Here’s What’s Missing From the Shareholder Primacy Debate

Critics Err When They Ignore Basic Risk/Reward Economics

Nov 02, 2018
Finance

SMITH BRAIN TRUST – Recent op-eds in Fortune, Financial Times and Stanford Social Innovation Review all come down hard on shareholder primacy — the idea of putting investors first above all other stakeholders.

Finance professor Michael Faulkender, associate dean of master’s programs at the University of Maryland’s Robert H. Smith School of Business, acknowledges that companies stumble when they overlook the interests of customers, employees, suppliers, communities and the environment. But critics of shareholder primacy err, he says, when they ignore basic risk/reward economics.

“The shareholders are the ones taking the risk,” he says. “If the product fails, the employee still gets paid. The supplier gets paid. The customer chooses whether or not to buy the product. The other stakeholders aren’t bearing the residual risk. It is the shareholders that are.”

The Redeeming Qualities of Shareholder Primacy: Finance professor Michael Faulkender at the University of Maryland's Robert H. Smith School of Business explains the rationale for putting shareholder interests first.

Oftentimes, investors provide money up front before any product or service exists. They must fund the building of infrastructure, the research and development of a product, the hiring and training of employees and the purchase of raw materials without guarantee of profit. “If it is the shareholders who are going to take the losses when the product fails, it’s the shareholders who should receive the residual benefits when the product succeeds,” Faulkender says.

That doesn’t mean companies should exploit other stakeholders. “Those other stakeholders have to be compensated such that they are willing to participate,” Faulkender says. “But what it means is that once you have sufficiently encouraged them to participate, any leftovers belong to the shareholders.”

Faulkender, nominated in 2018 as assistant secretary of the U.S. Treasury for economic policy, explains the rationale for putting shareholder interests first in a Maryland Smith video, The Redeeming Qualities of Shareholder Primacy (2:18)...

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About the Expert(s)

Michael Faulkender's research focuses on empirical corporate finance in the areas of capital structure, risk management, corporate liquidity, and executive compensation. His work has been published in the Journal of Finance, Journal of Financial Economics, and Review of Financial Studies and has been cited in the Wall Street Journal, Washington Post, and The New York Times. He was awarded the Barclay's Global Investors / Michael Brennan Best Paper Award in the Review of Financial Studies in 2013, was runner up for that prize in 2006, and won the Jensen Prize for Corporate Finance – Second Prize in the Journal of Financial Economics in 2013.

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