When shareholder vampirism jeopardises the value of a company
The importance of changing business narratives to accelerate the sustainability transformation.
Why this topic now?
Those who know me, know that I am a plane enthusiast. The development of the Boeing 777 was an example of excellence in engineering project management during my master’s degree. So I feel quite saddened to see how things went down there, moving from one scandal to the next ever since the Dreamliner’s faulty - read burning - lithium battery scandal.
The woes of Boeing are a cautionary tale on how the extreme, and short-sighted, approach to ‘shareholder value maximisation’ is coming at the expense of the long term success of companies. Variations of this mindset are acting as a significant barrier to the sustainable transformation of companies, greatly limiting the resources available to innovate, while decreasing the patience for return on those investments.
Shareholder primacy at Boeing had some staggering short-term effects. Over the past 10 years, Boeing has returned over USD 59bn to shareholders - 20 as dividends and 39 as buyback. Between 2013 and 2018, Boeing stock was returning 20% a year on average compared to Airbus, its main competitor, 10%.
Good things did not last however. Under-investment in R&D combined with the critical change in management practices and culture that originated in the early 2000s led to dramatic consequences that cost hundreds of lives. If we look at the actual performance for shareholders over the full decade, Airbus’s annual returns have averaged 9.5% to Boeing’s 7.1%1.
The fact that corporate governance, geared towards a narrow view on shareholder primacy has hindered companies’ agility, resilience and ability to innovate is well documented. One of its most eager and early adopters - Jack Welsh - even called it the ‘dumbest idea in the world’ retrospectively. But too late, the evil was out of the box.
Over the years, there has been numerous attempts to broaden the purpose of businesses, from Shared Value to Stakeholder Capitalism. It seems that few managed to survive beyond the launch hype.
First, because they add a lot of complexities. Including the perspective of ‘stakeholders’ in decision and appraisal of businesses is inherently complex. Which stakeholders should be considered, is nature a stakeholder, how do we manage for competing agendas that may exist between those stakeholders to set priorities, without looking arbitrary. These difficulties then to lead to a creep back to satisfying what historically has been the main stakeholder, shareholders.
Before going any further I want to caveat that I do not have a proper answer to this challenge, however I believe this conversation needs to be kept alive and I propose a few ideas for discussion.
Milton cannot be allowed to win the narrative war
One of the main challenges is to keep the message simple. One stakeholder, one objective. Despite all the conceptual errors made by Milton Friedman, and despite the evidence that shareholder primacy destroys shareholder value over the long term, the simplicity of the narrative is linked to its persistence.
Today's alternative narratives are much more complicated, involving more stakeholders and more objectives. It is a lot less challenging to solve a problem with one unknown than one with five.
So, what might the alternative story be? It should give the impression of transition, provide familiarity, while hinting at a fundamental change in direction. It needs to recognise that focusing on the value a company creates for its shareholders is not all bad, but it needs to be put into context. And, balanced with other priorities.
It is essential that the business creates long-term value and is not exploited for the benefit of speculators or investors looking for a quick buck.
Inspired by the thesis of Generation Investment, we could postulate that the purpose of a company is to serve its markets in a way that enables it to return value to today’s shareholders, without compromising tomorrow’s value. This broadening of the lens could create a new dynamic and solve a few major issues.
Value creation versus value extraction
A company’s raison d’etre is to solve a problem or add value to its customers, by using a unique set of intellectual property, talent, operations, and technology.
Putting shareholders first has led to a progressive move away from those priorities. It leads to aligning executives interests with investors and not with their markets, and to treating the performance of a company as being equal to the performance of its stock.
The priority given to shareholders has led to a gradual shift away from these priorities. Executives' interests are aligned with those of investors, not their markets. The performance of a company is now equalled to the performance of its stock.
The result is a reduction in product performance2 and quality. Iterations are no longer made with the customer in mind, but with the aim of minimising investment and maximising short-term profitability.
See the development of the 737 Max, which was very cheap and fast, but full of shortcuts, compared with the development of the 747, which almost bankrupted the young Boeing, but which ended up becoming one of the most profitable commercial aircraft programmes of all time.
Real versus synthetic value creation
It is hard to admit, but given the finite nature of most markets, it is normal for a company’s growth to plateau at some point3.
When performance begins to plateau, companies resort to financial trickery to maintain stock performance, like stock buybacks, to increase the money returned to shareholders and artificially boost stock performance. In Q4 2023, S&P 500 firms bought back around $205 billion of stock4, and their prevalence continued to grow amongst firms in the UK, EU and Japan5.
By transferring a large proportion of the free cash flow that could have been allocated to more productive uses, like innovation or research and development, a company undermines its long-term performance in the name of short-termism.
Effectiveness versus efficiencies
With the aim of returning money to shareholders, the quest for efficiency gains and the resulting cost reductions are becoming an addiction. To the point where it becomes too much of a good thing. Efficiency gains are a great tool when used in moderation.
When pushed to the limit, where any sort of ‘fat’ in the business has been eliminated - i.e. teams are tight or inadequately staffed, there is no stock and everything works ‘just in time’ - efficiency gains become a source of fragility.
Effectiveness, on the other hand, takes a more systemic approach and creates deliberate redundancies or inefficiencies, which can foster greater resilience and are necessary for the achievement of the company’ real world mission.6
So what
Without a new business paradigm that puts that puts effectiveness and long-term performance back at the center, progress on sustainability will remain complicated.
In recent weeks, brands have been singled out for their lack of support to Renewcell, which filed for bankruptcy in February, but the incentives and job security of their executives are not aligned with the realities of paying more for more sustainable fibres.
Their job description is to maximise short term stock market performance and meet the expectations of financial analysts.
To move industries towards more virtuous practices, we need to change the way they are governed. And that means overturning the diktat that companies should maximise shareholder value and be managed based on stock market performance.
I understand that there are a lot more subtleties and layers to this conversation. This post is meant to provoke an important conversation on some of the very real barriers to change across industries.
Resources to go further
One of my all time favourite analysis of the Harvard Business Review on the damaging effect of stock buybacks: Profits without Prosperity
A brilliant conversation with Roger Martin, professor emeritus at the Rotman School of Management at the University of Toronto, on the HBR on strategy podcast, where he discusses the shortcomings of the extreme focus on efficiencies, the need to think in systems and build resilience, and the beauty of balanced scorecard to manage multiple, potentially apparently conflicting business priorities and find innovative solutions.
A brief but on point analysis of what went wrong at Boeing by Bill George, Executive Fellow at Harvard Business School.
A great debunk of ‘the dumbest idea of the world’ by Steve Denning in Forbes.
A great book by the economist John Kay on how financialisation has changed corporations and the world.
https://www.barrons.com/articles/boeing-stock-price-737-max-b8aee149
Performance is meant in a broad way, across actual performance, but also quality and durability.
This very good article offers perspective for what could be management best practice when a company transitions from a growth to a sustaining phase: https://hbr.org/2017/01/curing-the-addiction-to-growth
https://www.barrons.com/articles/stock-buybacks-bad-good-thing-6fefb787
https://www.schroders.com/en-gb/uk/intermediary/insights/2023-share-buybacks-activity-continues-to-rise-outside-of-the-us/
The topic of efficiencies vs effectiveness is eloquently discussed by Ken Webster in numerous pieces including this one: https://medium.com/@circularconversations/new-thinking-new-story-new-economy-an-interview-with-ken-webster-105efe15087d