The near constant refrain from activist investors is that they’re just working to maximize shareholder value, an objective that many of us take for granted even if we don’t automatically assume that hedge funds are being sincere about their goals. But the title of James Montier’s latest white paper “Shareholder Value Maximization: The World’s Dumbest Idea,” leaves no doubt where he stands on the matter.
Based on his October talk at the European Investment Conference earlier this year with the same title (taken from a Jack Welch quote), there are two big takeaways from Montier’s paper on shareholder value maximization (SVM).
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Montier – High compensation has lowered CEO performance
Since we entered the era of SVM, which Montier marks at 1990, CEO compensation has skyrocketed. Base salaries have gone up in real terms, but it’s the stocks and stock options that have really driven pay rates sky high. Even if that doesn’t bother you in and of itself, the additional compensation hasn’t had the desired effect: total real returns have actually ticked down. But correcting for changes in valuation, Montier argues that underlying performance has actually gone down as CEOs focus on hitting compensation targets instead of building a great company.
If that’s surprising, it’s because we have been too close attention to economists and not enough to psychologists, at least in Montier’s estimation. He points to a 2005 study where rural Indians were given the chance to earn money by playing six different games, with three different compensation schemes each an order of magnitude apart. Under the highest paying scheme, the participants could potentially earn a half year’s salary, but performance collapsed as they focused too much on the goal and not enough on the games themselves. It’s certainly true that incentives affect behavior, but not in the simplistic linear way that we expect.
SVM has failed shareholders and society, says Montier
Montier’s other big point is that SVM is one of the main factors behind growing inequality. You’ve probably seen the incredible growth in CEO pay in the last few decades, from about 30x workers’ pay to 300x today (actually down from 400x during the tech bubble), and other measures of rising inequality. But Montier connects the dots, citing evidence that 58% of the change is directly due to rising pay for the finance industry and executives.
His conclusion is that SVM has failed both shareholders and society, extracting value from companies and contributing to slower growth as public investment falls far behind private investment. Unfortunately, it may be more accurate to say that it has succeeded at meeting the goals of people who are interested in doing exactly that, extracting value and moving on to the next stock.