Not that responsibility to shareholders is the wrong concept. Quite the opposite: Building long-term shareholder value is the right approach. Instead, the problem lies in the fact that shareholders themselves are an endangered species in our economic system.
Increasingly, corporate ownership lies not in the hands of shareholders, but in the hands of an entirely different species: shareflippers. How can we possibly talk about responsibility to shareholders when so few are holders at all?
According to a recent study by Bain & Company, corporate shares now turn over at a rate six times greater than in 1960 (76% churn versus 12% churn), and nearly double the rate of just a decade ago. Even for companies such as IBM, Wal-Mart and McDonald's, the average share now flips after less than two years. And in new economy companies, according to Bain, the shares flip in a matter of months (Dell Computer, 3.7 months; Microsoft, 6.3 months) or even days. A recent Sanford C. Bernstein study found that the average public share across all companies, old and new economy, now flips after only eight months.
The confusion between shareholders and shareflippers is epidemic. When executives intone the phrase building shareholder value, increasingly what they really mean is maximizing shareflipper price.
The shareflippers are growing in all camps, including management itself. The proliferation of stock options with relatively short vesting and holding requirements has begun to align people inside companies more with shareflipper interests than shareholder interests.
As a technology CEO who recently visited my management lab told me: I've always assumed market valuation is an outcome, not a driver. I no longer hold that assumption. Today, people often evaluate their company by looking at the stock price in the short run and move quickly to other companies with better near-term appreciation potential.
Indeed, whenever we consider the return on a stock in anything less than a five-year horizon, we are confusing the concepts of value and price. And if this confusion persists, the inevitable result will be the decline of great companies. For the simple fact of the matter is that no company can become or remain great by managing the stock pricenot Merck, not General Electric, not Hewlett-Packard, not Amazon.com, not America Online, not anyone. If Bill Allen had managed for the short-term, Boeing would have never built the 747. If Walt Disney had just been out to flip his stock, he would not have created Walt Disney World. If Gordon Moore had managed share price rather than share value, we would probably not have Intel inside our computers.
I could give numerous examples of long-term diligence from my research on enduring great companies, from Fannie Mae to Nucor Corporation, from Merck to Citigroupcompanies that systematically have outperformed the market over the long haul. But they all add up to the same pattern: dogged determination to take the steps necessary to reward the long-term shareholder and refusal to play the shareflipper's game.
One of the best examples comes from Gillette, which found itself in the late 1980s under siege from an earlier incarnation of today's shareflippers, the corporate raider. On the one side sat the shareholders, who would best be served by a $175 million investment in a new shaving system (later known as Sensor) and keeping the company intact. On the other side sat the shareflippers, who wanted to see Gillette put up for sale to the highest bidder, for a quick flip-gain on their stock.
Fortunately, Gillette was blessed with a quiet, determined chief executive named Colman Mockler Jr., who argued that, although selling out would have produced a 44% price premium, it would result in a significant value discount for shareholders, given Gillette's long-term plans. The boardclearheaded on the distinction between price and valueagreed and, after a bitter proxy battle, Mockler's view triumphed.
I realize the raider-flippers of the 1980s are a slightly different animal from the widespread swarms of shareflippers we see today. But bear with me, for there are two important punch lines to the Gillette case.
First, consider how much worse off Gillette's shareholders would have been had the shareflippers triumphed. In the decade after the proxy battle, the cumulative value of a Gillette share grew 1,655%, fully 3.4 times better than the Fortune 500 median. To put that in perspective, that's 1.9 times better than a share in Jack Welch's GE over the same decade. Put another way, if a shareflipper had accepted the 44% price premium and then invested the proceeds in the general market, he would have come out between 50% and 65% behind a shareholder who stayed with Gillette, depending on which market index you use.
But, now, here's the second punch line: Gillette won its proxy battle by only a 4% margin, with the individual shareholder taking the long view and institutional investors taking the quick flip. If that same battle were to happen today, I believe the shareflippers would win, and the shareholders would lose.
And yet, while this trend is dangerous to both society and the economy, I believe it offers an opportunity if executives and boards come to see that they have no responsibility to a large chunk of the people who own their shares at any given moment, namely the shareflippers, and refocus their energies on creating great companies that build lasting value. Yes, the shareflippers have increasing power, but we should not confuse their power with our responsibility. That someone has power over us does not mean we are responsible to him.
And, so, I would like to challenge all of us to invest with at least a 5-year horizon, and preferably 10 or more. And I challenge executives to accept that managing your stock for anything less than a 5-to-10-year horizon confuses price and value, and isquite simplyirresponsible to your shareholders.
If we continue to do otherwise, we will lose the magical interplay between investors and creators, between holders and builders, on which our capitalist system depends.