A company while doing business develops relationships with its internal and external stakeholders. All these relationships are contractual. Some are explicit and legal and some implicit. For example, there are explicit contracts between a company and its employees, the workforce, suppliers, creditors and debtors and government. With society and the shareholders, the contract is implicit. Society expects that the company will pursue policies which will be good for the society. Jamsetji Tata put it so eloquently when he said: “In a free enterprise, the community is not just another stakeholder, but is, in fact, the very purpose of its existence.”

Without shareholders a company cannot exist. They are the suppliers of capital. True, they have only voting rights, but no right to dividend, they cannot demand it, nor can they get their money back from the company. They take a risk when they buy the shares of a company, with the implicit assumption that the company will be governed and managed well and the board and the management will adopt policies which maximise their (shareholders’) interests. This implicit assumption gives rise to expectations. The implicit contract which the shareholders have with the company is borne out of these expectations. Ipso facto, it becomes incumbent on the management to respect all contracts — explicit and implicit. This respect for contracts helps a company to gain the trust of shareholders, other stakeholders and society.

There is always the possibility that managements may resort to creative accounting, which can artificially inflate cash flows and profits which in turn will positively impact share value and shareholder value; but that will only be temporary. Temporaneous cannot be vested with the garb of permanence. In the long run, the discovery of the artificiality will affect the reputation of the company. It will lose trust. Shareholder value will suffer.

Trust, whether in business or in life, is something which once lost is difficult to regain. The case of Satyam is a good example — non-existent profits and cash at the bank were consciously used with creative accounting to show inflated profits, impact share prices, and artificially enhance shareholders value. Satyam and Ramalingam Raju, the Chairman and CEO, once highly respected and much sought after, lost trust and never regained it. Unethical practices create an illusion that the company is doing well, but ultimately, it will lead to loss of trust, and taint the board and the management. The company will be in a downward vortex.

Cascading effect

The Gita in verses 62 and 63 of Chapter 2 nicely brings out the cascading effect of “attachment” per se, be it to wealth or any object of desire:

“Contemplating on the objects of the senses, develops attachment to them, attachment leads to desire, from desire arises anger.” (62)

“Anger clouds judgment, mind is bewildered; when mind is bewildered, the intellect is destroyed; when the intellect is destroyed, one is ruined.” (63)

Enron, Satyam and other similar financial collapses, inevitably followed this path on their way to oblivion. If the companies and managers (who primarily are agents serving the interests of their principal — that is, shareholders) follow the shareholder wealth maximisation principle, i.e., they believe that their goal is to increase shareholder wealth, they must ask themselves, while taking decisions, if their actions are consistent with ethical and moral standards?

And whether the company is concerned with the well-being or the welfare of the shareholders and stakeholders? Mercenary behaviour of the top management is not unheard of and often they flourish in an atmosphere within the company, in which ethical considerations may take a back seat to profit considerations.

As giving priority to ethical considerations will have financial implications for the company, it must be clearly articulated in the company’s objective and mission statements. The CEO of Danone had to step down because his concerns with climate change and quality of products had financial implications and the decline in share prices.

Championing shareholder wealth maximisation is not an advocacy of making society’s goal as unconstrained shareholder-wealth maximisation. The objective of shareholder wealth maximisation should necessarily be constrained by current and future laws and overarching ethical customs.

Indeed it is true that the principle of shareholder wealth maximisation is one of the several principles of managerial behaviour. There is an economic rationale behind it, besides the welfare consequences of managers pursuing this principle. But it cannot be denied that this principle has as many votaries as opponents. It is equally true that there are not many principles in the world of finance which arouse simultaneously so much intense scrutiny, adoration, and condemnation.

An ethical decision is a rational choice between alternative courses of action on the basis of right and wrong, based on individual’s belief system and values such as trust, responsibility and respect. In making this choice, one should not look to the fruit of works, but decide whether a particular act is right or wrong by looking into its nature. Milton Friedman said in a speech in New York in 1970, that managers as shareholders’ agents should “conduct the business in accordance with their desires, which will generally be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

There is no immorality involved in maximisation of wealth so long as it is legal, ethical and does societal good. Nicomachaen Ethics of Aristotle says that “every action and pursuit, is thought to aim at some good; and for this reason the good has rightly been declared to be that at which all things aim.

Maximisation of shareholder value will be sustainable if the company pursues ethical policies. Ethics is the touchstone to judge a company’s policies. In that sense, management of shareholder value becomes a ethical responsibility of the management.

The writer was an Executive Director of SEBI, a Consultant to the World Bank and IFC, an Independent Director, and an Advisor to Deloitte Tohmatsu Touche LLP India