D Murali

Restoring the core of capitalism

| Updated on: Sep 03, 2011
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The world being a crowded, politically unstable, and economically inequitable place, the prosperity of its inhabitants depends in considerable part on the rational and responsible creation of wealth through the operation of successful businesses, says Roger L. Martin in Fixing the Game: How runaway expectations broke the economy, and how to get back to reality ( Harvard ). Sadly, the advent of shareholder value theory and the structures that have taken shape in its wake – such as stock-based incentive compensation, and hedge funds – have de-legitimised capital markets and cast a shadow over capitalism itself, he adds.

Thankfully, however, the author is positive that we can fix things, and restore the core of business and capitalism, by rethinking the role of boards and creating the right incentives.

A case for board chairs

A section titled ‘The problem with directors' opens by stating that a board of directors is asked to span a wide gulf, resolving the tension between two very different markets with very different actors, viz. the outside shareholders (who want the greatest possible return), and the executives (motivated to maximise their own returns, even at the expense of shareholders). “Unfortunately, it is a job directors can't perform effectively, owing to problems with capabilities, incentives, and selection.” No matter how smart and diligent the independent directors are, they will never match the knowledge of executives, who, by definition, spend much more time engaged on the business than directors do, notes Martin. .” The antidote suggested in the book is to frame the directors' role as public service – protecting the institutions of business by auditing the operations of the firm, keeping management fixed on customers and on long-term, real-market goals. ‘Board chairs,' as the author calls them, can set the tone for the entire board, by being much more like judges.

Break the guidance habit

A chapter on ‘restoring executive authenticity' offers suggestions that may seem radical, such as the elimination of the use of stock-based compensation as an incentive. Clarifying that while executives may be allowed to buy stock, Martin insists that they should be prevented from selling any stock even for several years after leaving their posts.

Another drastic proposal in the book is to break the guidance habit of executives. There is simply no societal value to earnings guidance, avers the author. “The market will know exactly what earnings are going to be at the end of the quarter, in just three or fewer months. Society is not better off to have an executive publicly guess at what that number is going to be.”

To CEOs, the author's simple advice is to change the nature of the conversation with the analysts and the media. “The CEO should aim to establish the widest possible range of possible outcomes on the narrowest set of measures when speaking about the future of the company, so that the company has the freedom to make smart, long-term investment decisions that might otherwise cause it to miss a narrowly-defined target in a specific quarter.” Reassuring read for the hope it gives that all is not lost even if everything around seems broke.

Published on September 03, 2011

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