There are two dangerous and linked cults on the lose in companies that I have consistently attacked: the Cult of the Chief Executive and the Cult of Shareholder Value. This double disaster has a simple intellectual foundation.
The purpose of the corporate economy is to enrich its owners. To that end, an able chief executive is appointed and girded with all the powers necessary to direct the corporation in the right way in order to create capital gains for the shareholders.
Creating wealth will at the same time garner huge rewards to the CEO and his key staff.
The CEO, with the incentive of wealth, will perform as brilliantly as expected, and the share price will dutifully respond.
You could describe this formula as the Welch Effect. At General Electric, Jack Welch oversaw sustained outperformance for over 20 years, enormously enriching himself and satisfying the more modest desires of the investors.
In late 2001 Jeff Immelt took the reins and has delivered good results by sticking to the GE tradition of proactive succession.
He has moved the management in different directions, emphasising growth and creativity. Earnings per share have gone up by 22 per cent since 2001. However, the Welch Effect has failed to materialise. The share price has dropped by 14.9 per cent over the same period – so what's wrong?
The simple answer is that the Double Cults aren't working now because they never did – they were based on false premises. Take another look at them and judge whether they are true or not.
1. The purpose of the corporate economy is to enrich its owners.
False: Other parties are more significant – most of all, the customers. If you don't have customers, you don't have a business.
2. To that end, an able chief executive is appointed and girded with all the powers necessary to direct the corporation in the right way in order to create capital gains for the shareholders.
And many lauded strategies, such as mergers and acquisitions, destroy much more wealth than they create.
3. Creating wealth will at the same time garner huge rewards to the CEO and his key staff.
False: While the rewards might be huge, they bear little relation to the actual achievements.
Finally, far from being incentivised by the wealth, the CEO cannot affect the share price because it is moved by forces beyond any control of management.
This truth fully explains the Immelt Paradox. Business Week reports that investors have simply gone off 'large-cap' companies. The returns on the S&P 100stock index have dropped to 2.3 per cent annually with dividends, 0.19 per cent without dividends.
If you had invested in large-cap US stocks five years ago, $10,000 would have grown only to $11,058 - relative peanuts.
But the same investment in commodities would now be worth $15,150; in energy, $17,537; in small-cap US stocks, $19,997; in gold, $21,400. Emergent markets top the pile, where the $10,000 would have more than doubled - to $21,500.
It is clear that smaller companies have something that large ones almost invariably lose, as history confirms.
The advantages of small-time management have been spotted by big-time managers and their advisers, and they have tried to replicate them. I have long espoused the flat organisation which keeps its central establishments small, bureaucracy minimal, and staff focused on the new – putting the onus on new ideas and perpetually seeking to equal or surpass the best standards in all significant activities.
The reality is the Double Cultists have been worshipping at the feet of false idols. It could be they will rise from the dead one day but they will be false nevertheless.
