Do Scholars Have a Duty to Maximise Shareholder Value? *

If Lucian Bebchuk still thinks he's "mainly a kind of ivory tower academic", his record as a shareholder activist is up for a long fight.

Considered one of America's leading scholars in law and economics, the director of Harvard's Program on Corporate Governance has a reputation for aggressively championing the cause of big companies with big share portfolios and their attacks on public companies.

He might insist he's living a life of the mind, but the Professor can't run away from the pin striped shadow cast by his many papers - "The Case for Increasing Shareholder Power". "The Costs of Entrenched Boards", "The Myth of the Shareholder Franchise", "The Myth that Insulating Boards Serves Long-Term Value", "The Long-Term Effects of Hedge Fund Activism" "Toward a Constitutional Review of the Poison Pill".   You don't have to share the Professor's obvious intellect to appreciate his radical corporate governance agenda.

To a critical eye, the goal of Bebchuk's econometric research seems more about business than scholarship.   Delivering the good news to Bill Ackman, Carl Icahn and their fellow hedge fund managers.  First, that they're the good guys and second, the "proof" needed to convince institutional investors and policy makers to dismantle the corporate defenses that stand in the way of the activists' latest business strategy.

The Professor even invited his students to join him in the pursuit of greater shareholder power.

The Shareholder Rights Project was established by the Harvard Law School Program on Institutional Investors to "contribute to education, discourse, and research related to efforts by institutional investors to improve corporate governance arrangements at publicly traded firms."  Omitted from the project's benign mission was "to change real world election policies to reflect their professor's research and their client's commercial objectives".

In 2014, the Shareholder Rights Project at Harvard boasted that more than 60% of companies that received their proposal had agreed to move to annual elections.  Opening the door to investor business strategies is harder to execute when directors have staggered tenure.

Unexpectedly for a project sponsored by a lauded professor and an elite university, the Shareholder Rights Project actively prosecuted the investor's agenda despite a substantial body of academic research which was contradictory to their claims in support of annual elections: an omission that now has an SEC Commissioner and a Stanford law professor publicly questioning whether Harvard violated US Federal Securities Law by not disclosing the full body of evidence.

But, that's the side issue.

The much bigger question is why the world's most famous university appears to be pushing the interests of big investors on to its students, regulators and public companies

This is the fifth in a series dedicated to the 6th Global Peter Drucker Forum that examines the twelve ways shareholder value is marketed as the goal of public companies.   It briefly looks at the relationship between university research and shareholder primacy and questions the conflict raised when scholars get involved in maximizing shareholder value.

The Ivory Tower on Wall Street

The Ivory Tower moved into Wall Street forty years ago and the neighborhood has never really looked back.

The head of the Chicago School of Economics arrived with an unlikely promise - liberation from the tyranny of the free market.  For centuries, companies relied on their value proposition to assure their success.   In the free market, no company had a duty or responsibility to assure the profitability of another.  This was the moral framework that greetedAlexis de Tocqueville when he arrived in America 1831.

Milton Friedman undermined the foundations of capitalism with his remarkable academic discovery -  the duty to maximize shareholder value.  In the future directors and managers would willingly yield their firm's interests to Wall Street based not on self interest rightly understood, but out an invented moral obligation.

Friedman’s crime was to steal the jewel of capitalism - the virtue ethics of self interest rightly understood - and replace it with the de-ontological ethics and duty regardless of the cost to people or the planet.

Even better news for investors came in 1976.   Rochester finance professors Michael Jensen and William Meckling published the "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure".    Relying on the same now-discredited assumptions as Milton Friedman had 6 years earlier, their paper set out a practical guide to increasing shareholder wealth by paying managers in securities. Economists think themselves above the precautionary principle.

Companies like IBM turned Jensen and Meckling's math into their mantra.   James Montier writes "IBM's mission statement was outlined by Tony Watson (the son of the founder) and was based on three principles...1) respect for individual employees, 2) a commitment to customer service and 3) achieving excellence".  By the early 1990's not only had IBM had been transformed to fit its new-found function as the creator of shareholder value but so too had business schools

Though executives are portrayed as the beneficiaries of this intellectual revolution, with Bebchuk himself leading the attack on executive remuneration, the real winner has been the investment industry and the industrial complex it spawned.

At the time Jensen and Meckling's findings were first published, US Corporate equities - as a percentage of US GDP - was around 32% - it's now over a 120%.  Their research had managed to do for the investment industry what performance enhancing drugs had done for the 1976 Olympics.        

How could share based business models not rise to the dais of capitalism when producing leaders perfectly sympathetic to the needs of Wall Street became the principal goal of the modern business school.  Investors have become the opportunistic beneficiaries of an education system that inexplicably tilts the playing field in their direction.  For more on the relationship between business education and investment business models please read here. 

Even today, Wall Street can still count on having strategic friends in high places.

A decade ago activist hedge funds held around $US12 billion under management.  That figure is now estimated to be over $US200 billion.  Activism has become an asset class in its own right with pension funds piling into activist business models over the targets of their attacks - Apple, Microsoft, Sony, DuPont, and PepsiCo.   

Quick to assist hedge fund activists prove they're running benign businesses worthy of encouragement is a group of academics led once again by Professor Bebchuk.  In the paper titled “The Long-Term Effects of Hedge-Fund Activism”, the Professor and others considered nearly 2,000 activist interventions by activist funds from 1994 to 2007.  They claimed triumphantly that, based on their analysis:

Empirical studies show that attacks on companies by activist hedge funds benefit, and do not have an adverse effect on, the targets over the five-year period following the attack.

Only anecdotal evidence and claimed real-world experience show that attacks on companies by activist hedge funds have an adverse effect on the targets and other companies that adjust management strategy to avoid attacks.

Empirical studies are better than anecdotal evidence and real-world experience.

Therefore, attacks by activist hedge funds should not be restrained but should be encouraged.

This partisan conclusion begs the need for another paper:  What are the long term effects of academic activism on the fortunes of Wall Street?

To rephrase de Tocqueville, the virtue of shareholder activism is incessantly talked about, but its utility is only studied in secret.  It's time we understood and weighed-up the other side of the Ivory Tower's relentless pursuit of the truth about Wall Street. 

The Financial Post reports that activists are the fastest growing in the hedge fund industry.  Another report indicates activist funds have earned an annual return after fees of about 20% on average, compared with 8% for all hedge funds and 13% for the stock market as a whole since 2009.  Not to (re)mention the explosive growth in funds under management.   Then there are the non-financial measures of value such as the radical makeover from "green mailers" to "democratic capitalists".  




Nothing is more dangerous than the shareholders mission statement masquerading as an economic theory.

Peter Drucker said, "the best way to predict the future is to create it".  He was referring to business managers, but he could equally have been referring to his academic colleagues in economics and law.

When Friedman and his fellow economists put shareholders in the center of the corporate universe encircled by all other stakeholders, they crossed the line from disinterested scholars pursuing the truth to the co-creators of that "truth".  It is no accident of nature that scholars profess:  

“Corporations are almost universally conceived as economic entities that strive to maximise value for shareholders”

Bebchuk takes it a step further.   He wants to create the future in the image of his own research.  

Not content to inquire into how managers maximise shareholders' value in line with his predictions,  the impatient professor feels compelled to give activist hedge funds the intellectual ammunition and student army to breach the defenses of their public company prey.       

Bebchuk even demands that his critics yield before his paperwork:

Wachtell should engage with the evidence, not use the “opinions of wise people with considerable experience” to run away from it. To be a constructive contributor to policy debates, Wachtell should stop asserting that the professed beliefs of its partners or clients should serve as the factual premises of policymaking.

Friedrich von Hayek warned us about economists saying things like "Empirical studies are better than anecdotal evidence and real-world experience".  In his 1974 Nobel Memorial Lecture the famous economist and philosopher outlined the danger posed by scientific pretensions in the analysis of social phenomena.  Blaming those who use the "pretense of knowledge” in their research as the reason why “as a profession we have made a mess of things”.

Donald Campbell expressed a similar fear:

"if we present our resulting improved truth-claims as though they were definitive achievements comparable to those in the physical sciences, and thus deserving to override ordinary wisdom when they disagree, we can be socially destructive.”

A concern that grows more ominous when the line between activism and scholarship appears forgotten.   Lost in the pursuit of a truth that does not serve those to whom the scholar owes their duty.   


If the conclusion were not absurd, I'd think that Milton Friedman and all those who have stood on his shoulders had lost their minds and were under the mistaken impression that they too were under a duty to maximize shareholder value.

The scholar's duty lies elsewhere.

In 1837 Ralph Waldo Emerson delivered to Harvard's Phi Beta Kappa Society what is now referred to as "The American Scholar" speech.  Considered by Oliver Wendell Holmes, Sr. to be America's "Intellectual Declaration of Independence", the speech sets out the obligations that come with scholarship.

Howard Mumford Jones recounts the duty - "The Scholar, said Emerson, is Man Thinking; and the principal instruments of his education are three - nature, books and action.  From nature rightly understood, he will learn that the laws of the universe are also the laws of the human mind.  The office of books is not to create book-worms but independent souls.  The life of action is not to be swallowed up in business, but to translate intellect into character.  And the final object of education is that the soul may be weaned from a passive clinging to what has been said and done in the world and prefer a vigorous intellectual independence".

Two hundred years on and the focus is back on Harvard and its Shareholder Rights Project and I ask what has become of the scholar's duty and the declaration of intellectual independence?

Witness as senior corporate and securities law professors from seventeen leading law schools at Boston University, Chicago, Columbia, Cornell, Duke, George Washington, Georgetown, Harvard, Michigan, New York University, Northwestern, Stanford, Texas, UCLA, Vanderbilt, Virginia and Yale defend students who tell half-truths and seek to silence those who pursue the truth:

We are thirty-four senior professors from seventeen leading law schools whose teaching and research focus on corporate and securities law. We write to respectfully urge SEC Commissioner Daniel M. Gallagher, and his co-author Professor Joseph Grundfest, to withdraw the allegations, issued in a paper released last month (described on the Forum here), that Harvard and the Shareholder Rights Project (SRP), a clinic at its law school, violated the securities laws by assisting institutional investors in submitting shareholder proposals to declassify corporate boards.

How do we reconcile the goal of the American Scholar with these 34 self-appointed arbiters of merit who invite comparison to a psychological phenomena?

In the last in this series, I asked whether corporate governance was groupthink masquerading as a paradigm

First described by social psychologist Irving Janis in 1972, groupthink is characterized by a group that sets itself above the law and will try to protect itself at all costs.  Typically associated with what goes on in the boardroom, the telltale signs of groupthink also exist in the way people think about the boardroom and its role in assuring a return to investors.

The seventh sign of groupthink is that members are under pressure not to express arguments against any of the group’s views.   Social pressure is applied to members who stand up and question the group’s judgement.  The eighth and last sign of groupthink is the emergence of self-appointed “mindguards”.  Individual members are said to take it upon themselves to protect the group and the leader from information that is problematic to the group’s decisions, cohesiveness and/or views.

Do those, like Yale Professor Jonathan Macey, who led the assault on the Gallagher-Grundfest paper, not see the problem?  By defending shareholders from managers and attacking those who stand in their way, like Lynn Stout and now the Commissioner and his co-author, he is choosing to side with one industry over the rest of the economy.  

Remembering the Scholar's Spirit

In this centenary year of the 1915 Declaration of Principles being published by the American Association of University Professors, both the duty and the accountability of the scholar are at risk of becoming a myth:

Since there are no rights without corresponding duties, the considerations heretofore set down with respect to the freedom of the academic teacher entail certain correlative obligations..... The liberty of the scholar within the university to set forth his conclusions, be they what they may, is conditioned by their being conclusions gained by a scholar's method and held in a scholar's spirit; that is to say, they must be the fruits of competent and patient and sincere inquiry, and they should be set forth with dignity, courtesy, and temperateness of language. The university teacher, in giving instructions upon controversial matters, while he is under no obligation to hide his own opinion under a mountain of equivocal verbiage, should, if he is fit in dealing with such subjects, set forth justly, without suppression or innuendo, the divergent opinions of other investigators; he should cause his students to become familiar with the best published expressions of the great historic types of doctrine upon the questions at issue; and he should, above all, remember that his business is not to provide his students with ready-made conclusions, but to train them to think for themselves, and to provide them access to those materials which they need if they are to think intelligently.

The AAUP's 1915 Principles go on to describe to whom the duty is owed.   The drafters were unequivocal.  The scholar's duty then, as it remains now, is owed to the community at large:

The responsibility of the university teacher is primarily to the public itself, and to the judgment of his own profession; and while, with respect to certain external conditions of his vocation, he accepts a responsibility to the authorities of the institution in which he serves, in the essentials of his professional activity his duty is to the wider public to which the institution itself is morally amenable.

A message that is repeated on the AAUP's website today - "The university is a public good, not a private profit-making institution, and corporations or business interests should not dictate teaching or research agendas".

Reading these principles and reflecting on much of the state of corporate governance research it is clear that scholarship takes more than just rigorous empirical inquiry.   Evidence that activist hedge fund attacks benefit the investing classes does not clear the bar set a century ago.  Neither does taunting those who express divergent opinions.

The integrity of truth in every field of university research, including corporate governance, depends on the allegiance of the professor to the public as a whole and their accountability to their duties.   Namely, the scholar's rigorous method and, what sadly seems to have been forgotten in the pursuit of shareholder value, the scholar's spirit.  




* A work in progress         

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