Legendary US funds management outfit, GMO, does a good line in big-picture think-pieces.
The latest in its thought-provoking series of articles takes a massive swipe at one of the tenets of modern investing philosophy: the concept of shareholder value maximisation (SVM).
In short, SVM theory posits that the only relevant detail corporations have to focus on is delivering financial returns to shareholders. According to James Montier, author of the GMO paper, SVM, has proven to be the dumbest idea in the world. And that explains the paper's title, 'The world's dumbest idea'.
Montier says while SVM might have deep historical roots, it traces its modern preeminence to the ideas coughed up in the 1970s by hard-line economist (and Nobel laureate) Milton Friedman. However, Montier says SVM only really took hold in corporate boardrooms from the late 1980s, where it continues to hold sway today.
By comparing a number of factors (including total shareholder returns, company lifespan and CEO pay levels) over the SVM era and the managerial culture that preceded it, Montier concludes that the obsession with shareholder value has failed on a number of levels - even on its core promise to deliver higher returns to shareholders.
I'm not going to go over all of his findings here (at only 14 pages, including a number of nice graphics, Montier's paper is easy enough to read in a single sitting) but the conclusion that CEOs are paid too much will resonate with most audiences - except the CEO audience.
Another interesting side-effect of SVM, according to Montier, is its role in labour's declining share of the financial pie. However, by stripping labour of income and concentrating wealth in the top 10 per cent (Montier says 90 per cent of the population has an effective savings rate of 0), the system is plotting its own downfall.
"The role of SVM in declining labour share should be obvious, because it is the flip-side of the profit share of GDP," he says. "If firms are trying to maximize profits, they will be squeezing labour at every turn (ultimately creating a fallacy of composition where they are undermining demand for their own products by destroying income)."
There's a lesson there for everyone, Montier says: "Shareholders are but one very narrow group of our broader economic landscape. Yet by allowing companies to focus on them alone, we have potentially unleashed a number of ills upon ourselves."
I'll tell my director friends to bring that issue up at their next board meetings.