Posted by The devastating effects of overblown short-termism and profit maximization are increasingly recognized as key issues for our societies at large and their importance and urgency is felt by all stakeholders. There is a fundamental issue though – most commentators and experts would strongly agree on the diagnosis, but nobody has yet come up with a viable alternative model that would be broadly accepted.
The agency theory (as conceived by Jensen and Mecking) that spawned the shareholder value model conveys the illusion of a scientific type of approach; it provides a fact based analytical model to make rational investment decisions into corporations with clear indicators providing the basis for current and future performance assessment. It has a built-in logic that seems compelling to the financial services community and to the investors. As Roger Martin would call it: it has progressed from a heuristics approach to an algorithm based model. However, it has become increasingly clear that the approach that has exclusively financial indicators at its core is only reflecting a fraction of the corporate reality. In reality there are multiple factors beyond financial indicators that determine the long term survival and success of corporations. What is worse – the prevailing shareholder value theory had major unintended consequences i.e. a corrupting effect on Boards and their management with obscene and self-serving remuneration schemes. It led into behaviours that are clearly conflicting with the long term prosperity of the enterprise.
Bemoaning the shareholder value philosophy is legitimate but by no means sufficient. We need a similar unifying intellectual foundation like the one that was produced by Jensen and Meckling in their article The Theory of the Firm: Managerial Behavior, Agency Cost and Ownership Structure. The alternatives that have been bee broadly discussed during the past years appeal to the ethical standards and good intentions of business leaders but have no convincing model which the asset management and investment community might embrace at a large scale – such as the HBR article on Shared Value by Porter and Kramer which is a laudable effort but falls short of providing a compelling model that has a chance to replace the current paradigm. The same is true for the Triple Bottom Line approach – there is no doubt which bottom line gets priority when push comes to shove.
Sumantra Goshal has been working on a landmark article but sadly passed away before he had finished it. It has been finalized by others and published but it is unfortunate that he could not put the final touches and additional thoughts he may have had on his mind into his article Bad Management Theories Are Destroying Good Management Practices. Interestingly though, Michael C. Jensen, one of the authors of the article that changed world of business since 1976 (see above) has published an academic paper in 2001, which regrettably is much less cited that the now infamous Theory of the Firm paper. It is remarkable though that Meckling calls in it for an “enlightened value maximization that would utilize much of stakeholder theory, but accepts maximization of the long run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders (cited from Paul Bernett, Four Ways to Save Capitalism). Maybe this is something to revisit by the research community of Business Schools and by those Economists with a keen interest in what is actually happing in real life, ready to move beyond abstract concepts, formula and aggregates.
On the other hand the sustainability movement has been too much focussing on the pure environmental perspective, which obviously represents key framework conditions for senior management but cannot be seen as a primary purpose of the business. From the Druckerian perspective the creation of a sustainable business based on value creation and the focus on human capital clearly comes first.
There is urgency for a cross-discipline approach as the current situation reflects a resounding failure of management and economic research to deal with the most burning issues of our time and to present viable solutions. What is needed is systemic perspective, not just soliciting and urging the mangers and executives to do good, but finding way of a profound dialogue with investors, asset managers, the financial services community and policy makers. Mangers are in way at the bottom of a chain of command and influence – they cannot implement fundamental changes without the endorsement of their boards and investors.
Hence there is more to do that pointing to corporate management as the culprits of the current unsatisfactory situation. Top economists and top management thinkers should stick their heads together and come up with another grand theory – this time hopefully one that contributes to a paradigm shift that demonstrates the economic benefits of a longer term perspective as a compelling case that even the number crunchers cannot ignore. Such a longer term perspective should create positive outcomes in the fields of investment, innovation and talent development. It should change the behaviour of investors who would take on more of a stewardship role comparable to “real” owners for the business as opposed to placing short term financial bets with strong speculative traits and with little consideration of the long term viability of the business. We have reached a tipping point where we cannot avoid thinking hard about the future. Enlightened self-interest means that businesses assume their role of being the engines of innovation, growth and prosperity. They are at the core of value creation that ultimately provides the glue for functioning societies.
Vienna and Paris, February 7
Note: Moving beyond excessive short-termism will be a theme at the 2014 Global Peter Drucker Forum on Novemer 13 and 14 in Vienna. See http://www.druckerforum.org/
This is a very timely and relevant article pointing to one of the root causes for the global financial crunch and following economic crisis. It coincides with the OECD’s announcement this week, where it is stated that rarely have the models for economic forecasting been so wrong as the last five years. The OECD acknowledges that better economic models is required, and also point to the fact that ‘global group think’ among IMF, OECD etc. have contributed to the miscalcultations.