Tag Archives: Book Review

Don’t Let Shareholders Hold Innovation Hostage

31 May

The markets and regulatory agencies governing publicly traded companies should borrow a page from the NFL’s playbook and purposefully manage the division between the real and expectations market, argues Roger Martin in his latest book Fixing the Game. In the (slowly) retreating shadows of the recent financial crisis, Martin rails against modern day American capitalism, arguing that CEOs need to address consumer needs instead of focusing on maximizing shareholder value.

Through the lens of agency theory, Martin discusses the pitfalls of tying managers’ incentives to the expectations market (stock market) instead of the real market (operations, cash flow, products and services, real customers). His running analogy compares the idea of shareholder value maximization to the way in which the NFL is proactively managed in order to ensure that the fans’ experience is maximized; for example, players and coaches are forbidden from gambling on football, which could influence their on-field performance, and salary caps ensure a more equitable distribution of capital, theoretically leveling the playing field for all teams. The analogy falls apart at times, but the general point rings true: companies should not be held hostage by their shareholders.

Martin’s criticisms of capitalism’s emphasis on the expectations market at times blur the lines between policy and management recommendations and a moral diatribe. He essentially argues that hedge funds have no societal value, where as venture capital and private equity firms play a prominent role in facilitating the creation of jobs and game-changing innovations.

Nevertheless, I agree with his central tenet that if businesses successfully address the needs of customers, shareholders will subsequently benefit; however, if the focus is exclusively on the shareholder, customers don’t benefit. Even former champion of shareholder maximization, Jack Welch, admitted that an expectations market-centric view of management is flawed: “On the face of it, shareholder value is the dumbest idea in the world,” he said in a 2009 Financial Times interview.

Focusing on the demands of external shareholders instead of meeting consumer needs stifles innovation and threatens long-term gains at the expense of short-term gains. Shareholders are not interested in well-designed products, services and customer experiences; instead, they analyze businesses through quantifiable financial metrics such as cash flow and profit margins.

Especially in today’s context of explosive startups and a wave of tech-driven IPOs, we must be cognizant of the fact that entrepreneurs are driven to build game-changing products and services above all else. The Mark Zuckerbergs of the world don’t need the fund manager of California’s pension system telling them how to run their business, after all.

Martin believes the shift of focus from shareholders to customers is inevitable, because, ironically, this way of thinking makes more money (as Steve Jobs proved at notoriously investor-averse Apple). Fixing the Game is a refreshing read, at least for all of its sports references, and hits upon themes that will no doubt take center stage in this year’s presidential election. Martin has my vote.

 

 

King of Capital: Innovation Lessons from the PE World

20 Dec

In King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone, authors David Carey and John E. Morris discuss the history of the storied private equity firm and discuss what factors have enabled the company to grow from a two-man shop to an international, publicly-traded financial powerhouse. The authors address some of the most significant charges that have been trotted out against private equity and leveraged buyouts – namely the “buy it, strip it, flip it” mentality that many argue leads to job-cutting and cost-slashing, which result in weaker companies that are less likely to survive the mountains of debt accumulated during the takeover – and ultimately defend the practice, citing market data and academic research.

King of Capital is mostly a corporate biography, with a significant emphasis on the Chairman, CEO and co-founder Stephen Schwarzman, who has often been pilloried in the media for representing the excesses associated with the mountains of wealth created in the private equity business. Carey and Morris brilliantly lay out the development of the firm through an exploration of its deals – both the successful and the utterly dismal investments – and its investment team. It was particularly interesting to read about the deals by Blackstone and its competitors within a broader economic context; for example, telecommunications deals that occurred during the heady days of the internet boom were discussed, as were real estate investments that occurred during the run up to the 2007-2009 financial crisis.

The book was both entertaining and educational, as the authors took pains to delve into various financial tools and functions, debating the relative merits of stock buybacks, recapitalizations, vulture investing, etc. What I wasn’t expecting from the book, however, were valuable insights regarding innovation. As it turns out, co-founders Schwarzman and Peter Peterson weren’t just savvy investors – they were innovative entrepreneurs as well.

Here are a few key takeaways around building a successful business from Blackstone, a firm that has grown its assets under management to $157.7 billion, invested in 159 separate transactions in a wide range of industries and geographies with a transaction value of over $300 billion since 1987 by maintaining a disciplined, risk-averse investment philosophy:

Maintain flexibility in your business model. Blackstone co-founders knew they wanted to jump into the world of leveraged buyouts, but they began operations by providing M&A advice, as it was a business with high-margins, little overhead and low fixed capital costs. As Blackstone’s assets under management grew, it expanded its offerings into private equity, real estate investments, and hedge fund solutions, among others.

Attract like-minded entrepreneurial types, and award them with generous stakes in the venture. As Blackstone evolved and expanded the scope of its offerings, co-founders Schwarzman and Peterson lured the most talented investors away from established firms such as Credit Suisse and Goldman Sachs by offering partial ownership of the firm.

Do what’s best for the firm, not the individual. From the beginning, proposed deals at Blackstone were vetted among the entire partnership, often many times. Partners would poke holes in the investment argument – this promoted risk-averse, well thought out investment decisions rather than people lobbying Schwarzaman to see their deals get through.

Stick to the business that you’re best at. During the internet boom when Blackstone remained on the sidelines while its competitors and other investors were making millions of dollars seemingly overnight, Schwarzman was wise to insist that “this is not what we do well,” a position that saved the firm billions when the bubble burst.

Acknowledge when additional help is required. Schwarzman realized that he was becoming a bottleneck to investment decisions, and that further growth would only occur if he relinquished much of the day-to-day management of the firm. Blackstone looked externally, and brought on Tony James as the president and COO.