James Montier of GMO, a large investment firm with $120 billion AUM in fixed income and equities, has penned a paper entitled The World's Dumbest Idea. I think I may know where this is heading.... Montier reminds us that shareholder value maximization (SVM), with roots in Arrow-Debreu, assumes perfect competition and fully complete markets, before being picked up by Milton Friedman (1970) and then Jensen & Meckling (1976).
With that backdrop, Montier points out that in the shift from the era of Managerialism (1940 - 90) to SVM (1990 to present), CEO compenstation has jumped, with an emphasis on stock-related pay. Yet S&P returns during this later period, when one adjusts for valuation shifts, have been disapointing to say the least, supporting those that would question shareholder theory and its everlasting pursuit of profits. Focusing on the psychology of incentives, Montier posits that very very hight incentives diverts attention away from the task at hand. As evidence, he presents the CEO-to-worker compenstation ratio (source: EPI) which has increased from 20x in 1965 to 300x today. As a result of following SVM, Montier might say business has paid a big price - declining and low rates of business investment, rising in-equality, and low labour share of GDP.
This is ground covered on earlier blogs which highlighted Denning's views on this same issue of the costs to the economy of the shareholder approach and the need to be simply client focussed. Does all of this mean the future of corporate governance, in this post financial crisis and bank fine world we live, is shifting decidedly in the direction of stakeholder theory where creditors, employees, community and society at large become more important/
This article was brought to my attention by an article bhy Michael Pascoe of the SMH entitled CEO Pay more complicated than it looks dated January 12th 2015.
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