Shareholder Value and the Financial Crisis

Topics: Stock market, Stock, Economics Pages: 7 (2697 words) Published: August 7, 2013
To what extent can the economic and financial crisis starting in 2007-8 be attributed to the flaws of the shareholder value principle of corporate governance?

Corporate governance is a critical concept in the commercial world of today with the idea originating initially from the U.S. The importance of corporate governance is made more considerable due to the increasing influence and consequences companies have on the daily lives of individuals and making up a large proportion of economic activity. Corporate governance can be shortly described as the whole framework within which companies operate. It is most likely the case that the shareholder value principle was not the only part of corporate governance which contributed to the financial crisis and other factors will also be discussed as the recession was a result of a contribution from many aspects of corporate governance and not only the shareholder value principle. Shareholder value can be referred to as shareholder wealth maximisation. This essentially means that directors have a main goal to direct the company in a way to ensure that the maximum wealth possible is generated for the shareholders. This gives the pure incentive to managers to do what is necessary to improve the shareholders wealth. With this incentive it can be determined therefore that the activities of the managers and operations of the company are centred around the needs and demands of the shareholder leaving any other responsibility as a secondary objective.

The ideology of shareholder value has become a staple for corporate governance established first by companies in the U.S and the UK in the 1980's/90's and was later accepted among European nations in the late 90's. The sole focus on shareholder value was helped into prominence in the U.S by the election of Ronald Reagan and in the UK by the election of Margaret Thatcher. Executives and managers from Europe and Japan have been greatly impressed by the performance primarily in the U.S stock market and acknowledged their shareholder value principle as being a large contributor towards their success which led to them adopting this model with the help of American investors and investment bankers who promoted the potential of shareholder value. Before this principle of corporate governance was established, in the 60's and 70's it was the principle of retain and reinvest which was widely accepted by the ruling corporations at the time. This meant that they would hold on to the income earned and would also reinvest into bettering their human resources and improving physical capital. This model promoted intense growth for the corporations who followed it as the retained income allowed enough allowances for internal growth in the form of more complex and diverse managerial structures and those with the technical knowhow of operating plant and equipment. However, it was in the same decades where those implementing it discovered issues with the model, firstly, due to the vast amounts of reinvestment funds available a corporation was seeing very quick growth often leading to multiple divisions in many different brands and leading to the main issue of main offices being too far from where the actual business processes occurred making it more difficult to make informed investment decisions. Those in charge therefore would hit a dead end where they could no longer utilise the model of retain and reinvest, this inevitably saw corporations declining in performance in the 70's after seeing success in the 60's. However the decline of this model was also a result of increased international competition mainly from Japan with foreign industries becoming more efficient in mass production and the ability to discover and make use of newer technologies. It was Japan's ability to compete with American industries who were market leaders through better innovation and skill deployment which later led to the collapse of many American industries. Support...

Bibliography: Richard Straub. (2012). Shareholder Value – a theory that changed the course of history – for the better or the worse?. Available: Last accessed 07/08/2013.
Simon Deakin. (2010). CORPORATE GOVERNANCE AND FINANCIAL CRISIS IN THE LONG RUN. Centre for Business Research, University of Cambridge Working Paper. 417
William Lazonick & Mary O 'Sullivan (2000): Maximizing shareholder value: a new ideology for corporate governance, Economy and Society, 29:1, 13-35
William Milberg (2008): Shifting sources and uses of profits: sustaining US financialization with global value chains, Economy and Society, 37:3, 420-451
Wei Xiong. (2012). Bubbles, Crises, and Heterogeneous Beliefs. In: Jean-Pierre Fouque and Joe Langsam Handbook for Systemic Risk. Princeton: Princeton University.
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