In 1976, Michael Jensen, a renowned law school professor, wrote a paper claiming that executives have a legal and fiduciary duty to maximize shareholder wealth. The basis of this claim rested on a previous statement from Noble economist Milton Friedman.
The thesis of Jensen’s paper has since been debunked. Executives do not have a legal responsibility to maximize profits at all costs. However, while they cannot be sued for failing to take steps to increase shareholder wealth, they must remember that this is their job description. Executives that do not prioritize shareholder profits will have a difficult time keeping their jobs.
Here are some ways that executives can maintain their job security by promoting shareholder wealth.
Try to stabilize quarterly earnings reports instead of inflating a single one
Many executives find creative ways to pad shareholder reports over the short term. These include identifying underutilized buildings and selling all of them in the same quarter at a profit to create the illusion of stronger earnings. While there isn’t anything illegal or unethical about this approach, it creates a highly misleading perception of the company‘s earnings.
The bigger problem is that inflating a single quarterly earning’s report this way is not a sustainable way to assure your shareholders that you are growing their long-term wealth. You won’t be able to pull the same accounting trips the next quarter, which will make it look like there was a decline in revenue. Even worse, the change in year to year earnings reports will reflect a steep drop a year later, when most people forgot about the one-time revenue boosting strategy that you had taken.
It makes more sense to take a long-term perspective and spread earnings from asset sales out if possible.
Exploit Customer trends for better profitability
A lot of trends have shaped the corporate world in recent years. The #MeToo, focus on sustainability, the trend towards being more generous to employees by offering them corporate gifts and other movements influence the way that Customer’s shop and the type of publicity that businesses can get.
As an executive, you need to understand how to leverage these trends to your benefit. You also need to understand the new liability certain trends create and try to mitigate them.
You can’t make influential trends go away. All you can do is be reactive to them.
Know when a market is saturated
Putting all of your eggs in one basket is a very risky move. It is also foolish for the larger companies that have the resources to diversify. Smaller companies may have no choice but to invest in a single product. It would be reckless for you to do the same when you have alternatives.
The unfortunate reality is that any market can be saturated at any time. Any product can become obsolete. Even if the market is growing, that doesn’t mean that your business model will be sustainable.
This is exactly the problem that IBM faced after Michael Dell competed with the company head to head. Dell found a much more efficient and cost-effective supply chain model, which left IBM unable to compete in the personal computer business. If IBM failed to adapt to the changing industrial landscape, it would have gone out of business.
The executives at IBM recognized this and took appropriate action. They revamped their business model and focused on larger business computers instead. By recognizing the fact that the market was becoming too saturated, they were able to find a new approach that kept them in business. Of course, if the executives didn’t change their approach, they would have lost their jobs when Big Blue went bankrupt.
