It’s about more than just shareholders! Business writers are excited! Bernie Sanders supporters are gratified! Long-time members of the KJR community are wondering (1) why this is even news, and (2) how could so many commentators all miss the point so completely?
The subject is the Business Roundtable’s discovery that creating shareholder value is too cramped a metric to tell the whole story. It’s breathing new life into the ancient mantra that businesses need to create value for all their other constituencies as well — the communities in which they do business, their employees, suppliers, and even (gasp!) their customers.
The discovery fits nicely into the developing narrative that capitalism, in its unfettered, laissez faire form, often creates damage that ranges from minor inconvenience to monstrous harm and injustice.
So let’s congratulate the Business Roundtable for trying to soften the impact of the emerging backlash — for modifying its allegiance to the newly unpopular proposition that pure-play economic theory automagically defines good public policy.
But ethics predicated on fear of punishment isn’t ethics at all. To the extent this is all an attempt to placate those who see capitalism as a system that mostly looks out for someone else’s best interests, it’s a shallow and fragile change.
What matters more, as was first pointed out in this space seventeen years ago, there are bigger reasons for CEOs to reject such a puerile and shallow fiduciary philosophy as the pursuit of shareholder value.
It’s like this: Shareholder value, which is EconomistSpeak for making the price of a share of stock increase, is a poor predictor of future performance. Heck, it doesn’t even reliably describe current performance.
Why? you might ask. Answering a question with a question I might ask you in return, what does reliably describe current performance and accurately predict future performance?
Well, you might answer, steps that increase a company’s competitiveness in the marketplace are what describe current performance and accurately predict future performance. Steps like developing superior products; instituting efficiencies that let the company sell its products for less; making doing business with the company in question more convenient. Steps like that.
The steps companies have been taking to increase shareholder value aren’t just different from what it takes to be more competitive. They interfere.
Take, for example, the popular practice of using cash assets, often supplemented with borrowed money, to buy back stock. The theory is that the same assets, divided by fewer shares of outstanding stock, result in the remaining shares being more valuable.
Which they would be if the CEO and board of directors were to immediately liquidate the company. Otherwise, all buybacks do is make this money unavailable for such trivialities as product improvement and customer care.
Debt-funded stock buybacks might be the most egregious paean to the shareholder value theory of business governance, but it’s hardly the most prevalent, or the most banal. That award goes to the constellation of practices focused on artificially deferring profitable expenditures so as to “make the numbers.”
And by profitable expenditure I mean all expenditures, because any expenditure that isn’t a profitable one shouldn’t be deferred. It should be eliminated on the grounds that why would you do anything else?
For example: You need to hire a systems administrator. There are only two possibilities: The company will, in the long term, be more profitable because IT has filled this position, or it will be less profitable. If it will be more profitable, deferring the expenditure defers profit.
Imagined conversation between the CEO and board of directors:
Board: We understand you deferred some profit this quarter.
CEO: (Proudly) that’s right! And we’ve identified lots more profit we can defer in future quarters!
Board: What the hell is wrong with you?
Real-world board: Great job! Keep it up!
Much of the problem, as should be evident, is that cost reduction is easy to measure. Just about all other value creators are not. Deferring a hire, or an equipment purchase, or what-have-you reduces expenditures in easy to recognize ways. The benefits resulting from having enough staff with the right skills and equipment to do the work is, in contrast, easy to understand in principle, but devilishly hard to measure.
And as we’ve all had the tiresome mantra drilled into our heads that anything we can’t measure we can’t manage, the results are as easy to predict as they are hard to avoid.
Which leads to this conclusion: The Business Roundtable has taken a correct step.
It’s for the wrong reason, but at least it’s a step.
So it seems you’ve pointed out that Shareholder Value is not necessarily measured only in dollars and cents. Neither are corporate goals. Those that are not are simply harder to measure and thus to control. That has very little to do with the viability and validity of capitalism as a superior economic system. Maybe the Business Roundtable hasn’t come to a new conclusion but just started telling their story in new language for a different audience.
It seems that your new portrait has made you even smarter than before!
Nice article.
Well done. Implied but would love to hear your thoughts on where long term vs. short term thinking comes into this discussion. Is there a remote possibility there may exist a set of values along the lines of enlightened self-interest that could create a win-win for all stakeholders – perhaps even including maximizing long term shareholder value? Nah.
Short version: It used to be that With sufficient long-term thinking, competitive advantage and shareholder value tended to converge.
But as business cycles have compressed, the temptation to “move the metric” through financial engineering has, I think, become much stronger because the time to harvest investments in competitive advantage (the “Stay the Same / Change ratio” Scott Lee and I introduced in The Cognitive Enterprise) has become shorter.
In the 9 years I worked for Arthur D, Little, Inc. the Management Consultants preached “improving shareholder value.” As one of their Technology Consultants, I sensed that this was wrong, but until this column, I could not put together the reasons why. Thank you Bob. If only they taught this in B-School.
a counterpoint: “improving shareholder value” can be interpreted as purely dollars=”value.”
But there are funds such as Citizen Funds which invest in “good” companies trying to avert world problems. You can also divest yourself and boycott Israel (or South Africa).
This isn’t mere semantics. Many folks do not want to buy stocks in munitions companies or tobacco companies. And in a larger sense, this makes perfect sense. The value of a stock is what people perceive it to be. It’s not an actual, hard fact.
Bayer aspirin used to be the maker of soft baby wipes and talcum powder (now found out to be toxic). As soon as they become known as the pushers of OxyContin, their stock price will drop. Some will say it’s because of future lawsuit payments but you can rationalize any stock at any price using any “facts,” especially facts about the future.
Museums won’t even accept free money from the Sacklers now.
The thing that’s always puzzled me, at least since I became aware of the BRT’s existence with their ridiculous pronouncement in 1998 (I think it was), is how the BRT ever rose to the importance of a semi-regulatory entity. “Investors” have used their guidelines as fodder for suing companies for quite a while and the courts have upheld them. Glad to see they finally did something right.
(I use the term “investors” loosely” because the ones in question are usually of the get-rich-quick, “I got mine” variety. For my money, if you’re not in it for at least 5 years you’re not an investor — and if you’re playing the market you’re strictly a speculator.)
This article written by Emily Stewart in Vox 2018 – https://www.vox.com/2018/8/2/17639762/stock-buybacks-tax-cuts-trump-republicans gives some much needed background on the antecedents to this activity. Thanks again Bob for a trenchant article.
Bob,
So clear and well written. In a few years when the BBB barely over junk corporate bond rating is gone leaving only debt and more debt, we will hear, “What the Hell were we thinking?” and “Where was the board?”.
Thanks again for pointing out the truth.
Within days of the BRT’s announcement, a number of articles appeared in the business press explaining why the new standard wouldn’t work and the old standard – share price – should remain the only metric for management performance: it was too hard to measure those other things, but easy to measure share price. In other words, how in the world can boards maintain accountability if the metrics aren’t easy to see and understand?
All those pundits were engaging in three of Bob’s metric fallacies:
#2: Measuring the wrong things, right or wrong.
#3: Failing to measure important things.
#4: Extending measures to employees.
Just shows how easy it is for reasonably intelligent people to make dumb mistakes.
FYI: The metric fallacies were just one part of a seminar Bob ran ten years ago, the notes from which I still reference. If he still hosts such seminars, I highly recommend signing up. It was well worth the time and cost.
Thanks for the kind words. I’m not currently conducting seminars but rest assured that if I do get back into the business, KJR’s subscribers will be the first to know.