From Managers to Markets: Valuation and the Shareholder Wealth Paradigm

Abstract

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, investors believed that companies with strong management teams would develop efficient internal capital markets that generated predictable earnings over time. Participants in external capital markets became more confident in forecasting earnings for companies with superior management. As investors focused on projecting the future performance of corporations, it became important for managers to verify 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.

Understanding the role of valuation in shaping the incentives of the public corporation provides a new lens for understanding corporate purpose. 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 new managerialism where managers of some companies can make meaningful commitments to consider stakeholder interests.

Keywords: Corporate Purpose, Corporate Governance, Shareholder Wealth Maximization, Managerialism, Corporate Law, Securities Regulation