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Here Is The Reason Why The Average Lifespan Of US Corporations Has Never Been Shorter
In his latest letter (link), GMO's James Montier destroys the concept of shareholder value maximization or SVM, which, as defined by Friedman in 1970 is roughly as follows: “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits..." As an aside, Montier is anything but a fan of Milton: 'It is quite staggering just how many bad ideas in economics appear to stem from Milton Friedman. Not only is he culpable in the development of SVM, but also for the promotion of that most facile theory of inflation known as the quantity theory of money. Most egregiously of all, he is the father of the doctrine of the “instrumentalist” view of economics, which includes the belief that a model should not be judged by its assumptions but by its predictions."
And while the full letter covers many topics, not the least of which is corporate obsession with buybacks, which as we warned back in 2012 would soon be the only game in town thanks precisely to the same failed Federal Reserve policies that were meant to boost the economy but merely ended up benefiting the 1% and is therefore directly leading to the record wealth disparity and middle-class destruction which everyone - even the Fed - has finally noticed, there is one point that bears emphasis: the plunge in S&P500 corporate lifespans to record lows.
From Montier:
From the collected evidence on the psychology of incentives, it appears that when incentives get too high people tend to obsess about them directly, rather than on the task in hand that leads to the payout. Effectively, high incentives divert attention away from where it should be.
One of the other features that stands out as having changed significantly between the era of managerialism and the era of SVM is the lifespan of a company and the tenure of the CEO. Both have shortened significantly.
In the 1970s, the average lifespan of a company in the S&P 500 was 27 years (already down massively from the 75 years seen in the 1920s!). In the latter half of the last decade, the lifespan of a corporate in the S&P 500 had declined still further to a paltry 15 years.
In parallel to this trend, the average tenure of a CEO has fallen sharply as well. In the 1970s, the average CEO held his position for almost 12 years. More recently this has almost halved to an average tenure of just six years. It is little wonder that CEOs may be incentivized to extract maximum rent in the minimum time possible given the shrinkage of their time horizons (not independent of the shrinkage in time horizons for investors perhaps).
How can one explain this unprecedented collapse in corporate viability? Simple: in Montier's words, upper-management is merely focused on maximizing its own compensation, virtually at any cost, up to an including encumbering the corporation with record amounts of debt and using the proceeds to boost equity value, which in turn leads to a direct surge in executive compensation. To wit:
From the mid 1980s onwards, equity issuance has been net negative as firms have bought back an enormous amount of their own equity (and geared themselves by issuing debt – a massive debt for equity swap). One of the most common raison d’êtres for stock markets that gets offered up is that they are providing vital capital to the corporate sector – the evidence suggests that this is nothing more than a fairy tale. Far from providing capital to the corporate sector, shareholders have been extracting it from corporates.
This is also one of the main reasons provided by Montier why SVM has gone so horribly wrong.
... what went wrong? I think one of the most obvious candidates concerns the pay of CEOs. When one casts even a cursory glance over Exhibit 4 (CEO median pay) the increasing dominance of stock-related pay becomes obvious. During the era of managerialsim, the vast majority (i.e., over 90%) of the total compensation for CEOs came through salary and bonus. In the last two decades one can see the increasing dominance of stock-related pay. In the last decade some two-thirds of total CEO compensation has come through stock and options.
This has certainly aligned managers and shareholders à la Jensen and Murphy, but doesn’t seem to have generated the kind of impact that one might have expected. At least two reasons for this stand out. Firstly, as is now well known, options aren’t the same thing as stock. They give executives all of the upside and none of the downside of equity ownership. Effectively they create a heads I win, tails you lose situation.
In addition, incentives don’t always work in the way that one might expect (yet more evidence of the law of unintended consequences). Economists tend to have complete faith in the concept of incentives, driven by their obsession with a very specific definition of rationality. However, the evidence on the way incentives work may surprise you (and recently raises questions for many economists).
And here is the CEO "incentivization to extract maximum rent in the minimum time possible" in one chart:
Is there any wonder why the most powerful entities in the US - corporations - and rather their chief executives, have been so enthralled and supportive of central bank money printing? After all, how much of the exponential rise in executive pay, most of it tied to stocks and options, would have been possible had central banks not backstopped not only the financial system, but the equity tranche in the S&P 500? It also shows why in a day of low yields, corporations have been so happy to issue every more loans and use the proceeds to directly serve as the primary bidder of stocks to ever higher valuations; valuations which as Montier explains are far above where intrinsic values suggest buybacks make corporate sense.
... if one were feeling charitable, one might choose to suggest that there just weren’t many new investment opportunities, and thus this return of capital was a perfectly reasonable thing to do. If this were the case, one might hope that the buybacks were done at prices that were below intrinsic value (since this would have genuinely improved the lot of shareholders). However, as Exhibit 14 shows, this hasn’t been the case. When market valuations were high (prior to the financial crisis) a record number of buybacks were conducted. Conversely, at the market lows, firms were hardly doing any buybacks at all. As Warren Buffett said in his letter to shareholders back in 1999, “Buying dollar bills for $1.10 is not a good business for those who stick around.”
The obsession with returning cash to shareholders under the rubric of SVM has led to a squeeze on investment (and hence lower growth), and a potentially dangerous leveraging of the corporate sector.
Again, all topics we have covered in the past.
Montier's conclusion: SVM, buybacks, and all other derivatives of the unprecedented capital misallocation resulting from 6 years of global QE is directly to blame for record wealth inequality - again, something we have said is the case for a little over 5 years!
To see how this is related to the rising inequality that we have seen it is only necessary to understand who benefits from a rising stock market (i.e., who gets the “benefits” of SVM and its buyback frenzy). The identity of this group is revealed in Exhibit 15. The top 1% own nearly 40% of the stock market, and the top 10% own 80% of the stock market. These are the beneficiaries of SVM.
Another reflection of the role of SVM in creating inequality can be seen by examining the ratio of CEO-to-worker compensation. Before you look at the evidence, ask yourself what you think that ratio is today and what you think is “fair.” A recent study by Kiatpongsan and Norton (2014) asked these exact questions. The average American thought the ratio was around 30x, and that “fair” would be around 7x.
The actual ratio is shown in Exhibit 16. It turns out the average American was off by an order to magnitude! If we measure CEO compensation including salary, bonus, restricted stock grants, options exercised, and long-term incentive payouts then the ratio has increased from 20x in 1965 to a peak of 383x in 2000, and today sits somewhere just short of 300x!
* * *
The role of SVM in declining labour share should be obvious, because it is the flip-side of the profit share of GDP. If firms are trying to maximize profits, they will be squeezing labour at every turn (ultimately creating a fallacy of composition where they are undermining demand for their own products by destroying income).
Montier's conclusion:
[W]e need to think about the broader impact of policies like SVM on the economy overall. Shareholders are but one very narrow group of our broader economic landscape. Yet by allowing companies to focus on them alone, we have potentially unleashed a number of ills upon ourselves. A broader perspective is called for. Customers, employees, and taxpayers should all be considered. Raising any one group to the exclusion of others is likely a path to disaster. Anyone for stakeholder capitalism?
Sadly no. Because nobody seems to mind: after all there are such epic distractions on TV as Ferguson, Bill Cosby and, of course, Dancing with the Stars. So for now at least, the Ponzi that enriches only very, very few continues, and remember: there has never been a revolution on an uptick. However, if Bill Gross is correct, those days may be finally coming to an end.
What happens then will be the biggest, and likely most lethal, "mean-reversion" in history.
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And about to get shorter...People that is.
Restaurant in China hires robots as waitershttps://www.youtube.com/watch?v=3OgFZovYS9U
Cause the people didnt build them, .Gov did.
At least thats what .Goc thinks.
RIP Capitalism.
yeah i had imagined alot of it has to do with technology. moores law and such. the other having to do with companies like herbalife, rediculous business models, and the relentless tidal wave of money needing to go somewhere- eventually these companies go belly up because they shouldnt have existed in the first place. FB is a great example. fucking billion dollar market cap for fucks sake, REALLY??
can hardly wait to get to single digits.
But buybacks......
LOL @ avatar
Big business and big government go together because of big money and if you ain't big, you ain't shit......
So you're telling me that paying them in stock and options encourages fraudulant business practices such as understating depreciation costs or listing liabilities as assets? /shocked
Aeropostale - closing 75 Stores in its Fiscal 4th Quarter
Heck DELL was doing this all along to inflate their stock prices and so was IBM. Look where Dell is today. Wonder how long Dell can keep the gig up?
Agree with the premise, but tech companies likely contribute. The tech companies have a short life-span in part because of legacy. While the older companies have to continue to service old technologies created under different eras, new companies can more easily come online using recent techniques that have lower overhead costs. This allows them to compete and unseat the large corps without all of the capital investment required in previous generations of that technology.
While I agree with your observations, I believe they pale in comparison to the financialization of the economy and the resulting executive compensation that is being disussed here.
something happened in 1987 which made this possble
The short lifespan (and consequently the short CEO span - as well as the outsized CEO pay) is driven largely by M&A activity. So they don't disappear, they become part of a bigger company. I'm not a fan of this, but as government gets bigger, corporations tend to feel the need to get bigger too. Time to reverse the growth of government and we'll start to see more divestitures and breakups than mergers and acquisitions.
I am libertarian so I am going to walk a fine line here. The moronic socialist-leftist-collectivists are incompetent on economics which is why their countries always will fail over time.
However, I live in the real world and I work for corporations and I will say the CEO thing does not surprise me at all. Greed does not exist as an economic concept but it does exist as a very real moral concept.
What we see with the modern CEO is a sort of brass ring-lottery ticket mentality. None of these guys are as good as their paychecks indicate. My proof is the S&P 500 over any time period but 50 years is generally enough. Fifty years ago GM was the biggest company in the world. By 2011 it is a welfare queen. How many well paid CEO's went through it over that time as it continued to underperform? Also, how many utterly brilliant Wharton, Columbia and A-business school grads went through that company with great pay packages? Probably tens of thousands. None of them stopped the eventual disintegration until the tax payer was forced to bail them out.
The basic things that make a CEO are not the same as those who found the company. They are good at the sort of animal instincts of working an organization, up through the levels, protecting their record, padding their resume's and similar things that actually have no bearing on better products or services. Once, they and their cronies reach the top levels they use the company as their personal piggy bank. If the company is failing they leave with a handsome package. CEO has become the best job in America. If you do crappy you leave with a nice paycheck and severance and are filthy rich. If you succeed, you leave with an enormous pay package and become obscenely rich even though you were not a founder. Your buddies on the board are other CEO's and you have a gentleman's agreement to do the same for each other.
Look up names liken Nardelli (Home Depot), Hank McKinnel (Pfizer), William McGuire (United Health), Lee Raymond, (Exxon) and a host of others. These guys went home with enough money to make at least three generations or more of their family wealth even if they have Paris Hilton type kids. McKinnel got paid the same in retirement as his working salary. We can think of a few who actually got prosecuted like the Tyco CEO (name?) but most everything is actually legal.
I do not like or trust the financial structures of corporations. They dilute stock, screw up dividends and play financial smoke and mirror games on top of mediocre management. But, win, lose, or draw they pay themselves well. They pay themselves for performances that would get you and me fired at times or at least career-limited.
The finance guys are always the last ones to come in and rip the company up for salvage.
If it weren't for the Federal government penalizing "salary"-based income to the point that non-"salary" income is the only form that's acceptable to high-net-worth individuals, why in the hell would ANYONE be surprised that they choose to take non-"salary" based income?
Holy shit. It's really simple, you dunderheads (Montier, in particular). If I "earn" $2.5 million as "income," I end up paying a large chunk of that (39% income tax + 15% Social Security tax + 5% Medicare tax) to the Federal government for no reason.
On the other hand, if I "elect" to take that income in the form of stocks, or even better if I take it purely in options, my tax burden drops to the 12% owed on the capital gains.
Of course, some yutzes will argue that "CEOs didn't draw stock-based salaries like that in the 1950s, when the income tax was north of 65%" BUT these same yutzes ignore the fact that there were THOUSANDS of tax shelters available to the America of 1950 that were closed in the late 1970s and early 1980s.
So yeah, this is not rocket science. Anyone blaming Milton Friedman for something like this certainly needs to have their head examined.
And yes, the "solution" to this is to get the money-grubbing fucking government out of our goddamn pockets. Simplify the tax code back to the point where "reasonable" exceptions to the tax code are REASONABLE, and not social-justice oriented. And reset our corporate tax system to be competitive with the REST OF THE WORLD.
Who would've guessed that post Reagan, America would become Soviet Russia?
PPS: The corporate "destruction" rate is skewed heavily due to small businesses created solely for the purpose of tax "optimization" (i.e., businesses created for the pure reason of "generating losses," which under the hobby loss rule must be closed after not earning profits for more than 3 out of every 5 years.)
It's like these "socially astute" financial academics are completely ignorant of the tax law or something. Teh Sh0kx.
Well, I guessed it, right after Mises and Rothbard found their way into my life, that is. Before that, it all seemed one mass of incoherence.
Well, there you have it. Profits are the only reason for business to exist.
Not to help create a functioning society, not to assist in the distribution of assets and commodities, not to introduce new technologies to the world...but to make profits. Period.
Wow, this Friedman is just SO fucking WRONG it boggles my mind. But it explains our massive attitude problem, and all the troubles we are dealing with today.
Greed is always a self-destructive behavior. Always. It must be kept in check. In small amounts, it encourages the entrepreneur to invest money, time and effort in something he hopes to get a return on. In return, society benefits from the new enterprise. Too much, and we have Friedman's statement, where the ONLY valid motivation for anything must be greed. Such enterprises return nothing to the larger society, they exist only as self-enriching mechanisms for the already-wealthy.
Well everybody wants a piece of the pie and instant gratification. Egoism at all levels explains pretty well the mess we're in collectively. ME, ME, ME... ME too
Taking it from an IT professional who's seen it all...
The 90's were the edge of the cliff that proved where financial corporations were headed taking businesses (many times blindly) from a private to a public concern discarding modest steady growth for a "lottery mentality".
Once large stock options are given out like candy to an emerging growth business productivity and work ethic goes down the toilet and dissention (he or she got more than I did) takes on a life of it's own!
You can only wonder now what might have happened if those Corporation(s) now extinct and in the bone yard had travelled the "low road" instead?...
More often than not the "turtle really does end up winning the race"!!!
Um. . . That would be tortoise. Turtle was not at all raciss.
It is refreshing to see a relatively mainstreamy investor criticize Friedman's misguided positivism. Economic theory is neither a matter of "empirical evidence" nor the ability to furnish "predictions". It is the logical and rationally deduced theory of human action.