I am a fan of James Montier. I find his insights into behavioural finance very interesting and mostly rather entertaining. Some of his essays, such as the one on Abu Ghraib and the Milgram experiment, are memorable if depressing. He has his obvious prejudices and his bêtes noires (Milton Friedman, the CAPM, efficient markets – actually, pretty much anything that seems to be remotely associated with the University of Chicago – and quite a few more). If one wanted to find fault, it would be that he occasionally draws very pointed conclusions on somewhat slender evidence. But in his latest piece, The World’s Dumbest Idea, he appears to have decided that, this time, logic and reason should not get in the way of a good rant, particularly since the targets are all among his favourites.
The dumbest idea referred to in the title of Montier’s piece is shareholder value maximisation (SVM), i.e., the idea that a firm’s objective should be to maximise the value of the existing shares. According to Montier, SVM is responsible for an impressive list of ills: lower equity returns over the past two decades, excessive executive compensation, increased income inequality and the plight of the middle class. Serious accusations indeed. Unfortunately, there is no evidence to support the accusations. The chain of causality that Montier constructs is flimsy and does not hold up to any scrutiny.
SVM is, of course, based on a simplistic, purely economic view of the world. Montier dismisses it on the basis that IBM stock has underperformed Johnson & Johnson (J&J) stock. He claims that IBM used to have a sensible mission statement but has lost its way, while J&J still has a mission statement that talks about social responsibility and the like. In essence, Montier condemns SVM on the basis that one, arbitrarily chosen, stock has outperformed another, just as arbitrarily chosen. Is he pulling our legs? Obviously, counterexamples abound. Montier presents no alternative to SVM. Is he suggesting that we evaluate equities on the basis of the quality of a firm’s mission statement? I hope not; the firms responsible for Bhopal, the Alaskan oil spill and other disasters also had lovely sounding mission statements where corporate responsibility and the like figured prominently.
Actually, SVM would not be a bad idea at all if it were applied over a sufficiently long time horizon. In order for a corporation to survive over the long run, it must take into account the interests of all stakeholders, not just shareholders, and also consider sustainability issues, all of which is completely compatible with SVM. The problem is not SVM but the horizon over which it is applied.
There are almost no long term investors left and, consequently, investors apply SVM over a very short horizon. I agree with Montier that this is a nonsense. But he suggests that this is the fault of corporate management. I think that he has the direction of causality all wrong. It was not corporate management that started to insist on quarterly reports, it was institutional investors. One of the exhibits in the study shows the well-known fact that the average holding period of US equities has dropped significantly. As a result, most listed firms no longer have a stable group of shareholders who are interested in their long-term results. Instead, they have two basic types of disinterested shareholders. One, active asset managers, many of whom turn over their portfolios once a year or more, will simply sell if they do not like what they see. Two, passive managers buy with their eyes closed and simply hold on. Both will sell out instantly if there is a bid for the company, regardless of the long-term merit of the bid. Given the myopia of their shareholders, is it really surprising that corporate management has adapted to the situation and seeks to grab what it can in the short run? Executives have simply reacted to the casino atmosphere in the markets. And since there are no (or not enough) responsible shareholders to control them, they often get away with it.
It is probably to be expected that in this year 1 A.P. (after Pickett), the Gini coefficient makes an appearance as well. Following Montier’s logic, SVM is also responsible for the increasing inequality in income. It is, of course, true that in some countries, the Gini coefficient has increased. But Montier goes one step further. He argues that, since the share of Labour of GDP has dropped over the years, workers are less well off. This is obviously pure nonsense. The share of labour may have dropped but GDP has increased at the same time. The issue is not the relative share of labour but the absolute level of income of the average (median or mean) worker – and that has increased in most places.
There are also some amusing details in the article. Montier compares the level of fixed asset investment of listed and private firms and praises private firms for their higher level (blaming SVM for the lower level in listed firms, of course). But readers of Montier’s books may recall that he used to worry that firms might spend too much, so he was in favour of lower capital expenditure. So what is it to be? (Note the lesson here: if you are in favour of it, you call it fixed asset investment; if you are against it, you call it capital expenditure or capital spending.)
I admire Montier’s courage in commenting on excesses in executive compensation. I would have thought that those of us who work in an industry that, as a whole and on average, destroys value, might want to be somewhat more circumspect in expressing views on other people’s compensation. Naturally, some people are overpaid, but it is quite possible that a CEO with an eight digit compensation package may add substantially more value (from a social viewpoint) than an active portfolio manager earning one tenth as much or less.
I hope that Montier enjoyed his rant. But his imaginary chain of causality is a bit of an insult to his readers. To my mind, his dumbest idea article is not his brightest idea. His fans, I included, deserve better.