ANS -- How The 'World's Dumbest Idea' Killed The US Economic Recovery

I just wanted to show you that even Forbes thinks what the big corporations are doing is wrong!  I've included the comments because they were interesting and literate. 
Find it here:  http://www.forbes.com/sites/stevedenning/2013/07/29/how-the-worlds-dumbest-idea-killed-the-us-economic-recovery/   
--Kim



Steve Denning, Contributor

I write about radical management, leadership, innovation & narrative
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7/29/2013 @ 10:36AM |95,073 views

How The 'World's Dumbest Idea' Killed The US Economic Recovery

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Readers of this column know that short-term shareholder value, which is still pervasive in large organizations, has a lot of accomplishments to its credit. It has led to "bad profits" that have destroyed customer loyalty. It is responsible for massive offshoring of manufacturing, thereby destroying major segments of the US economy. And it has even undermined US capacity to compete in international markets.

Now the Financial Times reports that the short-term shareholder value theory has a new feather in its cap: it is responsible for killing the economic recovery that should have occurred after the financial meltdown of 2008.

Over the last month, the Financial Times has been doing a great job in cataloguing the problems caused by the shareholder value theory. Now Robin Harding has terrific article pinpointing its role in undermining the US economic recovery.

In his article entitled " Corporate investment: A mysterious divergence" he explores a conundrum that has puzzled the world's top economists: why is net investment at a measly 4 per cent of output when pre-tax corporate profits are now at record highs – more than 12 per cent of GDP?

In standard economic theory, this makes no sense. When profits go up, companies should be seizing investment opportunities to lay the groundwork for even more profits in future. In turn, that investment should create jobs, generate more capital goods and lead to higher wages. That's how capitalism is meant to work. So why isn't it happening? Mr. Harding explores systematically why all the leading scapegoats for what's gone wrong­regulations, Obamacare, tax policy, fear of another financial crisis and so on­and shows why they don't add up.

Then he comes up with the kind of thing that you rarely see in economics­a study that enables us to pinpoint the problem by offering "with" and "without" data.

A brilliant study by economists from the Stern School of Business and Harvard Business School, Alexander Ljungqvist, Joan Farre-Mensa, and John Asker, entitled "Corporate Investment and Stock Market Listing: A Puzzle?" compares the investment patterns of public companies and privately held firms. It turns out that the lag in investment is a phenomenon of the public companies more than the privately held firms.

"They find that, keeping company size and industry constant, private US companies invest nearly twice as much as those listed on the stock market: 6.8 per cent of total assets versus just 3.7 per cent."

As Matthew Yglesias at Slate writes:

"On this account we are reaping the bitter fruits of the "shareholder value" revolution. Executives at publicly traded companies are paid to generate higher share prices, which is done by hitting quarterly earnings targets. This leads to underinvestment relative to the behavior of managers of privately held firms. Not because managers of private firms are indifferent to the interests of shareholders, but because there's less need for creating the shareholder value link via a simplistic relationship between compensation, share price, and quarterly earnings."

As Mr. Harding concludes, it is "time to stop thinking about corporate governance and executive pay as matters of equity and to regard them instead as a macroeconomic problem of the first rank."

There is another way: the Creative Economy

There is of course another way to run organizations, as illustrated by Amazon [AMZN] and other companies that are pursuing the Creative Economy. Their objective is not short-term profits but value for customers. The financial returns from this different approach are extraordinary.

The argument offered by executives that "the stock market made us do it" has the same legitimacy as "the dog ate my homework", when public companies like Amazon [AMZN], Whole Foods [WFM] and Costco [COST] have successfully pursued customer value, despite the pressures of Wall Street. So isn't it about time we stop compensating corporate leaders for meeting their quarterly numbers and instead shift the focus of business to its true goal of adding value to customers?

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And read also:

The origin of the world's dumbest idea

How modern economics is built on the world's dumbest idea

When will the world's dumbest idea die?

Leadership in the Creative Economy

The five surprises of radical management

________________________

Steve Denning's most recent book is: The Leader's Guide to Radical Management (Jossey-Bass, 2010).

Follow Steve Denning on Twitter @stevedenning

 



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Comments

•   daviddelosangeles 4 weeks ago Mr. Denning,
  You quoted Mr. Harding as saying "time to stop thinking about corporate governance and executive pay as matters of equity and to regard them instead as a macroeconomic problem of the first rank."
  
  This is no doubt so but this is a political issue to be addressed by the United States Congress. However, there is no one in Congress with enough political will to even raise this issue in a serious way, much less address it substantially. This is so because the people who benefit the most from the current system are the ones with the greatest political clout. Capital is entirely triumphant in the United States from a political perspective. In decades past, labor unions, farmers, small businesses and the like has sufficient political strength the force congress and the president to pass laws limiting the power of the big business. That is all long gone.
  Moreover, how much of this emphasis on short-term profits is a symptom and how much is the cause? May not be this management philosophy merely be a reflection of changes in how the economy operates? In the United States, in the past, capital took the form of factories, mills, refineries, mines, and the like. A company's investments were physical facilities which were expected to yield profits over decades. Today this is much less the case. Capital is much more likely to take the form of money invested in a factory owned by another company overseas or patents on technology that can be manufactured by a sub-contractor. Apple once owned its own factories in the United States but now has the vast majority of its products manufactured by Foxconn overseas. While in the past Apple might have worried about long term investment in its own facilities, today it has little in the way of concerns for these matters, those are contracted out. In a world of sub-contracted manufacturing overseas, why would a firm not focus solely of stock-holder value? The long-term is someone else's problem.
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• Author   Steve Denning, Contributor 4 weeks ago
  Dear daviddelosangeles
  
  Thanks for sharing your viewpoint.
  You write "corporate governance and executive pay {are] … a political issue to be addressed by the United States Congress."
  That's not what I am saying. Corporate governance and executive pay is a matter for corporations to sort out. If they can't or won't do it, it's true that they will have it done to them. But my suggestion is that they get their own house in order.
  "The long-term is someone else's problem." You certainly epitomize the issue here. When everyone thinks the long term future is someone else's problem, there is no long term future.
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•   prost 4 weeks ago I would guess Congress and the President would do much more harm than good if they tried to correct any perceived or real problems with corporate governance or executive–the right place is at the corporation, but there is little stockholders can do, and the people who sit on corporate boards who are supposed to hire/fire the executives have a substantial conflict of interest–if they start demanding accountability of the kind your "Radical Management" book advocates, then wouldn't they be facing the same accountability in the companies they run from their own boards?
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•   ectrimm 4 weeks ago "That's not what I am saying. Corporate governance and executive pay is a matter for corporations to sort out."
  Actually, this should be a mater for the market to sort out. The status quo rarely changes when an entity makes decisions outside of a competitive environment. Those corporations that choose a corporate structure that leads to under-investment and eventual loss of market share should die (e.g., GM).
  The idea of making best use of current information (which I would argue is what basing compensation on short-term variables such as quarterly earnings) could be more relevant in faster moving industries such as tech. Irrespective, corporate structure flexibility should be allowed with the caveat that failure is possible.
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•   daviddelosangeles 3 weeks ago Hello ectrimm,
  I believe the salient point here is that equity markets have sorted this issue out, the equity markets find that maximizing shareholder valve makes the most profits for holders of equity in companies.
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• Author   Steve Denning, Contributor 3 weeks ago
  Dear daviddelosangeles
  
  "I believe the salient point here is that equity markets have sorted this issue out, the equity markets find that maximizing shareholder valve makes the most profits for holders of equity in companies."
  It's true in a sense that "equity markets have sorted this out" in a way that leads to bad profits, increasingly short-lived firms, low long-term returns for shareholders, destruction of whole sectors of the economy through short term focus, an inability to compete internationally, an overall decline in rates of return for the private sector as a whole, widespread unemployment and underemployment, a dispirited workforce and blighted communities, along with huge gains for the C-suite and the financial sector through short-term arbitraging. There are some who are understandably happy with that kind of "sorting out". The catch is that it's not sustainable.
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•   daviddelosangeles 3 weeks ago Mr. Denning,
  You are basically arguing that managers of large, publicly held companies do not know what is best for their own companies. I do not believe that this is the case, even if it is macro-economically self-destructive. This is exactly why the study of economics is divided the way it is, processes at the micro-economic level are very different the process at the macro-economic. The drive toward short-term profit maximization over longer a long-term focus is an example of this dichotomy. This is exactly why there is a Federal Reserve Bank, there are decisions that maximize profits for individual banks but are bad for the economy as a whole. What applies to banks applies to any individual company, what makes perfect sense for that company may not be good for the economy overall.
  
  It is rather like a Greek tragedy. Every "failure" in a Greek tragedy is completely logically and morally necessary, that is the point. In a Shakespearean tragedy, there is a villain who is wrong (Shylock) and there is hero – or victim – (Antonio, the Merchant of Venice) who is right. The tragedy is when good people go wrong and cause suffering on those who have not gone wrong.
  Agamemnon sacrifices his eldest daughter, Iphigenia, to the gods for victory in the Trojan War. This is his duty as king. Clytemnestra avenges her wronged daughter by murdering Agamemnon upon his return from Troy. This is her duty as a mother. Orestes and Electra must murder their own mother to avenge their father. They are morally obligated to right the wrong done to their father but to do so, they must commit an equal crime. Every one is doing the "right thing", Agamemnon must do everything that he can to assure victory, Clytemnestra is righting the wrong done to her daughter, and Orestes and Electra are righting the wrong done to their mother. Yet in doing "right" they must then do "wrong", kill one's own daughter, kill one's own husband, kill one's own mother.
  
  In a Greek tragedy, everyone is doing the right thing, and that causes more tragedy, and that is the greater tragedy.
  
  The same is true in your story. The manager is right to maximize profits in the short term and the Champions of the Creative Economy are right in the long term. Neither is a villain or motivated by ill will or lacks vision but each has a different perspective and set of interests.
  
  The tragedy is that everything goes wrong because everyone is right.
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•   Christian Day 3 weeks ago David, He comes out and states what he believes in the article, which is that short term thinking is not good for a company or investors. I think you are projecting here. You are also projecting your thoughts on the Greek tragedy mythos and missing the larger point in that when someone does something bad there are ramifications. The focus in the Greek plays are not about who does things right, but rather on what happens when people do the wrong thing, like adultery and greed, etc… You are assuming to know what the moral of a Greek tragedy is while looking at the stories written as if they were written with our values and our way of life, which they were not. Besides the point I'm not sure that this whole comparison is really applicable to this discussion.
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•   reltonoone 1 week ago Sort of, kind of, but not really – recall that the tragedies in Greek tragedy are the result of divine punishment (usually with plenty of collateral damage) for misdeeds caused by a fatal character flaw – usually but not always hubris. The analysis you are providing above is a very modern interpretation of segments of a much longer story involving, in general, the House of Atreus – cursed in the long run for the arrogance and temerity of one of its early members, and punished for generations after in a sins-of-the-fathers manner.
  If anything, the appropriate analogy to be drawn from the Greek tragic tradition would be that the degree and scale to which this articles eponymous "dumbest idea" influenced actual management decisions is a testament to our collective intellectual arrogance when trying to model forces that we understand, but not fully.
  In short, the tragedy is that there appears to be something fundamentally wrong with the shareholder value model, that it was propped up by human confidence and belief in its accuracy, and that said confidence and belief resulted in a whole lot of damage.
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•   Guido Galliani 4 weeks ago Dear Mr. Denning,
  While reading your article I have noticed one thing. The "champions" of Creative Economy are all companies where the founder still has (or had until recently) an active role in managing it: Apple (Steve Jobs), Amazon (Jeff Bezos), Costco (James D. Sinegal), Whole Foods (John Mackey). From a certain perspective, they are "privately held", i.e. there is somebody at the top who cares about the company. That's I believe the key: whoever has the responsibility of running the company has to have the future prosperity of the company as his goal. And that is the "natural" behavior of a founder (and owner) of a company. We need shareholders (no hope with C-Suite) to embrace this behavior if we want to stop the decline of the economy.
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  Steve Denning Contributor
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My most recent books are the Leader's Guide to Radical Management (2010), The Leader's Guide to Storytelling (2nd ed, 2011) and The Secret Language of Leadership (2007). I consult with organizations around the world on leadership, innovation, management and business narrative. At the World Bank, I held many management positions, including director of knowledge management (1996-2000). I am currently a director of the Scrum Alliance, an Amazon Affiliate and a fellow of the Lean Software Society. You can follow me on Twitter at @stevedenning. My website is at www.stevedenning.com.

The author is a Forbes contributor. The opinions expressed are those of the writer.

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