VALUE MAXIMIZATION, STAKEHOLDER THEORY, AND THE CORPORATE OBJECTIVE FUNCTION

This paper examines the role of the corporate objective function in corporate productivity and efficiency, social welfare, and the accountability of managers and directors. The author argues that because it is logically impossible to maximize in more than one dimension, purposeful behavior requires a single‐valued objective function. Two hundred years of work in economics and finance implies that, in the absence of externalities and monopoly, social welfare is maximized when each firm in an economy maximizes its total market value. The main contender to value maximization as the corporate objective is stakeholder theory, which argues that managers should make decisions so as to take account of the interests of all stakeholders in a firm, including not only financial claimants, but also employees, customers, communities, and governmental officials. Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing interests, they leave managers with a theory that makes it impossible for them to make purposeful decisions. With no clear way to keep score, stakeholder theory effectively makes managers unaccountable for their actions (which helps explain the theory's popularity among many managers). But if value creation is the overarching corporate goal, the process of creating value involves much more than simply holding up value maximization as the organizational objective. As a statement of corporate purpose or vision, value maximization is not likely to tap into the energy and enthusiasm of employees and managers. Thus, in addition to setting up value maximization as the corporate scorecard, top management must provide a corporate vision, strategy, and tactics that will unite all the firm's constituencies in its efforts to compete and add value for investors. In clarifying the proper relation between value maximization and stakeholder theory, the author introduces a somewhat new corporate objective called “enlightened value maximization.” Enlightened value maximization uses much of the structure of stakeholder theory—notably the need to consider the interests of all corporate stakeholders—while continuing to posit maximization of long‐run firm value as the criterion for making the necessary tradeoffs among stakeholders. The paper comes to similar conclusions about the Balanced Scorecard, which is described as the managerial equivalent of stakeholder theory. Although the Balanced Scorecard can add value by helping managers better understand the drivers of shareholder value, it should not be used as a performance measurement and incentive compensation system because it fails to provide a single valued score, a clear way of distinguishing superior from substandard performance.