Question

What does Lynn Stout mean when she refers to ‘fishing with dynamite’? Does her argument support short-term or long-term growth strategies? How might a focus on short-term growth negatively affect long-term sustainability? Provide at least one example.

Answer 1

Lynn Stout discusses how the traditional managerial focus on the Shareholder’s interest can be harmful for
the Corporation and even for Shareholders themselves and how it is more valuable to spread the focus over several objectives. In her Book,“The Shareholder Value Myth,” Lynn Stout shows how Shareholder primacy actually hurts Individual Investors by obscuring their real, diverse human interests in the name of serving a hypothetical, homogenous, abstract and conscienceless Shareholder. First, she demonstrates that it is not a requirement of U.S. law; second, she shows how it misinterprets Corporate Economics, and lastly she examines the evidence that it is effective in increasing returns to Shareholders. The evidence on returns is inconclusive but it becomes clear that a firm’s adoption of the shareholder value model can destroy the commitment of its Employees to the Enterprise.

Professor Stout shows clearly that the notion that the sole purpose of a firm is to maximize shareholder value is not grounded in law. U.S. corporate law holds that Corporations are controlled by their Boards of Directors and it calls for them to exercise their best business judgment, which in the normal course of business can override any duties to shareholders. The famous Dodge v. Ford case, which is often cited in support of Share Holder Value Model (SHV), deals with the treatment of minority Shareholders by a majority Shareholder in a closely-held firm and not really with a Public Corporation. Secondly, the shareholders do not “own” the Corporation legally. It owns itself, just as human beings own themselves. In the normal course of business a Share of Stock is a Contract between a Corporation and a Shareholder that gives them highly limited rights. Only in bankruptcy are shareholders entitled to any residuals after legal obligations have been met.

This undermines the whole principal-agent theory that underpins organizational economics. This is the idea that the Shareholders hire Directors and Executives to act as their Agents, which Stout states is simply wrong as a description of Public Corporations. To put it in ecological terms, one might say that a Corporation develops like any other person; first it is conceived and then it is born. Only once it is incorporated and a Board of Directors has been appointed, can it issue stock. And outside of bankruptcy – while it is “alive” – the Board of Directors controls it, not the Shareholders.

Lastly, Professor Stout reviews the evidence that SHV improves returns to shareholders. She argues that one cannot focus on individual companies for short periods of time. In these circumstances SHV can “unlock” shareholder value for particular investors at particular times but reduce aggregate shareholder wealth over the long term. The author likens it to “fishing with dynamite” – the first fisherman gets a tremendous “harvest” but destroys the system in the process. It is the well-known “tragedy of the commons”, where what is rational for a wealth-maximizing individual is destructive of community welfare. Example cutting expenses for Marketing or Research and development, over time, this kind of activism diminishes the size and health of the overall population of Public Companies, leaving investors as a class with fewer good investing options.