Shareholder Value

The idea of maximizing shareholder value has caught the imagination of the corporate world. On the face of it, it makes sense. The true owners of a company are its shareholders. Shareholders invest in a company in the expectation of increasing returns over time. As such, they have a stake in the long run success of the organization. By maximizing shareholder returns, a company is simply giving its real owners a return that they expect and should receive. By this reasoning, any other objective would hurt the shareholders and is therefore inefficient.

There is one major problem with this argument. Value is built over time i.e. in the long run. Shareholders typically hold shares for a limited period. So most shareholders have a short term view of the company. This results in a fundamental mismatch in timing horizons. The effect is that shareholders (specially the larger ones) can pressure company management to produce immediate returns in the short run. Unfortunately, such actions often come at the expense of the long run. The result is that over time, lost value and become increasingly vulnerable to external shocks.

This vulnerability is reflected in the decreasing lifespans of companies. The repercussions of a failing company go well beyond its shareholders and employees. A very large number of people are negatively affected. One company's failure can easily set of a chain reaction. For example, suppliers to the company can also start to fail setting off chain reactions of their own. Even competitors can be negatively affected since companies within an industry have very similar supply chains. Any weakening of one supply chain can reflect onto others.

We also have to keep in mind that companies are always embedded in communities. They do not exist in a vacuum. Much of the salaries that are given to employees are spent in the local community. If these jobs vanish, the external community falls onto hard times with its attendant social problems. So focussing on shareholder value alone is doing a great disservice not just to the organization but also to its supply chain and to the larger communities in which the organization operates in.

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Are Markets Perfect?

The Free Market: A False Idol After All? (Photo credit: elycefeliz)

Current economic thinking essentially states that any demand will be met by a supply because people are rational who are constantly striving to maximize their "happiness". Ofcourse, happiness needs to be defined more closely. So acquisition of material goods is deemed to be a proxy for "happiness". The more goods and services someone acquires, consumes or accumulates, that person is considered to be "happier" relative to someone else who is unable to do the same. By this reckoning, rationality indicates that any demand will be met since by doing so, all parties concerned will be "better off" or "happier".

That is the theory. What about practice? Currently business organizations provide many of the goods and services that we depend on. These are profit making entities whose primary, if not sole mandate, is to make a profit for their shareholders. So any demand should be met. But it isn't. Why not? One of the biggest flaws in the current capitalist paradigm is that it overserves some goods and services and underserves others. The free market system is very powerful. If all costs are properly factored in, then it serves as an excellent allocator of resources most of the time. Most of the time, not all of the time. Why is this so?

If markets are perfect, then no segment of a population should be left unserved. If this happens, then markets are flawed and some corrective mechanism needs to be applied.

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Infinite Growth?

Can any economy grow indefinitely? If it can, should it do so? What is the point of economic growth? For over 200 years, we have lived in a system that takes infinite growth for granted. This has been coupled with a growth in basic science and associated technologies. As a result, there is a firm conviction amongst many (perhaps most) that all problems can be resolved by better and new kinds of technologies. Thus the conclusion is drawn that there are no limits to growth.

In my mind, this is a false conclusion. In a universe of ultimately finite resources, there are going to be limits to infinite growth. The picture is further complicated by the effect that increasing wealth has on demographic growth. In country after country, as the economy has taken off, there has been a baby boom followed by a baby bust. Sometimes governments have intervened in order to limit population growth but even without such intervention, fertility rates have fallen with increasing development. The reason is simple: wealthier parents generally choose to limit the number of their offspring since there is a reasonable chance that their children will outlive them. So they choose to concentrate greater amount of resources on a smaller number of children.

I believe that there are ultimately hard limits to growth. No economy can grow infinitely. The time taken to reach such limits however is dependent on the type of economic growth. Western Europe and later North America developed a peculiarly wasteful form of economic growth. Products are built not to last but to fail. This is exacerbated by carefully and cleverly creating demand for the latest, greatest even if current models function perfectly well. This results in overflowing landfills and enormous garbage dumps in the seas. It also leads to stresses on eco-systems which all too often lead to their collapse. After 200 years of largely unbridled capitalism, we seem to be reaching a point of looming economic collapse simply primarily because of wasteful resource usage.

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The Unending Quest For Productivity

What is productivity? Why is it important? What is the benefit of ever increasing productivity? Is there a natural limit to productivity gains? Modern economies are built around a platform of unending productivity. Much has been written and continues to be written about productivity. The basic assumption of our society (and by society I mean the world) is that ever increasing productivity is unquestionably good.

A basic definition of productivity as given in Wikipedia is total output per one unit of total input. This definition also helps to give an answer to the question of why productivity is important. The more we can produce per given amount of input, the more productive we are and so our production processes are more efficient. This also helps to address a benefit of ever increasing productivity. Greater efficiency in production processes helps to reduce waste and should provide superior quality and service.

Viewed from this lens, productivity per-se is good and greater productivity is even better. Hence it makes sense to try and constantly increase productivity. This is an economic argument that is accepted almost without question. This same argument also easily flows into the private sphere. Thus apart from taking about work productivity, there is constant discussion about improving personal productivity. An entire industry has grown up on how to improve personal productivity. Books, blogs, talks, seminars, there is a huge amount of information and advice available . Anyone wanting to explore this area is quickly overwhelmed. The key assumption behind all this is that only economic activities are worthwhile.

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Broken Promises - III

The process of industrialization makes an implied promise of providing relatively secure, well paying jobs. Indeed in the modern world, governments have to go for industrialization. There is no other alternative. At the same time, there is the process of globalization underway. The problem is that the imperatives of globalization and that of industrialization are often at odds with each other. The interactions of these two trends enables corporations to play one country against another and at the same time successfully impose harsh working conditions on their workforce. The level of the individual concerned is immaterial. The high ranking manager is just as terrified of losing his or her job and all the benefits that accrue with it as the factory worker. This is why both types are willing to sacrifice family and personal life and work insane hours for what are relatively meager rewards for the amount of effort and hours put in.

Quite apart from globalization, companies are putting efforts in the development of advanced robotic machinery and computerized systems. There is a clear logic behind these efforts. Robots can work 24/7, do not require time off and do not do things like going on strikes. Similarly, knowledge systems seek to incorporate knowledge and insights that a manager will typically acquire over his career. Here the primary effort is to "lock" in the knowledge and insights so that they can be used after the manager is no more on the scene. Both trends tend to have a similar effect. The number of people required to run the system gets smaller. In the past, new forms of technology came along to absorb the people thus rendered surplus. The same will happen again. The question is one of timing. Unfortunately, the process of people being rendered surplus is happening far faster than the development of promising new technology and processes. So a large number of people, specially older workers both managerial and non-managerial, are finding their skills obsolete and their services no longer required.

Clearly something is amiss. Workers of all stripes, educational background and skill level face an uncertain future in which they can never be sure when they become redundant. It does not matter if they are in a developed country or a developing one. The normal argument given in such cases is that people must upgrade their skill and knowledge levels. This ignores their academic inclinations as well as their willingness and ability to learn the new skills required. Besides the problem is that many of the upcoming technologies are in their infancy. They are still being heavily developed. Most have not yet emerged from scientific laboratories. As a result, the knowledge of these industries is changing rapidly as new discoveries are made and new theories are propounded and proved or disproved.

There is the additional question of exactly what new technologies will provide the basis of future growth? The situation is currently murky. Betting on the wrong horse means wasted time and effort for little or no reward. Blithely saying upgrade skills and knowledge does not give people an idea of how to direct their efforts. We are thus faced with a deadly combination of redundancy, globalization and rapidly changing technology with concomitant rapid advances in knowledge. The pace of change is blistering and ever increasing.

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Broken Promises - II

The process of globalization and outsourcing means that jobs are coming to developing countries. While developed countries may be losing jobs, developing countries are gaining them. These jobs are no longer just manual labor or factory work although these are still coming. Higher end "knowledge" jobs are also being outsourced. Basically any job that does not require face time with clients is at the risk of being outsourced.

Most economists generally view this as a net positive when looking at the system as a whole. Consumers in the developed countries get goods at a cheaper cost while people in the developing countries get gainful employment. What's not to like? The problem lies in the very factors that under-gird the process of globalization.

At the lower end of the job spectrum, workers face the constant threat of jobs moving to still cheaper locales. As a result, they become willing work under appalling, often unsafe conditions for exceedingly low "market" wages. The argument that they are nevertheless still better off than previously simply highlights their desperate poverty. The availability of cheap goods comes at a high human cost that is largely invisible to more well off consumers. The wages that these workers get generally allows them no better than subsistence living. This in turn hampers the economic development of the host country. Since domestic consumers are too poor to buy the goods that they help to make, companies do not have an incentive to produce goods for them which means that the foreign investment that comes in is geared towards the export sector while neglecting domestic needs. The only way to break this circle is if the host government takes active steps to mitigate these effects and promote domestic development. However, this is not an easy task since the foreign companies then threaten to shift jobs to other, more pliant governments. There is then the distinct possibility of thousands of workers being unemployed with the concomitant social problems; something that no government will contemplate with equanimity.

At the higher end of the job spectrum, middle class, "knowledge" workers face the same threat both in developed countries and in developing countries. The advances in logistics and communications technology that made it possible to outsource low end jobs are now doing the same at the upper levels. Basically, all back office work can be outsourced. This includes jobs that range from accountancy to engineering design to paralegal work to software creation and so on. All of this work was supposed to be the domain of developed countries but that ignores the fact that anyone can get the same level of knowledge while sitting anywhere in the world. Also, these jobs are much easier to move around than factory work. In the latter case, companies have to shut down physical plants and rebuild them elsewhere. For much knowledge work, all one needs is a computer and fast internet access. Now companies are in the happy position of being able to pit knowledge workers around the world against each other. This reduces the value of this work and lowers wages in these areas. So graduates in developing countries are not immune to the forces that brought them the higher end jobs; these same forces can easily shift such jobs into still lower wage areas.

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Broken Promises

We have been betrayed. All of us. No exceptions except for a tiny minority. It does not matter whether we live in a developed country or a developing one. We were made a promise that has been broken. False reassurances were given. We were lulled into a stupor and now are slowly awakening to conditions that we don't recognize and never agreed to.

The promise was made as a result of the development, export and expansion of the industrial revolution. As a result of this, technological innovation has exploded. New inventions and new ways of doing things are constantly being developed. At the same time there is an increased emphasis on obtaining technical education to fulfill the demands of the new technologically oriented society. This has affected both developed and developing countries. The only difference between the two is that the latter experience these trends later than the former although the time delay has been shrinking rapidly.

So people in the developed countries have been strongly encouraged to obtain a university education. This encouragement has been backed up by reams of statistics from "experts" which showed that people with a university degree earn significantly more than their less educated peers. People were told that the future was in the "knowledge" economy. Thus when the first wave of outsourcing to the developing world hit the labor classes in the developed countries, "experts" were on hand to reassure everyone that the future did not lie in the "dirty" manual labor. Brain power was more important. The blue collar jobs lost will be replaced by higher paying, white collar jobs in which knowledge is more important. No need to get hands dirty when the more important, higher value added, better paying cerebral jobs will be available.

A little thought on this claim would have quickly exposed it as being largely a piece of fiction. There is no monopoly on knowledge. A person in the developing world can acquire the same amount and level of knowledge that anyone in the developed world can. Furthermore, developing countries have lower living costs than developed ones so such a person can be acquired at a cheaper price than a similarly knowledgeable person in the developed world. The same technological, economic and communication factors that have made outsourcing of manual jobs feasible do the same for "knowledge" jobs. So for example a qualified accountant in the developing world can be acquired for a fraction of the cost of an equally qualified one in the developed world. Similarly a developing country hardware designer can design a new computer chip at a much lower cost than a developed country hardware designer. Thus outsourcing of middle class, higher end "knowledge" jobs was only a matter of time and already this process is well underway. What is left are jobs that require face to face, physical interaction with clients and customers. That is why McDonalds can add jobs in developed countries whereas General Motor is shedding them. It is to be noted that at the high end, face to face, physical interaction is becoming less important as technology advances to a point where it becomes possible to transmit holographic images around the world. So at the high end, these jobs will also be under the threat of being outsourced.

All of the above means that people in developed countries are sitting pretty right? After all, jobs are coming to them. Their counterparts in the developed countries may be getting fired but they are getting hired. And it is not simply low end manual jobs that are coming their way. As the above indicated, high end, "knowledge" jobs are also coming their way.  Therefore for the developing countries, good times indeed. Not quite. The picture here is not as rosy as it seems.