Baupost CEO Seth Klarman said that the traditional notion of shareholder value maximization is not sustainable for a healthy economy.
- Baupost Group CEO Seth Klarman gave a speech calling for a shift away from what he sees as toxic short-termism.
- He believes this is the result of the theory of shareholder primacy, and that other stakeholders like employees and community need to be considered for the sake of long-term growth.
- He called for companies to reconsider their actions as society's calls for change become increasingly stronger.
- This article is part of Business Insider's ongoing series on Better Capitalism.
Seth Klarman, the renowned founder and CEO of the $30 billion hedge fund the Baupost Group, recently gave a speech on the ramifications of shareholder primacy.
"Business schools have sometimes taught that shareholder value maximization is the Holy Grail, the sole proper focus of corporate managements," he said. "So I ask, should managements be focused solely on a company's share price, which itself is ephemeral, and do everything within their power to levitate it? What longer-term good would this possibly accomplish? And does anyone really believe that shareholders are the only constituency that matters: not customers, not employees, not the community, or the country, or planet Earth?”
Klarman gave the speech at a dinner celebrating the opening of Klarman Hall at Harvard Business School on Oct. 1.
Klarman is an avowed value investor, which means that his approach to managing money involves buying shares of companies he thinks are cheap relative to their peers. It's a philosophy employed by other industry heavyweights, such as Warren Buffett and Joel Greenblatt, the managing principal and co-chief investment officer at Gotham Funds.
It makes sense, then, that he's in favor of an approach creating long-term value. But his speech declared the notion of shareholder primacy, as it's been practiced for the last 40 years, as an impediment to the health of the economy and society at large.
"A capitalist economy should be judged not just on the aggregate economic improvement driven by its innovation but also on the design and strength of the social safety net that cushions the ill, or disadvantaged, or those who simply fail to thrive in their particular setting, geography, industry, or trade," Klarman said.
What is the role of business in society?
The debate over the pursuit of short- versus long-term value, and how that is related to the responsibilities of public corporations, has been drawn out over many decades.
In the wake of the Great Depression, the economist John Maynard Keynes wrote in "The General Theory of Employment, Interest and Money" that the American stock market encouraged public companies to prioritize short-term gains, temporarily benefiting their stock price, over long-term gains, benefitting both their business and society as a whole. It frustrated Keynes and the Keynesians that followed.
But for free-market economists like Milton Friedman, who published "Capitalism and Freedom" in 1962, there was no need to differentiate between the short and long terms. For Friedman, a company's sole social responsibility was to make as much profit as possible, as long as it followed the rules. A free market would reward the best companies, which would take care of all stakeholders.
American executives and politicians embraced Friedman's ideas in the 1980s, and judicial precedents in the United States cemented the notion that public companies existed to maximize profits for their shareholders.
This debate has resumed in earnest, however, during the recovery from the financial crisis of 2008, and this time, the other side has more momentum. Klarman isn't the only billionaire calling for change.
In 2013, investor Paul Tudor Jones, for example, cofounded JUST Capital, which measures public companies' value added to all stakeholders, not just shareholders. It launched an ETF in partnership with Goldman Sachs earlier this year. On the corporate side, more large companies, like food giant Danone, are seeking "B Corp" status (the "B" stands for "benefit") — this certification proves they received high marks from the company B Lab, founded in 2006, that measures a company's societal benefit.
And, notably, this past January, BlackRock CEO Larry Fink wrote in his annual letter to CEOs that, "To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society."
At the New York Times DealBook Conference in October, Fink defended himself against accusations from critics like Wall Street Journal columnist Holman W. Jenkins, Jr. that he was just trying to be en vogue or "buy indulgences" from the public. As Fink put it, the demand from customers and employees for customers with purpose has become so strong that he wrote his letter as a way to improve his clients' performance.
There's evidence this is more than just intuition. Boston Consulting Group found that companies pursuing initiatives that benefit ESG (environmental, social, governance) metrics actually boost their bottom lines. Fink said that in the near-future — as early as the next five years — all investors will measure a company's value along ESG metrics.
Where Klarman stands
While Klarman called for an improvement of capitalism in his speech, he did not consider his suggestions to be drastic.
He specifically mentioned as something he considers too radical to be Sen. Elizabeth Warren's Accountable Capitalism Act, which would require billion-dollar public companies to obtain a federal charter that binds them to creating value for stakeholders beyond shareholders, as well as have 40% of its board members elected by employees.
The way he sees it, businesses should determine how they are going to grow more responsibly before regulators decide for them.
He noted that, "when capitalism goes unchecked and unexamined, and management is seduced by a narrow and myopic perspective, the pendulum can quickly swing in directions where capitalism's benefits are discounted and its flaws exaggerated, thereby leaving its future even more clouded and uncertain."
"While it's hard to see how this proposed regulation would solve the problems that I've raised tonight, it’s exactly the kind of proposal that business will have to contend with when complex issues go unexamined, and when character, sound values, restraint, and long-term thinking fail to gain the upper hand."