Happy Systematic Eradication of Labor Day

[CountDeMoney]

WashingtonPost
Opinions

In corporations, it's owner-take-all
By Harold Meyerson

Labor Day — that mocking reminder that this nation once honored workers — is upon us again, posing the nagging question of why the economy ceased to reward work. Was globalization the culprit? Technological change? Anyone seeking a more fundamental answer should pick up the September issue of the Harvard Business Review and check out William Lazonick's seminal essay on U.S. corporations, "Profits Without Prosperity."

Like Thomas Piketty, Lazonick, a professor at the University of Massachusetts at Lowell, is that rare economist who actually performs empirical research. What he has uncovered is a shift in corporate conduct that transformed the U.S. economy — for the worse. From the end of World War II through the late 1970s, he writes, major U.S. corporations retained most of their earnings and reinvested them in business expansions, new or improved technologies, worker training and pay increases. Beginning in the early '80s, however, they have devoted a steadily higher share of their profits to shareholders.

How high? Lazonick looked at the 449 companies listed every year on the S&P 500 from 2003 to 2012. He found that they devoted 54 percent of their net earnings to buying back their stock on the open market — thereby reducing the number of outstanding shares, whose values rose accordingly. They devoted another 37 percent of those earnings to dividends. That's a total of 91 percent of their profits that America's leading corporations targeted to their shareholders, leaving a scant 9 percent for investments, research and development, expansions, cash reserves or, God forbid, raises.

As late as 1981, corporations directed a little less than half their profits to shareholders, but the shareholders' share began rising in 1982, when Ronald Reagan's Securities and Exchange Commission removed any limits on corporations' ability to repurchase their own stock and when employers — emboldened by Reagan's destruction of the federal air traffic controllers' union — began large-scale union-busting. Buybacks really came into their own during the 1990s, when the pay of corporations' chief executives became linked to the rise in the value of their company's shares. From 2003 through 2012, the chief executives of the 10 companies that repurchased the most stock (totaling $859 billion in aggregate) received 58 percent of their pay in stock options or stock awards. For a CEO, getting your company to use its earnings to buy back its shares might reduce its capacity to research or expand, but it's a sure-fire way to boost your own pay.

Exxon Mobil, for instance, devoted 83 percent of its net income to stock repurchases and dividends, and 73 percent of its CEO pay was stock-based. Cisco Systems devoted 121 percent of its net income to repurchases and dividends, and 92 percent of its CEO pay was stock-based.

About that 121 percent: With companies lavishing virtually all their net income on shareholders and executives, the way many of them cover their actual business expenses — their R&D, their expansion — is by taking on debt through the sale of corporate bonds. A number of companies, however — most prominently, IBM — borrow specifically to increase their payout to shareholders. And IBM is not alone. Friday's Wall Street Journal reported that U.S. companies are currently incurring record levels of debt, much of which, the Journal noted, "is being used to refinance existing debt, being sent back to shareholders as dividend payments and share buybacks, or banked in the corporate treasury as executives consider how to potentially deploy funds as the economy expands." Many of the companies that have spent the most on buybacks, Lazonick demonstrates, have also received taxpayer money to fund research they could otherwise afford to perform themselves.

What Lazonick has uncovered is the present-day American validation of Piketty's central thesis that the rate of return on investment generally exceeds the rate of economic growth. Indeed, Lazonick has documented that wealth in the United States today comes chiefly from retarding businesses' ability to invest in growth-engendering activity. The purpose of the modern U.S. corporation is to reward large investors and top executives with income that once was spent on expansion, research, training and employees. To restore a more socially beneficial purpose, Lazonick proposes scrapping the SEC rule that permitted rampant stock repurchases and requiring corporations to have employee and public representatives on their boards.

Lazonick's article does nothing less than decode the Rosetta Stone of America's economic decline. The reason only luxury and dollar stores are thriving, the reason German companies outcompete ours, the redistribution of income from workers to investors – it's all here, in Lazonick's numbers.

The lesson for Labor Day 2014 couldn't be plainer: Unless we compel changes such as those Lazonick suggests to our model of capitalism, ours will remain a country for investors only, where work is a sucker's game.

[CountDeMoney]

From Forbes.com

HBR: How CEOs Became Takers, Not Makers

Business leaders generally present themselves as the creators of jobs, the real makers of the economy, claiming to add value to their organization, to the economy and to society. But in the US over the last few decades, through the pervasive practice of share buybacks, the incumbents of C-suite have turned themselves into takers, not makers.

That's the thrust of "Profits Without Prosperity," an article by William Lazonick, professor of economics at the University of Massachusetts Lowell, in the September issue of Harvard Business Review.

Instead of creating value for their firms, their shareholders and society, top executives of these firms are, through the massive use of share-buybacks, doing the opposite: they are extracting value. Although the purported goal of share buybacks is to be "friendly to shareholders," the overall impact of share buybacks is to destroy long-term shareholder value, jobs and the economy.

Thus between 2003 and 2012, publicly-listed firms in the S&P 500 used a colossal amount of their earnings—54 percent or $2.4 trillion—to buy back their own stock. The article reveals that this wasn't done for the most part when stock prices were low: astonishingly, most of the big purchases came when the stock price was high. Why? "Because stock-based instruments make up the majority of executives' pay, and buybacks drive up short-term stock prices." These firms are engaged, the article says, in "what is effectively stock-price manipulation."

In addition to helping themselves through share buybacks, the C-suite also generated windfall benefits for other "takers" from the economy: activist shareholders. For instance, "in recent years, hedge fund activists such as David Einhorn and Carl Icahn—who played absolutely no role in [Apple's] success over the decades—have purchased large amounts of Apple stock and then pressured the company to announce some of the largest buyback programs in history." The transaction transferred large profits to the activists, with no gain to the real economy.

The consequences of these share buybacks are an economic, social and moral disaster: net disinvestment, loss of shareholder value, crippled capacity to innovate, destruction of jobs, exploitation of workers, runaway executive compensation, windfall gains for activist insiders, rapidly increasing inequality and sustained economic stagnation. Yet despite these obvious problems, the practice of share buybacks is now pervasive and increasing. According to Lazonick, share buybacks area now "an obsession", even "an addiction."

The situation is one of fundamental institutional failure. CEOs are extracting value from their firms. Business schools are teaching them how to do it. Institutional shareholders are complicit in what the CEOs are doing. Regulators do no more search for individual wrongdoers, usually those below the C-suite, while remaining blind to overall systemic failure. In a great betrayal, the very leaders who should be fixing the system are complicit in malfeasance. Unless our society reverses course, it is heading for a cataclysm.

How did "value creation" turn into "value extraction"?

How did this disaster happen? Lazonick's research reveals that the shift came in the late 1970s, i.e. at precisely the time that shareholder value theory got going.

    From 1945 to the late 1970s, the dominant approach was retain-and-reinvest. Firms "retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth—what I call 'sustainable prosperity.'"
    From the late 1970s to day, it became downsize-and-distribute: The principal focus has been on "reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality."

"Given incentives to maximize shareholder value and meet Wall Street's expectations for ever higher quarterly earnings per share (EPS), top executives turned to massive stock repurchases, which helped them 'manage' stock prices. The result: Trillions of dollars that could have been spent on innovation and job creation in the U.S. economy over the past three decades have instead been used to buy back shares for what is effectively stock-price manipulation."

The root cause: maximizing shareholder value

Lazonick is explicit on the root cause of the problem: the philosophy of "maximizing shareholder value" (MSV), namely, the idea that the purpose of a firm is to maximize shareholder value and increase the share price, or what Jack Welch has called "the dumbest idea in the world."

MSV theory ignores the claims of "other participants in the economy who bear risk by investing without a guaranteed return... As risk bearers, taxpayers, whose dollars support business enterprises, and workers, whose efforts generate productivity improvements, have claims on profits that are at least as strong as the shareholders'."

It also ignores Peter Drucker's foundational insight of 1973: the only valid purpose of a firm is to create a customer. It's through providing value to customers that firms justify their existence. Profits and share price increases are the result, not the goal of a firm's activities.

"Executives who subscribe to MSV," says Zalonick, "are thus copping out of their responsibility to invest broadly and deeply in the productive capabilities their organizations need to continually innovate. MSV as commonly understood is a theory of value extraction, not value creation."

Debunking the justifications for buybacks

Executives give four main justifications for open-market share buybacks, Lazonick says. They are: "I'm helping shareholders who own the company—everyone knows that." "We're preventing shareholder dilution." "We're buying when prices are low to strengthen the company." "We have run out of good investment opportunities." Not so, says Lazonick. He debunks them all.

    "Creating value for shareholders:" Wrong! Most share buybacks provide temporary wins, but systematically kill long-term value for shareholders.
    "Signaling confidence in the company's future." How can this be so, asks Lazonick, when "over the past two decades major U.S. companies have tended to do buybacks in bull markets and cut back on them, often sharply, in bear markets"? What sort of a game is it when executives "buy high and, if they sell at all, sell low"? Lazonick is unambiguous. It's "share price manipulation."
    "Offsetting the dilution of earnings from employee stock options" Bad idea! This defeats the purpose of using stock options in the first place, namely, to encourage long-term performance.
    "Nowhere to invest?" A smokescreen! This pretext signals, says Lazonick, that the chief executives are not performing their principal function of discovering new investment opportunities. In effect, executives are setting aside the hard work of creating sustained innovation, when they can—risk-free–make money for themselves and their colleagues with the stroke of a pen? Top management, says Lazonick, are not doing their jobs properly.

In any event, the case for shying away from investment because returns are low is weak. Dennis Berman in the Wall Street Journal points out that the returns on "net business assets" i.e. "actual stuff used in actual business," have historically been much higher than share buybacks. For instance:

    Honeywell International [HON] has been making about 4 percent on its share buybacks, compared to 13 percent on business assets.
    Oracle [ORCL] is spending half its cash flow in share buybacks, when the return on buybacks has been around 5 percent, compared to around 32 percent on past investments.

Why don't CEOs see this? Clayton Christensen has argued in HBR that the analytic tools in use, such as the various ways of measuring rates of return, have led managers to go for short-term investments and miss real investment opportunities.

If the members of the C-suite are not doing their jobs properly, it has yet to register in their paychecks. C-suite compensation is now a large multiple of what it was when firms were doing their jobs properly and focused on "retain and reinvest." In the period 1978 to 2013, CEO compensation increased by an astonishing 937 percent, while the typical worker's compensation grew by a meager 10 percent. As Upton Sinclair noted long ago, "It is hard to get a man to understand something when he is being paid not to understand it."

Moreover, this is not a situation where each CEO is on his or her own. The problem is compounded by cronyism and reciprocal rent-seeking. Thus in a recent study published in the Accounting Review, an astounding 62 percent of directors, who had a disclosed friendship with the CEO, said they would cut the budget for research and development in order to assure the bonus for their friend, the CEO. The most highly paid people, who should be actively leading in fixing the system, are busy helping their friends extract rents from it. The failure in leadership is breathtaking.

The reasons given by the C-suite for share buybacks thus are shields to hide what's really going on. Lazonick offers "a simple, much more plausible explanation for the increase in open-market repurchases: the rise of stock-based pay. Combined with pressure from Wall Street, stock-based incentives make senior executives extremely motivated to do buybacks on a colossal and systemic scale." In business, it's now official: greed is seen as good.

Good buybacks and bad

True, not all share buybacks are bad. Lazonick argues that some private share buybacks are justifiable. Share buybacks thus could make sense "when the share price is—truly—below the intrinsic value of the productive capabilities of the company and the company is profitable enough to repurchase the shares without impeding its real investment plans." But these "constitute only a small portion of modern buybacks."

Surgical interventions with private tenders are the exception. Most of the $2.4 trillion in share buybacks have been made on the open market, often when the share price is high. Open-market share buybacks generally "come at the expense of investment in productive capabilities."

Share buybacks are thus being undertaken, says Lazonick, for "what is effectively stock-price manipulation." Theoretically, the SEC has power to intervene to prevent share price manipulation. But here, as in other areas, the SEC is asleep at the wheel. "The SEC has only rarely launched proceedings against a company for using them to manipulate its stock price."

The consequences of share buybacks

The economic consequences of pervasive share buybacks are dire:

Net disinvestment: "the amount of stock taken out of the market has exceeded the amount issued in almost every year; from 2004 through 2013 this net withdrawal averaged $316 billion a year. In aggregate, the stock market is not functioning as a source of funds for corporate investment."

Declining shareholder value: Even shareholders are finally waking up that maximizing shareholder value actually destroys long-term shareholder value. Thus Laurence Fink, the chairman and CEO of BlackRock, the world's largest asset manager, in an open letter to corporate America in March 2014. "Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks."

Crippling the capacity to innovate: With 54 percent of earnings going to share buybacks, and 37 percent going out in dividends, there is little left for investing in innovation. "Many academics—for example, Gary P. Pisano and Willy C. Shih of Harvard Business School, in their 2009 HBR article "Restoring American Competitiveness" and their book, Producing Prosperity,—have warned that if U.S. companies don't start investing much more in research and manufacturing capabilities, they cannot expect to remain competitive in a range of advanced technology industries."

Destruction of jobs: "While the top 0.1% of income recipients reap almost all the income gains, good jobs keep disappearing, and new ones tend to be insecure and underpaid."

Exploitation of workers: Workers are no longer receiving their fair share of the gains in productivity that their work has generated. Lazonick's article shows how since the mid-1970s, the share of returns that should have gone to workers has been increasingly "diverted" into share buybacks, dividends and executive compensation. Trickle-down economics doesn't work when the gains made by workers are being diverted to the pockets of their bosses.

Runaway executive compensation: Buybacks are driven by, and contribute to, runaway executive compensation—an almost tenfold increment over the last couple of decades.

Windfall gains for activist investors: The windfall gains made by hedge fund activists David Einhorn and Carl Icahn from the buybacks at Apple, undertaken at their urging, are in effect the fruits of a massive gambling casino that adds nothing to the real economy.

Increasing inequality:  "Buybacks contribute to economic inequality in a major way...  "Though corporate profits are high, and the stock market is booming, most Americans are not sharing in the economic recovery... Instead of investing their profits in growth opportunities, corporations are using them for stock repurchases..."

Economic stagnation: "Because they extract value rather than create it, their overuse undermines the economy's health."

Moreover, practices like share buybacks, writes Roger Martin in Fixing the Game, generate inauthenticity in executives, filling their world with encouragements to suspend moral judgment. They receive incentive compensation to which the rational response is to game the system. And since they spend most of their time trading value around rather than building it, they lose perspective on how to contribute to society through their work. Customers become marks to be exploited, employees become disposable cogs, and relationships become only a means to the end of winning a zero-sum game.

A kind of reverse-Ponzi scheme

In the US, many publicly-owned companies have thus turned into a kind of giant reverse Ponzi-scheme. A Ponzi-scheme attracts investments into a firm on the false premise that it is a valuable company. A reverse-Ponzi scheme takes a valuable firm and systematically extracts value from it. The firm appears to be making profits even as it systematically destroys its own earning capacity. A reverse-Ponzi scheme is what's happening now in many publicly owned American firms.

By themselves, massive share buybacks are a bad idea. But when combined with other types of financial engineering, the consequences are even worse. Take IBM [IBM]. It has combined share buybacks with tax gimmicks, capability-crippling outsourcing, unsustainable work pressures, relentless cost-cutting, automatic culling of staff, fading technical expertise, strengthened bureaucracy, acquisitions ahead innovation, and reliance on financial incentives, and has committed to doing so over two successive five-year period. The result is sagging staff morale, an imploding business model, a cloudy future strategy and systematic destruction of long-term shareholder value.

What to do about share buybacks?

What to do about such a massive intractable problem? Lazonick's article has some suggestions. I have more: if we look carefully, I believe that we can find a clear bright light within this heart of darkness.

What is clear that the solution to fundamental institutional failure goes beyond passing a few regulations or changing the behavior of a few CEOs. It involves a whole set of institutions: business firms, institutional investors, legislators, regulators and business schools will need to think and act differently. The good news is that some of this is beginning to happen, as a consensus is emerging on the way forward.

Pervasive share buybacks are an economic, social and moral disaster: they contribute to loss of shareholder value, crippled capacity to innovate, runaway executive compensation, destruction of jobs, rapidly increasing inequality and sustained economic stagnation. Yet share buybacks have become "an unhealthy corporate obsession," even "an addiction."

The situation is one of fundamental institutional failure. CEOs are extracting value from their firms. Business schools are teaching them how to do it. Institutional shareholders are complicit in what the CEOs are doing. Regulators pursue individuals but remain indifferent to systemic failure. Rating agencies reward malfeasance. Analysts applaud short-term gains and ignore obvious long-term rot. Politicians stand by and watch. In a great betrayal, the very leaders who should be fixing the system are complicit in its continuance. Unless our society reverses course, it is heading for a cataclysm.

The solution to fundamental institutional failure goes beyond passing a few regulations or changing the behavior of a few CEOs. It involves changes in behavior in a whole set of institutions and actors: CEOs and their firms, investors, legislators, regulators, rating agencies, politicians, analysts, thought leaders and business schools all need to think and act differently. The good news is that some of this is beginning to happen, as a consensus emerges on the way forward.

Four reforms proposed by HBR

In his HBR article, Lazonock puts forward four proposals for reform:

End open-market buybacks. In a 2003 update to Rule 10b-18, the SEC explained: "It is not appropriate for the safe harbor [for share buybacks] to be available when the issuer has a heightened incentive to manipulate its share price." In practice, though, the stock-based pay of the executives who decide to do repurchases provides just this 'heightened incentive.'" To correct this glaring problem, the SEC should rescind the safe harbor.

Rein in stock-based pay. "Overall the use of stock-based pay should be severely limited. Incentive compensation should be subject to performance criteria that reflect investment in innovative capabilities, not stock performance."

Transform how boards that determine executive compensation. "Boards are currently dominated by other CEOs, who have a strong bias toward ratifying higher pay packages for their peers." Other risk-takers such as "taxpayers and workers should have seats on boards. Their representatives would have the insights and incentives to ensure that executives allocate resources to investments in capabilities most likely to generate innovations and value."

Tax reform: "Congress should fix a broken tax regime that frequently rewards value extractors as if they were value creators and ignores the critical role of government investment in the infrastructure and knowledge that are so crucial to the competitiveness of U.S. business."

What's missing: The root cause

Lazonick's prosposals are sensible, but they're not enough. Thus his article itself identified as the root cause of the problem, the notion that the purpose of a firm is to maximize shareholder value. Unless we do something about the root cause, the problem will remain.

So long as maximizing shareholder value governs the thinking of CEOs, , institutional investors, legislators, regulators, politicians, analysts and business schools, changes in a few regulations or the tax code won't make much difference. Firms and their leaders will find ways around such changes.

We have here an instance of intellectual enslavement. As John Maynard Keynes pointed out: "Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

Few people today read the NYT article by Milton Friedman in 1970 that launched the shareholder value movement or know that it assumed its conclusion from the outset and then proceeded to offer incompatible quasi-legal proofs. Even less do they attempt to read the widely-cited article co-authored by Michael Jensen in 1976, which clothed the same preconceived conclusion in nonsensical psychology and abstruse mathematics.

The rotten foundations of shareholder value theory in the writings of Friedman and Jensen are now lost to the public view. Yet the unthinking recitation of the dictum that "the purpose of a firm is to maximize shareholder value" is on the lips of most CEOs, institutional investors, legislators, regulators, politicians, analysts and business school professors. Recently, even the President of the United States himself paid unwitting homage to it.

Maximizing shareholder value is the intellectual pillar on which this pervasive and pathologically asocial behavior on the part of our business leaders ultimately rests. Legislation and rules may help, but they won't solve the problem until this noxious theory is erased from brains of the C-suite.

A very bad idea

Let's first of all remind ourselves just how bad maximizing shareholder value is. It causes not only share buybacks, but also a host of other problems, including massive offshoring of manufacturing, thereby destroying major segments of the US economy, undermining US capacity to compete in international markets and killing the economic recovery.

In banking, it is responsible for:

Trading gone awry, as in JPMorgan's "London Whale."
Price fixing at LIBOR.
Foreclosure abuses.
Money laundering.
Facilitation of tax evasion.
Misleading clients with worthless securities.
Gambling in the $700 trillion derivatives market.
High frequency trading.
Trading in secret "dark pools."

The emerging consensus on the way forward

Change won't happen merely by pointing out that shareholder primacy is a bad idea. Bad ideas don't die just because they are bad. They hang around until a consensus forms around another idea that is better.

Fortunately, a consensus is emerging around a better idea. The idea isn't new. It's Peter Drucker's foundational insight of 1973: the only valid purpose of a firm is to create a customer. It's through providing value to customers that firms justify their existence. Profits and share price increases are the result, not the goal of a firm's activities

Drucker's idea has fresh urgency today because of the epic shift in power in the marketplace from seller to buyer. As a result of globalization, customers now have choices and the Internet provides instant and reliable information about those choices and an ability to communicate with other customers. Consequently the customer is now in charge. As Roger Martin has pointed out, we live now in the Age of Customer Capitalism. Firms that focus on short-term share price ahead of customers are unlikely to survive for long.

In the last few years, more than a score of books have been written about this better idea, including notably Roger Martin's own book, Fixing The Game. The language, terminology and emphases differ somewhat from book to book, but there is a great deal of common ground on the overall direction of change.

Moreover in a recent report from the Aspen Institute, which convened a cross-section of business thought leaders, including both executives and academics, the most important finding is that a majority of the thought leaders who participated in the study, particularly corporate executives, agreed that "the primary purpose of the corporation is to serve customers' interests." In effect, the best way to serve shareholders' interests is to deliver value to customers.

The direction of change is simple, clear and measurable. It doesn't involve a complicated exercise of weighing the interests of multiple stakeholders.

There will remain debates about the details of implementation and the nuancing and emphasis and the language and so on. Better and more sophisticated measures will emerge. But we don't need to wait for these improvements in order to move forward. The broad direction of needed change is now clear.

We are thus beginning to see a great awakening—a foreshadowing of a great transformation in the way our society functions. We need to recognize it, applaud it, encourage it, nurture it, and protect it from those with an interest in preventing it from happening.

Change is hard, but doable

Interestingly, the main defense of the status quo is likely to be that it will be hard to change entrenched habits and practices. One hears this even from those, like Joe Nocera in the New York Times, who believe that shareholder value is a very bad idea.

Well, surprise! Change is always difficult. Shareholder value is a big societal problem and big actions are needed to fix it. It cannot be fixed by single individuals acting alone. Actions by the entire society are needed.

It's important to keep in mind that we have solved such big societal problems before: slavery, cigarettes, industrial poisoning, to name just a few. As Roger Cohen pointed out just this week in the New York Times, it would be wrong to underestimate "America's capacity for reinvention, its looming self-sufficiency in energy, its good demographics and... its vigor."

The science of getting change in asocial behavior

We can also benefit from what science has also learned about what works—and what doesn't—in changing sustained asocial behavior and addictions. The standard responses—regulations, general rewards and punishments—are generally ineffective. Instead, to get sustained change in behavior, one also needs to change the context in which the behavior is occurring and focus more precisely on the incentives and disincentives for the specific change needed.

Effective action involves:

Explicitly identifying the changed behavior.
Measuring improvement.
Recognizing progressive improvement.
Creating expectations of regular improvement:
Modeling the desired behavior.
Avoiding actions that reward asocial behavior.
Identifying specific instances of offending behaviors.
Training in good behavior.
Connecting the reward with the specific behavior expected.

Some CEOs already moving

Change obviously begins with the CEOs themselves. Some have already begun.  Thus while many CEOs are still managing quarter to quarter, looking at short-term results in a traditional paradigm, other CEOs have built a culture of innovation and long-term value and developing their people.

There are now more than a handful of famous publicly owned firms, along with many privately owned firms and small and medium enterprises. None of these firms are perfect, and even some, like Apple [AAPL] have on occasion engaged in large-scale share buybacks. But by and large, these firms are focused on adding long-term value, rather than maximizing the stock price in the short term.

Such firms will become a steadily larger part of the economy—the Creative Economy—as this radically different management focus on customers ahead of share price will be the basis for success in a marketplace in which the customer is collectively in charge.

In 2009, at the Aspen Institute's Corporate Values Strategy Group twenty-eight leaders representing business, investment, government, academia, and labor (including Warren Buffett, CEO of Berkshire Hathaway and Lou Gerstner, former CEO of IBM) endorsed a call to end the focus on value-destroying short-term-ism in our financial markets and create public policies that reward long-term value creation for investors and the public good.

Also in 2009, the much-heralded supposed exemplar of shareholder primacy, Jack Welch, declared it to be "the dumbest idea in the world." Current CEOs are also speaking out. In 2013, Paul Polman, the CEO of Unilever has declared that it is "time to put an end to the cult of shareholder value." In July 2014, Xavier Huillard, the current Chairman and Chief Executive officer of Vinci in France declared, "To say that our enterprises belong solely to our shareholders is totally idiotic."

Yet CEOs of publicly owned firms still live in a world in which there are strong pressures to do the opposite of what is good for their organization and society. When a whole society is on the wrong track, as Hannah Arendt has pointed out, many will follow unthinkingly and do whatever the incentives and directives dictate.

CEOs pursuing shareholder primacy are thus not wrongdoers in the sense of people who deliberately set out to do wrong. They are people who find themselves in situations where actions that are causing great harm to their firm and to society are seen as normal and expected and even strongly rewarded. CEOs who are going along with the status quo are not thinking about the consequences of their actions. Many will take the easy path and simply accept the status quo until the society itself changes. Yet CEOs are intelligent and well-educated. They are obviously capable of doing some hard thinking.

As outlined below, actions by society as a whole are needed to spur CEO thinking and speed up the pace of change.

Chief Financial Officers

Chief Financial Officers [CFOs] often act as guardians of "the single objective financial function" by which shareholder value is enforced in decisions taken throughout the whole organization. Every decision and action is evaluated in terms of its impact on short-term earnings per share.

The financial function needs to be redefined so that it takes into short-, medium-and long-term interests of the organization.

In the Age of Customer Capitalism, the objective decision-making criterion for all organizational decisions needs to be in terms of "adding value to customers," not simply finance results. Financial considerations are still present, but they are not the only driver of actions.

As Clayton Christensen has argued in HBR, different analytic tools need to be used.

The leading indicator for short-term decision-making becomes not earnings per share, but rather a measure of customer delight, such as the Net Promoter Score. The Net Promoter Score (NPS) methodology was developed by Fred Reichheld and described in The Ultimate Question 2.0. Asking a single question ("How likely is it that you would recommend this [product or service or company] to a colleague or friend?") can provide a quick and reliable guide as to whether customers are being delighted or not. True, the measures can be gamed and represent the beginning, not the end, of the search for generating customer value. But it is a minimal first step that, until better measures are developed, should become as routine and as publicly accessible in big corporations as audited financial statements.

For the longer term, design thinking as outlined by Roger Martin in The Design Of Business, needs to be deployed to explore and validate bold investments in innovation and market-creating strategies. Instead of using analyses of past data, which shed little light on the future, firms need to be deploying abductive reasoning, in terms of "What could become true?" and "What would need to happen for that to become true?"

These new tools mean a new role for the Chief Financial Officer. Instead of the "single objective finance function" being the final arbiter on all decisions, the finance function ensures that the firm makes enough profits to continuously innovate and add value to customers. Instead of Chief Financial Officers spending time single-mindedly focused on reducing costs and chasing profits, they serve in a supporting role of ensuring that the firm continues to be profitable as it steadily innovates. Profits become a result, not a goal.

This is not just about the adoption of new metrics. It's about a shift in power: who is calling the shots in the firm. Currently, the finance function are in charge because it can quickly move the needle on quarterly profits and thus assure the CEO's bonus. CFOs are smart and articulate, even if they don't always know much about the firm's product or services. The people who understand the customers and create real value for them—the product engineers, the designers and the marketing folks—who in the past got shoved aside because they didn't "move the needle" in terms of quarterly profits, must now have their say.

Compensation committees

We cannot expect CEOs and CFOs to act differently when multi-million dollar bonuses are dangled in front of them by compensation committees to act irresponsibly.

As Lazonick's article suggests, stock-based pay should be reined in. "Overall the use of stock-based pay should be severely limited. Incentive compensation should be subject to performance criteria that reflect investment in innovative capabilities, not stock performance."

The problem is structural, with cronyism and reciprocal rent-seeking. Thus in a recent study published in the Accounting Review, an astounding 62 percent of directors, who had a disclosed friendship with the CEO, said they would cut the budget for research and development in order to assure the bonus for their friend, the CEO.

Given the structural nature of the problem, structural solutions are needed: the composition of boards and compensation committees should also be revisited. As Lazonick suggests: "Boards are currently dominated by other CEOs, who have a strong bias toward ratifying higher pay packages for their peers." Other risk-takers such as "taxpayers and workers should have seats on boards. Their representatives would have the insights and incentives to ensure that executives allocate resources to investments in capabilities most likely to generate innovations and value."

Executives should be rewarded for progressive improvement. Investors should reward firms that make gains in their relative NPS, even if in absolute terms, their NPS is still low. Firms should be recognized for progress in the right direction, even if there is still a long way to go.

Regulators

The C-suite currently receives rewards for asocial behavior (short-term financial performance and stock market gains) and no more than slap-on-the-wrist punishments on the rare occasions when bad behavior is actually identified as such, (SEC settlements, court cases against individuals below the level of the C-suite).

When many big corporations are involved in value-destroying activities on a regular basis, then the challenge for regulators is not one of responding reactively to spot the odd individual wrongdoer, but to think proactively as to how to inspire change in the way of doing business that is deeply flawed. This is a challenge for instance that the SEC has yet to undertake.

Regulators should require regular reporting on progress towards the organization's primary goal: the customer. With most big corporations, investors have little information about how it is serving customers. Yet a standard methodology for measuring customer satisfaction is now available. Hundreds of firms are now conducting audited NPS and some firms are now publishing their results, such as Philips [PHG], Schwab [SCHW], Intuit [INTU], Progressive [PGR], and Allianz [AZ]. Reporting such information to shareholders should become compulsory.

Regulators should have the power to include compulsory training of executives as part of any settlement. Just as in cases of serious traffic offenses, the courts should have power to require executives and traders to take compulsory training in acting more responsibly.

Regulators should be able to impose sanctions with teeth. What to do when nothing else works? Enhanced financial sanctions will have little impact when they don't affect those responsible: the executives and the traders. In addition, regulators should have the power to remove recalcitrant actors from the game.

Educating investors

Investors themselves must learn that chasing short-term gains is a fool's errand. So long as they focus on, and reward, short-term gains in quarterly earnings, without regard to the fundamentals of how those gains were generated, they are not only engaging in predictably irrational behavior: they are reinforcing conduct that will soon undermine those very returns. Instead, the investors need to realize that slavish pursuit of short-term gains tends to result in medium-term losses in value. They need to turn their attention to those aspects of corporate performance that create real value for shareholders, i.e. customer delight.

Some investors will continue to chase short-term returns. If share buybacks are outlawed, the easy gains from those activities will make short-term gains that much harder to predict and capture. Firms will have to actually earn their returns, rather than simply manipulating the stock price.

Institutional investors

Institutional investors have a particular responsibility in showing the way forward and refraining from participating in behavior dictated by short-term moves in the share price. Thus Lazonick's article cites Laurence Fink, the chairman and CEO of BlackRock, the world's largest asset manager, in an open letter to corporate America in March 2014, called on companies to stop borrowing "to boost dividends and increase share buybacks." Yet BlackRock itself was a participant in the cabal that set out to do exactly that in the case of IBM. Major shareholders must cease being complicit in these shenanigans.

Politicians

The political debate about the reprehensible practice of inversion—moving the firms' headquarters to reduce taxes overseas—has now brought the discussion of shareholder value theory to the highest political levels. Thus in July 2014, President Obama explained his view of shareholder value theory.

President Obama: People are paid to maximize profits. But people are also paid to be good corporate citizens. They're also paid to make sure that they're thinking about– in addition to shareholder value– how do you grow a company over the long term.

Technically, of course, in pure mathematical terms, it's not possible to maximize more than one variable. So if it is true, as President Obama suggests, that firms have to be thinking about things in addition to profits, then they are not "maximizing" profits.

Perhaps this was a slip of the tongue. But not only should such slips be avoided.  In addition, we need political leaders who stand up and fight for what is the right idea.

Doris Kearns Goodwin in her new book "The Bully Pulpit" discusses the massive economic inequality in the US in the early 20th century and how Theodore Roosevelt had only his voice to use against the injustices going on in banking, labor and industry. Congress didn't want to hear or do anything about it. The key was the stories he told about real people, and that the stories got repeated everywhere people gathered because there was only newspapers and conversation. So it was story telling (and retelling) that built up the momentum for reform that eventually succeeded.

We need political leaders who have the understanding and courage to tell the right stories.

Business schools

Business schools in particular have a responsibility to stop teaching shareholder value in their core curriculum to their students and start systematically teaching the better idea: the primary purpose of the corporation is to serve customers' interests.

Business schools must recognize that it is not enough to teach Customer Capitalism as an optional subject. Textbooks that teach shareholder value theory as a basic assumption must be discarded.

Analysts and the press

What is good performance for a corporation? When analysts exult because a stock is "on fire", as I heard this morning on CNBC, they need to be analyzing what is the underlying basis of its performance. Is the stock on fire because of genuine strong performance, or is it financial engineering of the worst kind? This kind of analysis is rarely heard now from analysts. It needs to become the norm.

Analysts and journalists should also point out good behavior. They should draw attention and celebrate firms that area excelling in customer delight as shown by audited NPS scores. For instance, in the financial sector, USAA is the leading bank, with an NPS of plus 87 percent, whereas most of the big banks are near zero or negative.

Rating agencies

The rating agencies must also clean up their act. The rating agencies were complicit in condoning and even rewarding some of the riskiest practices in the 2008 meltdown; they received significant compensation for doing so. They must take a harder look at the noxious consequences of share buybacks, particularly when funded by anomalously cheap borrowing.

A plan of action

Obviously, this is a large agenda involving many people and institutions all around the world.

One option is to despair of getting change, continue as now and watch society undergo steady economic, social and moral decline.

Here's another, more positive, way of how the future might unfold:

    Let's suppose that most of the world's thought leaders on management were to come together to address and help resolve the issues facing management today at the same place at the same time.
    And what if their discussion took place under the guiding spirit of a thinker like the late Peter Drucker, who enjoyed universal respect and whose wisdom brought out the best in everyone, so that the focus was less on emphasizing the differences between their individual contributions and more on how much they had in common?
    What if the thought leaders were to explicitly embrace a common view of the way forward, with passion and commitment?
    And what if this was a common vision of a revitalized concept of leadership and management began to be seen as a guiding beacon for organizations all around the world?

Time will tell, but the first steps have already been taken.

Drucker Forum 2014

The place and date for bringing many of the world's management thought leaders together are set: the Drucker Forum in November 13-14, 2014 in Vienna, Austria.

"We have arrived at a turning point," says the launch abstract of the Global Peter Drucker Forum 2014. "Either the world will embark on a route towards long-term growth and prosperity, or we will manage our way to economic decline."

Many of the world's thought leaders in leadership, management and strategy will converge on Vienna in November for the Forum. The theme of the 2014 Forum is: "The Great Transformation—Managing Our Way to Prosperity."  The abstract of the Forum is here. The participating speakers are listed here.

Is this a time for debate or for action?

In the past, progress in moving away from shareholder primacy has been stymied by hesitation about the viability of any alternative, as the single, clear measure of corporate performance. Even those who condemn shareholder value often suggest global debate about what to do, rather than action.

We are now arriving at a time when there is not only widespread recognition that shareholder primacy is indeed "the dumbest idea in the world," but also an emerging consensus as to what would constitute a better way forward.

If this emerging consensus to strengthen, thought leaders will need to set aside any minor differences on terminology, emphases, sequencing and so on, and voice their support for the broad direction of change. They will need to recognize that they will have a much louder voice as part of a joint effort for change than a cacophony of individual voices urging apparently different solutions.

To be sure, there is still plenty of room for substantive debate on the details of implementation and the nuancing and emphasis and the language of change and so on, but the emerging consensus of the way forward is now becoming clear. What is needed is the courage and wisdom to pursue it.

[Grallon]

Sudden hard-on about hunting down and slaughtering capitalist parasites.



G.

[Grey Fox]

@Seedy. Preach it, brother!

Public shareholding is dangerous for our society.

[Tamas]

https://www.youtube.com/watch?v=PF_iorX_MAw

[Tamas]

@Seedy. Preach it, brother!

Public shareholding is dangerous for our society.

States which eliminated it have performed soooooo much better the last 50 years.

[garbon]

Off to the Labor Day Parade!

[Grey Fox]

@Seedy. Preach it, brother!

Public shareholding is dangerous for our society.

States which eliminated it have performed soooooo much better the last 50 years.

There are more alternative to capitalism than communism.

[Tamas]

@Seedy. Preach it, brother!

Public shareholding is dangerous for our society.

States which eliminated it have performed soooooo much better the last 50 years.

There are more alternative to capitalism than communism.

You are living in a corporatism, friend, not capitalism. In true capitalism corporations would not be state protected and sponsored tools of money grabbing. The problem is that you (we) make legislative powers that can interfere with the economy. And then act surprised when those legislative powers fell prey to the strongest influences.

[Razgovory]

So when was the period of "Pure" capitalism?

[Ideologue]

Doris Kearns Goodwin in her new book "The Bully Pulpit" discusses the massive economic inequality in the US in the early 20th century and how Theodore Roosevelt had only his voice to use against the injustices going on in banking, labor and industry. Congress didn't want to hear or do anything about it. The key was the stories he told about real people, and that the stories got repeated everywhere people gathered because there was only newspapers and conversation. So it was story telling (and retelling) that built up the momentum for reform that eventually succeeded.

Ha, yeah, succeeded thirty years later, and continued to succeed for thirty years more, when it failed again for forty and will continue to fail for decades to come.

Even assuming a natural lifespan, we won't live to see the shining city on the hill, if it even exists.

Anyway, when I say it--that CEOs are overpaid, tend to destroy value, and should be curbed--I'm a crazy person.  When some economist or Forbes says it, it must be true.

[CountDeMoney]

Anyway, when I say it--that CEOs are overpaid, tend to destroy value, and should be curbed--I'm a crazy person.  When some economist or Forbes says it, it must be true.

They say it with gravitas.

[Ideologue]

They say it with three and half movie reviews' worth of words and a lot of fucking repetition, too.

[Admiral Yi]

It's interesting to me that those who don't own stock, and are therefore the least exposed to the alleged depredations of CEOs, are the quickest to criticize.

[Ideologue]

Wow, looks like someone didn't read the long, boring article.