I am a religious follower of the Daily Show with Jon Stewart. His succinct and insightful summaries of important topics enable ordinary people like me to get at issues which seem otherwise purposely complicated to keep us in the dark. In watching the recent media-created “feud” between Jon Stewart and CNBC’s Jim Cramer I was able to articulate my frustration with the stock market in the current financial crisis.
As the market unravels and fingers are pointed at the investment houses that concocted and pushed substance-less derivative schemes, and at governments for allowing this in their hands-off approach to what they believed was a rational system; few are pointed at some of the mechanisms that gave rise to and continue to reward the behavior that led to the crash in the first place.
Most firms strive to be recognized as performers in the market, and to attract shareholders. Attraction drives up share price. To sustain attraction and share price, firms must continue to be recognized. Much of this is based on the confidence firms portray in their ability to achieve next quarter’s performance targets. To achieve these projections, firms frequently undertake activities to meet short-term targets, irrespective of whether these activities are intrinsically sustainable, ethically sound, or economically justified. Recent events show that when firms are doing well and projecting future growth, their means of achieving this growth is seldom questioned as shareholders sit back happily contemplating their increasingly valuable share portfolios.
And many firms seem to get away with this year after year. Others, however, like Bernie Madoff, are less lucky; bringing down hundreds, sometimes thousands and even millions, as their ill-conceived strategies unravel. This is playing out across the world in the current economic recession. Firms that have for years implemented strategically flawed growth schemes in pursuit of market support and share price inflation, like Starbuck’s, are hitting the skids as customers’ wallets shrink and revenue projections – and thus shareholder happiness – are threatened.
Disappointing their shareholders is a major concern for these firms. As a result of firms’ histories of unrealistic projections, they are unable to explain to their hundreds of thousands of nameless, faceless owners that their previous growth plans were ill-conceived, and that this opportunity must be taken to adjust their strategies and downgrade their revenue projections. Such actions would quickly result in shareholder flight and rapid stock price devaluation leading to take-over threats.
And while these explanations are inevitable and plans to redress previous bad decisions crucial, these firms dig themselves deeper, making even worse decisions going forward in order to clutch at the last straws of investor confidence. Firms move from high-value to low-cost strategies without any apparent consideration of their ability to execute or gain from such moves in the longer term. Massive cost-cutting actions being taken almost across the board by firms hit by the crisis involve recklessly dispensing of the people who enabled the firms to succeed in the first place. And while getting rid of these people might allow firms to sustain revenue projections in the short term, it puts these firms in jeopardy as they confront rivals head-on, and as they end up opening up the market to smaller, more agile, entrants. The move to cost-based competition strips most firms’ of their original competitive advantage, limiting their ability to survive into the future – and virtually precluding them from succeeding in an economic upswing where they will be one among many, devoid of a strategy that would enable them to deliver the level of service they once offered.
So who’s really to blame for this value-destroying business model? The government has put in place regulations that encourage and demand transparency. And executives implement the plans for which they are rewarded. These executives’ incentive schemes are driven and approved by shareholders, who dictate to executives their expectations in terms of short-term measures such as quarter-on-quarter share price growth and p/e ratios. Therefore, if the model of growing firms through dodgy, baseless, and shareholder-pleasing activities is to stop, then it is firms’ governance models that must be restructured.
Firms’ focus should move away from satisfying the expectations of fickle investors. Governance models should move to rewarding on-average-market-beating-performance, where the average is taken over several years, or several industry cycles, rather than daily or quarterly. That means attracting and catering only to investors who are prepared to sit tight during downturns, and protect firms that stick to their strategic guns in revenue slumps, from share price collapse and hostile take-over threat.
This does not mean simply changing executive compensation packages, or passing increasingly onerous transparency regulation (although this is undoubtedly essential). It means revisiting the entire, flawed shareholder model. For example, floors on the number of stocks in a firm a shareholder can own should be instituted. Minimum lengths of time for which shares must be held before selling, and minimum time between trades, should be required. Perhaps ceilings on the dividends firms are allowed to issue should be considered. All of these suggestions can be quickly argued and perhaps easily dismissed; but it is clear that something is fundamentally wrong with the governance model in place today. And unless something is done to correct this model, it is only a matter of time after we recover from this meltdown that we find ourselves in a similar situation all over again.
As Jon Stewart begins to put names and faces to some of the institutions that enabled and supported the demise into economic crisis, I hope that others begin to understand their part in a system that seemed destined to lead us here. Instead of calling on President Obama for bail-outs to perpetuate current practices, North Americans should take the opportunity to evaluate and redevelop the model of public ownership itself, and make changes before people begin making money again and forget that there was ever a problem in the first place.
By Lisa Papania
17 March 2009