Current-Shareholder Bias and the Limits of Shareholder Empowerment

Abstract

Why do managers of widely-held firms fail to maximize firm value? The standard answer is that managers often pursue their own interests rather than shareholders’. I explain, however, that even managers completely loyal to the investors who hire and fire them -- the firm’s current shareholders will act in ways that diminish firm value. In particular, managers loyal to current shareholders will reduce value to enrich current shareholders at future shareholders’ expense. This problem, which I call “current-shareholder bias,” arises even if markets are perfectly rational, and even if all current shareholders are long-term investors. My analysis suggests that empowering current shareholders is unlikely to solve (and may exacerbate) certain corporate governance problems that have long afflicted U.S. firms, including earnings manipulation, real earnings management, and value- destroying acquisitions.