In today's Outside the Box the redoubtable James Montier of GMO lifts his lance to prick the underbelly of the Mighty SVM. (That's Shareholder Value Maximization, for you newbies.) “The world's dumbest idea” (among many candidates in the world of finance), says James, citing none other than “Neutron Jack” Welch in support.
After noting that taking on SVM “is a little like criticizing motherhood and apple pie,” James sets right to work, tracing the monster's birth to an editorial by Milton Friedman in 1970, in which Saint Milton wrote, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits…”
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. (Other work by James and some of the brightest minds around can be found at www.gmo.com.)
Last night there was a small dinner/reception/fundraiser at Harland and Amy Korenvaes' home for the foundation of Ayaan Hirsi Ali. Ayaan wrote the books Infidel and Nomad, detailing her journey from Somalia, where as a young girl she actually joined the Muslim Brotherhood. (That's what her family and all her friends did. When she started asking questions, it became a problem. She was told that girls simply did as they were told.) She ended up fleeing to Europe and went on to become a member of the Dutch parliament (one of the great political twists of all time) and an outspoken advocate of Islamic women's rights. For those not familiar, she was integral (as in, provided the outline and ideas) for Theo van Gogh's movie outlining the problems that some Islamic young women have in the parts of Muslim society that considers them property.
This past November was the 10th anniversary of the murder of van Gogh on the streets of Amsterdam by an Islamic radical, who considered the movie an affront to his religion, a transgression that called for the death of anyone involved. Ayaan has lived with death threats for over 20 years now. She is accompanied by serious security everywhere she goes. I've actually gotten to know some of her security detail over time. Talk with Ayaan and her husband, Niall Ferguson, about the constraints imposed upon them by the constant worry that at any moment she could be attacked, and you are introduced to another world.
Niall, too, is outspoken. But thankfully, being a forceful critic of neo-Keynesianism merely gets you vilified by Paul Krugman. I didn't even need security when I went to Japan a few years ago and told them their debt problem was going to create a significant crisis and the yen was toast. (The yen was close to its all-time high at that point.)
The majority of the people around the dinner table last night were women, and the evening was designed to stimulate free-flowing conversation, so it was interesting to observe the kinds of questions people asked of Ayaan. While everyone in the room (other than your humble analyst) would've been in the upper reaches of the 1%, they came from varied backgrounds. Yet there was clearly somewhat of a struggle to understand the depth of oppression and desperation in the world Ayaan came from.
If you are a young girl in a very closed culture and are told certain facts by your parents and your religious authorities and all your neighbors, then what can you do if you see that those facts don't square with actions? How can Islam be a religion of peace with ISIS and Boko Haram beheading people simply because they believe differently? Why would you, as a girl, not be allowed the same rights as your brothers? What is the true line between belief and practice?
There is a part of the world where honor killings, genital mutilation, beatings, forced marriages of girls under 15, and so on are common practice. That world was so far removed from our Dallas table, and yet Ayaan's story moved everyone in the room.
As you consider your Christmas giving, why not take some time to read Ayaan's books, get to know her through her work, and then consider a donation to help her help other girls growing up as she did. You can make a donation at her foundation's website, http://theahafoundation.org/. I can think of nothing that is more in the spirit of the season than helping those who can't help themselves.
Before I close, I want to mention that Jack Rivkin (CIO of Altregris) and I are going to be interviewing Ian Bremmer next Tuesday. We'll be talking about the geopolitical situation all over the world and how it will affect our investments. I hope to steer the conversation to what is happening in Russia and the Middle East, with of course a nod to China; but we'll see what Jack and Ian want to talk about. My goal is for listeners to walk away with greater clarity about the changing geopolitical landscape and an actionable perspective on global markets and the potential for diversifying investment alternatives in 2015. If you are a member of the Mauldin Circle, you should have already received an invitation. Otherwise, if you would like information on how to gain access, see below.
Have a great week.
Your thinking the Christmas tree goes up this week analyst,
John Mauldin, Editor
The World's Dumbest Idea
By James Montier
GMO White Paper, Dec. 2104
When it comes to bad ideas, finance certainly offers up an embarrassment of riches – CAPM, Efficient Market Hypothesis, Beta, VaR, portfolio insurance, tail risk hedging, smart beta, leverage, structured finance products, benchmarks, hedge funds, risk premia, and risk parity to name but a few. Whilst I have expressed my ire at these concepts and poured scorn upon many of these ideas over the years, they aren't the topic of this paper.
Rather in this essay I want to explore the problems that surround the concept of shareholder value and its maximization. I'm aware that expressing skepticism over this topic is a little like criticizing motherhood and apple pie. I grew up in the U.K. watching a wonderful comedian named Kenny Everett. Amongst his many comic creations was a U.S. Army general whose solution to those who “didn't like Apple Pie on Sundays, and didn't love their mothers” was “to round them up, put them in a field, and bomb the bastards,” so it is with no small amount of trepidation that I embark on this critique.
Before you dismiss me as a raving “red under the bed,” you might be surprised to know that I am not alone in questioning the mantra of shareholder value maximization. Indeed the title of this essay is taken from a direct quotation from none other than that stalwart of the capitalist system, Jack Welch. In an interview in the Financial Times from March 2009, Welch said “Shareholder value is the dumbest idea in the world.”
A Brief History of a Bad Idea
Before we turn to exploring the evidence that shareholder value maximization (SVM) has been an unmitigated failure and contributed to some very undesirable economic outcomes, let's spend a few minutes tracing the intellectual heritage of this bad idea.
From a theoretical perspective, SVM may well have its roots in the work of Arrow-Debreu (in the late 1950s/early 1960s). These authors demonstrated that in the presence of ubiquitous perfect competition and fully complete markets (neither of which assumption bears any resemblance to the real world, of course – break these assumptions and you break the link between SVM and social welfare; but trivial details like the critical realism of assumptions never seem to bother the average economist) a Pareto optimal outcome will result from situations where producers and all other economic actors pursue their own interests. Adam Smith's invisible hand in mathematically obtuse fashion.
