The World's Dumbest Idea

Barry Ritholtz has John Maudlin's comments on The World's Dumbest Idea by James Montier.

SVM is Shareholder Value Maximisation.

Our intrepid author then explains how in the 1970s the Gospel According to Milton translated into the challenge of how to get corporate executives to focus on maximizing the wealth of shareholders. The solution: pay them a s***load of money (but not just cash — stock and options now constitute about two-thirds of total CEO compensation).

But, alas, there is pretty good research to suggest that larger incentives actually translate to lower performance, for reasons that James runs down for us. To make matters worse, both the average tenure of a corporate CEO and the average lifetime of an S&P 500 company have plummeted since the 1970s.

Bottom line: SVM has pretty well laid the kingdom to waste. James focuses on three areas of damage: (1) declining and low rates of business investment, (2) rising inequality, and (3) a low labor share of GDP. James takes these outcomes on one at a time, in his usual convincing manner. …

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But the question Maudlin and Montier do not ask: whom does the kingdom benefit? If they were to ask the question, I suggest their answer would be, based on their criticism, everyone.

One example Montier gives of the alleged distortion of Capitalism by this SVM paradigm is that of business investment. Here, funds that should have been used for investment are given to the shareholders instead:

This diversion of cash flows to shareholders has played a role in reducing investment. A little known fact is that almost all investment carried out by firms is financed by internal sources (i.e., retained earnings).

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Isn't the right of the owners to determine how their capital is used? If it is the short-term interest of the Capitalists to have their capital in money rather than machinery or such like, then why shouldn't it be so?

As Karl Marx wrote, one of the laws of motion in Capitalism is the reproduction of Capital. Capital is reproduced through investment. However, if the rate of return on investment is too low (subjective view of the individual Capitalist), then Capital is manifested as money.

This is what is happening here. The rate of return on investment has dropped below a certain threshold, and individual Capitalists are realising their Capital as money through the running-down of the firm's retained earnings (aka past profits).

Montier's conclusions are:

Shareholder’s Lesson

Firstly, SVM has failed its namesakes: it has not delivered increased returns to shareholders in any meaningful way, and may actually have led to poorer corporate performance!

Corporate’s Lesson

Secondly, it suggests that management guru Peter Drucker was right back in 1973 when he suggested “The only valid purpose of a firm is to create a customer.” Only by focusing on being a good business are you likely to end up delivering decent returns to shareholders. Focusing on the latter as an objective can easily undermine the former. Concentrate on the former, and the latter will take care of itself. As Keynes once put it, “Achieve immortality by accident, if at all.”

Everyone’s Lesson

Thirdly, we need to think about the broader impact of policies like SVM on the economy overall. Shareholders are but one very narrow group of our broader economic landscape. Yet by allowing companies to focus on them alone, we have potentially unleashed a number of ills upon ourselves. A broader perspective is called for. Customers, employees, and taxpayers should all be considered. Raising any one group to the exclusion of others is likely a path to disaster. Anyone for stakeholder capitalism?

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Is stakeholder capitalism really another way of saying that the means of production should be in the hands of the public? In other words, is Montier calling for Socialism? I do not think Montier and Maudlin have really thought this through.

Anyway, in any class society, the rulers are one very narrow group of our broader economic landscape. That is the nature of class society. And the rulers rule in their own interests.

Only if their survival is threatened and blatant oppression is not an option, then do they consider the minimum possible to quieten down the masses. Reform is is inly the placebo of oppression.

The workers must realise that only when the means of production are in their own hands, then they can start building a most just and humane society.