Why only for the shareholders? A guide to avoiding bubbles.

If you ask any business professor, or read any book on business to find the purpose of a company, you will invariably get the answer ‘to provide a return to the shareholders’.  When I did my MBA this principle was constantly reinforced, the prime goal of a manager is to provide a shareholder return.  The reasons for this are understandable to a point.  The typical business is quite complex and the different facets that make up success are impossible to control or even measure accurately.  Using a proxy measurement like monetary return gives a method to at least approximate the quality of management.

For better or worse we have moved away from profit as a measure of shareholder return though, with share value becoming the way most people gauge corporate success.  This method develops into an even baser representation of value when it is applied over a short time frame of quarters, weeks or even days.  Management and executive reward then gets tied to these poor approximations of performance and we then wonder why some businesses make stupid, uncaring or even criminal decisions.  In the end the share price is a function of both the real value of the company and the perceived value.  As such, even if you believe that shareholder return is the best measure of company success, share price is a poor indicator to use.  We need to get some sanity back into the process.

A company has 4 key stake holders; the shareholders, the employees, the community (customers) and the environment.  To be truly successful, a company must ensure that each of these groups are better off, and this can only be measured over the long term.  This makes more sense if we look at the real reason companies exist.  If we were living in the stone age we would be in a loose family group.  Every thing that contributed to a families health, wellbeing and comfort would be produced by that groups direct effort.  As humans developed they started to learn new skills that made things easier like cultivating crops; developed tools to make tasks easier and made discoveries like fire and building techniques to make life more comfortable.

The number of tasks became too large for one person, or even one family group to master and trade developed so gaps could be filled.  This led to specialisation and commerce.  Eventually certain objectives came about that were too complex for a single specialist to do themselves, they required multiple people with different skills to be completed.  This required organisation.  These tasks could also take some time to complete, so they would need money to finance the task before a finished object could be sold.  This all led to the companies we see today.  This history allows us to have a better perspective and hence a better definition of what a companies purpose is.

A companies purpose is to serve the community by organising the labour of its members so they can perform tasks they are competent in, allowing them to trade that labour for the goods and services they need and want.  To do this it must provide goods that are of value to the community (either directly or indirectly) using the resources available to them (labour, capital and environmental) in the most efficient way possible.  The success of this can be measured by comparative levels of price, profit and pollution.

This is not a plea to abandon our current method of company valuation, there is no such thing as a perfect performance measure and I cannot suggest a better one.  My purpose here is to discuss the hidden complexity of company performance where all of the stake holders interests need to be in balance.

• Ignore your customers and they will ignore you.  You might have a huge company valuation, but if your customers go you will be worthless (take note Mr Zuckerberg)


• If you manage your staff you will get a better and more reliable output.


• While environmental effects are harder to take into account, if you ignore them eventually your customers will do it for you, either directly or through their government.

If you are a manager remembering the real complexity of a businesses purpose will help you make better and longer term decisions.  If you are in investor knowing this will help you better judge the potential success of a company.  Companies that balance their 4 stake holders may not deliver the spectacular short term returns, but they will almost always deliver a better return over the longer term.

And for goodness sake, please realise that share price is not a good measure of company value.  If you want to gauge the true shareholder value created, it is the profit compared to the resources it uses.  You can and should get more complex than that but you will often be in a better position than using the share price, particularly if the company has a lot of hype around it.