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Maximizing Shareholder Value

January 3, 2012

This post is in reference to:
The Dumbest Idea In The World: Maximizing Shareholder Value

One of the problems with economists reading business writing and vice versa is that our languages sound similar, but have very different meanings. For example, when an economist says “the purpose of businesses is to maximize profit”, what he means is “I am not a naive idiot”. When a businessman says that, he means “I am a cutthroat son of a bitch”. At first, I was not impressed by it, but eventually I was able to translate it into something I could understand. I admire the author’s willingness to dive into the comments and engage the audience.

When Stephen Denning first introduces the “expectations market” he implies that the CEOs who maximize shareholder value are spending all their time misleading and defrauding investors rather than running the company. While people like that do exist, no one thinks that their behavior is good. Everyone wants the CEO to create real profits by selling things to consumers. Later in the article, Denning covers some sensible advice on how to improve corporate governance, but early on, he implies that promoting financial trickery is more common and encouraged than it really is.

Creating Customers
I have a great idea for a company. It’s called “The Free Pizza and Beer Company”. You call us up, and we’ll send you any pizza and/or beer you like, totally free. If you’ve already ordered the pizza, don’t worry, just let us know and we’ll send you the money. I guarantee it’d create a lot of delighted customers very quickly. Why wouldn’t investors sign up? Because the company would lose tons of money. Businesspeak means: creating customers is a good way to make money.

Companies exist to create profit. That is their one and only purpose, and so long as they don’t hurt anyone or break any laws, it’s fine. A firm with a ton of customers is more likely to make tons of profit than a firm with only a few. Ford is more profitable than Bentley and Walmart is more profitable than Nordstrom. As Schumpeter pointed out, “The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.” In the capitalistic system, the consumer is sovereign. If you don’t offer the consumers a good they want at a price they can afford, they will go to your competitor. The article is an explict recognition of the endgame of competition.

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