What Do Shareholders Really Want?

Shareholders are essentially individuals or companies who have decided that their funds would be better invested in the share of ownership of a company rather than investing this money elsewhere, such as in a bank or in other asset classes. But what do these shareholders really want to happen to their funds?

Now, I own shares, mainly in the volatile oil and gas sector, which probably portrays my personal perception and acceptance of the risk and reward concept. But what do I want to happen with these shares? Well, I suppose the ideal situation would be for the price of these shares to rocket sky high so I could sell them and buy Ferrari’s and go travelling forever. However unless something crazily unforeseen occurs, this is not a realistic objective of holding these. A more realistic view would be for my personal wealth to be maximised through maximum long term dividends and in turn, increased share price. This shareholder wealth maximisation view is one likely to be held by the majority of shareholders in business, however in reality is arguably not as easy as it sounds. The long term approach is key to shareholder wealth maximisation. Essentially a business could increase short term profit and pay large dividends with relative ease, however this is unlikely to be beneficial in the long term. To analyse this concept further here is an example:

Manchester United Football Club could sell their star players, their entire first team and make hundreds of millions of pounds which could then be paid out to shareholders in the form of dividends. On the outset this high dividend payment may appear favourable, however the impact this would have on shareholders is likely to be negative. This is because they would then be left with a weak team which would be unlikely to achieve any form of success both domestically and on a European scale. Other areas such as sponsorship would also likely suffer as companies would have less desire to be involved a less successful, less star-filled club along with lower attendances and less matches shown on television for example. Therefore future dividend payments would significantly decrease due to the club’s poorer financial position and the lower potential flow of future dividends and less potential success will lead to the share price falling, thus decreasing long term shareholder wealth. Now using football is probably not the best example, but this concept applies to all companies and demonstrates how profitability can be maximised in the short term, yet this is not necessarily beneficial for long term shareholder wealth maximisation.

As mentioned the concept of shareholder wealth maximisation is not as easy as it sounds. This is because the agents acting on behalf of shareholders, therefore the directors and managers within companies tend to have conflicting interests to those of the shareholders. As a shareholder, I want the directors to maximise my wealth by improving the long term prospects and success of the company. However it is often discussed how directors do not share this view and are more concerned with their own personal success. For example increasing their own pay, avoiding risky projects and focusing on short term profitability are all areas which benefit directors yet do not maximise shareholder wealth. Increasing profitability may look like a director has performed well and increase their yearly bonus, however if they have reduced investment into research and development to achieve this, then it is at the detriment of the long term success of the business. This conflict of interest between shareholders and directors/managers is known commonly as agency theory in business.

In order to avoid such agency issues and managerialism, methods must be implemented to align the actions of directors with the interests of shareholders to essentially achieve a goal congruence between the two. I feel one of the best approaches in this situation is to introduce incentives such as share options, thus giving directors and managers the chance to buy shares in the future at a price determined at the current date. Such a scheme is likely to encourage directors to focus on the maximisation of share price and therefore essentially shareholder wealth, discouraging managers from an otherwise short term focus. There are also a number of other ideas to consider such as offering managers bonuses based on share price growth or offering pension plans to retain directors for longer periods of time. Whilst such methods come at a cost for shareholders, they are likely to increase their long term wealth, which when linking back to the title of this blog, I feel is what shareholders such as myself really want.