The Myth Of The Fiduciary Duty To Maximize Shareholder Value
Donald Trump admitted at a rally the other day in Colorado that he had been a substantial beneficiary of tax laws but insisted he would “game the system” for the people if he is elected. This approach that Trump has worked the system so he will know how to fix it seems to be the campaign’s response to the clear indications that Trump has not paid taxes for years. I’m sure his supporters will buy it hook, line, and sinker.
But I want to point out a statement that Trump also made at that same rally. He said he had a “fiduciary responsibility” to make sure he pays as little taxes as possible. Now, a fiduciary responsibility using only applies to a company with stakeholders. It certainly does not apply to one’s personal tax returns which is what Trump’s scandal actually involves. But I really want to explore the idea that a fiduciary responsibility automatically means you have to take every tax break you possibly can, that fiduciary responsibility means that you MUST maximize shareholder value. This is a common theme among the business elites and they use it cover a multitude of sins, both legal and illegal. But the idea is totally false – it is a myth. A fiduciary responsibility means working in the best interests of both the shareholders and the company. That does not always entail maximizing profits. If it were true, then all the CEOs and board members of all those companies that continually advertise all the good things they do for charity would be taken to court for breaking their fiduciary responsibility because they weren’t maximizing shareholder returns. But they aren’t. In fact, as recently as the horrific Hobby Lobby decision in 2014, thee Supreme Court said, “Modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not.”
It wasn’t always this way. In the post World War II era, the focus for companies was certainly to make a profit but to also take care of its workers and the community the company was invested in. Way back in 1963, Thomas J. Watson, the founder and CEO of IBM said, “We acknowledge our obligation as a business institution to help improve the quality of the society we are part of.” Even in 1981, the Business Round Table, a prominent business group, stated, “The long-term viability of the corporation depends upon its responsibility to the society of which it is a part”.
So when did the focus for a corporation change from being a responsible citizen to prioritizing maximizing shareholder value. It all started with an article by renowned economist Milton Friedman in 1970 who said the “social responsibility of business is to increase its profits.” Other economists picked up the ball and ran with it, declaring that executives and board members were essentially “employees” of the shareholders and worked for them. The idea certainly appealed to shareholders in the 1970s who were enduring a decade of a sluggish stock market. When the Reagan revolution came, deregulation and the idea that tax cuts for the wealthy would create investment and innovation only enhanced the supposed primacy of the shareholders. And then hedge funds and activist investors used and continue use the idea to pressure companies to maximize returns at all costs., primarily for their benefit. The idea also led to the ever-growing CEO pay as rewards for increasing shareholder returns and the counterproductive focus on quarterly earnings.
This one single myth, that the shareholders should be the primary concern of companies, has probably done more damage to the American economy over the last 40 years than any other single factor. It resulted in the destruction of unions, the off-shoring of jobs, the tax-abatement shopping, and an overwhelming focus on short-term results at the expense of long-term planning. Even Jack Welch, the former CEO of GE who was one of the biggest supporters of maximizing shareholder value, admitted in 2009, “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal… Short-term profits should be allied with an increase in the long-term value of a company.” And for once I can agree with Welch.