophic forest fires were ravaging New South Wales and Victoria in Australia, a few months after raging in Brazil’s Amazon and, again, in California. Social fires were burning too. France was gripped by strikes over the government’s proposed pension reform, following months of protests initially triggered by a rise in fuel prices. Mass protests had broken out in Lebanon, Chile, Ecuador, Bolivia, and elsewhere. Unrest over the economy and, more generally, growing inequality was feeding a global wave of populism while demands for more action on climate change inspired a rising tide of protests around the world, led by younger generations rallying behind Swedish teenage activist Greta Thunberg.
Around the dinner table, my children talked about how excessive consumerism and waste was contributing to global warming. They pointed out that young professionals in their generation were turning to start-ups in search of inspiration and fulfillment at work because they were disillusioned with large traditional employers. Both felt that governments and business were not doing an adequate job to address the climate crisis, seemingly lacking the sense of urgency that they felt so acutely. What kind of world would they and their children be living in over the decades to come?
One thing was clear to us: our capitalist system and the way business was operating no longer seemed sustainable.
My children are not alone in believing that our economic system has reached an impasse. Multiple surveys have made it clear that social inequality and the environmental crisis are feeding disenchantment with capitalism, especially among younger generations.1 Of course, capitalism has led to an unprecedented period of economic development, driving extraordinary innovation and taking billions of people out of poverty. But we are undeniably facing a crisis.2 In fact, in January 2020, Marc Benioff, the outspoken CEO of Salesforce, declared at the annual meeting of the World Economic Forum in Davos, where discussions largely focused on how to address climate change and inequality: “Capitalism as we have known it is dead.”
We need to rethink how our economic system works.
One of the first things I learned in business school, back in 1978, was that the purpose of business was to maximize shareholder value, and I believed it. My training focused on acquiring techniques to optimize profits. No time was spent thinking about the role of business in society. The history, philosophy, and ethics I had studied in high school and during my early college years disappeared from the curriculum, and I went straight into double-entry accounting and financial analysis. I clearly remember a strategy game that we played in which winning was entirely based on who made the most profit. I carried this ethos into the early 1990s, when I transferred to the McKinsey office in New York. Despite a decade of financial excess and banking scandals, that view held. As strategy consultants, our objective was generally to maximize shareholder value for our clients.
We largely owe this gospel to Milton Friedman, one of the most influential economists of the twentieth century. In a New York Times article published in September 1970, he argued that business has one and only one “social” responsibility: to maximize profits for shareholders. According to Friedman, people who believe that business should not be concerned merely with profits but should also promote social ends such as providing employment or avoiding pollution are preaching pure socialism.3 Milton Friedman’s perspective has one obvious advantage: it is simple. There is just one constituency to please—shareholders—and one performance metric that matters—profits.
The Friedman doctrine remained business gospel for decades. In 1997, the Business Roundtable, which includes the CEOs of the largest and most influential companies in the United States, published a statement that declared: “The Business Roundtable wishes to emphasize that the principal objective of a business enterprise is to generate economic returns to its owners.”4
My view started changing when I was still a consultant, and my subsequent experience at the helm of several companies only confirmed what I started to feel in those latter days at McKinsey. I now see shareholder primacy as the root cause of the problems that my children and I were talking about around the dinner table. Although making money is of course vital and a natural outcome of good management (as we discuss in chapter 5), considering profit as the sole purpose of business is wrong for four fundamental reasons: (1) profit is not a good measure of economic performance; (2) an exclusive focus on it is dangerous; (3) this singular focus antagonizes customers and employees; and (4) it is not good for the soul.
Profit Is Not a Good Measure of Economic Performance
Profit does not take into account the impact of a business on the rest of society. The full cost of waste or carbon footprint on the environment does not appear on a financial statement, even though it is very real and can be very painful. Food and beverage companies using single-use plastic bottles, for example, do not bear the cost of oceans being clogged up with plastic waste. The profits of businesses relying on coal as their main source of fuel do not reflect the costs they generate on human health and the environment.
Even within the confines of a company’s four walls, a company’s profit can be a misleading measure of economic performance. I learned just how arbitrary accounting norms can be when, in April 2003, I became the deputy CFO of Vivendi, overseeing the company’s financial reporting and planning.
It was a chaotic context. After a string of acquisitions, the group faced a liquidity crunch that had led to the exit of the CEO, Jean-Marie Messier, about nine months earlier. Concurrently, the company’s auditors, Arthur Andersen, had collapsed after the Enron scandal. Vivendi had decided to issue a high-yield bond in the United States and in Europe to extend the maturity of its existing debt, so it could sell some of the company’s assets without being under cash pressure. We had to close the books in order to be able to market the high-yield bond.
As I worked with the company’s new auditors to unpack our financial reporting, I was struck by disconnects between reported earnings and economic reality. For example, according to accounting rules, a parent company can include 100 percent of the operating income of the businesses it controls in its own operating income, even if it owns only a fraction of these businesses. The income of businesses it does not control, on the other hand, is not included at all in that line, even when the parent company owns a significant portion of these businesses. Vivendi had been—somewhat conveniently—consolidating profitable businesses in which it held a minority stake, namely mobile operator SFR (44 percent) and Maroc Telecom (35 percent). At the same time, it was not consolidating unprofitable businesses, such as Polish telecom company PTC and internet platform Vizzavi, even though it owned about 50 percent of each. This was entirely legal and in line with accounting rules, but it inflated Vivendi’s operating income and divorced profit from the actual health of the business.
In addition, it is hard to account for other signs of a healthy business, like motivated and skilled people, a company’s most important asset. Engaged employees were the engine of Best Buy’s successful turnaround and remain the number-one reason for its continued success today. Yet you cannot find them on the balance sheet. As a result, investing in people, like Walmart CEO Doug McMillon decided to do back in 2016, and like we did at Best Buy, can depress profits in the short term, whereas investments in tangible assets such as real estate or plants will be amortized over several years.
A Singular Focus on Profit Is Dangerous
Profit—like the temperature of a patient—is a symptom of other underlying conditions, not the condition itself. And focusing on the symptom alone can be dangerous. Think of a doctor who is rewarded merely for keeping patients’ temperature within a healthy range. The thermometer might end up in the fridge whenever a patient runs a fever.
It is an easy game to rig, and not just through accounting. I can maximize profit by underinvesting in people and other assets that directly benefit customers. It works, but for a short time. Expenses go down, and the numbers look good for a time while the long-term health of the business suffers. This is precisely what happened at Best Buy between 2009 and 2012, when the company slowed down spending on its stores and invested too little in e-commerce. At the same time, it increased prices. For a while, that helped sustain its bottom line—until customers grew tired of battling with the company’s website, and of the dusty stores and poor customer service I encountered when I went to buy my flip phone. The path to bankruptcy is littered with retailers like Sears and others that focused more on short-term profits than on investing in talent and better serving customers. Best Buy, as the following chapters show, illustrates that focusing on talent and customers is what underpins sustainable success.
A relentless focus on just “hitting the numbers” stifles innovation too. A Stanford University study found that innovation at tech companies slows by 40 percent after initial public offerings (IPOs) because management becomes more cautious once they are subject to market pressures.5
If you try to manage to a certain number, you also risk missing the opportunity to play offense during downturns. During the 2008 Great Recession, I was at Carlson, and the hospitality industry was severely hit. I could see how the leaders in that industry, Marriott or Starwood, to name a couple, continued to invest even if it meant hurting their profits in the short term.
Of course, financial performance does matter a great deal. Profit creates space and time. Listed companies that don’t hit market expectations can quickly lose value. In January 2014, for example, Best Buy’s share price dropped from $39 to $25, on the back of disappointing holiday sales numbers. I had to remind myself that, over the previous year, the share price had gone from $11 to $42. Markets react fast—and often overreact in the short term. And in the longer term, a CEO who consistently fails to deliver financial performance will be ousted, and a company that is not profitable is doomed. Whereas such pressures cannot be ignored, they do not justify myopia.
And they certainly do not justify wrongdoing. A steady stream of corporate scandals through the past two decades, such as Enron’s house of cards, Volkswagen’s “dieselgate,” and Wells Fargo’s scandal, are direct consequences of an excessive focus on numbers. The 2008 recession was the result of bad behavior on a large scale, demonstrating the danger of this approach to running a business.
A Singular Focus on Profit Antagonizes Customers and Employees
Consumers are smart and demanding. Like my children, they have high expectations of companies. They want to do business with companies they respect and trust to be competent, ethical, and actively improving the society around them.6 Consumers increasingly will turn away from companies that do not meet these standards. One of the points that my children raised over our dinner was the forced obsolescence of the products they buy, how quickly tech companies stop supporting older products and how often some clothing retailers come up with new lines, a phenomenon known as “fast fashion.” They see these tactics as merely a profit strategy, and not beneficial to them or the planet.
Multiple industries, from food to fashion, are feeling the pressure to clean up their climate act. Concerns over global warming are shaping behavior—and consumption. Before Covid-19 devastated air travel, one in five people said they were flying less out of concern over the environment.7 A “flight shame” movement was spreading beyond Sweden’s borders. These trends cannot be ignored.
Employees are also pushing for social and environmental change from their employers. For example, in September 2019, Amazon employees walked out to pressure their employer to be more ambitious about reducing its carbon footprint, stop servicing the oil and gas industry, and no longer support politicians who deny climate change.
Even shareholders—the very people who supposedly benefit the most from the belief that the sole purpose of companies is to make money—are looking beyond short-term profits and increasingly adopting the view that being a good citizen is ultimately good for business. BlackRock, the world’s largest asset manager, has embraced sustainability as its new standard for investing. In its 2020 annual letter to CEOs, BlackRock head Larry Fink explained that climate change, in particular, creates investment risks. “Climate change,” he wrote, “has become a defining factor in companies’ long-term prospects […] Our investment conviction is that sustainability- and climate-integrated portfolios can provide better adjusted-risk returns to investors.”8 Business leaders, nongovernmental organizations (NGOs), and academics surveyed by the World Economic Forum in its 2020 Global Risks Report ranked the failure to mitigate and adapt to climate change as the top threat facing the world over the next 10 years.9
Shareholders’ expectations are shifting because investors themselves are not soulless entities unable to lift their gaze past the next quarterly results. Shareholders are people or organizations of people—whether institutional investors or mutual funds—that are looking after the financial security and pensions of other people. Either way, they are individuals. And as such, they are not homogeneous; they tend to have varying objectives and time horizons. They are also human beings who share the same planet and the same human aspirations as everybody else, as well as concerns about the future. They are consumers and employees too.10
The push from investors away from the primacy of shareholder value is not just in words. Assets invested and managed taking into account environmental, social, and governance criteria rose from $22.8 trillion in 2016 to $30.7 trillion at the beginning of 2018.11 In addition, climate considerations are increasingly being included in financial reporting, affecting investment decisions.12 It is not going away. Customers, employees, and even shareholders are resetting expectations.
An Exclusive Focus on Profit Is Not Good for the Soul
In early 1999, when I was president of EDS France, I attended a leadership meeting with the new CEO of the global group, based in Texas. He was presenting the company’s strategy. This presentation only strengthened my growing conviction that the Friedman doctrine was wrong. The CEO’s entire approach was focused on profit. I felt uninspired. When he asked for feedback, my contribution was to point out that financial results could not be our sole focus. Over the following few months, the new CEO’s approach heightened my sense of alienation, which convinced me to leave EDS.
If, when I joined Best Buy in 2012, I had told everyone at the company that our purpose was to double our earnings per share to $5, what do you think would have happened? Not much. And for good reason. When we ask Best Buy employees what drives them, no one ever says “shareholder value.” This is not why people jump out of bed in the morning. If we want employees to be more invested, we must acknowledge that their souls are not wrapped up in a stock price. Remember, work does not have to be a chore; it is not a curse. It is a quest for meaning. Maximizing profit does not answer that quest and therefore cannot solve the epidemic of disengagement at work we discussed in part one. It is not what drives people to give their very best to save companies like Best Buy.
I am not for a second suggesting that we should ignore profits. Of course, companies must make money—or they do not survive. And there are situations where a keen focus on the bottom line is a good thing. When a business is bleeding money and at risk of dying, for instance, you have to prioritize stopping the hemorrhage. Also, it is healthy to know how and why the business will make money.
But what is healthier still is to disavow the obsession with the bottom line. The true bottom line is this: although profit is vital, it is an outcome, not a purpose in itself.
Then, you might ask, if not profit, what is the purpose of a company? Properly framing the answer to this question is how we start reinventing capitalism, transforming business from the inside, and helping to shape our collective future. In so doing, we can begin to answer the aspirations and concerns that my children—and probably yours as well, together with millions of other people—voice around the dinner table.
For me, this journey started in 1993 around a different dinner table, with a business discussion that would start opening my eyes to the true heart of business.
Questions to Reflect On
- Do you believe that the only purpose of companies is to maximize profits, and their primary responsibility is to shareholders? If so why, and if not, why not?
- Do you think that the expectations of your company’s customers, employees, and shareholders have changed? And if so, has your company changed with them?