Shareholder Value and Current Financial Crisis: An Analysis of the Relationship

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Shareholder Value and Current Financial Crisis: An analysis of the Relationship

INTRODUCTION

Corporate governance in a particular firm is inevitable for its administration, policy making and overall health. In other words, ‘Corporate governance affects the development and functioning of capital markets and exerts a strong influence on resource allocation[1].’ Not only does it conduct the present running of a firm but it also has a futuristic outlook and a good corporate governance system encourages innovations in the firm[2].

There may be counter arguments that the existing cut-throat competition in the market can be left for taking care of good governance in a corporate because one lacking good governance will definitely be thrown out of business for under-performing. Then why is there the need to formulate and execute certain benchmark of principles and policy intervention for good corporate governance[3].

But there are certain situations where competition can’t prevent mal-practices. There are cases where the managers get corrupt and embezzle shareholders’ profits. The product-competition threat has no bearing on such mal-practices. Hence a policy intervention is indeed justified[4]. Adopting of a certain form of corporate governance model also helps in comparing the performance of economies- the ones that have a set model of corporate governance with the ones that don’t.

One such corporate governance model is the shareholder model of corporate governance. Also known as the Anglo-American model of corporate Governance, it is one of the most widely accepted and adopted models of corporate governance. This present paper deals with the nuances of the model and whether or not this model had any role to play in the last financial crisis. If it indeed had a hand in the building up the debacle, the paper will look into the ways it did so.

Chapter 1: Understanding the concept of shareholder value.

The shareholder value hypothesis is one of the key hypotheses of the financialized capitalism of the 1980s onwards. In their influential study of globalisation, shareholder value and the convergence of company law, Hansmann and Kraakman present the shareholder model (also known as the Anglo-American model), more or less as a fait accompli, their comparative corporate governance argument proposed that there is "no longer any serious competitor to the view that corporate law should principally strive to increase long-term shareholder value’[5].In other words they say that in all the convergent developments across the world in the field of corporate governance, the most significant is that of the convergence towards shareholder model.

In order to understand the reason behind such convergence and wide acceptance of shareholder value model by the corporate firms, one has to first understand the concept of shareholder value and thereafter the corporate governance model based on it.

1.1 Shareholder value: Origin and Meaning.

In the 1960’s the United States economy was dominated by giant corporations which believed in earning profits and retaining both the profits, and the employees of the Company. Shareholders were seen not just as passive, but as irrelevant to the running of the company[6]. But towards the 1980’s due to growth of larger corporations and rise of new competitors, retaining and reinvesting the profits earned by the company became cumbersome.

By the 1970s, due to poor performance of the companies, agency theorists agreed that there was indeed a need for takeover market, functioning as a market for corporate control which could discipline the managers to run their companies properly. Return of corporate stock was supposed to be the indicator of superior performance of a certain company[7]. Therefore till the 1990’s the companies worked incessantly to ultimately become adept at creating more and more shareholder value[8]. For this, they...
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