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Shareholder Primacy

Who do corporations really serve?

What is Shareholder Primacy?

Shareholder primacy is a shareholder-centric form of corporate governance that focuses on maximizing the value of shareholders before considering the interests of other corporate stakeholders, such as the society, community, consumers, and employees.

The debate between a shareholder approach and a stakeholder approach has been going on for a long time. Advocates of the shareholder approach stress that corporations should focus on shareholder wealth maximization while proponents of the stakeholder approach highlight the importance of corporations as employment resources, sources of higher quality products for consumers, and for social responsibility improvements within the general community.

 

Shareholder Primacy

 

Who owns corporations?

One of the primary issues in the shareholder primacy debate revolves around the idea of who actually owns these corporations and whether corporations are capable of actually being “owned.” The generally accepted view is that corporations are owned by its shareholders, who ultimately have the ability to control the company. Therefore, employees, directors, and executives are part of the corporation that must produce work in order to maximize shareholder wealth.

On the contrary, others believe that shareholders do not actually own the company and that companies are considered legal entities in and of themselves. Since the global financial crisis in 2008, the doctrine of shareholder primacy has been under intense scrutiny. However, shareholder primacy is still argued heavily in favor of because shareholder-centric corporations have a clear litmus test to measure overall performance. Because shareholder wealth is one convincing way to assess performance, the idea of shareholder primacy provides a coherent and compelling rule of thumb for companies to follow after.

 

Criticisms of shareholder primacy

Although shareholder primacy may be favored by some, there are many limitations and disadvantages to a shareholder-centric approach of corporations. Some key problems include:

  • Corporate decisions and strategy may transition into reaching short-term goals, which may result in hasty decision-making and decisions characterized by short-term incentives and bonuses to meet certain targets.
  • Lack of willingness to take on risks and invest in new technologies may limit the growth of corporations and the potential to improve overall well-being with better products.
  • More dividends paid out by corporations to provide income to shareholders instead of using the generated cash to make more and better strategic investment decisions, e.g., research and development.

 

Going forward

Although numerous suggestions have been put forth to implement more of a stakeholder approach from corporations, in the end, it is a change that can only start from within.

A few recommendations include reforming the countries’ codes of corporate governance and stewardship to focus more on the long-term successes of companies, overhauling legislation to enforce the social and environmental duties of corporations, or improving the diversity of board members.

However, no matter how many regulations and laws are put in place, a genuine change away from shareholder primacy approach can only start from within a company through its internal culture, environment, and overall business strategy.

 

Additional readings

We hope you have enjoyed CFI’s guide to shareholder primacy. To further your financial education, we recommend the following resources.

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