Business

AN INFLATED NOTION OF WORTH

The push for shareholder value is out of control

KATHERINE MACKLEM July 1 2002
Business

AN INFLATED NOTION OF WORTH

The push for shareholder value is out of control

KATHERINE MACKLEM July 1 2002

AN INFLATED NOTION OF WORTH

The push for shareholder value is out of control

Business

KATHERINE MACKLEM

SHAREHOLDER VALUE: the words themselves exude goodness. Even though the expression refers to straightforward financial gain—through the dedication of managers and directors to increasing their company’s share price—it comes across as a timeless virtue. Shareholders are participants—all in this together—and value, according to the Oxford dictionary, means worth, desirability, utility—qualities so upbeat and upright, every upstanding citizen would want them. There’s even the notion of defending the little guy, as directors are supposed to be looking out for the interests of investors. The thinking is steeped in logic and difficult to criticize. But the truth is, shareholder value is a concept that has gotten out of control.

In ever-increasing numbers, shareholders—justifiably—want their companies to be beholden to them. They are the owners, after all. The middle class, expecting little from government in its retirement

years, saves less and invests more than ever before. About half of all working Canadians are involved in the stock market, according to the Investment Dealers Association of Canada—and their investments have doubled in the past 10 years to more than $550 million.

The middle-class investor is not alone, of course, in the drive for better results. The traditional corps of old-money players, and more importantly, that small army of professional money managers that handles billions for mutual fund companies, pension funds and the very wealthy, are behind it, too. We all want the same thing—more money—and the pros are paid big bucks to make it happen. Our futures, their bonuses, and all of our egos depend on it. Smart company managers are responding. Their bonuses, too, not to mention stock options, are rooted in better returns. The effort is so concerted and so forceful as to be almost unanimous.

The focus on shareholder value has spawned feeder businesses. Consulting firms have whole divisions that provide companies with advice on how to improve it. One of these firms, New Hampshire-based Kennedy Information Inc., publishes a magazine six times a year called Shareholder Value. There are Web sites on the subject, including, naturally, shareholdervalue.com, and academics argue in serious papers over what drives it. The American Management Association even wants to teach it: the group has a certificate program in shareholder value creation.

The value of our investments has so captured the imagination it’s long since taken over the table talk at dinner parties. House prices, anyone? Could you pass the stock tips, darling? Does anyone ever dare mention Nortel anymore, for fear of casting a pall over the party? Ironically, Nortel Networks Corp., the company that’s lost a lion’s share of value—$167 billion, or 95 per cent, off its July, 2000 peak—is committed, like so many other companies, to enhancing shareholder value: its mission statement says so. It’s also a company that has laid off 52,500 people, or more than half its employees—thanks to the collapse of overinflated shareholder value.

The pressure to create that kind of false worth has become relentless. Nortel and the tech companies that went bust after the bubble burst are just one part of the phenomenon. Another is the push for convergence by telecom and media companies, designed to squeeze more profits out of their businesses. An enormous amount of money and energy has gone into making convergence work, and for a moment or two, share prices in this sector bumped upwards. The only thing lacking so far is substance—and real value. It’s turning out to be a hollow promise—as witnessed by the fall from grace of Jean Monty, formerly CEO of BCE Inc. The few companies that haven’t bought in to either convergence or the supremacy of shareholder value—such as Power Corp. of Canada, the Montreal-based media and financial services conglomerate controlled by the Desmarais family—haven’t had a share price boost, but neither have they had to ride a roller coaster.

While more shareholder disappointment is inevitable, it’s not the only fall-

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out. The pressure to produce better returns pulls attention away from other important factors, such as long-term strategic thinking. If the payoff from a major, balance-sheet-depleting investment is going to take 10 years, what do we tell the stockholders this year? Decision-making, by managers and board members, is increasingly focused on maintaining ever-expanding returns— effectively to feed the insatiable shareholder maw.

Then there’s the impact of corporate decisions on other stakeholders, from the community to employees. In their shortsighted focus on instant returns, investors may be ignoring corporate actions that cause havoc or harm in their own backyards. Almost every year at the annual meeting of the Ontario Teachers’ Pension Plan Board, a teacher or two will stand up and insist that the fund divest of certain investments considered unpalatable. But Claude Lamoureux, the board’s CEO, always defends the pension fund’s fiduciary duty to invest with the best return as its full objective. The managers don’t make ethical calls, he says, just investment judgments.

Enron Corp. is almost too easy to point to as the poster company of shareholder value gone mad. This is an enterprise that, once its cover was blown, saw US$68 billion in false equity evaporate. More than 4,200 employees lost their jobs, as well as their retirement savings held in company stock. What brought Enron down was the way it kept its books—whisking the nasty bits off the balance sheet in order to make its numbers look good, with the willing co-operation of auditors Arthur Andersen LLP. In other words, to make the company look more valuable. The executives, of course, continued to talk up the company even as they quietly sold their shares at vastly inflated prices.

There are other examples of over-

Decision-making is focused on maintaining ever-expanding returns -effectively to feed the insatiable shareholder maw.

wrought bids to improve shareholder value that are perfectly legal and much closer to home. One is the battle for control of Fisheries Products International Ltd., which pitted locals from Newfoundland against Bay Street power brokers. Last year, a group of institutional investors decided FPI could be managed more efficiently and make more money. The company, created in 1983 by the merger of small, mostly failing, fish plants, had been run by Vic Young, who’d managed to turn a profit at the company, although not at its maximum potential. Enter rival John Risley, owner of Clearwater Fine Foods Inc., a major Nova Scotia-based seafood company. Risley managed to oust FPI’s board and planned to cut 600 jobs out of roughly 1,300 when he merged the two companies. But the planned job cuts met with vociferous outrage in Newfoundland’s coastal communities. As the government prepared legislation to put new ownership limits on the company, effectively stymieing the merger, Risley called it off. In Newfoundland, protecting those jobs—and a way of life—was more important than eking out a few more percentage points of profit. It’s an unusual victory.

There is a new, and for now limited, move afoot in the investment community to promote socially responsible investing. It has taken more than a decade to catch on, sparked largely by the 1987 report by the UN’s Brundtland Commission on the environment and development. A few firms have created portfolios to invest in companies committed to sustainable development—and, according to the Conference Board of Canada, they tend to match or outperform their benchmarks. These portfolios make up a tiny portion of the overall market—at $50 billion in assets in 2000, they accounted for only 3.2 per cent in Canada. In the U.S., the proportion is better, at 13 per cent. It’s a start—and it’s reassuring that this kind of investing makes as much, if not more, money than others. Still, it’s not enough. There’s nothing wrong with making money—unless it’s pursued to the exclusion of all else. As owners, shareholders have the power to insist that corporations take into account more than the immediate bottom line when decisions are made. They just haven’t yet recognized the value in that. I?1