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Shareholder value and Adam Smith

January 13, 2012

I’m reading a fascinating “Ethnography of Wall Street” called Liquidated. This was written by anthropologist Karen Ho, who did her graduate student field work at an investment bank in the mid-1990’s.

As a woman and as a minority, Ho had an interesting, outsider’s view into the culture of investment banking, and the first third of the book describes that culture in painful detail; I might write a further post on her observations, but suffice it to say I recognize her experiences as both shocking (because awful) and totally unsurprising (because familiar).

What I’ve really gotten into in the middle third of the book (not done yet! I’m reading it on my kindle app on the phone on the subway to and from work) is her explanation of the history of the cult of shareholder value. Although she starts in the present and goes backwards, I’ll summarize (and simplify) her narrative by starting earlier and going forward.

Back when Adam Smith wrote his book, most commerce was conducted by small business owners. Smith wrote that the small business owner, by having complete control and by profiting directly from his business, will improve the overall system by acting in his self interest. This is the fundamental belief behind the “invisible hand” theory.

Fast forward to the beginning of the 20th century. The stock market was created, and sold to people, as a way of having ownership of companies without having responsibility, or importantly, control. In other words the fundamental idea of owning a stock was to separate the Adam Smith “ownership/control” concept. Incidentally, Ho has quite a few excellent quotations from Adam Smith explaining that if you do this, your enterprise is destined for failure.

Now move forward to post-World War II. At this point we see the rise of the large corporation, and stock holders continue to own but not control, and managers of the corporations consider the corporations to be social entities, and consider their obligations diffused among stake holders such as employees, customers,stockholders, and the general public.

At some point it seems that investment bankers, who wanted a bigger piece of this pie, and economists got together and cooked up the shareholder value theory. According to Ho, modern economics at this point in history was still relying on the Adam Smith concept of individuals working in their self-interest. It had no theory of corporations, and didn’t know what to make of them.

Except it did know how to squeeze them into the tiny box they’d already built. In order to do this, though, they had to recombine the concept of ownership and control, and reimagine the corporation as an entity, where the role of the small business owner would be taken by the collection of shareholders.

Essentially, then, the idea was to convince the managers and the market itself that the only stakeholder to really pay attention to is the supposedly unified group of shareholders. The corporation should do everything in its power to increase share price, for the sake of this shareholder which was essentially mute (because they didn’t have power) but for whom the investment banker was more than happy to speak (for a large fee involved in restructuring the corporation). It also resulted in the CEO-as-shareholder concept of stock options etc. so that the CEO would be more aligned with his “natural” duties.

One reason this is a screwy concept: shareholders don’t actually have control, nor do they really want control (or responsibility). Most shareholders want to think of their stocks as fluid, like money, except riskier. Indeed Ho makes the argument, which I buy, that shareholders traded control and responsibility for liquidity, which is more meaningful to them.

Another reason this is a screwy concept: in effect, the only people who actually gain from the “shareholder value” revolution in the 1980’s and 1990’s were the investment bankers themselves, and some of the managers of those corporations. Ho goes into detail on how she reached this conclusion, and her facts are convincing, but I was already convinced by observing the lack of faith in the markets right now by regular shareholders (most people through their 401K’s) and by the monstrous size of the financial system.

I really like the way Ho explains this stuff. In particular I enjoy the way she pokes holes in invented nostalgic histories; she talks about how people generate authenticity for their “shareholder value” theory by inventing a past that never was, when shareholders had more say in the running of the company. In fact she does that more than once, and you start to realize how much you can get away with by relying on people not knowing even recent history.

I am looking forward to the last third of the book!

Categories: finance
  1. Constantine Costes
  2. January 13, 2012 at 9:19 am


    I really like that article, and I may write a later post on its message. One thing that I don’t get though is that Martin suggests that, instead of caring about the shareholder to the exclusion over everyone else, the corporation should instead care about the customer to the exclusion of everyone else. He ridicules the idea of football teams caring only about the “expectations market” (i.e. the betting market on point spreads), but it seems equally silly to me to run a football team only caring about whether you’ve gained fans at the end of the day.

    Can’t we all decide that life is actually a balance of demands? We should hope that corporations could actually care about more than one set of stakeholders at a time. That’s what we do, as people, in our lives. I care about my family, my friends, my coworkers, and humanity. It’s a natural thing to do, and conversely it’s unnatural, in my opinion, to decide only to please one group.


  3. January 13, 2012 at 10:07 am

    Is it true that corporations are required by law to maximize their ‘bottom line’? Is that the same as ‘shareholder value’?


  4. January 13, 2012 at 4:10 pm

    1) Maximising a business’ profits is not the same as maximising the shareholder return. If the share price goes up, that increases shareholder return regardless of how well the actual business is doing. If a business retains its profits to invest, rather than issuing them as dividends, the shareholders get nothing in the short run.

    2) Adam Smith is very selectively quoted by those in favour of the current model of capitalism (while others usually haven’t read him carefully enough to know how badly he is being misrepresented)

    3) In general we seem to like social anthropological research into primitive tribes in remote places but not into the ‘tribes’ within our modern western societies. Why, and what are we afraid of? (and, because, Cathy will protest that she is very interested, I will define that the research in which we, as a society, are interested is precisely that for which we will provide research funding)


  5. January 14, 2012 at 9:09 am

    This is a good book. And it’s great to highlight it for a broader audience.


  6. sglover
    September 13, 2012 at 1:08 pm

    The excellent Doug Henwood wonders why stockholders are necessary at all:


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