Why Do Corporations Need A Single Purpose?

The idea that corporations need a single purpose is based not in law, but in economists' arguments that unless we have a single, objective, easily-observed metric to judge how well directors and executives are running firms, corporate "agents" will run amok. As the Harvard Business School's Michael Jensen put the argument in a 2002 article, "Any organization must have a single-valued objective as a precursor to purposeful or rational behavior. . . It is logically impossible to maximize in more than one dimension at the same time . . . telling a manager to maximize current profits, market share, future growth profits, and anything else one pleases will leave that manager with no way to make a reasoned decision. In effect it leaves the manager with no objective."

To many, the obvious candidate for measuring corporate performance is share price. A generation of economists, finance theorists, business school professors, and would-be governance experts has embraced the notion that companies exist only to maximize "shareholder value."

This is — let's just say it — a bizarre notion. There are few human activities whose success is measured by a single metric. Suppose, for example, you decided to go out to lunch. Was your only goal to minimize time spent (in which case you skipped lunch) or to maximize time spent (in which case you are still eating)? To maximize calories (again, you are still eating)? Maximize pleasure (you ate nothing but desserts)? Maximize nutrition (you ate only salad)? Most human projects, from eating lunch, to buying a house, choosing a career, and setting life goals, measure success along many dimensions. We try to get reasonably decent results for several objectives, "satisficing" different goals rather than maximizing only one. Although this approach makes measuring success more difficult, it certainly does not make measuring success anything close to impossible. And it avoids confusing success with measurability.

In my new book, The Shareholder Value Myth, I argue for applying the same approach to the question of corporation purpose. Why should we expect corporations, which may have hundreds of thousands of shareholders (not to mention employees, creditors, and consumers) to be less complex than a single person?

Beyond that, the very idea of a single "shareholder value" is fundamentally flawed because different shareholders value different things. Some want to hold their shares for only a short time and care only about tomorrow's stock price. Others are investing for retirement or to pay for a child's college tuition, and care about long-term returns. (The old "efficient markets" idea that stock prices perfectly measure future returns has long been discredited.) Some want their firms to make informal commitments to build employee and customer loyalty that will pay off in the future. Others who plan to sell soon want firms to opportunistically renege on such commitments. Some hold widely-diversified portfolios and worry how the corporation's behavior affects their other assets and interests; others are undiversified and unconcerned. Some may care only about their own material wealth. But, as the rise of socially responsible investing demonstrates, many are "prosocial" and prefer that their companies not increase profits by harming third parties or breaking the law.

The idea that directors' only goal should be to raise share price in the near future resolves these differences among shareholders by privileging the small subgroup who are most short-sighted, opportunistic, willing to impose external costs, and indifferent to ethics and others' welfare. This single-dimension approach to shareholder value is not only unrealistic, but dysfunctional, leading managers to leverage firms to the brink of insolvency, to focus on short-term earnings reports at the expense of long-term performance, to neglect investment and innovation, to harm employees, customers, and communities, and to indulge in socially-irresponsible behaviors. Directors and executives do these things even though they often feel uneasy about it.

The dogma of "maximize shareholder value" shows all the signs of what John Maynard Keynes called a defunct economists' idea. In the real world, shareholders are human beings who have many different goals and objectives. Corporations serve their shareholders better when managers and directors recognize that corporations can pursue many different corporate goals and objectives, too.