The slow murder of the listed company

13 December 2017 -

In society, few things are more important than how companies are managed. Right now, however, we are asking managers to be little more than returns-obsessed value-appropriators. For the good of us all, we need to relegitimise the calling of management

Simon Caulkin

The company is a marvel of human ingenuity – perhaps the most remarkable economic construct of all time. A company can be a corner shop or a conglomerate, a social enterprise, an Apple, a platform or a farm. It can have a million employees or one. It scales in all dimensions.

The first corporations came into being under the Romans. The Finnish company Stora Enso began life as a Swedish copper mine in 1288. No advanced economy has taken off without a thriving, self-renewing corporate sector; the inability of poor economies to achieve lift-off is reflected in a corresponding shortfall.

We live in organisational economies, and companies are what make them tick.

At their best, companies are the spinning hub of the economic flow. They not only create wealth, but, through jobs and wages for employees, payments to suppliers and dividends to investors, they distribute it throughout society.

What’s more, as the legal scholar Lynn Stout has elegantly shown, they do it backwards and forwards across the generations. Investing in projects to benefit future generations, well-run publicly quoted companies can monetise some of those anticipated gains in a higher share price today.

Companies as socio-economic time machines – this is the nearest we have to economic magic.

But the balance is a delicate one. It is true that, as the Financial Times’ Martin Wolf has put it, “almost nothing in economics is more important than thinking through how companies should be managed and for what ends”.

Yet even more remarkable than the company’s importance is the degree to which it is at best taken for granted and at worst catastrophically misunderstood. This is particularly the case for the publicly quoted company, for so long the flywheel of Western capitalism.

Over the past 40 years, ‘how it is managed and for what ends’ has been so misconceptualised (‘abused’ or ‘betrayed’ are other ways of putting it) that this balance has been destroyed. The company’s strengths have increasingly been turned against itself and now constitute a danger to the society it operates in.

The stakes could not be higher.

In a lecture self-explanatorily entitled ‘Reinventing the corporation’ to the august British Academy in 2015, corporate governance scholar Professor Colin Mayer, former dean of Oxford’s Saïd Business School, noted that we are on a cusp.

The modern company could unlock the greatest prosperity and creativity we have ever known, or the opposite: “Social disorder, national conflicts and environmental collapse on scales that are almost impossible to conceive of today. We are therefore on the border between creation and cataclysm, and the corporation is in large part the determinant of which way we will go.”

The misconceptualisation that makes corporate reinvention necessary has a name. It is shareholder value maximisation, and the corollary of that: shareholder control.

The shareholder myth

The idea that the sole purpose of the company is to make money for shareholders is ideologically rather than empirically based, and dates back to the 1970s. This is not the place for a detailed critique; suffice to say that putting shareholders first has not made most shareholders better off (activists, hedge funds and executives are conspicuous exceptions).

It is also driving their golden goose towards extinction. As R&D spend, return on assets and innovation have fallen, corporate lifespans in the US and UK have shortened and the birth rate declined – which is no healthier for companies than for humans.

Extraordinarily, over the past 15 years, numbers of listed companies in both countries have more than halved as firms have gone bust, gone private or not gone public.

To spell it out: listed status under shareholder-driven Wall Street and City of London rules is not a recipe for long-term survival. Rather, it looks like an evolutionary dead end. Private companies invest at twice the rate of public firms; shareholder value maximisation drives the ratchet of soaring executive pay, which is politically unsustainable.

“UK corporates are run not for long-term health, but for executive wealth, with bad results for the businesses themselves and, still more, for the entire economy,” as Wolf crisply notes – not to mention for managers and management.

In the Anglosphere, the rule of shareholder value maximisation is near absolute. It’s at the heart of governance codes and assumptions, and of the motivations of the activists, hedge funds and private equity firms that move the capital markets.

In business schools, consultancy advice and most boardrooms, it goes without saying. Standouts such as Paul Polman’s Unilever are rare. “Managers largely think and act like shareholders,” says one authoritative governance scholar – even if GE’s ex-CEO Jack Welch, once shareholder value’s most high-profile management advocate, in retirement dubbed it the “dumbest idea in the world”.

Yet shareholder primacy is based on a myth; in law shareholders do not own companies (despite this line being parroted every day of the week in the media). They own shares that confer specific rights, but these do not include ownership or control. Directors are not agents of shareholders – another myth – and they owe their duty to the company, not investors.

The difference is much more than semantic. Ownership is the justification for the doctrine of shareholder value maximisation, and shareholder value maximisation defines the role of management, which, stripped of inessentials, boils down to preventing anyone else from stealing the shareholders’ lunch.

As the late Sumantra Ghoshal noted in a famous paper regretting how bad business theory subverted good management practice, one of the most widely accepted models of strategy “asserts that, to make good profits, a company must actively compete not only with its competitors, but also with its suppliers, customers, regulators and employees. Profits come from restricting and distorting competition, which, though bad for society, are the key tasks that managers are paid to do”.

As for governance, in his history of US business schools, Rakesh Khurana added: “Agency theory [the idea that managers are the agents of shareholder principals, the keystone of today’s governance codes] dissolved the idea that executives should be held – on the basis of notions such as stewardship, stakeholder interests, or promotion of the common good – to any standard stricter than sheer self-interest.”

Under the principles of shareholder value, management explicitly shuns moral content, and its only responsibility is to make a profit.

The picture of the manager that emerges from these theories is depressingly familiar. Its ultimate expression is the ruthless, business-of-business-is-business, top-down, shareholder-value-obsessed, stock-option-loaded mercenaries who brought us Tyco, WorldCom, Enron and, yes, The Apprentice.

Their most spectacular production, of course, was the great banking crash of 2008.

These are extremes, but they differ from many others on the same spectrum only quantitatively. It’s safe to say that they don’t represent the profession that most CMI members would knowingly have signed up to.

The toxic duo of shareholder value and control traduce the purpose of companies and their managers in another way. If the primary focus of management is nurturing today’s share price, any manager knows how to do it: cut costs, outsource, sell underperforming subsidiaries, slash R&D and pare back investment.

Sound familiar? Not coincidentally, this is the stock formula of every activist and buyout specialist. Mostly, what they say goes.

For every Unilever that fights it, many more succumb or quietly give in. No wonder gurus such as Clayton Christensen worry that innovation rates are tumbling as companies focus almost entirely on defensive investment to milk current advantage. Or that companies now only create jobs as a last resort.

Professor Gerald Davis of Michigan Ross says that “under current conditions, creating shareholder value and creating good jobs are largely incompatible”, and that won’t change without “a fundamental shift in the purpose of the corporation”.

No question here, of course, of the magical time machine. Intergenerational transfer is impossible if managers are tasked with maximum extraction of present value for the sole benefit of shareholders on the register today. By breaking the tacit bargain on employment and wages, many companies are barely in societal credit in the present, let alone the future.

But such behaviour is a travesty of what companies could and should be for. It is based on a gross misunderstanding of the role and relationship of organisations and markets. It’s no accident that the best-performing economies are characterised by both vigorous companies and competitive markets.

They are living, evolving ecologies in which companies and markets play different but complementary roles.

Consider the semiconductor industry cycle. First, the leader, typically Intel, creates a new-generation microprocessor that gains a temporary market advantage for which it can charge high prices and begin to recoup its massive investment. As competitors catch up, prices fall until the chip becomes a commodity.

In this way, Intel’s initial advantage is competed away by the wider market, handing the benefit to society as a new constellation of resources, and the cycle begins again.

The beauty of markets is that they are blind, impartial and without intention. Markets tell you what different options cost. Companies, on the other hand, are human, intentional and able to strategise.

Unlike markets, they can take one step back to move two steps forward. Like Google and 3M, they can forgo immediate efficiencies – ‘waste’ and ‘inefficiency’ to shareholder value maximisers – to allow employees to spend some of their time on their own projects, in the hope of much greater dynamic efficiencies in the future.

That, in short, is the genius of companies – not resource allocation or efficiency, as in the conventional view, but their unique capability for innovation and creation in the evolutionary process that economist Joseph Schumpeter termed “creative destruction”.

The way forward, then, is hiding in plain sight. To reinvent companies, we don’t need to imagine new entities, structures or frameworks of obligations. We just need to free them up to fulfil the incredible potential of the form they already inhabit.

To relegitimise management, we don’t need new regulations and codes. We just need to reframe its job in a more positive and realistic light.

The function of business is value creation (innovation), not value appropriation. That makes it a positive-sum game in which companies, in Ghoshal’s words, are “society’s main engine of discovery and progress”.

A reset of this kind, casting businesses as society’s problem-solvers and growth as a measure of the rate at which problems are solved, realigns companies and all their stakeholders, present and future, on the same side.

It also recasts the role, and methods, of management, not just as the agent of corporate success, but as the main force for economic and social progress: management as more than a profession – a calling.

Simon Caulkin is a writer and former management columnist for The Observer