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The Best Management Article Of 2014

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This article is more than 9 years old.

Good news: Harvard Business Review has announced that Bill Lazonick is the 2014 HBR McKinsey Award winner for the best HBR article in 2014 for his brilliant, hard-hitting piece, "Profits Without Prosperity" (September 2014 HBR). Lazonick is a professor of economics at the University of Massachusetts Lowell, where he directs the Center for Industrial Competitiveness.

In the article, Lazonick described the horrifying impact of massive stock buybacks: net disinvestment, loss of shareholder value, crippled capacity to innovate, destruction of jobs, exploitation of workers, runaway executive compensation, windfall gains for activist insiders, rapidly increasing inequality and sustained economic stagnation. Lazonick’s article explained with quantitative detail why buybacks are an economic, social and moral disaster.

The article revealed for instance that share buybacks weren’t done for the most part when stock prices were low: astonishingly, most of the big purchases came when the stock price was high. Why? “Because stock-based instruments make up the majority of executives’ pay, and buybacks drive up short-term stock prices.” These firms are engaged, the article said, in “what is effectively stock-price manipulation.” In September 2014, The Economist called them the “corporate cocaine.”

So congratulations to Lazonick for writing the article, to HBR for publishing it, and to the independent panel of business and academic leaders for selecting it as the best HBR article of 2014.

If you missed the article itself, HBR has prepared a short and illuminating video that explains Lazonick's study in clear and simple terms: watch the video here.

The video explains why the purported reasons given by executives for stock buybacks—undervalued shares, offsets for share dilutions, returns of unneeded cash to shareholders—are fake and offers two real reasons for the proliferation of buybacks:

  • A way to manipulate the stock price for the short-term to please investors; and
  • A way to increase pay for the executives.

The video makes clear that managers in the C-suite have been acting badly. It lists four main remedial actions that need to be taken to make them act better:

  • Ban buybacks, by rescinding the 1982 rule that permits them.
  • Rein in stock-based pay for the C-suite.
  • Change corporate boards to include more stakeholders, such as workers and taxpayers
  • Fix the tax regime, with incentives to fund investment.

The root cause of the problem: : shareholder value theory

Yet in the six months since the article was written, little has been done to implement these sensible recommendations. Share buybacks remain pervasive and are increasing: some $3.4 trillion between 2004 and 2013. According to Lazonick, share buybacks are “an obsession”, even “an addiction.” The Economist has called them “corporate cocaine.”

One reason for the lack of action is a reluctance to name and address the root cause of the problem. For example, HBR’s otherwise excellent video fails to say, as Lazonick’s HBR article itself points out, that the underlying reason for the bad behavior is the prevailing business ideology that the very purpose of a firm is to maximize shareholder value as reflected in the current share price.

So long as maximizing the current share price governs the thinking of CEOs, institutional investors, consultants, legislators, regulators, politicians, analysts consultants and business schools, there won’t be a political consensus to implement sensible changes like Lazonick’s. And even if the changes were made, ways would be found to get around them.

An age of acquiescence

One reason for this reluctance to speak about, and come to terms with, the deeper issue of shareholder value theory is suggested by the just-published book, The Age of Acquiescence: The Life and Death of American Resistance to Organized Wealth and Power, by Steve Fraser (Little, Brown, 2015). Our current age—a second Gilded Age—lacks the imaginative capacity to envision a world in which corporations and their chief executives are not focused on short-term gains for themselves.

Although the origins of shareholder value theory are quite recent--Milton Friedman’s NYT article in 1970 and the 1976 article by Jensen and Meckling about the theory of the firm--there is now no memory of a world in which corporations and their executives were mainly focused on generating value for customers and investing heavily in their firms and their employees to achieve that goal.

Until we can imagine a very different philosophy of business, narrow regulatory remedies aimed at making a relatively small number of wayward executives act less badly will be ineffective.

So while management journals are willing to endorse narrow changes to our current regulations, they still baulk at calling for the deeper changes in societal values and ideology needed to make those narrow changes happen.

Thus it should come as no surprise that The Economist, which in September 2014 published a pair of articles condemning share buybacks as “corporate cocaine,” should turn around in February 2015 and headline the idea that hedge fund activists, with their support of share buybacks, are “a breath of fresh air” and “good for the public company.” They are “capitalism’s unlikely heroes,” even “saviors.” Suddenly “corporate cocaine” that was truly evil just a few months earlier has become something wonderful.

This kind of thing will go on happening, until there are changes in thinking and fundamental attitudes in a whole set of institutions and actors.  CEOs and their firms, investors, legislators, regulators, rating agencies, politicians, analysts, thought leaders, consultants, business schools and management journals all need to think and act differently.

Yet change is under way

The good news is that some of this is beginning to happen, as a consensus emerges on the way forward. The idea isn’t new. It’s Peter Drucker’s foundational insight of 1973: the only valid purpose of a firm is to create a customer. It’s through providing value to customers that firms justify their existence. Profits and share price increases are the result, not the goal of a firm’s activities

In the last few years, more than a score of books have been written about this better idea, including Roger Martin’s book, Fixing The Game. The language, terminology and emphases differ somewhat from book to book, but there is a great deal of common ground on the overall direction of change.

Moreover last year, a report from the Aspen Institute, which convened a cross-section of business thought leaders, including both executives and academics, found that a majority of the thought leaders who participated in the study, particularly corporate executives, agreed that “the primary purpose of the corporation is to serve customers’ interests.” In effect, the best way to serve shareholders’ interests is to deliver value to customers.

And individual leaders are speaking out.

Jack Welch has called shareholder value theory “the dumbest idea in the world.”

Vinci Group Chairman and CEO Xavier Huillard has called it “totally idiotic.”

Alibaba CEO Jack Ma has said that “customers are number one; employees are number two and shareholders are number three.”

Paul Polman, CEO of Unilever [UN], has denounced “the cult of shareholder value.”

John Mackey at Whole Foods [WFM] has condemned businesses that “view their purpose as profit maximization and treat all participants in the system as means to that end.”

Marc Benioff, Chairman and CEO of Salesforce [CRM] has declared that shareholder value theory is “wrong."

Tim Cook, the CEO of Apple [AAPL] has made clear that he “doesn’t consider the bloody ROI” of every expenditure.

We are thus seeing the beginning of a transformation in the way our society functions. We need to recognize it, applaud it, encourage it, nurture it, and protect it from those with an interest in preventing it from happening.

Publishing Lazonick’s article and awarding it a prize represent positive steps for HBR. What we need now is consistent follow-through on the root cause of the problem.

And read also:

How CEOs Became Takers, Not Makers

World's Dumbest Idea: Shareholder Value

Capitalism’s Future Is Already Here

Why The World’s Dumbest Idea Is Finally Dying

The five surprises of radical management

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Follow Steve Denning on Twitter at @stevedenning