Oliver Hart and Luigi Zingales have weighed in on an important question:
What is the appropriate objective function for a firm? We analyze this question for the case where shareholders are prosocial and externalities are not perfectly separable from production decisions. We argue that maximization of shareholder welfare is not the same as maximization of market value. We propose that company and asset managers should pursue policies consistent with the preferences of their investors. Voting by shareholders on corporate policy is one way to achieve this.
It is clearly not the law that company managers must "pursue policies consistent with the preferences of their investors."
The value of a shareholder's investment, over time, rises or falls chiefly because of the skill, judgment and perhaps luck-for it is present in all human affairs-of the management and directors of the enterprise. When they exercise sound or brilliant judgment, shareholders are likely to profit; when they fail to do so, share values likely will fail to appreciate. In either event, the financial vitality of the corporation and the value of the company's shares is in the hands of the directors and managers of the firm. The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.
Paramount Commc'ns Inc. v. Time Inc., 1989 WL 79880, at *30 (Del. Ch. July 14, 1989), aff'd sub nom. Literary Partners, L.P. v. Time Inc., 565 A.2d 280 (Del. 1989), and aff'd, 565 A.2d 280 (Del. 1989), and aff'd sub nom. In re Time Inc. S'holder Litig., 565 A.2d 281 (Del. 1989).
Why is that the default rule rather than the one proposed by Hart and Zingales? Hart and Zingales discuss many of the standard tropes, many of which have been neaten to death on these pages and elsewhere. So let's take a different approach.
Let's start with the assumption that the current legal rule is the majoritarian default. Why?
I suspect it's less costly for firms to shareholders to learn about firm policies than for firms to try to gather information about shareholder preferences.
Public companies exist in a fluid and constantly changing market. This is presumably one reason, for example, that shareholders get a say on pay every year (or two): As shareholder demographics shift, so may their preferences. Hart and Zingales' proposal thus would only work if shareholder preferences are stable and homogenous. Neither seems likely to be true, as my friend and colleague Iman Anabtawi has pointed out. Indeed, shareholder policy preferences can shift very rapidly when activist shareholders arrive on scene and demand sweeping changes in core policies.
Let's think of the stock market as a cafeteria. The investor can move down the line, selecting those companies that match their preferences and declining those that don't.