Stock Market Valuation and Management Control
Probably the strongest argument currently in favor of the shareholder model challenges business leaders in their capacity to be responsible and exercise effective control of their management.
The idea is simple. Serving the interests of shareholders means making strategic decisions based on the assessment of financial players. If this assessment is fair, it is desirable.
The shareholder model will provide a management and evaluation criterion, a condition for effective control, that is both objective (public) and relevant (reflective of performance as far as possible) with the stock price.
On the contrary, a partnership model raises the problem of the lack of clear criteria that can guide the management of companies. Officials and directors may then take advantage of the absence of objective criteria to serve their personal interests.
The previous argument justifying the shareholder model with its ability to limit management offenses can be reduced to the following question:
- Is stock market value the best indicator of corporate performance?
- Or is there a gap between firm performance and stock prices?
Here we find discussions on the informational efficiency theory of financial markets that questions the links between stock prices and fundamental value.
If the efficiency hypothesis is confirmed, the valuation produced by the stock market may seem fair; shareholder governance model has been strengthened.
On the other hand, if prices do not reflect the ability of firms to make long-term profits, the choice of market value as an evaluation criterion, however objective, becomes very problematic.
The partnership model will then find a strong argument. However, productivity theory poses a certain number of difficulties and is subject to increasing criticism.
The first possibility is that the efficiency hypothesis is not valid. Because stock prices do not reflect the set of information presented to investors, regardless of how this information set is defined. There are several reasons for this.
The irrationality of investors who can't optimize is a logic that has been studied largely by behavioral finance.
The developed self-referential speculation hypothesis emphasizes that even with rational actors, the interaction structure specific to the stock market may cause prices to detach from the real economy.
Finally, arbitrage can have limits. This means that prices adapt very slowly to public information. If enough investors operate at these prices in the relatively short term, distortions are likely to continue in the long term.
However, it is not necessary to reject the efficiency hypothesis to doubt the relevance of stock market valuation as a reflection of firm performance. Consider the situation where markets are weakly or semi-strongly efficient but not strongly efficient.
This means that the information set on which investors will make their buying or selling decisions and conduct their arbitration does not contain proprietary information known only to insiders.
If proprietary information is crucial, the assessment of future performance of stock market-generated companies would be logically flawed. Prices will miss an important element.
To say that proprietary information is important is to say that the publicly available documents produced by companies alone are not sufficient to provide a relevant assessment of wealth creation in the long run.
One possible reason is that all the information required for the evaluation of production processes is difficult to code and can therefore be passed on to external players such as market finance.
What we would call non-financial data today typically falls within this framework. If these dimensions were non-financial, they would not have an impact on profitability. But today it means that they are little integrated into traditional financial analysis.
This is the case of investments in human capital and, more broadly, the accumulation of so-called intangible assets that are still very difficult to account for.
Typically, these assets, such as individuals' implicit skills, are complementary. Because effectiveness depends on their interaction, not their juxtaposition.
The team production situation described above very clearly explains the difficulties that arose at that time. No one can externally assess the contribution of a particular input.
Because only an actor (manager) from within the company who specializes in observing and controlling production processes can solve the problem.
Team generation, whose developments in the theory of the firm have characterized a large number of contemporary firms, therefore raises the problem of external observability of wealth creation processes, which is likely to limit the stock market's capacities to value companies.
By emphasizing certain limitations of stock market valuation, this argument tends to diminish the importance of the shareholder governance model.
But it also highlights the usefulness of internal mechanisms that can direct and control the management of companies on the basis of knowledge associated with participation in the production process.
From an economic point of view, this makes it possible to rationalize the system of joint nomination, in which employee representatives sit on the supervisory boards of companies with more than 500 employees, with the same rights as shareholder representatives.
Dr.Yaşam Ayavefe
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