Marko Jukic, in a Twitter threat flagged by reader dk, advances a neat, sound, and wrong theory. He rightly points out that the inclusion of CEOs who come out of money at stable companies such as Boeing, Intel, and Sony, has directly led them to adopt policies that destroy these companies.
However, he elaborates that the replacement of engineering CEOs throughout Corporate America by finance/MBA CEOs is the cause of their decline. While that is true in the most visible examples he cites, the monetization trend was continuing at the time he presented it as revolutionary, in the early 2000s. And its main initiator was the engineer Jack Welch at General Electric, who from the mid-1980s onwards was considered the leader of modern management. In the early 1990s, more than 40% of GE’s profits came from its financial services arm. McKinsey was trying to sell its manufacturing clients to expand into financial services like General Electric.1 Another popular trend at the time was that large multinational companies began to run their treasury functions as a profit center, which often led to unpleasant results. 2
The second major driver of the financialization trend was the rise and incredible success of the 1980s raiders, which were reinvented many times (leveraged buyouts, then private equity, which admittedly included other strategies but leveraged buyouts still accounted for most of the costs). The deals of the 1980s were mostly financial engineering games. At that time, there were many conglomerates that were very different, they were ignored. The fashion in American business at the time was to have fat corporate headquarters, and that was even more true of these companies. These deals were an exercise in financial engineering. The hard part was taking it almost always hostile. Even after paying the merger premium, the buyers can break up the company and sell the shares for more than the original whole value. This system didn’t break until the buying artists, in the 1980s, bought up bankrupt companies with exorbitant debts. Purchased credit losses have been overshadowed by the massive savings and loan crisis. It didn’t hurt that big foreign banks were big customers of LBO loans, making the mess for American regulators less than it might have been.
Despite the LBO crash, a body of academics, including Harvard’s Michael Jensen, has blasted the idea, first promulgated by Milton Friedman at an ill-conceived New York Times conference, that corporations should be run to promote the interests of shareholders above all others. That conflicts with their legal status, as residual claimants after all other obligations have been fulfilled. While I can’t prove it’s negative, I’ve read a few guidelines for corporate board directors produced by large real estate law firms, focusing on Delaware, which, aside from Elon Musk’s accent, is a corporate-friendly place. I did not find a single mention of prioritizing shareholder value as a function of the board. The vague main goal instead was “Don’t die”.
Jensen later retracted his position after realizing the damage it had done. But too many people benefit from this idea to leave.
Let’s go back to Jack Welch as an example of how a company to achieve short-term results started well before the era of financiers and MBAs became popular as CEOs. Another reason Welch was lionized was the supposedly miraculous strength of GE’s corporate controls, enabling them to hit their forecasted earnings like clockwork. For a sprawling company with huge exposure to cash, that should have been seen as a near-Madoff reference to a ridiculous accounting business, even if it wasn’t a hoax per se. GE played a lot of games with its financial arm to get these results, such as adding and subtracting from the loss and timing of sales recognition from their large cash portfolio. From the 2021 post:
My hard take on Jack Welch is not only due to the destructive expansion of finance and his investing in the “CEO as a celebrity” which was a great success for him and General Electric during his administration but which caused great damage to the performance of management in the US. . And that Welch’s success as a manager has been exaggerated, but it will be almost impossible to be sure to what extent because of the cheerleading and the code of omerta among the outgoing managers. Another colleague who worked under Reg Jones and later under Welch, and turned to a manufacturer that remains a top player in its field, said Welch ran on the smoke of Jones’ product. And some of his popular practices, like Six Sigma, were all PR.
Jack Welch and General Electric were lucky enough to ride the big financial markets, driven by the country’s long-term trend of low interest rates. Welch also inherited a highly efficient company at a time when America was still a manufacturing powerhouse, despite Japan and Germany.
Granted, General Electric, like many American manufacturers, was in the financing business because of lending to consumers. But it had increased its role in the late 1980’s, until it took big hits in LBO lending (I knew a former McKinsey partner who ran its business. He had two conference rooms, one he named “Triage” and the other “Don Quixote”.)
But even in the early 1990s, GE Capital was celebrated for accounting for 40% of General Electric’s operations, doing everything from corporate ventures to private credit labels to credit guarantees. And General Electric got the best of both worlds. It avoided being tarnished by being seen as an old economic producer; when Jack Welch left, in 2000, it was classified in the Fortune 500 as a diversified financial firm. But you should borrow at industry AAA rates, which are more attractive than any AAA-rated bank or insurance company.
GE Capital’s big deals gave Welch more of a shine than he deserved in the second way: he made General Electric able to play earnings games, so they always met their quarterly pen guidance. Granted, GE Capital unwisely continued its growth after Welch left, in a time of dot-bomb interest rates, including increasing its leverage and re-entering the subprime mortgage business in 2004.
Let’s turn to more evidence of how financialization and short-termism established the characteristics of Corporate America before that trend was reinforced by engineers being fired from CEO positions. In 2005, the Conference Board Review published our piece, The Incredible Shrinking Corporation. In that, we explained how much public companies were focused on short-term earnings that McKinsey consultants complained to me that they are not willing to invest even with a payment of less than one year, because there will still be quarterly expenses nearby. Similarly, the anti-investment trend was so pronounced that throughout American business, companies were engaging in unnatural behavior that saved money from growth. That means they were turning off slow motion.
Mind you, that’s not to diminish the importance of Jukic’s discovery, that companies in the early 2000s used a big pig in milking rather than growing to the point where they put spreadsheets and PowerPoint jockeys in charge. And his tweetstorm included some totally justified outrage:
You would think that a company in the process of killing its CEO would see poor financial performance and a drop in the value of the shares by investors, but in fact killing the company seems to increase profits significantly and stimulate investor enthusiasm like never before.
The obvious conclusion—unpleasant if unthinkable to free marketers—is that MBA/finance thinking and decision-making is not only unhelpful but hostile and detrimental to running a successful, efficient company.
How is that possible? However, if you accept that there are such things as a trade-off between short-term profit versus long-term performance, in the examples above we see MBA/finance theory ruthlessly exaggerate that trade-off in favor of short-term profit. Including killing the company!
But this change in leadership style was a continuation of a long-standing process, as opposed to something new. However, a difference in degree can be a difference in kind. The question for another day is whether the destruction of Intel and Boeing, both not only symbolic but so important that they cannot be allowed to fail, amounts to robbery, as described by George Akerloff and Paul Romer, in their classic paper, Robbery: The Economic Underworld of Bankruptcy for Profit :
Our theoretical analysis shows that the underground economy can survive if firms have an incentive to hack for profit at the expense of society (robbery) instead of for money (gambling on success). Bankruptcy will occur if poor accounting, compromise, or low penalties for violations give owners an incentive to pay themselves more than their firms are worth and default on their debts.
Mind you, Boeing or Intel may be on the path to automation. But that may end because they get government support before things get to that point.
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1 The apotheosis of that trend, of course, was Enron, which under McKinsey’s tender guidance went from being primarily an energy producer to what McKinsey hailed as a light commercial operation. The one executive responsible for leading Enron to ruin, Jeff Skilling, was COO, not CEO, and had originally studied engineering before switching to business executive. Its CEO and chairman, Ken Lay, didn’t have an MBA but he wasn’t an engineer either. He was an economist growing up even though the energy industry seems to depend on regulatory knowledge.
2 I had an unusual client assignment in the early 1990s, when I was working with a derivatives firm to help advise a new client, a Fortune 500 company, that had recently suffered a hemorrhaging in foreign exchange. A close client of mine, a partner in derivatives trading, actually had no desire to try to help a corporate client: “These things are really dangerous. You have to know what you’re doing so you don’t blow yourself up.” This engagement took place just before the famous Proctor & Gamble case, where Bankers Trust dealers who sold products from Bankers Trust were shown to be happy to cheat and deceive customers.
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