Corporate constituencies: shareholder value vs. real performance

December 27, 2011 12:27 PM

“On the face of it, shareholder value is the dumbest idea in the world” — Jack Welch, 2009. As GE’s CEO in the 80s, however, Welch championed corporate focus on shareholder returns. “Converts to the creed”, the Economist summarizes, “had little time for other ‘stakeholders’: customers, employees, suppliers, society at large and so forth.” What went wrong? Steve Denning describes how such a stance is counterproductive, creates turmoil in capitalism and fosters an environment in which “CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services.”
posted by the mad poster! (38 comments total)

The other capitalism: stakeholder firms in Germany. (pdf)
posted by mek at 12:57 PM on December 27, 2011 [3 favorites]

Why does it seem that so often what seems somewhat obvious to the casual observer is some kind of blinding revelation to the business and economic press.

So a myopic short-term focus is detrimental to long-term success. Got it.
posted by Hello, I'm David McGahan at 1:02 PM on December 27, 2011 [24 favorites]

Jack Welch: Capitalist Tool.
posted by sfts2 at 1:07 PM on December 27, 2011

I don't like his grapefruit juice neither!
posted by TwelveTwo at 1:08 PM on December 27, 2011 [7 favorites]

Just goes to show you there are only two products in the business world, profits and widgets. Which category do you think those "other stakeholders" fall into?
posted by Blue_Villain at 1:13 PM on December 27, 2011 [1 favorite]

Ever notice how companies like Apple, for example, constantly "beat analyst expectations"?
I remember reading somewhere (sorry, my link-finding skills are failing...) about how Apple basically forces analysts to use their given internal expectation numbers by threatening to withhold access to information. This way, the company is able to set themselves up to beat their own expectations quarter after quarter.
posted by musicismath at 1:15 PM on December 27, 2011 [2 favorites]

Blue_Villain wrote: Which category do you think those "other stakeholders" fall into

Collateral damage.
posted by wierdo at 1:24 PM on December 27, 2011

Not all large companies are run with this mindset, but I've seen enough of it that it's pretty much disabused me of the notion that we have a healthy, well-functioning corporate landscape. I've seen so many jobs and so much potential destroyed in the name of short term bottom line thinking promulgated by executives who were simply gaming the system: gut your "overhead", outsource everything, cut costs dramatically, cancel R&D, etc., then reap the reward of bonuses and whatever other performance-based compensation, then leave and be gone by the time people start waking up to the fact that there simply is no business left and the whole thing is doomed. I feel like I'm turning into chicken little with my commentary here lately, but this just feels increasingly broken. I've seen this take down everything from several hundred million dollar internet companies to internationally recognized institutions and it doesn't seem to be slowing down.
posted by feloniousmonk at 1:30 PM on December 27, 2011 [26 favorites]

My general feeling about this is that most companies should avoid going on the public markets in general. But I know there are several mitigation strategies and that being privately held is no guarantee that all owners will have a healthy long term view. This is why I'm in favor of 'opinionated' corporations in general; it's almost a joke to some degree that corporations are going to profess values, but there's a real difference between companies that do make an effort to have a personality that aligns with customers' values regardless of such adherence causing their products/services to be more expensive and companies that make no such effort.
posted by the mad poster! at 1:37 PM on December 27, 2011 [1 favorite]

I remember reading somewhere... about how Apple basically forces analysts to use their given internal expectation numbers by threatening to withhold access to information. This way, the company is able to set themselves up to beat their own expectations quarter after quarter.

After reading those articles, I'm hard pressed to fault The Steve from handling it this way. Seems like he recognized the dilemma and successfully insulated his baby from it.
posted by fatbird at 1:39 PM on December 27, 2011 [1 favorite]

I was once picked up by an employer as part of an acquisition right before the company went public. I did my research about who I'd be working for and the buzz was generally positive even if I didn't like the actual industry very much. (It involved a lot of borderline SEO stuff.) Because I worked on the editorial side I got to see how my new bosses dealt with freelancers, and things were pretty good initially. They weren't as institutionally respectful toward of "the editorial help" as we'd been at my last company, but what they lacked in empathy and flexibility they made up for in efficiency: Checks went out on time, and when we needed small changes to contracts or rates to accommodate high performing writers, we got them.

Then the IPO happened and everything went to hell. Meetings stopped being about how to execute well and started being about "what the Street likes to see." There were a few layoffs and editorial managers were told that we were to just drop any outstanding assignments with our freelancers for a month because it was "time to focus on quality."

All the managers knew that the issue was margins: We'd been torpedoed by Panda, and some key producing sites were badly hurt. In order to get margins in line with expectations they just decided to slash every single expense they could, and they started by screwing freelancers out of agreed upon assignments then running around panicking because traffic bottomed out (which is what it does when your website stops providing new content).

Middle management positions were turnstiles, no plans we made survived to full implementation because upper management lost any ability to think about long-term value, and it seemed like teams were being shuffled around or split up every few weeks. The short-term thinking became deep rot.

I'm not sure how, as a prospective employee, one can gauge a company's culture when it comes to street-driven thinking, but if I ever have to leave my current, small, non-publicly-traded employer I'll have to figure that out: I don't think I want to go back to the sort of culture my ex-employer's IPO created.
posted by mph at 1:48 PM on December 27, 2011 [10 favorites]

There is one major problem with looking at "Shareholder value" and that's the fact that, when you look at middle class people with pension funds, the shareholders often have multiple relationships with the company.

Let's look at a hypothetical example. Let's say you have 1,000 people who all own stock in AT&T through company retirement plans, and each of them has an AT&T mobile phone. Let's say AT&T decides to jack their rates by $5 a month using some new loophole.

Now, each of those 1,000 people has to pay $60 extra a year. You basically end up transferring cash from people who don't own much of the stock to those that do. But that's true even if the median shareholder has less then the mean shareholder.

The decision-making power is, in practice, not linear with respect to the amount of equity you have. So one rich investor can show up to a board meeting and demand the company screw over the median American, even though many of them own stock in ATT through retirement funds and so on.

The problem gets worse when you look at something like polution: You could be harming the people who actually hold stock by making them sick. Or something like government policies and lobbying.

You could be distorting the government to make policies that are worse for the middle class person, while benefiting rich shareholders.

So simply saying the company should work for the "benefit of the shareholders" and then define that as maximizing returns, at the expense of anyone who gets in the way, is highly problematic.
posted by delmoi at 1:52 PM on December 27, 2011 [16 favorites]

So a myopic short-term focus is detrimental to long-term success. Got it.

I sort of got that feeling too, but the Forbes article is actually quite good. It's trying to elucidate the difference between the "real" market (which is products and services and profits and losses) from the "expectations" market, which is basically our entire financial system.

Adam Smith was against usury for the same reason: when you disconnect profits from actual work, you're introducing a massive moral hazard into your economy. Who wants to sweat over pennies per unit when they can resell pretend financial instruments? Who wants to invest in a factory to build a new breed of efficient cars when they can give the same money to Bank of America and see a return in one year instead of ten? And is Bank of America doing anything useful with their investment? No, they're dreaming up exotic financial charges while they play the spread between the interest rate they pay the Fed and the one they charge their hapless customers.

The incentives for our economy need to be reworked. Usury needs to be outlawed again so corporations will stop sucking the middle and lower classes dry. Investment instruments need to be regulated or outlawed on pain of revocation of corporate charter. We need to return to a society that produces for income instead of playing spreads for income — and yeah, that includes outsourcing. Otherwise we will continue to slide backward in the world economy, wondering why our imaginary market cap values aren't putting enough food on the table.
posted by deanklear at 1:58 PM on December 27, 2011 [14 favorites]

The other capitalism: stakeholder firms in Germany.

Forcing companies to give employees an equal number of seats on the board... can you just imagine what would happen on Fox News the day that law was proposed in the US...

My (completely inexpert) idea for this has been to force companies who issue stock to give half to employees... but this would accomplish the same thing, I guess.
posted by Huck500 at 2:04 PM on December 27, 2011 [2 favorites]

gut your "overhead", outsource everything, cut costs dramatically, cancel R&D, etc., then reap the reward of bonuses and whatever other performance-based compensation...

I've seen this attitude in a huge multinational organization where I worked, after they had decided to "modernize" by bringing in some big guns from the "private sector." There were no shareholders to please or bonuses to be earned, but the hired guns were evidently using the short-term boost in numbers resulting from outsourcing everything to trampoline to the higher levels of the civil service, they'd be long gone before anyone realized how much irreplaceable human value and expertise had been shed by the organization.

I knew some of these folks, and they were truly convinced that they were there to show the neanderthals how to make fire, they were completely sold on the management culture to which they belonged.

In addition to the economic arguments against this sort of thinking, I think we really need a cultural reformation too, whatever consensus is left that these people represent The Way, that consensus needs to be over.
posted by tempythethird at 2:14 PM on December 27, 2011 [1 favorite]

Apple was helped by the fact that it was at rock bottom. They were circling the drain. The fact that there was no way to drive the stock price lower allowed them some leeway in doing something unthinkable, like building shit people wanted to buy. Nobody expected anything so they could try anything.

SGI never pulled back from the brink. They could have slapped a new frontend on IRIX and had MacOS X before MacOS X was cool.

Wall street expects profits to go up every quarter. It is easier to increase your profits by cutting costs than it is to create new customers. If you keep hitting your numbers quarter after quarter by cutting costs you impair your ability to create new products or even service existing customers. You are burning your clothes to stay warm.
posted by Ad hominem at 2:17 PM on December 27, 2011 [10 favorites]

Yeah,there is a new way of thinking that employees are not assets, but a burden. Take Kodak, stuck with thousands of people in the film manufacturing end of the business when film is dying. Nobody wants to end up like that, so outsource everything.
posted by Ad hominem at 2:20 PM on December 27, 2011 [1 favorite]

Too much game not enough actual business savvy. I'm no guru, but everything I need to know about finance I've learned from being a "gentleman farmer". Production and earnings come from nurturing and building.

Why the heck are "earnings" coming from investment? Isn't investment supposed to go toward expansion and r&d? To grow a company and earn from the growth?

That is the most simple business model. Anything beyond that is simply gaming the system. (Which I could understand if the idea and eventual result was growth.)

The only thing growing around here are the bottom lines of certain individuals and the exact reason why the U.S. is still in financial decline.
posted by snsranch at 2:20 PM on December 27, 2011

I agree that a big portion of this can be laid at the feet of the contemporary management culture which believes that not only is not necessary to understand how the sausage is made in order to sell it, it's actually desirable not to know. The professional management culture is going to destroy us if we're not careful. I should say, if it hasn't already. I hate to be such a pessimist, but all it takes is one bad apple executive and the next thing you know your whole company is rotten, because once someone uses these tactics, others will follow, some simply out of self-preservation and others because they wish they'd thought of it first. I don't know how you really recover from this, and although I think there are a few high profile and notable turnarounds, they strike me as outliers. I think the best recent example of a company being gutted this way is HP with Yahoo! running a close second and the print media in general lagging behind in third (as usual).
posted by feloniousmonk at 2:38 PM on December 27, 2011 [3 favorites]

As someone in business school right now (please do not flame me for being in business school and being surprised by this), my biggest frustration is that the focus on "shareholder wealth" is so strong that people in class are congratulated for saying things such as, "Yes, a company should find ways to get subsidies from the government for doing nothing. It's free money."

This is coming from a school that bills itself as a creating people who make change in organizations by being disruptors.

Yes, yes, and yes to the articles and your comments. There needs to be a more holistic understanding that shareholders do have a complex relationship with the company that is much more than the financial markets care about.

If you want to see change in this area, start focusing on the schools that train "future managers" to understand systems and macroeconomics and social policy.
posted by foxywombat at 2:40 PM on December 27, 2011 [7 favorites]

foxywombat, for what it's worth, I try very carefully to not lay this at the feet of people with MBA's in general. I think, as you imply, it is a much larger issue that transcends the individual. I.e., don't hate the player, hate the game.

As I alluded to in a previous comment, my general feeling is that if you're paying close enough attention to notice when this sort of stuff starts going down at your company, the pressure to do the exact same thing is immense for many reasons, not least of which the smug confidence that comes with any interaction with Serious Money in public markets or even just high dollar VC. It's a vicious cycle.
posted by feloniousmonk at 2:46 PM on December 27, 2011

Yes, a company should find ways to get subsidies from the government for doing nothing. It's free money."

Haha right? It is like the bailouts. From the company perspective it is not a giant fuck up at all. Lose all your money on risky investments and get someone to bail you out. It is win win, no downside baby!
posted by Ad hominem at 2:50 PM on December 27, 2011

I remember reading somewhere (sorry, my link-finding skills are failing...) about how Apple basically forces analysts to use their given internal expectation numbers by threatening to withhold access to information. This way, the company is able to set themselves up to beat their own expectations quarter after quarter.

So a company that is legendary for being tight-lipped and not telling anyone anything they don't absolutely have to, is using access to information as a lever to manipulate people? This theory might make some sense if it didn't make no sense at all.

These are the same "analysts" who very regularly predict that Apple will make all manner of products it never does, release software they never would, and make huge business shifts that never materialize. I think it's far more likely, and more in line with the facts, that an awful lot of "analysts" are paid a tremendous amount of money to pull numbers out of their asses, and they do so poorly.
posted by Tomorrowful at 2:53 PM on December 27, 2011 [2 favorites]

Even if the red text on the cover of the book says Past performance is no guarantee of future performance ( in Financial Communications industry terms that disclaimer text is called a "red herring") everyone always thinks it will.

Apple has had a good run but it can't last forever.
posted by Ad hominem at 3:01 PM on December 27, 2011

Apple consistently issues guidance 12% - 18% below it's actual revenue numbers (except for a blowout Q3 2011 quarter). That doesn't stop plenty of Wall Street analysts from consistently getting it wrong.
posted by PenDevil at 3:01 PM on December 27, 2011

I don't like his grapefruit juice neither!

That was Robert Welch. He wasn't much of an improvement on Hatchet Jack.
posted by Kirth Gerson at 3:47 PM on December 27, 2011

Fucking duh.
posted by stavrosthewonderchicken at 4:10 PM on December 27, 2011 [2 favorites]

The article seems on point about not focusing on short term returns... but it still seems to be operating under the framework that there is a long term coupling of a company's financial performance and it's stock price... you know..... talk of shareholder value would make a lot more sense if actual financial performance was actually directly coupled to stock price.... if you look at the transactional last bid/ask nature of equity prices... you start to notice that there is a madness when it comes to financial literature, education, and talk. It's almost as if everyone has suspended disbelief when they start talking stocks. Benjamin Graham used to say that the stock market is not a weighing machine, it's a voting machine..... somehow over the years this has been bastardized to effectively "it's a voting machine in the short term, and it's a weighing machine in the long term" Thats a lot like saying I don't really care what direction i'm walking in moment to moment, but with the accumulation of these moment to moment steps, I know i'll eventually end up at my desired location.... I think this is why when most people hear explanations about why this or that happened they don't seem to make a lot of sense.... I think those people are often right.

That being said the if you replace 'performance' with 'managing the expectations market' everything makes a lot more sense. But then it just turns into a shadow puppet show.
posted by khappucino at 4:22 PM on December 27, 2011

Take Kodak, stuck with thousands of people in the film manufacturing end of the business when film is dying. Nobody wants to end up like that, so outsource everything.

Except that the writing has been on the wall since the first digital camera was invented; Kodak had the resources to deal with this fundamental shift when that happened. If a few decades of warning wasn't enough for them to deal with the inevitable death of film, then I have sympathy for their workers, but certainly not for their executives.
posted by emjaybee at 6:27 PM on December 27, 2011 [2 favorites]

I work in a large multi-national and I see this all the time. We are so focused on the next quarter that it's hard to get people to look at how to grow a business. It's made particularly difficult since managers rarely hang around long enough to see the results of what they do. As others have mentioned, it's easier to cut than invest and consequently performance suffers.

Cost does not equal value.
posted by arcticseal at 8:26 PM on December 27, 2011 [1 favorite]

Wait, does Welch's even make a grapefruit juice? I meant grape juice.
posted by TwelveTwo at 12:18 AM on December 28, 2011 [1 favorite]

...Kodak had the resources to deal with this fundamental shift when that happened.

They did try to deal with it, by attempting to make digital imaging proprietary. Remember PhotoCD? Still management failure, though.
posted by Kirth Gerson at 6:27 AM on December 28, 2011

I remember reading somewhere... about how Apple basically forces analysts to use their given internal expectation numbers by threatening to withhold access to information. This way, the company is able to set themselves up to beat their own expectations quarter after quarter.

After reading those articles, I'm hard pressed to fault The Steve from handling it this way. Seems like he recognized the dilemma and successfully insulated his baby from it.

The Steve quipped a long time ago about the markets being a study in overreaction; I think he got early on just how irrational they can be. Whether his strict info quarantine strategy had any intent to manipulate markets, I doubt; it's more about protecting the thing that really matters, making not just a good but an excellent product:

…something unthinkable, like building shit people wanted to buy.

Apple's relevance to the shareholder value fallacy is simply that, as naïve as it might sound, their goal is not profit per se, but, as the more astute commentators have put it, "delighting the customer". Profit follows from this. Lose sight of this goal, and get greedy and too attached to your high margins, as Apple did in the interregnum years after Sculley pushed Jobs out, and you will tank.

I remember reading somewhere (sorry, my link-finding skills are failing...) about how Apple basically forces analysts to use their given internal expectation numbers by threatening to withhold access to information. This way, the company is able to set themselves up to beat their own expectations quarter after quarter.

So a company that is legendary for being tight-lipped and not telling anyone anything they don't absolutely have to, is using access to information as a lever to manipulate people? This theory might make some sense if it didn't make no sense at all.

These are the same "analysts" who very regularly predict that Apple will make all manner of products it never does, release software they never would, and make huge business shifts that never materialize. I think it's far more likely, and more in line with the facts, that an awful lot of "analysts" are paid a tremendous amount of money to pull numbers out of their asses, and they do so poorly.

For a week-by-week breakdown of just how far up their butts these analysts' heads are (and those of their sycophantic business & tech press cohorts), you could do worse than to read Macworld's Macalope Weekly (free online) - it's a highly entertaining look at the ungodly melange of wishful thinking, egregious use of logical fallacies, conflicts of interest, and the occasional complete non sequitur, that consistently passes for analysis. If you were amused by Jon Stewart's takedowns of Jim Cramer's Mad Money blatherings, this will be even more fun.

There's a misguided view that what Jobs was good at was just marketing - as if he could've taken any old product and sold it, as a highly successful snake oil salesman. (If that was true, the Cube would've sold like hotcakes.) This goes hand-in-hand with a denigration of (and incomprehension of) design - the core of Apple's success - as a matter only of surfaces, of slapping on a shiny coat of paint (cue Tom Waits' "New Coat of Paint") at the end of an otherwise design-indifferent engineering process. It's not surprising that those who miss the point about design - that it's integral to every step of a truly successful product - will be mystified and cast about for some cynical explanation of Apple's success and not see how its production philosophy better insulates it against economic hard times and provides a more sustainable profit stream - not as a goal, but as a side effect of the goal of delighting the customer. Any company could do this if they got this point.

Apple has had a good run but it can't last forever.

Maybe not, but they have a better chance at surviving and even continuing to thrive than most, given that Jobs spent the last years of his life imbuing his design ethic into the company DNA. He left so abruptly the first time that that didn't happen then.
posted by Philofacts at 9:12 AM on December 28, 2011

Coming out of the carnage of the mergers & acquisitions bloodbath of the 1980's, the prevailing mentality at Business Schools and on Wall Street has been fundamentally sociopathic. When executives are rewarded for quarterly or year over year performance, they will sacrifice every working part of the company for short term growth.

Great companies of any size can be defined by "respect:" respect for the consumer/end user, respect for the stock-holder, respect for the environment.
posted by ohshenandoah at 10:52 AM on December 28, 2011

Philofacts - Gruber, that you?
posted by tempythethird at 12:04 PM on December 28, 2011

Nope.
posted by Philofacts at 2:53 PM on December 28, 2011

Anyone interested in analysis of Apple should follow Horace Dediu's Asymco.
posted by andendau at 7:38 PM on December 28, 2011

From Asymco:

The study of these two companies’ forecasts is a study in contrasts. We can say that the forecasting is disturbingly consistently inaccurate but we can also say that there seems to have been a bias of pessimism for Apple and optimism for RIM. We can only guess at the cause, but the consistency of bias points to something institutional.
posted by Philofacts at 4:54 AM on December 29, 2011