Thursday, December 22, 2011

"The Dumbest Idea in the World"

In a recent article in the online version of Forbes, Steve Denning writes intriguingly of the American corporate model and its penchant for short-term profit seeking. His views are something of a vindication for those, myself included, that have long felt the American management system is flawed. His basic premise is that in the mid 1970s US corporations began to shift their focus away from their products and processes, and towards catering to the short-term interests of investor.

Denning cites the work of Roger Martin in his new book, Fixing the Game. As Denning relates, 'Martin says that the trouble began in 1976 when finance professor Michael Jensen and Dean William Meckling of the Simon School of Business at the University of Rochester published a seemingly innocuous paper in the Journal of Financial Economics entitled “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.'"

In short, Martin says US corporations began a fateful and undue focus on the interests of investors in the 1970s. And that means, generally, the short-term interests of individuals and firms that are less interested in what a company makes, or how it makes it, and more interested in making money off the company's stock, preferably sooner than later. As a result, managers, especially CEOs, are motivated to turn in quick, impressive results, measured primarily by quarterly earnings. 

CEO compensation has become tied to the stock price, not product quality, and that is because they too are focused on the short-term. Boosted earnings will please the investor class, and also line the CEOs' pockets through stock options. They have less incentive to focus on a company's long-term health, the way a founder would, and more on making sure their stock options pay out. The ability to quickly increase "shareholder value" is thus the holy grail by which investors judge management.

Accordingly, both Steve Denning and Roger Martin argue that corporate America's dogma regarding the importance of shareholder value, e;g. making the investor class rich, is proving ruinous. Martin specifically identifies US business schools as culprits in promoting the primacy of shareholder value. Denning reminds us that none other than Jack Welch, legendary former head of GE, said the concern over maximizing shareholder value was "the dumbest idea in the world."

Now let me take a moment to remind readers what most business writers don't often explicitly acknowledge: business in America, especially big business, is predominately Republican. More to the point, management at major US corporations is conservative, often deeply so. The American corporate model is, or has become, a conservative model; labor should be cheap, regulations should be minimal, taxes are always too high, and business should be free to move cash and assets around, including overseas, as it sees fit. This model implicitly says that the sum and substance of capitalism is the microeconomic interests of the corporation and the investors to which it is supposed to owe its greatest allegiance: that allegiance must prevail over the broader interests of country, citizens, and communities. As it turns out, that includes just about everyone in the world except the investor class and their subset, upper management. It is business economics for the chronically selfish and short-sighted.

In other words, the interests of the 1% must prevail over the 99%. Anything less is socialism and an invitation to stagnation and decline. Real patriots must give the 1% all they want or you will jeopardize civilization. And if you have not noticed how much further to the right the Republican party--starting notably with Ronald Reagan--has helped both corporations and the investor class reap ever higher portions of economic output, then you are not paying attention. 

So it is grimly satisfying to see some business thinkers and leaders, and not just those on the Left, questioning the efficacy of a model that obscenely enriches the few while it provides decreasing benefits for most. 

Again, Steve Denning provides an example. He writes:
The new bottom line of business is customer delight. If a firm isn’t delighting its customers, the prospects of its long-term survival in today’s highly competitive low-growth economy aren’t promising. Fortunately, as a result of almost three decades of research by Fred Reichheld and his colleagues at Bain, we have a robust methodology for measuring customer delight. It’s the Net Promoter Score discussed in the second edition of The Ultimate Question 2.0 published in September 2011.
The parameter they developed, the Net Promoter Score, basically attempts to quantify (crucial for numbers-obsessed business schools) how well companies are winning and keeping satisfied customers.

What a novel thought; actually pleasing the customer with an eye towards long-term loyalty. This is beginning to sound almost progressive; worry about your products, and how you treat customers and workers, and the stock price will follow suit. Your allegiance should be to those who build and buy your products and services.

It's enough to give Ayn Rand a fit.

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