Convocation Address at the Indian Institute of Management by Raghuram Rajan, Economic Counselor and Director of Research, IMF
IMF News, April 2, 2005
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Bibliographic details
- Published: April 2, 2005
Context and opening
- Given in Ahmedabad, India.
- Date: April 2, 2005.
- Speaker: Raghuram Rajan, Economic Counselor and Director of Research, International Monetary Fund.
- Remarks to: Chairman Narayana Murthy, Director Professor Dholakia, members of the faculty, students.
Core advice to graduates
- Explore broadly, try different things, and be unconventional rather than pursuing fame and rapid promotion as primary goals.
- Focus on enjoying the process of work: "the goal itself is of limited utility, it is the process that matters."
- Use the diploma from IIM Ahmedabad as assurance of employability and a platform to find a vocation that fits passion and productivity.
- Nurture an inner moral compass: when analysis reaches its limits, decisions must be guided by conscience.
Rationale for shareholder value maximization
- Definition: managers should focus on maximizing the value of their company's shares.
- Underlying logic:
- Transactions are assumed arm's length: employees receive fair wages; customers receive fair value; residual surplus accrues to shareholders.
- Maximizing shareholder returns incentivizes investors, expands finance availability, and supports firm creation, employment, and growth—especially valuable in an emerging market like India.
- Shareholder value maximization does not condone crimes; it provides guideposts for allocating corporate effort and resources.
Limits of shareholder value maximization — practical examples and principles
- Excessive customer generosity:
- For a mature company to "significantly exceed its customers' expectations every day" is likely inefficient and reduces shareholder value.
- Occasional or moderate exceeding is useful for goodwill; consistent large excess indicates poor management of expectations.
- "Cholesterol pricing" case (bank practice):
- Practice: quoting outrageously high prices to clients and negotiating down if client objects.
- Reasons this fails shareholder-value test:
- Destroys long-term client relationships and trust — short-run profit can be destructive of shareholder value.
- Fails the "light of day" test: actions that would inspire public revulsion cannot be sustained in an era of transparency.
- Erodes internal trust: permissive external sharp practices encourage internal sharpness and undermine organizational cohesion.
- Corporate social responsibility (CSR):
- CSR is consistent with shareholder value maximization when it can be justified in terms of long-term shareholder value (e.g., beautifying a neighborhood where government capacity is weak).
- CSR funded directly from corporate coffers that yields no firm benefit fails the test (example cited: Tyco alleged CEO Dennis Koslowski spent $46 million of the company's money on charitable donations for his own benefit, including a donation to the Nantucket Conservation Foundation to preserve land next to his $5 million home).
- Managers should create wealth for shareholders and allow shareholders to decide personal charitable giving; managerial philanthropy should come from personal funds.
Aligning managerial incentives and preventing abuse
- Equity-based pay can align manager and shareholder interests but is often misused:
- Timing of stock option grants can lead to correlation with subsequent firm performance without true causation.
- CEOs may receive payouts tied to external factors (example: CEO pay rising simply because oil prices rose) unrelated to managerial effort.
- Promoters can extract value via allotments of shares without full shareholder oversight.
- Stock/options may be under-accounted for in financial statements, obscuring true cost to shareholders.
- Remedies recommended:
- Greater transparency in awarding payouts.
- Greater shareholder voice and oversight in approving payouts.
- Clearer links between payouts and genuine incentives.
- Tighter accounting of costs to shareholders.
Criticisms addressed and organizational responses
- Response to Sumantra Ghoshal's critique:
- Ghoshal argues over-emphasis on shareholder value (via agency theory) fosters opportunistic managerial behavior.
- Rajan contends that corporate scandals reflected weak governance (boards asleep) rather than governance mechanisms causing crime; good corporate governance verifies ("Trust but verify").
- Complementary critique (Luigi Zingales / Ghoshal variant):
- In firms where employees and shareholders are mutually dependent (human-capital intensive firms), employees can be residual claimants; maximizing only shareholder wealth may not maximize firm value.
- Market solutions: organizational forms that align employees and shareholders—partnerships or extensive employee stock holdings—resolve this tension.
- Anticipates further innovations in corporate organizational forms as human capital becomes more important, particularly relevant for India’s service economy.
Management practice — bridging theory and judgment
- Management rules are not cookbook recipes; situational analysis often unclear and contexts vary.
- Best management education teaches how to think, not what to think.
- Ultimately, practice must be guided by an inner sense of rightness that distinguishes competent from great managers.
Closing remarks
- Graduates have been tempered by a rigorous program and are prepared for competitive global environments.
- Congratulations to graduating students and best wishes for fulfilling futures.
Convocation Address at the Indian Institute of Management by Raghuram Rajan, Economic Counselor and Director of Research, International Monetary Fund, April 2, 2005.