shareholder value – Escondido Framework

“…… because they still do the same thing: they primarily serve shareholders”

Dame Vivien Hunt, until this year managing partner of McKinsey’s offices in the UK and Ireland, has written in today’s Financial Times on workplace diversity and equality under the heading “Change how boards work to achieve to true diversity”.

She asks why, when one third of the seats on the boards of FTSE 100 companies are now occupied by women, “those boards still look similar……still filled with people who have the same skills carved out of similar professions, networks and university degrees.” Her explanation is that it is “because they still do the same thing: they primarily serve shareholders.”

I am pleased that one of the current leaders of the organisation where I started my professional career takes such an unambiguous and very public position strong position on both the composition of boards and their purpose. Back in the 1980s, most of my colleagues were beholden to the orthodoxy of “shareholder value” and, although there were a small number of senior non-white consultants (including Keniche Ohmae, who led the Tokyo office, and Rajat Gupta, who became an office managing partner shortly after I left and subsequently global managing partner), the firm was anything but diverse.

Dame Vivien argues that “we need to find people who represent not only our investors but everyone else – from buyers to suppliers, to local communities, to our natural environment”. Her use of language and her argument is not entirely clear here: her article could easily be interpreted as making a case for a board of representatives of stakeholders as opposed to a board that understands the broader mandate of the company and the need to take all stakeholders’ interests into account.

I have argued elsewhere against boards being composed of representatives of stakeholders. As is implicit in Dame Vivien’s article, directors should have a duty to all stakeholders, because their wellbeing of all groups is critical to the wellbeing of the company. Furthermore, in UK unitary boards composed of executives and non-executives, at the board may be the executive directors responsible for sales and marketing who should be the effective advocates for interests of consumers if they are fulfilling their role understanding and satisfying consumer needs. Similarly, executive directors of workforce and of operations should be able to represent to colleagues, who may place a primacy on the interests of shareholders and customers, the interests of the people they recruit, support, and manage. Whether or not they are full board members, most large companies employ directors of communications and public affairs (or similar) whose primary role may be to advocate externally for the company but also represent to the board the case for taking into account the interests of local communities, the environment, politicians and lobbyists.

Her underlying argument for diversity on boards is compelling, not for the purposes of representation but because a genuinely diverse board “brings diversity of thought, skills and experience that will lead to better decision making”. However, better decision making also depends on boards understanding their purpose of their companies, which is the sustainable creation of value for all those the company engages with, by producing goods or services more efficiently than would be possible in the absence of the company. The purpose of the company is not the creation of shareholder value: shareholder value is the necessary return provided to shareholders in return for their investment and the sustainable creation of shareholder value is the result of serving the interests of all stakeholders.

I was thrilled to read Dame Vivien’s piece and pleased to see her continued work championing diversity in business. But, notwithstanding my concern about some of the logical flow and detail in her argument, I was even more encouraged to see her set out the case that genuine diversity on boards will not be achieved until shareholder primacy is consigned to the waste bin.

Should customers have come first in the GKN battle?

I don’t disagree with Michael Skapinker often, but his commentary on the successful bid by Melrose for GKN in today’s Financial Times “Customers should have come first in the GKN battle” had me getting out a metaphorical red ballpoint to mark his homework.

It was a shame. He made such a good start, rehearsing points that he has made well in the past about shareholder value:

Whose interests should companies serve? For decades, the answer, particularly in the US and the UK, was shareholders’. Total stock market return, the argument went, was clear and measurable and it kept managers focused — until Jack Welch, former General Electric boss and one of shareholder value’s greatest champions, denounced it as “the dumbest idea in the world”.

That was in 2009. Mr Welch was not the only business chief to notice that the financial crisis had shredded the idea that if companies looked after shareholders, everything else would follow. Josef Ackermann, then-head of Deutsche Bank, said: “I no longer believe in the market’s self-healing power.”

A little later in his article, I also awarded him marks for citing the late Sumantra Ghoshal of London Business for arguing in 2005 that:

the people whose contribution should be recognised first were employees, who also took the biggest risks;

shareholders could sell their shares far more easily than most employees could find another job;

and employees’ “contributions of knowledge, skills and entrepreneurship are typically more important than the contributions of capital by shareholders, a pure commodity that is perhaps in excess supply”.

Not content with citing Sumantra Ghoshal with approval, Skapinker moved on later in the article, in the context of the intervention by the Tom Williams, chief operating officer of Airbus’s commercial aircraft division, about the need for long-term investment and strategic vision in the aircraft industry, to cite “the great” Peter Drucker for saying that

the purpose of business was to create a customer. Without that customer, there are no jobs for workers, no returns for shareholders and no strategic skills for nations.

All good stuff, and essentially consistent with Escondido Framework thinking, but Skapinker and others who were unhappy at the outcome of the bid seem to have missed the point about what was happening.

During the takeover battle, much was made of the heritage of GKN, whose origins lay in the founding of the Dowlais Ironworks in the village of Dowlais, Merthyr Tydfil, Wales, by Thomas Lewis and Isaac Wilkinson ion 1759. John Guest (whose name survives in the “G” of GKN – formerly Guest Keen and Nettlefold) was appointed manager of the works in 1767, and in 1786, he was succeeded by his son, Thomas Guest, who formed the Dowlais Iron Company. However, the links to the multinational automotive and aerospace components company of 2018 are slight and accidental.

The company acquired by Melrose consists of four major divisions: GKN Aerospace (Aerostructures; Engine Products; Propulsion Systems); GKN Driveline (Driveshafts; Freight Services; Autostructures; Cylinder liners; Sheepbridge Stokes); GKN Land Systems Power Management; PowerTrain Systems & Services; Wheels and Structures; Stromag); and GKN Powder Metallurgy (Sinter Metals; Hoeganaes). This is a collection of businesses that is the outcome of over a hundred years of acquisitions and disposals across the globe¹. At least at the parent company level, there is little to suggest the opportunity for much value creation from them all being part of the same corporate entity.

What business was GKN plc in? The management of a portfolio of business units, primarily in manufacturing but some in services, spread across a range of different industries and technologies serving a variety of different types and classes of industrial customers, many but not all being OEMs.

Who were the customers of the corporate entity, as opposed to the subsidiaries (which are the entities that interface directly with the purchasers of goods and services, with their employees, and with suppliers)? Perhaps the subsidiaries themselves, insofar that they derived value from the parent company and investment funds, in return for cash returned to the parent? Perhaps the employees of the subsidiaries, at least in so far as they were beneficiaries of a corporately administered pension scheme (that, incidentally, Melrose committed to topping up with an extra £1 billion)?

Much has been made, including by Michael Skapinker in his article, of the 25% of the shares that were in the hands of hedge funds and other short term speculators who had only bought them very recently in the hope of a quick return. Presumably they bought these shares from owners who were willing to sell at a lower price against the possibility that the Melrose bid failed and the share price under the existing management team would fall.

Melrose’s argument during the takeover battle was essentially that it is a management team with a record of successful managing corporate assets who would replace a management team that has been destroying value in its management of the GKN portfolio. The commitments Melrose made along the way to the customers for the GKN subsidiaries’ goods and services and to their employers (in part evidenced by the promises relating to the pension scheme), suggest that they are not old fashioned asset strippers, selling off assets as part of strategy to wind down wealth creating business units. Rather, they appear to understand the business that the GKN plc is currently in, which is managing a portfolio of businesses, adding value to those where it can, and selling those to which other companies can add more value.

If this is indeed the approach that Melrose takes, it will reflect a mindset in which the board thinks about the businesses within the portfolio as customers for the corporate centre, recognising that if there are other corporations that can provide individual business units with a better deal, let them go. And that will make it easier to keep their customers in the capital markets, to whom they have spent the last few months marketing themselves, happy, loyal, and committed.

¹ Wikipedia history of GKN plc since 1966

Revisiting Colin Mayer’s “Firm Commitment”

I first read Firm Commitment[1] when it was first published in 2013 and found the opening chapters – which include a well-constructed critique of the shareholder value paradigm – offered the tantalising prospect that Colin Mayer might be about to expound a theory similar to the Escondido Framework description of the firm occupying a solution space bounded by market interfaces. Unable to recall where his diagnosis of the failings of the modern firm and his prescription for addressing them departed from my own, I recently revisited his book.

Returning to Firm Commitment, I rejoiced again at much of the description in the early chapters of the shortcomings in the classical model of the firm, in which share ownership is linked to provision of investment capital and the assumption of risk. In common with the Escondido Framework, he describes the company as an structure independent of ownership and sees one of its purposes being long term survival, delivering value to society at large. He comes close on occasion to describing some of the other risk bearing parties, the market related transactional considerations and the interests of different stakeholders. In particular, he bemoans the failure of corporations to engage with wider social and environmental concerns.

But rather than continuing down the path developed in the Escondido Framework he focuses on the shareholder and sees the failure of the modern corporation lying in the lack of commitment of shareholders to the company. His prescription is reform to tie in shareholders to the company, to increase their commitment to the firm – hence the book’s title. In contrast to our model, Mayer remains committed to a view that shareholders “own” the company, rather than owning pieces of paper that entitle them a share in the profits of the company and which have a value reflecting a market perspective on the discounted value of the expected future cash flows. What he is unable to explain is how tying in shareholders in this way will improve the quality of decision taking by managers, enhance their accountability, or contain their ability to extract economic rent in the form of salaries, bonuses and equity incentives.

[1] Firm Commitment, Colin Mayer, Oxford University Press 2013

Is Capitalism Killing America?

I was stopped in my tracks this morning by an email from the Stanford Graduate School of Business with the subject line “Is Capitalism Killing America?”. It is not the sort of thing that the world’s top business school (at least that was how it was rated forty years ago when I was there) normally sends to its alumni.

The key feature in the email newsletter was an article with the subheading “Young & Rubicam Chairman Emeritus Peter Georgescu says it’s time to end the era of shareholder primacy[1] which reviews Georgescu’s new book Capitalists Arise! End Economic Inequality, Grow the Middle Class, Heal the Nation (Berrett-Koehler, 2017). Georgescu, a fellow Stanford GSB “alumn”, is looking to chief executives to think about how, and for whom, they run their companies.

Capitalism is an endangered economic system, Georgescu says. He cites by economist William Lazonick, who studied S&P 500 companies from 2003 to 2012 and discovered that they routinely spend 54% of their earnings buying back their own stock and 37% of their earnings on leaving just 9% of earnings for investment in their business and their people.

“Innovation is the only real driver of success in the 21st century, and who does the innovation? Our employees. How are we motivating them? We treat them like dirt. If I need you, I need you. If I don’t, you’re out of here. And I keep your wages flat for 40 years,” says Georgescu, who points out that growth in real wages has been stagnant since the mid-1970s.

Georgescu continues by noting that the lack of investment in business and their people feeds back into demand, undermining sales growth. With median household income in the US less than 1% higher today than in 1989: “There’s no middle class, and the upper middle class has very little money left to spend, so they can’t drive the economy. The only people driving the GDP are the top 20% of us”. 60% of American households are technically insolvent and adding to their debt loads each year. In addition, income inequality in the U.S. is reaching new peaks: The top layer of earners now claim a larger portion of the nation’s income than ever before — more even than the peak in 1927, just two years before the onset of the Great Depression.

Georgescu blames the ascendency of the doctrine of shareholder primacy.

“Today’s mantra is ‘maximize short-term shareholder value.’ Period,” he says. “The rules of the game have become cancerous. They’re killing us. They’re killing the corporation. They’re helping to kill the country……..

“The cure can be found in the post–World War II economic expansion. From 1945 until the 1970s, the U.S economy was booming and America’s middle class was the largest market in the world. In those days, American capitalism said, ‘We’ll take care of five stakeholders,’. Then and now, the most important stakeholder is the customer. The second most important is the employee. If you don’t have happy employees, you’re not going to have happy customers. The third critical stakeholder is the company itself — it needs to be fed. Fourth come the communities in which you do business. Corporations were envisioned as good citizens — that’s why they got an enormous number of legal protections and tax breaks in the first place.

“If you serve all the other stakeholders well, the shareholders do fine,” he says. “If you take good care of your customers, pay your people well, invest in your own business, and you’re a good citizen, the shareholder does better. We need to get back to that today. Every company has got to do that.”

It’s refreshing to hear this from one of the grand old men of the commercial world in the United States. But in his critique of “shareholder value”, he fails to single out the principal beneficiaries, the chief executives and top management teams themselves (including our fellow business school alumni) who have exploited the system to cream off an ever increasing share of the rewards in salaries, bonuses and options, all the while failing to invest in productive assets, innovation, securing long term positions with customers and local communities, and in the people who work in the companies themselves.

[1] https://www.gsb.stanford.edu/insights/capitalism-killing-america?utm_source=Stanford+Business&utm_medium=email&utm_campaign=Stanford-Business-Issue-122-10-1-2017&utm_content=alumni

Jawbone, another unicorn washed away

And Noah looked out through the driving rain, Them unicorns were hiding, playing silly games.They were kickin’ and splashin’ while the rain was pourin’, Oh, them silly unicorns!

There was green alligators and long-necked geese, Some humpty backed camels and some chimpanzees.Noah cried, “Close the door ’cause the rain is just pourin’, And we just cannot wait for no unicorn!”

The ark started moving, and it drifted with the tide, And them unicorns looked up from the rocks and they cried.And the waters come down and sort of floated them away, That’s why you never seen a unicorn to this very day.

But you’ll see green alligators and long-necked geese, Some humpty backed camels and some chimpanzees.Some cats and rats and elephants, but sure as you’re born, You’re never gonna see no unicorn![1]

I advise a fitness monitoring technology company[2] and consequently have followed the rise and, as of this week, demise of Jawbone, which has run through $1 billion and was at one point valued in 2015 at $3.3 billion.

The company started out modestly, founded as Aliph in 1998, in the first dotcom boom. It started out making mobile phone headsets, launching a wireless version at the Consumer Electronics Show in 2007 prior to raising $5 million from Khosla Ventures later in the year and $30 million from Sequoia Capital in 2008. Bluetooth headsets followed (I think I may have had one) in 2009, and the Jambox, a Bluetooth compact speaker and speakerphone, in 2010.

Things started to go crazy in 2011, with three rounds of funding bringing in $160 million, new product launches and, most critically, entry into the into the lifestyle tracking market with a wristband product called UP by Jawbone. Product enhancements, acquisitions, awards for design, and citations – and the TED talks – for founder and CEO Hosain Rahman[3] all followed. May 2013 brought the addition of a heavyweight corporate board: Marissa Mayer, CEO of Yahoo!, and Robert Wiesenthal, COO of Warner Music Group as directors and Mindy Mount, corporate vice president and CFO for the Online Services division of Microsoft, as president of the company (although she was gone within 12 months) A further round of funding later in 2013 brought in $20 million more equity and $93 million of debt, followed by another round in 2014 bringing in $250 million and finally another $350 million of debt from Blackrock in April 2015.

A flurry of new product introductions, expanding into other areas of monitoring including heart rate and sleep – but complaints from consumers and technical criticism, and intellectual property suits from market leader Fitbit and a dispute with a manufacturing supplier in 2015 suggested all was not well. Later in the year a market research report suggested that Jawbone’s share of the fitness tracker market was only 2.8% and in November the company started to announce lay-offs.

After Reuters marked last week’s announcement that the company had placed itself in liquidation with a report titled “Death by Overfunding”, Jonah Comstock of Mobile Health News put out a call on Twitter to mobile health pundits for their views. Opinions included the company having too much money to spend and consequently under pressure to chase investor expectations with a need to do stuff – innovate (“random pet projects and pilot collaborations go no where and suck up precious engineering resources….. too pie in the sky- not enough rubber-meets-road”), launch new products, invest in marketing – probably ahead of its ability to deliver quality, and with the volume of activity generating internal turmoil and lack of focus, in marked contrast to the laser sharp strategy of rival Fitbit.

I’m not sure that this can be the whole story. But what is without doubt is that

the efforts of what I assume were bright and capable people on the front line – probably poorly led, directed and managed – failed to deliver output that delivered products and services that customers valued
the company burnt through a lot of money in a very short time, with the result that some very big investors destroyed a lot of value for the investors upstream of them
the presence of a board of heavy weight external directors did very little to secure the future of the enterprise.

(And perhaps sometimes it’s better to settle on being a green alligator, long-necked goose, humpty backed camel, chimpanzee, cat, rat or even elephant that can deliver value sustainably than a unicorn left “kickin’ and splashin’ while the rain was pourin’”)

[1] Shel Siverstein, 1962 (extensively covered, eg byThe Irish Rovers, Val Doonican and many others)

[2] HRV Fit Ltd, manufacturers of ithlete https://www.myithlete.com/

[3] Fortune magazine’s 40 Under 40; Fast Company magazine’s most creative people; Vanity Fair magazine’s New Establishment; TIME 100’s most influential people of 2014

Evidence at Pearson for management hi-jack at the expense of shareholders

News of a shareholder revolt at Pearson over chief executive pay illustrates the Escondido Framework analysis of the company as an entity owned by no-one, but open to hi-jack by the management.

Pearson’s shareholders have struck out at the company’s and its remuneration committee by voting down the proposed 20% pay increase to chief executive John Fallon after he presided over record £2.5 billion loss for the group last year. Meanwhile, employees are laid off and the returns to shareholders are in freefall. The comment of the company, that it was “disappointed” by the vote but that the pay increase goes ahead, supports the underlying Escondido Framework thesis of management capture.

“Naturally, we acknowledge this feedback and thank those shareholders who have already spoken with us,” the company said. “The remuneration committee is committed to continuing dialogue with our shareholders to help shape the implementation of our remuneration policy going forward.

“Mr Fallon said his £1.5m payout in 2016 was a matter for Pearson’s board and its remuneration committee, but added he had used his £343,000 bonus, net of tax, to buy shares in the company on Friday morning.”

The FT notes that the vote at Pearson was the biggest investor revolt against executive pay at a major UK company so far this season, with the next nearest being a 40 per cent vote against the remuneration report at AstraZeneca. FTSE 250 housebuilder Crest Nicholson is the only other large listed UK company to have suffered a defeat on pay this season, with 58 per cent of votes cast against its pay report.

It can only be regarded as good news that the FT further reports that other FTSE 100 companies that faced pay protests last year, including BP and Reckitt Benckiser, have cut remuneration packages in an effort to avoid similar difficulties at their shareholder meetings this year – and indeed make an effort to reposition the companies against the market interface with their investors.

Time to bury Milton Friedman?

Milton Friedman got a name check twice in today’s FT, on the letter’s page and in an article by Philip Delves Broughton on the facing comment page. What was it that Keynes said about defunct economists?*

The first reference was in a letter from Philip G Cerny, Professor Emeritus of Politics and Global Affairs, University of Manchester and Rutgers University, writing in response to Jo Iwasaki who was calling for moral leadership to prevent behaviour like that revealed in the VW Dieselgate:

“The first mandatory prerequisite for company executives is maximum profitability, whether for the company as a whole or shareholders in particular, as Milton Friedman and others have so successfully argued. Culture comes a long way behind, and only comes into play if it actually contributes to profitability. In other words, there is an inherent structural conflict between profitability and the kind of moralistic behaviour Ms Iwasaki wishes to prescribe.

“On the contrary, there is in fact a deep culture of profitability that prevents other sorts of cultural values from working. Only factors outside the company — whether government regulations, the courts, consumer rebellion, strong public interest pressure groups or exposure to scandal (as with Dieselgate) — can be effective, and only then if they do not seriously dent profitability. That’s capitalism.”

The shortcoming in the Friedman perspective on which Cerny relies is the failure to understand that the primary driver for the company executive is self interest, rather than corporate profitability. Corporate profitability is a driver of behaviour only to the extent that it affects self interest. Self interest is a function of lifestyle preferences, reputation enhancement, job security, bonus targets and personal moral compass. The challenge facing boards and investors, and indeed all those with an interest in how the company behaves, is how to align the interests of executives with their own.

The second reference to Milton Friedman is more insightful and comes in Philip Delves Broughton’s column, which is titled “American business is the master, not victim, of globalisation: If businesses saw more value in investing in US workers, they could have done so”.

Delves Broughton addresses the prospects for bring offshored jobs back to the United States, as promised by Donald Trump. Referring to Steve Jobs telling Barak Obama in 2011 that the jobs manufacturing iPhones wouldn’t be coming to the US anytime soon, he notes that manufacturing jobs are increasingly disappearing as automation takes over, and that Shenzen is way down the learning curve and now delivers quality that Apple would struggle to find in the US. However, the principle point of the article is that

“….the best US companies had become brilliant at managing across borders and directing resources to where they generate the highest returns. They weren’t victims of globalisation. They were its masters and had become less and less American.”

Delves Broughton continues later in the article:

“If one accepts Milton Friedman’s argument that a corporation’s sole responsibility is to its owners, then one cannot find fault with these multinationals. They plant their flag where the money is. Their shareholders don’t want them playing the “Star Spangled Banner” in the boardroom. And while they may not directly be investing in American workers, they are generating returns for US investors who can reallocate their capital as they see fit. Mr Trump has done precisely this with his own business, investing in property deals far beyond US shores.

“But this is a fragile argument and Mr Trump is gleefully smashing it to pieces. He knows you cannot respond to stagnant wages and economic insecurity among the working and middle classes with the crystalline logic of a Nobel-winning economist. And he is threatening to perp walk before the press any companies that disappoint him.”

Offshoring in order to harness skills and low cost labour has probably generated greater benefits overall for the US population as a whole, as a consequence of lower prices, higher quality and, for that matter, returns to shareholders. But Delves Broughton is right to challenge the shareholder value orthodoxy that is an expression of the Milton Friedman view of the world. One of the consequences of this way of looking at, and describing capitalism has been the increasing inequality in US society that has fuelled American populism and landed the US, to say nothing of the wider world, with President Trump.

We can only hope that the resilience of American society and politics can withstand four years of a Trump presidency. US companies face a challenging time, notwithstanding the appointment of representatives of large corporations to cabinet posts and promises of tax breaks, as the government tries to deliver on its promises to the rust belt. One way of understanding their plight is to reflect on an excessive focus on the “crystalline logic of a Nobel-winning economist” (while, at the same time, being complicit in the way that top managers were being rewarded by boards composed of their peers at everyone else’s expense) and not paying sufficient attention to the wider constituencies, particularly employees, suppliers and the political world.

*”The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” The General Theory of Employment, Interest and Money (1936), Ch. 24 “Concluding Notes” p. 383-384

“Shareholder value ……. the biggest idea in business” – Really?

The Economist has published a useful analysis of the place of “Shareholder Value” in contemporary thinking about business and the firm (Shareholder Value: the enduring power of the biggest idea in business*, The Economist, 2 April 2016).

The article describes the evolution of the idea that the purpose of the firm is to maximise shareholder value, its primacy first in the Anglo Saxon world, but its pervasiveness today globally wherever commerce is practised. It also cites the objections to capitalism of a society that sees corrupt and failing businesses and widening social inequality.

It describes the challenges faced by Shareholder Value. The first that is it

“is a licence for bad conduct, including skimping on investment, exorbitant pay, high leverage, silly takeovers, accounting shenanigans and a craze for share buy-backs, which are running at $600 billion a year in America”

but the Economist then argues that these are essentially perversions of Shareholder Value:

“These things happen, but none has much to do with shareholder value. A premise of “Valuation” is that there is no free lunch. A firm’s worth is based on its long-term operating performance, not financial engineering. It cannot boost its value much by manipulating its capital structure. Optical changes to accounting profits don’t matter; cashflow does (a lesson WorldCom and Enron ignored). Leverage boosts headline rates of return but, reciprocally, raises risks (as Lehman found). Buy-backs do not create value, just transfer it between shareholders. Takeovers make sense only if the value of synergies exceeds the premium paid (as Valeant discovered). Pay packages that reward boosts to earnings-per-share and short-term share-price pops are silly.

“Outbreaks of madness in markets tend to happen because people are breaking the rules of shareholder value, not enacting them. This is true of the internet bubble of 1999-2000, the leveraged buy-out boom of 2004-08 and the banking crash. That such fiascos occur is a failure of governance and human nature, not of an idea.”

The second is the challenge of the stakeholder model:

“that firms should be run for all stakeholders, not just shareholders. In a trite sense the goals of equity-holders and others are aligned. A firm that sufficiently annoys customers, counterparties and staff cannot stay in business.”

The Economist then goes on to describe the difficulty finding an objective to replace shareholder value, including risk of potentially unintended consequences of placing too much emphasis on specific stakeholder, for example by protecting employment to the point that a company goes under. It then concludes that “For these reasons shareholder value—properly defined—will remain the governing principle of firms” but with the qualification that “shareholder value is not the governing principle of societies. Firms operate within rules set by others.”

The Escondido Framework turns a lot of this thinking on its head. Maximising shareholder valuation is not an absolute objective: rather the management of a company need to deliver sufficient shareholder returns, including the prospect of returns, to secure the capital the company requires and to satisfy shareholder that they would not be better off using such influence as they have in the financial instruments they hold to replace them with other managers. This is fundamentally no different to the task they face setting terms of employment to secure the necessary workforce, and designing products and services and setting prices to attract and retain customers. The Escondido Framework also argues that other, non-financially mediated markets have also to be considered, to keep regulators on-side and to maintain a favourable climate among the public at large who may ultimately influence the behaviour of governments or even do such perverse things as consequence of their alienation as to cast votes to leave a continental economic union that underpins the welfare of the economy.

One of the underlying conclusions of the Escondido Framework is that shareholder value is not the governing principle of firms. This is a descriptive not a normative statement. Firms are managed to keep shareholders of management’s backs. Inefficiencies in capital markets and corporate governance result in perverse and/or satisficing behaviours by managers in relation to shareholders, as evidenced by the lack of control of executive salaries and value destroying M&A activity. Firms that are successful in the long term in terms of market presence, satisfying customers and being places that employees report as attractive places to work, whose standing and reputation with the public helps reduce pressure for adverse regulation from government, happen also to be those who are successful in providing returns to shareholders over the long haul that attract long term investors who, like Warren Buffet, manage to generate superior returns. The deal works this way round, not the other way!

*The authors regrettably seem unaware that Jack Welch once described Shareholder Value as “the dumbest idea in the world” – see blog post 10th April 2010