Interesting new paper from my friend and UCLAW colleague James Park:
The shareholder wealth paradigm displaced a managerialist model where investors deferred to managers with the expertise to efficiently allocate resources within the firm. The corporate managers who administered such internal capital markets faced less pressure to generate profits than they do today. The conventional explanation of the transition from managerialism to shareholder wealth maximization points to changes in ideology favoring shareholders. This Article argues that a more significant cause of the decline of the managerialist model was a fundamental shift in the way that investors value companies. As managerial skill improved, companies with strong management teams were viewed as more likely to generate earnings over time. Participants in external capital markets became more confident in forecasting earnings for companies with superior management and stock prices for companies increasingly reflected the present value of the company’s earnings potential. As investors focused on projecting future performance, it became important for managers to signal their ability to produce earnings by consistently meeting market projections of such performance. Rather than ideology, the need to demonstrate earnings potential is the primary reason why public companies generally prioritize shareholder wealth maximization. If the transition to shareholder wealth maximization was driven by changes in valuation, it is possible that shifts in valuation methods could result in a world in which shareholder wealth maximization plays a lesser role in shaping corporate purpose.
Park, James J., From Managers to Markets: Valuation and the Shareholder Wealth Paradigm (November 15, 2020). UCLA School of Law, Law-Econ Research Paper No. 20-09, Available at SSRN: https://ssrn.com/abstract=3731764