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SHAREHOLDER VALUE – Game for a theory in building value.

Tony Blair’s vision of a stakeholder economy (which, like the continental model of capitalism, suggests business has a broad social and legal focus that takes in employees and communities, as well as shareholders) has been seen by many as a direct challenge to the increasingly popular shareholder value model of business management. UK critics of the shareholder value approach (Managing for Shareholder Value or MSV) have implied that focusing on maximising returns to shareholders means exploiting your employees and your customers, and never cooperating with anyone, especially your competitors. In fact, MSV, rather than being a competing philosophy to stakeholder value, is a necessary precondition for it. A proper understanding of the connectedness of the two ideas would lead not only to a better public perception of business but to better managed companies – which would create greater value for shareholders and other stakeholders. To understand why, we must take a diversion into game theory. Following that, we show how companies that really practise MSV use it to inform and make meaningful the debate on stakeholder management. Game theory is a valuable tool for understanding how players interact in different types of games. Its principles illuminate, in particular, aspects of how businesses interact with each other and with their stakeholders (who may, for example, be customers, suppliers, employees or communities). One of the most important aspects of game theory is the concept of the ‘zero-sum’ game. The board game, Monopoly, is a game of zero-sum: if I win, everyone else must (according to the rules) lose – there is no other outcome. In a true zero-sum game, the size of the cake to be fought over is fixed, and the only issue is how to divide it. The majority of recreational board games are like this, and people in Europe – as opposed to the US – seem to carry this philosophy over into their understanding of how real businesses work. They assume that if you are enriched, someone else must have been impoverished. But people are wrong to make these assumptions. Real-world interactions can, all too frequently, be negative-sum – where the consequence of interaction is to make everyone poorer – but they are rarely, if ever, zero-sum. Yet, where the players get their strategies right, the size of the overall cake can be made much larger. The game that best illustrates the interactions relevant to business cooperation is called the Tragedy of the Commons. Imagine a village farming community with some common land on which all farmers have grazing rights for their cattle. The land can support a certain number of animals at no cost to any farmer; any number of animals greater than that will deplete the land, leaving the next year’s crop of grass able to support only a smaller number of animals. Each farmer can choose to cooperate with his fellow farmers and put no more than a fair share of his animals on the land, or he can cheat, put too many there, and gain some share of the grazing at the expense of his fellow farmers. It turns out that in this game, in the absence of a mechanism to encourage or enforce cooperation, it is rational for all the farmers to cheat (so everybody puts too many animals on the common); and the consequence is to turn the common into a desert. So competition leaves no cake at all to be shared – the ultimate in a negative-sum game. But if the game is played repeatedly, and the participants can see into the future, a different scenario is possible. The farmers will agree on a mechanism to monitor cooperation, and will share the cost of adding fertiliser. The total number of animals will then be larger than for an untended common, the cake will be bigger and all will benefit. So individuals do best if their strategy is based on maximising the amount of cake they can take sustainably, rather than (as is often the human tendency) maximising their share of the cake relative to the other players. The real world is a good deal more complex than the village and the farmers, but the principles still stand. The players in the world of business include owners, employees, managers, competitors, communities and so on. And we can resolve the debate between the shareholder and stakeholder value camps by looking at possible ways in which businesses might play their games. If the owners (or the managers on behalf of the owners) of a business believe that the only way to enhance shareholder wealth is to take that wealth off the other players (as it would be if they were playing a zero-sum game), they run the (considerable) risk of playing a negative-sum game. The productivity of the workers will decline (or they will leave), the customers will feel exploited and defect, the communities will refuse the business a licence to operate. Here is an example from business competition. In the early days of video recorders, individual companies tried to maximise their share of the cake by holding on to their proprietary standards (and locking in their customers). This strategy failed, and only when companies were forced to abandon proprietary standards (partially because JVC was a lot happier to cooperate with its competitors than Sony or Philips) did the market take off. A successful business, like JVC’s, is one that balances the distribution of value to the stakeholders: it provides its customers with superior (value) products, for which they are willing to pay; it provides its employees with realistic wages and conditions (and they, in turn, are productive in what they contribute to the company); it looks after the local communities in which it operates, and avoids the negative consequences that will come to it from polluting the environment; it provides a fair return to its owners (and they are happy to provide it with capital in return). Businesses that behave like this create bigger cakes for all the players (often, even for their competitors), and society benefits. Despite its cut-throat competition with BT, for example, Mercury still lets you dial BT numbers. (Imagine how few people would use a telephone if there were no co-operation between the competitors). Cooperation here creates a massively larger cake for all to share (and competitively fight over). A successful business is driven by this concept of balance. Customers will pay more for a superior product; a company is more likely to develop such a product if it treats R&D people well; it is more likely to see a large cake if its product is compatible (where appropriate) with its competitors’ products. Seen this way, taking care of stakeholders is a necessary precursor to taking care of shareholders. In particular, the most successful creators of shareholder value focus obsessively on the customer; value for customers and value for shareholders, they aver, are two sides of the same coin. The problems arise when people confuse the systems for measuring business success with the underlying sources of that success. Shareholder value is the least distorted way we know of measuring whether businesses are creating value, and some advocates have shown that shareholder measures correlate better with the social aims of business (that is, value distribution to other stakeholders) than any other measures. The downside is that shareholder value measures can become, in the hands of vision-impaired managers, a competing goal with stakeholder management, to be pursued without reference to what drives such success. As a result, some proponents of stakeholder value argue that businesses should implement measurement systems based on broader objectives. This, however, will only have the effect of plunging the company into confused disorder: with no agreement as to the primary goal, managers will make their own minds up about which measure to focus on, and shareholder value – and stakeholder value – will suffer. Great businesses are built from a unique insight into how to deliver value to their customers and stakeholders. They cannot be created by imposing arbitrary metrics of stakeholder satisfaction. Above all, successful practitioners do not confuse means with ends. Nor do they bundle multiple competing goals into a company, thus ensuring that none of the goals can be successfully pursued. They pursue one goal – shareholder value – using multiple ends – stakeholder objectives. In doing so, they create goods that people want, a valued and growing workforce, and good relationships with the community.

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