ABSTRACT. Shareholder value orientation has beenintroduced as a means to improve the performanceof the corporation. The paper investigates the theo-retical justification for the claim that increasing share-holder value is the purpose of corporate governance.It demonstrates that shareholder value is the controlprinciple, not the purpose of the firm. The idea thatshareholder value is the only goal of the corporationis a mistaken transfer from the financial to the indus-trial firm. The paper also questions that the mergerof manager interests and owner interests introducedby the remuneration of managers by stock optionsimproves the management performance. The self-apportioning of stock options by the management isin danger of becoming a form of insider trading.

KEY WORDS: corporate governance, holding struc-ture, shareholder value, stock options

Globalization increases the chances to realize ahigher shareholder value in financial investmentssince the investment opportunities increase in aglobalized market. The owner of capital is con-fronted with more opportunities to invest hercapital and undergoes higher opportunity costs ifthe capital is not properly invested. These devel-opments move the criterion of maximizing share-holder value to the centre of the debate. Theorientation on shareholder value is a means toincrease the allocation efficiency of investmentsin the world market, an effect that should be

welcomed. The shareholder value principle isalso an instrument to prevent the shirking ofmanagers and the shirking of whole firms.Managers and firms might have developed slackwhich can be reduced by a stronger emphasis onthe residual profit and the increase of shareholdervalue.

I. Shareholder value as a means of controlling the firm

The profit of the firm is the means to preventshirking in the operations of all members of afirm. In Alchian’s and Demsetz’s theory,1 theowner functions as the one who prevents theshirking of the firm’s members, and the firm’sprofit is the means to prevent the owner fromshirking in his duty to prevent the shirking of theother members of the firm. The idea is that ifthe owner does not fulfill her monitoringfunction the residual profit will decrease, and shewill be punished by decreased profits or evenlosses and thereby be kept to her function toprevent shirking in her firm.

The shareholder value principle with itsemphasis on future cash flows changes the per-spective on profit as residual profit. Profit is notmeasured any more as a figure of the past but asan

expected future residual. The firm mustmaximize the future profit measured in dividendsand the increase of the value of shares in thestock exchange. The management has to see thatthe future residual profit after reduction of allcosts is maximized. This orientation on a futureresidual profit with all the problems of forecastinga future return on investment does not changethe basic nature of profit.

The Limits of Shareholder Value Peter Koslowski

Journal of Business Ethics 27: 137–148, 2000.© 2000 Kluwer Academic Publishers. Printed in the Netherlands.

Peter Koslowski is director of the Center for EthicalEconomy and Business Culture, the Hannover Instituteof Philosophical Research, Hannover, Germany. Hisbook Principles of Ethical Economy (in German) of1988 has been translated into Chinese, French, andRussian, and will be published in English this year byKluwer.

Profit and shareholder value, seen from thepoint of the firm, are not the final purpose ofthe firm, but an instrumental end. Profit andshareholder value are the means to preventshirking and to make sure that all members ofthe firm deliver their contractual contributionsto the firm in an optimal way as agreed upon inthe contract.

Among all the members of the different groupsof the firm, it is true only for the group of theshareholders that the profit and the value of theshares are also their individual goal. For all theother groups this goal is only interesting as ameans to secure the success of the firm as awhole, not as a final end that they could maketheir own purpose.

This implies that the shareholder value can beconsidered to be the purpose of the firm onlyin a very mediated way. It is first of all thepurpose of one group of the firm, the share-holders, and its prominence amongst the goals ofthe other groups of the firm is only justified byits function of preventing the shirking of theowners who in turn prevent the shirking of allother members of the firm. From the point ofview of all other members of the firm share-holder value, however, cannot be considered tobe the purpose of the firm. It is only one crite-rion of the firm’s success. As the future residualit can be considered to be a control variable forthe other goals and purposes of the firm and forits success. The fact that shareholder value is aresidual and remains so even if it is projected intothe future cannot mean that it is the first prin-ciple or the first purpose of the firm. A residualcontrol principle remains what it is: a controlprinciple, and not the final end of an organiza-tion.

II. The purpose of the firm

The debate on shareholder value belongs to thediscussion of the purposes or goals of the firmin the theory of business administration. Whatis interesting of the partly scholastic distinctionsof the many goals of a firm for the problem ofshareholder value is that the idea that the firm bea one-purpose-institution is untenable. Every

firm has many purposes. The various groups ofa firm have their own purposes which they tryto realize in the firm. Labour expects high wagesfrom the firm, customers expect optimal goodsfrom the firm, shareholders expect maximumreturns on their investment, the communityexpects high taxes and public benefit paymentsfrom the firm and so on. Some of these goalsare conflicting, like the goal of maximum wagesand maximum profits; some are complementary.

If one wants to distinguish one of thesepurposes as the first purpose or final teleologyof the firm, it is clear that the goal of none ofthe particular groups constituting the firm can bethe only purpose of the firm since the othergroups also have the right to the pursuit of theirpurpose in the firm. If there is one majorpurpose of the firm, it must be a purpose thatcould be consented to by all groups of the firm.This means that it must be useful to all membersof the firm and to the public. Since all membersof the firm and all members of society are con-sumers in some way, either in the direct way ofbeing consumers of the product of the firm inquestion or by being consumer of the goods forwhich the product of the firm is an imput, onemust conclude that the most general purpose ofthe firm is to provide for consumers’ satisfactionby its products.

All members of the firm are consumers andtherefore interested in the maximum productivityof the firm leading to the optimal products of thefirm. Not all members of the firm are, however,shareholders. The shareholders’ purpose can,therefore, not be the purpose of all the firmmembers. It can be deduced from this that thepurpose of the firm is the production of optimalproducts or of optimal inputs for other productsunder the constraints that the goals of the majorgroups in the firm or touched by the firm’soperation are taken care of, i.e. under the con-dition that the goals of paying adequate wages,adequate dividends, and adequate prices to thesuppliers are fulfilled.

The necessary condition for the existence ofthe firm and the main purpose for which firmscome into being is the production of products,not the production of profits or shareholdervalues. This main purpose of the firm may only

138 Peter Koslowski

be realized if sufficient returns on investment areearned, and in this sense, the realization of share-holder value is a condition for the realization ofthe main purpose of the firm, it is however notthe first condition. The main purpose of thefirm, the production of best products, impliesthat the firm must be productive and efficient.How this productivity and efficiency is reachedis a secondary question. Since it is the purposeand task of the business firm to provide thepublic with the best products produced at thelowest opportunity cost, also those conditions areobligatory that best secure the realization ofthis purpose of the firm. The means of securingthe purpose of the firm are, however, not theprimary purpose of the firm. If the purpose ofthe firm, the production of optimal products, canbest be achieved by market efficiency and share-holder value maximization, they are the bestmeans to achieve this goal. If it can be achievedby other means or be achieved by other meanseven better, these means must be chosen.Productivity is an obligation of the firm inde-pendent of market efficiency.2

It is an old principle of the Aristotelian naturallaw tradition, also dominant in Catholic socialthought, that the obligation arises from thenature of the matter: obligatio oritur a natura rei.3

This principle is also central in Radbruch’sphilosophy of law. The idea of law and of legalobligation is derived, according to Radbruch,from

– the purpose of the institutional realm a lawis to rule,

– the principle of equal right, and– the principle of legal security or secure

expectations as to the content and theenforcement of the law.4

Applied to the theory of the firm, the prin-ciple that the obligation is derived from thenature and purpose of the matter or institutionin question requires that the main ethical andlegal obligation of the firm must be deducedfrom its first purpose, and not from the condi-tions which secure the realization of its purpose.This first purpose of the firm is, however, notthe maximization of the residual profit and of theshare value in the stock market but the produc-

tion of optimal products under the condition ofthe realization of the secondary goals of itsmember groups or stakeholders.

It is the virtue of the stakeholder approach thatit brings back to the theory of the firm the ideathat the firm is a multi-purpose-organization andnot a single-purpose-organization institutional-ized only for the purpose of the shareholders’wealth as it is assumed in the financial theory ofthe firm. The stakeholder approach, however,cannot give an integration of the several goalsof the stakeholders but leaves them to be onequal level. The principle of the integration ofthe different stakeholders’ goals with the over-riding productivity goal of the firm is notdeveloped in the stakeholder theory introducedby R. E. Freeman.5

The stakeholders’ goals are subordinate to thetotal purpose of the firm which implies that theirclaims to the total income of the firm are notonly limited by the strategic power they can exertin the firm in the contest with the claims ofthe other stakeholder groups, but that they arelimited by the claims the firm as such and itspersistence in time as an institution have on allits member groups. The continuing productionof first class goods is the disciplining force in thestrategic negotiations between the different stake-holder groups beside the disciplining force of theresidual or of the principle of shareholder valuemaximization. Productivity as an obligation andas the purpose of the firm defines the main goalof the firm and renders the other goals to be sub-ordinate purposes. It also renders the shareholdervalue maximization to be only one goal amongstothers and a goal that is subordinate to the pro-ductivity goal although it might, as the residual,exert dominance amongst the several goals of thestakeholders. The stakeholders’ stakes are rankedin the firm’s hierarchy of goals below the pro-ductivity goal. The purpose of the firm is theproduction of its product or products, the ren-dering of its specific service to the market andpublic.

The Limits of Shareholder Value 139

III. Shareholder value as the product andmain purpose of firms: the financialinstitutions

There is one group of firms in which the pro-duction goal of the firm coincides with the goalof maximizing shareholder value, the financialinstitutions in which the firm’s product is themaximization of shareholder value, however themaximization of its customers’ shareholder value.In the financial institutions, like investmentbanks, investment funds, life insurance com-panies, and pension funds, shareholder value isnot only the residual measuring the performanceof the firm but the very product for which thesefirms have come into existence. These institu-tions have come into being to render to theircustomers the product or service of securing themaximum return on their investment, themaximum shareholder value for them. In thefinancial institutions, shareholder value is themain purpose of the firm, and the performanceof the firm can be measured by its performancein maximizing its clients’ shareholder value.

A person that gives her savings to an invest-ment fund purchases from this firm the productof maximizing her shareholder value. The invest-ment fund in turn maximizes its purpose andoptimally fulfills its obligation if it maximizesthe customers’ shareholder value – but not itsown shareholders’ shareholder value. In thefinancial institutions and financial servicesindustry the shareholder value is not only theresidual condition for the optimal working ofthe firm but the very product of the firm andtherefore gains a particular importance unlike inother firms.

IV. Spill-over effects from the financialinstitutions to the industrial firm:predominance of the shareholdervalue orientation and the holdingstructure

The Western economies are presently character-ized by a transfer from the institutional condi-tions of the financial institutions to industrialinstitutions which, in turn, renders shareholder

value to be the only purpose of the firm. Sincein the financial institutions the costumers’ share-holder value is the product these institutionssell, shareholder value is the central and pivotalcriterion for their business operations and businesssuccess. In the financial institutions, shareholdervalue is the purpose and the criterion or instru-mental control variable of this industry.

The special conditions of the financial servicesindustries have been transferred to all the indus-trial firms assuming that in them also shareholdervalue is not only the control variable but also themain purpose of the firm’s operations. This spill-over from the financial firms to the industrialfirms has caused an inversion of the shareholdervalue principle from being the control principleto being the purpose of the firm. Since in thefinancial institutions the control principle is atthe same time the purpose of the institution –although in the first case it is defined as the share-holder value of the firm’s owners whereas in thesecond case it is defined as the shareholder valueof the firm’s customers – one has been temptedto think that the unity of the shareholder valueprinciple as the control principle and as thepurpose of the firm applies also to the industrialinstitutions.

In the radical version of the shareholder valueapproach as defended by Jensen and Meckling6

and others the inversion of the firm’s purpose andof the firm’s control principle takes place. Theradical shareholder value approach takes theresidual and the book-keeping of the firm’ssuccess for the firm’s final purpose. The share-holder value realized is the book-keeping for thefirm’s success but it is not its final purpose.

The spill-over from the financial institutionsto the industrial firms is particularly visible in thecareer of the holding firm, a trend which, inter-estingly enough, has been reversed recently inspite of the dominance of the shareholder valueprinciple.

In the transformation of the industrial firminto a conglomerate and a holding firm whichonly serves as the monitoring for the firms’investment funds in its different divisions, thefirm’s headquarters is considered to be the finan-cial service institution for itself that ensures thatall its divisions yield the maximum shareholder

140 Peter Koslowski

value for the holding. The holding’s head-quarters does not give for that purpose muchconsideration to the material purpose andproduct of the divisions themselves.

For the holding firm, the shareholder value hasbecome the purpose and the product of the firmjust like for an investment fund maximizingshareholder value is its original business andproduct. For the holding firm, the products ofthe divisions have become only a means tosecure the shareholder value of the holding head-quarters.

The holding firm is a particularly goodexample the inversion of means and ends. Itimplies that the end of the firm, the product ofthe divisions, becomes a means for the share-holder value of the holding although the share-holder value was originally the means forcontrolling and making sure that the firmproduces good products.

It is revealing that the newest economic devel-opments demonstrate that the holding structureis much less advantageous than it appeared to beseveral years ago. Industrial firms are returningand find it to be most profitable to return to theiroriginal strength and main task, the productionof the products of their core competence. Theyno longer envisage themselves as investmentfunds for their own capital and do not take theirdivisions only to be investment opportunities forthe funds of the holding’s equity.

Understanding shareholder value to be thecontrol principle of the firm makes sure that theholding firm considers shareholder value not tobe its main purpose and, thereby, fails to secureits optimal performance. Rather, understandingthe shareholder value principle rightly as acontrol principle grants that the firm realizes theoptimality of its product and, by it, the optimalityof its financial performance. The large corpora-tion can only maximize its shareholder value ifit considers shareholder value not to be thepurpose but only the control principle of itsoperations.

It seems to be the virtue of the shareholdervalue principle as a control principle that it isself-fulfilling and self-enforcing inasmuch as itmakes sure that it does not become the mainpurpose of the firm, since it does not realize the

maximum shareholder value if it is taken for thepurpose of the firm. There is no built-intendency in the shareholder value principle tocause by itself the inversion of means and endsand to turn itself from the means of the firm toits end or purpose.

V. Effects of the inversion of the meansand ends of the firm on corporategovernance: speculation instead ofproduction

The inversion of the purpose of the firm fromthe product being the first purpose to maxi-mizing shareholder value being the first purposeturns the management’s production task into aspeculation task, as the example of the holdingfirm demonstrates. The idea that, by the invis-ible hand of the labor market and by the con-tracts of the firm, the overall orientation onshareholder value necessarily also realizes thecommon good of the firm does not hold. It istrue that the industrial firm can only maximizeshareholder value if it produces some usefulgoods and keeps the implicit contracts withits employees and customers in some way. Itrealizes this common good of the firm, however,only “somehow” and “on the back” of theshareholder value maximization since the newoverall purpose of the firm, i.e. maximizingshareholder value, is increasingly realized bymere speculation.

Since the price of shares in the stock marketdoes not just reflect the real value of the firm’sproductivity and performance but is also subjectto mere speculation, the management has aninterest in becoming involved in speculativemanipulations of the value of the firm’s sharesand therefore of its shareholder value. This dis-traction of the management’s attention and inten-tion from the main purpose of the firm, itsproduct or products, to the secondary goal of thefirm, maximizing shareholder value, results intwo detrimental effects:

First it creates perverse incentives for the man-agement to take more interest in speculation thanin production or at least to become interested toomuch in speculation instead of concentrating on

The Limits of Shareholder Value 141

production. It results secondly in a certain short-termism in managing the firm, in looking atthe shareholder value and returns on investmentfor every quarterly report. The “terror of thequarterly report” is increased.

Incentives are central for any economic order,and it is one of the main arguments for the share-holder value principle that it creates efficientincentives for the management to maximize theoverall value of the firm. Incentives can howeveralso create perverse incentives, can distract theintention to activities that are not in the interestof the firm. If shareholder value becomes theoverall purpose of the firm, the managers havestrong incentives to invest their attention andtheir time in finding ways and means to manip-ulate the price of shares in the stock market andin means that are not in the interest of thosemembers of the firm that are not shareholders.The possible perverse incentives the shareholdervalue principle exerts on the management, if itis considered to be the only purpose of the firm,are considerable. They direct the resources of themanagement to unproductive instead of produc-tive action.

The second effect, the short-termism of anexaggerated attention to the short-term shareprice in the stock market, is also not in the long-run interest of the firm if profitable long-runstrategies are hindered by it. It is important tonote, however, that short-termism is not by itselfan economically and ethically negative phenom-enon. It might be necessary and ethically legiti-mate to liquidate an investment after a very shorttime if one has found out that it was the wrongdecision or subjected to sudden adverse devel-opments.7 The time structure of the manage-ment’s decision-making and of that of theshareholders can, however, be shortened undulyby the shareholder value maximization.

The inversion of the principle of shareholdervalue maximization from a control principle tothe main purpose of the firm treats the membersof the organization of the firm as means for theend of maximizing shareholder value. This usingthe members of the organization as a means foran end is not objectionable in itself. The Kantianformulation of the categorical imperative is thatone should act in such a way that one never treats

the other as a means only, not that one shouldnever use another person as a means for a legit-imate purpose. The firm that makes shareholdervalue maximization its first purpose may not treatits members as means only for this purpose butit will be in danger of doing so and it will giveits members the impression that they are meansfor this end only and not also ends in themselvesfor the firm.

The stakeholder principle, in turn, makes surethat all stakeholders and member groups of thefirm will have their interest respected but itdoes not provide the firm with a principle ofranking the stakes of the stakeholders in thenegotiation process of the firm. In the end, thestakeholder approach leaves the stakeholders withan open battle for power and rewards in thefirm. Whereas the shareholder approach seems toacknowledge only one interest of one stakeholdergroup, the shareholders, the stakeholder approachacknowledges the many interests but it gives noprinciple of justice for the process of mediationbetween the interests. It remains a principle ofstrategic bargaining.

This becomes evident from the fact that inthe bargaining process the different stakeholdergroups must refer in the justification of theirclaims to the firm to a principle of justice. Theprinciple of justice in the economy and the firmis that the payments and rewards for servicesrendered should be determined according to thevalue of the contribution rendered to the purposeof the organization or firm.8 This is the contentof Thomas Aquinas’ principle: Suum cuiquetribuere, give to each what is owed to him or her.Everyone should receive what she contributes tothe common purpose of the organization. Thisprinciple was also the deeper justification of thetheory of income in the theory of marginal pro-ductivity. Its normative content is that the factorsof production should be compensated accordingto their marginal product.

The principle that all members of the organi-zation should be paid according to their contri-bution to the goal of the firm is different fromthe shareholder value principle which tends toimply that it is the task of the firm to concen-trate, in its consideration of the principle thatpersons should be rewarded according to their

142 Peter Koslowski

contributions, on the return payments to share-holders only.

The idea that the residual profit belongsonly to the entrepreneur and/or the capitalowner has been questioned on the ground thatthe dispositive factor may not be the only oneresponsible for the dispositive success of the firmsince there might also be dispositive elements inlabour’s contribution to the success of the firm.Since however labour is usually not ready toshare also into the residual loss, the imputationof the residual profit primarily to the owners isjustified.

That the residual profit is imputed to only onegroup makes it necessary to strive for a strongerparticipation of the workers in the formation ofcapital and therefore in their sharing in theresidual profit and shareholder value. The call formore workers’ participation in the ownership ofthe means of production is a corollary of the newemphasis on shareholder value maximization. Ifthe shareholder value moves to the centre of thegoals of the firm, it should also be the case thatlabour as owner of shares has a higher share inthe shareholder value created by the firm.

There is a sequence of disciplining principlesin the firm and a sequence of controls that stepin when one of them fails: The shareholdersprevent the firm members’ shirking; the stake-holders discipline the shareholders and theirclaim to returns on capital and prevent themfrom believing that their goal is the only goal ofthe firm; the purpose of the firm, the product,and the principle of justice that any member ofthe firm should be compensated according to thisperson’s contribution to the firm discipline thestakeholders. The shareholder value principle andthe shareholders discipline the firm; the stake-holder value principle and the stakeholders dis-cipline and limit the shareholders; the purpose ofthe firm disciplines and limits both, the share-holders and the stakeholders.

VI. The emphasis on shareholder valueand the managers’ interests: mergerbetween shareholder and managerinterests?

The shareholder value principle cannot be inter-preted only as an increased control on the per-formance of the managers. Rather the firm’soveremphasis on shareholder value may also leadto a strategic alliance between shareholders andmanagers against the other stakeholders. If theshareholders and the managers form one stake-holder group with shared interests, the managersare tempted to decide in their own and theirshareholders’ interest to realize a higher sharevalue at the cost of the firm and of the otherstakeholders.

The development of income of the managersof the British state owned companies that havebeen privatized and turnt into joint-stock com-panies is an indicator for this process. The moststriking effect of the privatization of these firmshas been the multiplication of the managers’income.

Shareholder value maximization creates incen-tives for the managers to look more after profitsfrom speculative gains than after profit fromsuperior productivity and products. These incen-tives can become perverse incentives since thevalue of the shares in the stock market is not onlythe result of the management’s or firm’s real per-formance but also of its perceived performance.Its share price is influenced as well by the merespeculation of others in these shares.

The speculative element in the price of sharesand in the shareholder value renders it problem-atic to link the managers’ salary to the develop-ment of the market value of the firm’s shares. Ifthe firm’s shares increase their value and pricedue to mere speculation in the stock market andif the management receives higher additionalincome from stock options and the like, themanagers’ attention is attracted more to themovement of share prices than to the operationsof their firms.

A case study for this problem is the law suitagainst a stock option plan of DaimlerChryslerfor its managers. One of the shareholders of thefirm, Ekkehard Wenger, a professor of business

The Limits of Shareholder Value 143

administration, has brought the law suit againstthe firm that this plan violates the interests of theshareholders. Wenger argues that a conversionof stock options into real DaimlerChrysler sharesafter three years under the condition that theshare price had risen by 15 percent during theperiod of three years is not acceptable since, ata rate of increase of value of 5 percent p.a., thereis no extraordinary performance of the manage-ment if the average rate of increase in the stockmarket is just the same. A special remunerationbeing dependent on the success of the firm couldonly be justified if the rate of increase in theprice of the firm’s share were higher than theaverage rate of increase of share value in the stockmarket.

The court at Stuttgart, Germany, dismissed thisaction with the statement that “judging the man-agerial content of such a stock option scheme isnot the task of the court.”9 Even after this courtdecision, however, the question as to the man-agerial appropriateness of the scheme remainsopen to discussion. Whether an average increaseof the value of a firm’s shares justifies an addi-tional income of its management in stock optionsand whether such schemes may not induce anexaggerated concentration of the managers onthe price of the firm’s shares and thereby createperverse incentives is an open question.

It can even be asked whether the overemphasison share options and the like in the remunera-tions of managers does not include an elementof insider trading. If the management decides onthe firm’s share option plans and is, at the sametime, in control of the firm’s policy – and there-fore also of its share price policy – it first of alldecides itself about its remuneration and secondlyis able to maniplate the share price by its man-agement policy. The CEO of Porsche, WendelinWiedeking, described this kind of share optionplans introduced by the management’s owndecision as a case of insider trading.10 He suggeststhat managers, because of the danger that theyconduct insider trading, should not own anystock of the companies they are employed at.

Another argument against the overemphasis onstock options in the income of managers is thatthe ability of the firm to raise equity in thecapital market is reduced if the possible investors

or shareholders must have the impression thatthe management has already appropriated inadvance the main proportion of the future share-holder value to itself by the stock option plansfavoring the management.

Shareholder value as the control instrumentand disciplining method is particularly importantin making sure that the firm makes profit in everyperiod and in regulating the time structure andtime preference of investment. Rappaport11

demonstrates this effect of the shareholder valueprinciple which might be considered to be themain advantageous effect of the shareholder valueprinciple on the firm’s performance and ondividend policy. The shareholder value criterionforces the firm to make sure in every year thatinvestment in the firm is profitable in every yearwhich implies that a dividend is paid every year.

Rappaport’s argument is that, theoretically, itwould be useful not to pay any dividend at all ifthe returns on capital from the firm in thecoming years are positive and above marketinterest rate. In this case all profits should be keptin the firm since they will render even higherprofits in the future if they are accumulatedwithin the firm and not paid off as dividends.

Against this idea of keeping the profits in thefirm for self-financing and the formation ofequity the argument of the shareholder valuetheory is very simple: If the firm does not paydividend the shareholders leave it. Behind thisapparent unfaithfulness of the shareholders is adeeper wisdom: The shareholders cannot be surethat what the management says about futureprofits and dividends kept within the firm andnot paid off is true. They can secondly not besure about the future since the whole economicsituation might change in the next three yearsand the profits kept in the firm for three yearswill be lost in the fourth year. In this case theshareholder will not gain anything fromwaiting.12

The emphasis of the shareholder valueapproach on shareholder value in every year cor-responds to the shorter time horizon in renderinginvestments profitable in capitalist democraticsocieties. This shorter time horizon seems to bedesirable also from an ethical perspective. It is notobvious at the first glance that it can be efficient

144 Peter Koslowski

to favor the short term although decision makersare usually leaning towards short-termism andeverything that supports long-term investmentseems to have a higher ethical value. It is,nevertheless, reasonable to insist on paying-offinvestment in every period. The example ofundemocratic, non-capitalist societies demon-strates that in these societies the population hasvery often been cheated by justifying presentsacrifices in welfare by promising increasedwealth in the future. Stalin, for example, hadengineers decaptivated that told him that certainprojects of large investment in the North ofRussia or Sibiria would never be profitable. Sincehe disliked this forecast he had its conveyorskilled.

Beyond the cruel demanding and enforcing ofsacrifices for the future by terror, this case isinteresting for the time perspective on invest-ments, for the sacrifices that one is expected tomake for one’s investment and for the ethicalrelevance of this question. In a democraticcapitalist society the population and the investorsexpect a return on their investment within acomparably short time period. An investmentthat cannot secure its profitability in the shortrun will not be made. This recommendation sup-ported by the shareholder value criterion is notonly economically efficient but also ethicallylegitimate for wealthy societies. Whether itholds equally true for developing economies isanother question that cannot be answered here.

The other side effect of this compulsion to paydividend in every year induced by the share-holder value criterion is that the formation of amonopoly or market controlling position in themarket is rendered more difficult. If the share-holders can force the managers to pay dividendsand not to keep profits within the company toform reserves or equity and if the shareholdersuse the profits for consumption and not for rein-vestment in shares in the same company, it willbe more difficult for the firm to grow and todominate and control its market.

VII. Shareholder value as indirect intention

One of the difficulties of the shareholder valueapproach is that it makes profit maximization orshareholder value maximization a goal that isethically not questioned anymore. From thepoint of view of business ethics, however, thepursuit of profit is only legitimate, as is thepursuit of any finite goal, under ethical con-straints and in the order of goals the humanperson adopts for herself. Not every pursuit andformation of profit is accepted by the law as wellas by ethics. Profits from insider trading, e.g., area form of profit formation that might even beefficient from the point of view of allocation inthe economist’s judgement. Profits from insidertrading are, however, prohibited by the law sincethey contradict central principles of law, partic-ularly the principle of equality before the law.There are also other forms of profit and kindsof profit formation that are neither legally norethically acceptable, like all forms of profit thatarise from corruption. It is, therefore, obviousthat shareholder value maximization is illegiti-mate where bribery or other forms of corrup-tion are used to achieve it.

The constraints on kinds of profit maximiza-tion do not only concern the law, although thelegal restrictions are the most essential. Theyconcern also the ethical norms since there arealways lags in the development of the law.Usually ethical norms lead the formation oflegal norms. As an example insider trading inthe stock exchange was declared to be unethicalbefore it had become illegal and sanctioned bypenal law. It was declared unethical by theinformal rules of the ethics of the professions,of the stock market brokers’ and bankers’ pro-fessions.

The discussion about the purpose of the firmand the right relationship of means and ends isa methodological approach typical to the naturalright tradition. The idea that the firm has some-thing like a “natural” purpose and that thispurpose ought not to be made a means foranother end will be subject to criticism fromtheories of subjective value that claim that thehuman is free to set her purposes and that thereis nothing like a natural purpose and, therefore,

The Limits of Shareholder Value 145

also not anything like a “natural” purpose of thefirm.

There is some justification in this argumentinsofar as a person that is not interested in thepurpose of the firm per se, but only interestedin maximizing her shareholder value, might bemore successful and do more good than a personthat is very much striving for the purpose ofthe firm and not interested in profit but in theend does not achieve fulfilling the purpose ofthe firm, producing a good product, and thepurpose of high shareholder value, whereas theother person might have intended to maximizethe shareholder value as her goal only, butrealizes the “social good” of the good productas well.

At this point, two distinctions are useful: thedistinction between individual and social ethicsand the distinction between one-purpose moti-vation and multi-purpose motivation.

Social ethics cannot compel economic agentsto accept its concept of the order of purposes andto make it their own order of purposes but it canshow that for the social institutions and theethical foundations of the institutions it is betterif the right order of goals is followed althoughthe economic agents within these socio-ethicalinstitutions cannot be denied the freedom toreverse their order of goals. The natural righttradition does not force everyone to have thesame order of goals but it can justify and givegood reasons what the right order of purposesshould be and why the institutions should adoptand propagate this order of goals.

The fact that better results are sometimesachieved by bad motives and bad results aresometimes achieved instead of good motives doesnot discredit the nexus between desirable motivesand desirable results. It may be better in singlecases to achieve good results by bad motives thanto achieve bad results by good motives. For thejustification of social norms, motives, and expec-tations of results, for the theory of social ethics,this fact does not change the observation that itis even better to achieve good consequences withgood motives. Although it might sometimes bebetter to realize good results with bad motivesthan bad results with good motives, the best state,seen from the point of view of social ethics, is

still the one in which good results are realized bygood motives.

The idea that the maximum efficiency andcommon good of society is reached if the indi-viduals in the economy follow only their abstractconcept of maximizing their own profit andshareholder value is linked to the Protestant ideaof the incapability of the sinner to do the good.It is thereby also linked to the concept of originalsin. The Protestant idea of social coordination isthat since the human is so much distorted byoriginal sin he or she cannot intend the commongood as such. The common good can, therefore,only be reached by the invisible hand usingthe individuals’ inevitably selfish intentions andneeds for its good. The idea is particularly strongin Lutheran thought where the human is con-sidered to be so fallen that his or her will is aslave’s will, being the slave of the human’s ownselfishness.13 Nothing good can be expected fromthe direct intention of the human will. Societymust be instituted in such a way that it arrangesby its institutions that the common good isintended only as the indirect purpose or doluseventualis or even as an effect not intended at allbut only realized as the side effect in the pursuitof another selfish goal which is all that the fallenhuman is capable of.

If shareholder value maximization is made thefirst purpose of the firm, the firm’s commongood, the good product and the fulfillment of thestakeholders’ stakes in the firm, is made the sideeffect of the direct intention or dolus directus tothe realization of the private good, to shareholdervalue maximization.

In Protestant thinking, this is considered tobe the best solution possible. Catholic socialthought considers this situation to be the secondbest solution, second best even under conditionsof original sin which makes the human selfishand being interested in profit maximization onlyand not in the purpose of the firm itself. Catholicsocial thought considers this situation still to bea second best situation. It is only the second bestsolution since the best solution is possible evenunder conditions of original sin. Although thehuman is affected by original sin and, therefore,selfish and lazy, human action is still capable ofthe direct intention to the good. In contrast to

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the Lutheran concept of original sin which takesthe human to be incapable of doing the goodby intention, the Catholic understanding oforiginal sin holds that the human is able to dothe good intentionally even under conditions oforiginal sin. In the case of the purpose of thefirm, this implies that the human individual isstill able to adopt the purpose of the commongood of this community, the purpose of the firm,in addition to his or her intention to maximizeself-interest or shareholder value.

Catholic thought suggests that the humanperson is a sinner but that this sinner is still ableto do the good although the institutional frame-work, in the case at hand, the firm, must takeinto account the sinful human nature. Sharholdervalue maximization being the second bestsolution implies that the owners of the firm mustpursue the purpose of the firm and their ownpurpose of shareholder value maximization at thesame time and that they should consider the firstpurpose of the firm to be the good it produces.

The distinction between a one-purpose anda multipurpose motivation comes in here.Shareholder value as a control principle of thefirm should not imply that the owner of the firmknows only one purpose, the maximization ofshareholder value, but that he or she pursues thepurpose of the firm and his or her own purposeof shareholder value maximization at the sametime.

The motivational structure of the entrepreneurand manager can be described by the concept ofthe “overdetermination of action”, a concept thatis also close to the understanding of the structureof human motivation in common good thinking.The concept of the overdetermination of action,of the Überdeterminiertheit der Handlung, was orig-inally introduced by Sigmund Freud.14 Freuddeveloped this idea in his interpretation ofdreams: Our dreams are over-determined byseveral motives overlying and overlapping eachother. Not only our dreams but also our actionsand even our economic actions are overdeter-mined by several motives.

The concept of the overdetermination and ofoverlapping determinants of economic action ismore suitable for describing the firm’s and theshareholder’s purpose than the concept of the

inversion of intentions and purposes and ofmaking the purpose of the firm to be only themeans for shareholder value maximization. Goodshareholder value should be the side-effect of agood product and firm, rather than a goodproduct and a good firm being the side-effect ofshareholder value maximization.

Notes

1 A. A. Alchian and H. Demsetz: 1977, ‘Production,Information Costs, and Economic Organization’, inA. A. Alchian, Economic Forces at Work (Liberty Press,Indianapolis), pp. 73–110. 2 This point is also stressed in Lee A. Tavis: ‘TheMoral Issue in Allocating Corporate Resources.Shareholders Versus Stakeholders’, in M. Naughton(ed.), The Nature and Purpose of the Business Organiza-tion within Catholic Social Thought, forthcoming. 3 Luis de Molina: 1602, De iustitia et iure (Madrid).– Cf. P. Koslowski: 1982, 6th ed. 1998, Ethik desKapitalismus (Mohr Siebeck, Tübingen). English trans-lation: 1996, Ethics of Capitalism and Critique ofSociobiology. Two Essays with a Comment by JamesM. Buchanan (Springer, Berlin, New York, Tokyo). 4 Gustav Radbruch: 8th ed. 1973, Rechtsphilosophie(Philosophy of Right) (Koehler, Stuttgart), p. 114. 5 R. E. Freeman: 1984, Strategic Management: AStakeholder Approach (Pitman, Boston), and R. E.Freeman: 1994, ‘The Politics of Stakeholder Theory:Some Future Directions’, Business Ethics Quaterly 4,413ff. – Compare also David W. Lutz: 1998, ‘Kritikdes Shareholder-Ansatzes und des Stakeholder-Ansatzes’ (Critique of the Shareholder Approachand of the Stakeholder Approach), in P. Koslowski(ed.), Shareholder Value und die Kriterien desUnternehmenserfolgs (Shareholder Value and theCriteria of the Success of the Firm) (Physica,Heidelberg), pp. 187–200. 6 M. C. Jensen and W. H. Meckling: 1979, ‘TheTheory of the Firm: Managerial Behavior, AgencyCosts, and Ownership Structure’, in K. Brunner (ed.),Economics and Social Institutions (Martinus Nijhoff,Boston), pp. 163–231. 7 Cf. P. Koslowski: 1997, Ethik der Banken und derBörse (The Ethics of Banking and the StockExchange) (Mohr Siebeck, Tübingen). AbridgedEnglish version: P. Koslowski: 1995, ‘The Ethicsof Banking’, in A. Argandoña (ed.), The EthicalDimension of Financial Institutions and Markets(Springer, Berlin, New York, Tokyo).

The Limits of Shareholder Value 147

8 Cf. for this principle G. Schmoller: 1881, ‘DieGerechtigkeit in der Volkswirthschaft’ (Justice in theEconomy), Jahrbücher für Gesetzgebung, Verwaltung undVolkswirthschaft im Deutschen Reich 5, 19–54. – Cf. forthe Historical School of economics P. Koslowski:1991, Gesellschaftliche Koordination. Eine Theorie derMarktwirtschaft (Societal Coordination. A Theory ofthe Market Economy) (Mohr Siebeck, Tübingen); P.Koslowski (ed.): 1995, reprinted 1997, The Theory ofEthical Economy in the Historical School. Wilhelm Roscher,Lorenz von Stein, Gustav Schmoller, Wilhelm Dilthey andContemporary Theory (Springer, Berlin, New York,Tokyo); and P. Koslowski (ed.): 1997, Methodology ofthe Social Sciences, Ethics, and Economics in the NewerHistorical School. From Max Weber and Rickert toSombart and Rothacker (Springer, Berlin, New York,Tokyo).9 Cf. ‘Niederlage für Daimler-Kritiker Wenger’(Defeat for Daimler’s critic Wenger), in SüddeutscheZeitung 185, 13 August 1998, p. 17, as well as‘Wenger unterliegt Daimler’ and comment byMathias Philip: ‘Aktienoptionen’ (Share Options), inHannoversche Allgemeine Zeitung, Hannover, 188, 13August 1998, p. 9. The comment takes position forWenger against Daimler-Benz. See also FrankfurterAllgemeine Zeitung of the same day.

10 Cf. ‘ ‘Ich besitze keine einzige Porsche-Aktie’Der Manager hält wenig von Aktienoptionen zurSteigerung des Firmenwertes’ (‘I do not own a singlePorsche share’ The manager does not believe in shareoptions as a means to increase the firm’s value), inSüddeutsche Zeitung, München, 41, 20 February 2000,p. 28. 11 A. Rappaport: 1986, Creating Shareholder Value. TheNew Standard for Business Performance (The Free Press,New York), pp. 25ff. 12 Cf. Günter H. Roth: 1988, ‘Shareholder Value undDividendenausschüttung’ (Shareholder Valueand Paying-off Dividends), in P. Koslowski (ed.),Shareholder Value und die Kriterien des Unternehmenser-folgs, op. cit. 13 Cf. Martin Luther, De servo arbitrio. 14 S. Freud: 1900, Die Traumdeutung (The Inter-pretation of Dreams) (S. Fischer, Frankfurt am Main)1982.

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D-30169 Hannover.E-mail: peter.koslowski@t-online.de

148 Peter Koslowski