Marko Jukic, in a Twitter threat flagged by reader dk, advances a theory that is neat, plausible, and wrong. He correctly points out how the installation of CEOs coming out of finance at storied companies like Boeing, Intel, and Sony, directly led to them adopting policies that were destructive to these companies.
However, he goes wide of the mark in saying that the replacement of engineer CEOs across Corporate America with finance/MBA CEOs was the cause of their decline. While that is true in the highly visible examples he cites, the trend to financialization was well underway by the time he depicts as a turning point, the early 2000s. And its lead implementer was engineer Jack Welch at General Electric, who from the mid-1980s onward was touted as the pinnacle of modern management. By the early 1990s, over 40% of GE’s profit came from its financial service arm. McKinsey was making bank on selling its manufacturing clients to beef up in financial services just like General Electric.1 One vogue well underway by then was that major multinational started running their treasury operations as a profit center, which too often led to unhappy outcomes. 2
A second ginormous driver of the trend to financialization was the rise and stunning success of the raiders of the 1980s, rebranded multiple times (levaraged buyout, then private equity, which admittedly includes other strategies but leveraged buyouts still account for the majority of expenditures). The 1980s deals consisted overwhelmingly of financial engineering plays. At that time, there were plenty of over-diversified, undervalued conglomerates. The vogue in American business then was also to have fat corporate centers, and that was even more true for these companies. These deals were exercises in financial engineering. The hard part was the nearly always hostile takeover. Even after paying a merger premium, the buyers could break up the company and sell the parts for more than the value of the former whole. This process didn’t break down until the buyout artists, in the later 1980s, bought more and more marginal companies with more and more pricey debt. The leveraged buyout debt losses were masked by the much larger saving & loan crisis. It didn’t hurt that big foreign banks were major customers for the LBO loans, making the mess for US regulators smaller than it would otherwise have been.
Despite the LBO crash, a cadre of academics, with Harvard’s Michael Jensen, flogged the idea, first promulgated by Milton Friedman in a poorly reasoned New York Times op ed, that companies should be run to promote shareholder interests above all others. That flies in the face of their legal status, as residual claimants after all other obligations have been satisfied. Although I cannot prove a negative, I have read quite a few guides for directors of corporate boards produced by big building law firms, concentrating on Delaware, which despite Elon Musk’s hissies, is a corporate-friendly jurisdiction. I found not a single mention of prioritizing shareholder value as a board duty. The implicit prime directive instead was “Don’t go bankrupt”.
Jensen later recanted his position having seen the damage it did. But too many people benefited from this ideology for it to go away.
Let’s return to Jack Welch as a case study in how running a company for short-term results started well before the era of financiers and MBAs becoming prevalent as CEOs. One reason Welch was lionized was the supposedly miraculous tightness of GE corporate controls, enabling them to hit their forecasted earnings like clockwork. For such a sprawling company, with exposures in many currencies, that should instead have been seen as a Madoff-adjacent indicator of accounting funny business, even if it was not fraud per se. GE played lots of games with its finance arm to achieve these results, such as additions to and releases from loss reserves and the timing of the recognition of sales from their large venture capital portfolio. From a 2021 post:
My harsh take on Jack Welch isn’t just due to his destructive expansion into financial services and his cultivation of “CEO as celebrity” which was extremely successful for him and General Electric during his tenure but long-term destructive to management practice in the US. It is also that Welch’s success as a manager has been exaggerated, but it will be well nigh impossible to ascertain to what degree due to the cheerleading and a code of omerta among departing execs. One colleague who worked under Reg Jones and later under Welch, and turned around a manufacturer that remains a top player in its niche, has said that Welch ran on Jones’ brand fumes. And some of his touted practices, such as Six Sigma, were all PR.
Jack Welch and General Electric were lucky enough to ride the great financial markets boom, triggered by a long-term secular trend of declining interest rates. Welch also inherited a superbly run company at a time when America was still a manufacturing powerhouse, despite Japan and Germany making inroads.
Admittedly, General Electric, like many American manufacturers, was in the financing business by virtue of lending to buyers. But it had greatly expanded its role by the late 1980, to the degree that it took big hits from LBO lending (I knew the ex-McKinsey partner who ran its workouts. He had two conference rooms, one that he named “Triage” and the other “Don Quixote”.)
But even as of the early 1990s, GE Capital was celebrated for accounting for 40% of General Electric’s activities, doing everything from venture capital to private label credit cards to credit guarantees. And General Electric got the best of both worlds. It avoided the taint of being seen as a stodgy old economy manufacturer; by the time Jack Welch left, in 2000, it was classified in the Fortune 500 as a diversified financial firm. Yet got to borrow at industrial AAA rates, which were more favorable than any bank or insurer rated AAA.
The enormous GE Capital operations gave Welch more luster than he deserved a second way: they enabled General Electric to play earnings games, so they alway met their quarterly guidance to the penny. Admittedly, GE Capital unwisely continued its expansion after Welch left, in the low interest rate dot-bomb era, including increasing its leverage level and re-entering the subprime mortgage business in 2004.
Let’s turn to more evidence of how financialization and short-termism were established features of Corporate America well before that trend was reinforced by engineers being turfed out of CEO posts. In 2005, the Conference Board Review published our piece, The Incredible Shrinking Corporation. In that, we described how public companies had become so fixated on short-term earnings that McKinsey consultants complained to me that they were unwilling to make investments even with a less than one-year payback, because there would still nearer-term quarter costs. Similarly, the trend against investing had become so pronounce that across all American business, corporations were engaged in the unnatural behavior of net saving in an expansion. That means they were slow motion liquidating.
Mind you, that is not to minimize the importance of Jukic’s finding, that companies in the early 2000s had gone so whole-hog on milking rather than growing that they put spreadsheeters and PowerPoint jockeys in charge. And his tweetstorm does include fully warranted indignation:
You would think that a company in the process of being murdered by its own CEO would see worse financial performance and lower stock valuations by investors, but in fact murdering a company seems to greatly increase profits and excite investor enthusiasm to unheard-of heights.
The apparent conclusion—uncomfortable if not unthinkable for free marketeers—is that MBA/finance thinking and decision-making is not just not helpful but actively hostile and destructive to running a successful, functional company.
How could that be? Well, if you accept there are such things as trade-offs between short-term profit vs. long-term viability, in the examples above we see MBA/finance dogma ruthlessly maximizing those trade-offs in favor of short-term profit. Including killing the company!
But this change in leadership fashion was an intensification of a process long underway, as opposed to something new. However, differences in degree can be differences in kind. A question for another day is whether the destruction of Intel and Boeing, both not merely iconic but so important to the US that they would not be allowed to fail, amounts to looting, as defined by George Akerloff and Paul Romer, in their classic paper, Looting: The Economic Underworld of Bankruptcy for Profit:
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations
Mind you, neither Boeing nor Intel are likely to be on a trajectory to default. But that in no small measure may wind up being due to them getting government support before things get to that point.
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1 The apotheosis of that trend, of course, was Enron, which under McKinsey’s tender guidance went from being primarily an energy producer to what McKinsey praised as an asset-light trading operation. The executive singularly responsible for leading Enron to ruin, Jeff Skilling, was COO, not CEO, and had originally studied engineering before switching to a business major. Its CEO and chairman, Ken Lay, did not have an MBA but was not an engineer either. He was an economist whose rise though the energy industry appears to have rested on regulatory expertise.
2 I had an odd client assignment in the early 1990s, where I had been engaged by a derivatives firm to help advise a new client, a Fortune 500 company, that had just hemorrhaged losses on foreign exchange trades. My immediate client, a partner at the derivatives traders, was actually not exactly keen to be trying to help the corporate client: “This stuff is really dangerous. You have to know what you are doing not to blow yourself up.” This engagement came shortly before the famed Proctor & Gamble case, where tape recordings of Bankers Trust derivatives salesmen revealed them to be gloating over their ease of deceiving and screwing customers.