Shareholder Primacy

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What is Shareholder Primacy?

Shareholder Primacy is a kind of corporate governance that keeps the interest of shareholders above any other party. This kind of governance focuses on maximizing shareholders' wealth as they consider shareholders to be the company's owners. In a corporation, several parties are involved, like creditors, debtors, employees, consumers, etc.

What is Shareholder Primacy?

Shareholder primacy is the corporate governance that emphasizes shareholders' interests, maximizes their wealth, and treats them as owners while considering creditors, debtors, workers, and customers.
Shareholders are the main emphasis and conflicts over responsibility to customers and the environment exist. Governments aim to increase shareholder value through large NPV projects and competitive pricing.
This theory puts the interests of shareholders first. In contrast, stakeholder theory puts the interests of all parties involved in a project's success first and calls on management to recognize and defend their interests.

Explanation

The concentration on only the shareholders in shareholder primacy has been debated a lot. There are debates regarding the corporation's duty towards the environment and consumers, but shareholder primacy only focuses on the wealth creation of shareholders. So the governance stipulates rules for accepting projects with the highest NPV, even if that project is not environment friendly. The governance also focuses on charging the maximum competitive price to customers, increasing shareholders' wealth.

Background of Shareholders Primacy

Adolf Berle and Gardiner Mean published "The Modern Corporation and Private Property" in 1932. The book was regarding the foundation of United States Corporate Law. In the book, for the first time, the idea of "shareholders are the corporation's true owner" was introduced."

Later economist Milton Friedman added to the theory that the main purpose of corporations is to maximize shareholders’ wealth.

Criticism of Shareholders Primacy

The main focus of the management will be short-term earnings per share (EPS) if shareholders' priority is followed. So management will involve decisions that will benefit in the short-term and ignore the long-term effect. This will be devastating for the corporation. A corporation doesn’t have maturity; it goes on forever. So always, the long-term effect must be seen.
This governance will force management to have a high payout ratio. So most of the earnings will be distributed in the form of dividends, and no earnings will be retained for further corporation growth.
Management will be shaky to take the optimal risk to earn the optimal return because increasing risk may lead to negative earnings also. So shareholders will not be benefited in that year.

Is Shareholders Primacy Legally Mandated?

The modern economic era considers shareholders' wealth to be the primary factor for the corporation. There is still no law for shareholders' primacy. Shareholders' primacy is a belief in most parts of the world. Shareholder primacy in most places is described as "norm" rather than "law."

Shareholder Primacy vs. Stakeholder Theory

All shareholders are stakeholders, but all stakeholders are not shareholders. So shareholder primacy only focuses on the well-being of shareholders, whereas stakeholder theory focuses on the well-being of all related parties to a project. The management has to identify the most important stakeholders and protect their interests. Important stakeholders could be consumers, the environment, creditors, etc.

Advantages

Governance allows the maximum wealth creation of shareholders. Shareholders are considered the owner of a corporation, and shareholder primacy protects their interests. Shareholders take the maximum risk, so they should get the maximum wealth creation.
As the earnings of the company increase, so the share price also increases, which helps shareholders to sell shares at a higher price. Capital gains are taxed at low rates. So it is beneficial for the shareholders.
Shareholder primacy forces management to focus on profit maximization, which should be the ultimate goal of the management. The corporation needs profit to survive.
Companies opt for projects with the highest NPVs, so the chances of the project failing are less.

Disadvantages

Most of the profits are distributed due to a high payout ratio, so are fewer retained earnings. The growth of the corporation is hampered.
Management gets so involved in maximizing EPS that it accepts projects with huge short-term and low long-term benefits. This affects long-term profitability.

Conclusion

Shareholders' primacy is an outlook that portrays shareholders as the corporation's owners and other stakeholders are not so important. So the management's attention should be to protecting shareholders' wealth. Other stakeholders are not considered. This conduct is debatable and has been criticized on many platforms. Many believe that shareholders should be the ultimate owners as they take the full risk.

Frequently Asked Questions (FAQs)

Is shareholder primacy legally mandated?

The stockholders' priority still needs to be regulated by law. People in much of the globe maintain that shareholders come first. Most often, rather than "law," shareholder primacy is called the "norm."

What is shareholder primacy common law?

Common law articulates shareholder primacy in court precedents stating that managers and directors owe fiduciary responsibilities to shareholders and must make choices in their best interests (Smith, 1998). The 1919 case of Dodge v. United States is when the standard was most famously stated.

Is director priority the same as shareholder primacy?

The director primacy agrees. According to the principle of shareholder primacy, the shareholders should have ultimate decision-making authority regarding corporate governance. Director primacy, in this case, indicates no. The board of directors' management is unassigned and original.

Has the perception of shareholder primacy changed over time?

Yes, there has been a growing movement to reevaluate the role of corporations in society. Some companies and investors have begun to adopt more socially responsible practices, acknowledging the importance of environmental, social, and governance (ESG) factors.