The Architecture of Markets

1)    Discuss the rise of the shareholder value conception of control in the market for corporate control. What was the crisis that precipitated the change?  Who were the actors who invaded the field? What did they force management to do? What tactics did managements implement? How did shareholder value change the incomes of CEOs and the income share of the 1%?

“The Architecture of Markets”
P 84- 86
P 147-157
Lecture Slide
Useem (Extra reading)

Here is my lecture Note I think you can find all answer in here.

Shareholder value
P.84-86 / 147-157 / Lecture slide
Discuss the rise of the shareholder value conception of control in the market for corporate control.
– Since the early 1980s, large American publicly held corporations have been managed according to the principle of “maximizing” shareholder value
– this idea implies that the only constituency that management should pay attention to are shareholders
– the only goal of the firm is to maximize profits in order to maximize the value of the company
– the symbol of shareholder value is increasing the stock price, the value of one share of stock
– this was an ideology, a set of strategies that managers “ought” to pursue, and a restructuring of relationships between top managers, the institutional investors, and the stock market.

– Top management carried out the dictates of institutional investors and sued shareholder value strategies to increase profits and share price
– Useem argues that the “Shareholder value” revolution was a fundamental re-alignment in the relationships between investors, the financial markets, boards of directors, top managers, and employees
– this re-alignment meant an assertion of power by investors and a re-organization of corporations.

What was the crisis that precipitated the change?
– era of high inflation / era of economic stagnation / punishing interest rates / stagnating stock market

Who were the actors who invaded the field?
– institutional investors and corporate raiders from the financial community
– Useem shows that beginning in the mid 1970s, the shares of stocks of large corporations increasingly left the hands of private investors like rich individuals and families / and increasingly were being bought up by institutional investors. (include: Pension Funds, Mutual Funds, Insurance Companies, investment banks, and Commercial banks
– they began to take over firms / if the firm’s assets were worth more than its stock it was broken up / the era of “corporate raiders” had begun.
– Therefore, they proposed a new conception of control: the shareholder value conception of control.

What did they force management to do?
– maximize profits for shareholders

What tactics did managements implement?
– managers who initially tried to resist the invasion got on board
– managers realized that if shareholders wanted them to raise the stock price, then they needed to manipulate the financial information that stock analysts looked at in order to get stock buy recommendations
– managers began to engage in “financial” engineering
– top managers controlled firms, made investments, engaged in mergers and acquisition and formulated corporate strategy ?investors and their representatives on boards of directors listened to managers and felt they were closer to the situation and generally respected their power.
Top manager adopted shareholder value:
– de-diversified their firms by divesting divisions to please stock analysts
– sold off divisions in industries that were not growing
– bought market share in industries that were growing
– laid off workers to save money
– reduced layers of management to save money
– engage in financial engineering of balance sheet by paying attention to equity, debt, and assets
– lobby stock analysts to ask for buy recommendations for stock
– if all else fails, listen to stock analysts to change firm to get buy recommendation.

Shareholder value maximization tactics included
– downsizing
– outsourcing
– destroying unions
– making employees insecure
– reducing health and pension benefits
– employing computer technology to lower costs
– pushing debt onto firms to force them to engage in re-organization
– using financial engineering to raise profits

How did shareholder value change the incomes of CEOs and the income share of the 1%?
– if successful, they were highly rewarded with high pay and stock option.
– Useem shows how dramatically such incentives increased CEO pay during the late 1980s and 1990s.
– managers will focus on interest of shareholders if they are themselves shareholders ? to do this, the most common tactic is to give managers stock directly or stock options as part of their pay ? the stock options allow managers to buy stock at a lower price when the stock hits a higher price allowing them to pocket the difference ? this encourages them to maximize shareholder value.
– 80~90% of CEO compensation comes in the form of stock and stock options
– When companies are not doing well, CEOs can get higher pay.. How? CEOs are rewarded for share price increases and profit increases, not total employment, sales, or market share.

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