Roger Martin
The Man: The Dean at the Rotman School of Management, Toronto, gave us the terms ‘Integrative Thinking’ and ‘Design Thinking’; showed us why it’s important to draw lessons from diverse fields to learn and innovate; his latest book is on what capitalism can learn from the National Football League. He tells CEOs how to remain true to one’s character in the face of capital market pressure.
The Oeuvre: Advisor on strategy to several global CEOs, has written extensively on design; his recent works have been around corporate responsibility and why companies should be judged on parameters other than the stock market.
X-Factor: Knows the big picture.
The Message: Align executive incentives with real performance: Market share growth, earnings growth, customer or employee retention. Avoid stock-based compensation.
The Hypothesis
Trying to maximise value for those who provide the risk capital is a zero-sum game. Since expectations can’t keep rising forever—as every stock market darling finds out eventually—it is hard for executives not to fall into playing a game of jerking expectations up as far and fast as possible and then getting out before their inevitable fall.
So What?
Shareholders who provide equity capital deserve a fair return on the capital they provide. That ought to be above their risk-adjusted cost of capital. But shareholders who buy shares from the open market don’t deserve anything additional because they got it in a transaction that was without the involvement or consent of the company. If anything, customer value ought to be maximised while executives—CEOs in particular—ought to be provided only incentive-based compensation based on metrics that improve the real performance of the company.
Authenticity—the ability to stay true to one’s own character and morals while dealing with external forces in the world—is a characteristic we would want in all of our business leaders, for their own sakes and for ours. Authenticity has the potential to drive ethical behaviour, long-term thinking and thoughtful decision-making. It enables the integration of one’s personal and professional selves. Unfortunately, the external pressure of the capital markets increasingly represents a powerful force against CEO authenticity.
Executives used to have jobs that were conducive to living an authentic life. At core, companies existed to create customers. They built products (or services) that could be sold to buyers who valued those products more than the price they were charged for them. Along the way, companies could provide a good livelihood to employees and make an attractive return for investors.
It was a positive-sum game that was good for everyone: customers, employees, investors and the executives responsible for leading the system. An executive could work an entire career playing this beneficial game and also lead a very authentic life, a life in which no constituent needed to be fooled or taken advantage of in exchange for personal success.
But all of this changed with the emergence of Shareholder Value Theory in the late 1970s. The core of the theory is eminently sensible: A corporation must be run for the benefit of its shareholders, who provide the risk capital. It is not a silly idea. After all, without shareholder equity, there would be no corporations. But as with all theories, it is critically important how the core theory gets translated into procedures and practices.
In this case, four problematic operating principles have shaped the application of the initial theory:
Of course, in the long term, shareholders would be rewarded if the firm took good care of all constituents. But that is precisely the problem. Our practices and procedures demand that executives focus principally on the short term because we have chosen to measure shareholder value—that most important measure—by looking at the firm’s current stock price. This is sensible at one level: We know that over time, the stock price tends to be a good mirror for the long-term value of the company. But as economists say, in the long run we are all dead, so it doesn’t really matter. What does matter is the short run. Stock prices vary wildly on short-term news, especially on the downside. If a company misses its quarterly consensus earnings by a penny, its stock will get savaged.
(This story appears in the 25 May, 2012 issue of Forbes India. To visit our Archives, click here.)