The Dumbest Business Idea in History

Summary

This video script critiques the focus on maximizing shareholder value, arguing it has led to layoffs, environmental disasters, and corporate frauds. It recounts the history of shareholder primacy, starting with Ford Motor Company's court case, and how this ideology has evolved. It highlights the negative impacts of short-term thinking on stock performance, including risk-taking and creative accounting, and suggests that this approach is detrimental to all stakeholders, including shareholders themselves.

Takeaways

• 📉 The concept of maximizing shareholder value has been linked to negative outcomes such as mass layoffs, environmental issues, corporate frauds, and increased inequality.
• 💡 The origin of prioritizing shareholder value dates back to a court case involving Henry Ford, where the court ruled in favor of minority shareholders, setting a precedent for shareholder primacy.
• 🔍 It's a misconception that CEOs and boards have a legal mandate to solely maximize shareholder value; they can act in the best interest of the company even if it doesn't benefit stock prices.
• 🏭 Henry Ford's strategy of paying higher wages and investing in his business was not out of altruism but a business tactic to secure a larger market share and workforce.
• 🤝 The minority shareholders who opposed Ford's strategy were the Dodge brothers, who used their dividends to fund their own competing company, illustrating a conflict of interest.
• 💼 The shift towards aligning CEO compensation with stock performance in the 1990s led to a significant increase in CEO pay and a focus on short-term gains over long-term company health.
• 📉 The focus on short-term shareholder value can lead to risky business practices, as seen in corporate bankruptcies and scandals, which ultimately harm the company and its shareholders.
• 🛠️ Cutting corners in areas like risk management, safety controls, and long-term development to boost short-term revenue and stock prices can have disastrous consequences.
• 📈 Jack Welch's tenure at General Electric saw a radical reshaping of the company with a focus on shareholder value, which led to significant stock price increases but long-term decline and reputational damage.
• 📊 The practice of creative accounting to meet financial goals and analyst forecasts, as seen with GE, can lead to legal issues and is unsustainable in the long run.
• 🕊️ The decline in worker productivity and wages keeping pace with each other may be linked to the focus on shareholder value, as companies prioritize short-term profits over employee well-being.
• 📊 The average holding period for stocks has been decreasing, reflecting a shift towards short-term investment strategies and a focus on immediate gains rather than long-term growth.

Q & A

What is the main argument against the practice of maximizing shareholder value?

The main argument is that maximizing shareholder value has led to negative consequences such as mass layoffs, environmental catastrophes, corporate frauds, and record inequality in the workplace, and is not even beneficial for shareholders in the long run.

Who is credited with being the first champion of maximizing shareholder value in the 1960s, and what did he later call it?

The CEO who first championed maximizing shareholder value in the 1960s later referred to it as the 'dumbest idea in the world' that could rock capitalism to its core.

What was the Ford Motor Company case in 1916 that set the precedent for shareholder primacy in America?

The case involved Henry Ford wanting to reinvest profits and improve worker wages and conditions, which angered minority shareholders who wanted dividends. The court sided with the minority shareholders, setting a precedent that company executives must prioritize maximizing shareholder value.

What misconception about the Ford Motor Company case has some people believing that CEOs have a legal mandate to maximize shareholder value?

The misconception is that the court ruling was in favor of the minority shareholders to mandate CEOs to maximize shareholder value. In reality, the business judgment rule was upheld, allowing executives to make decisions in the best interest of the company even if it doesn't increase stock prices.

Why did Henry Ford raise factory worker wages and offer benefits like the 40-hour work week?

Ford did this not out of kindness but as a strategic business move to control a larger share of the growing automobile market by denying competitors a workforce and pricing his Model T just above cost, making it difficult for others to sell profitable budget automobiles.

Who were the minority shareholders that took Ford to court, and how did this affect the automobile industry?

The minority shareholders were John and Horace Dodge, who owned about 10% of the company. Their actions led to the growth of their own car company, Dodge, which became one of Ford Motor's biggest rivals.

What changes in CEO compensation in the 1990s contributed to the alignment of CEO interests with shareholder interests?

CEOs began to be paid with smaller cash salaries and stock options that directly tied their bonuses to stock performance, leading to a significant increase in compensation and an alignment with shareholder interests in maximizing stock prices.

How did the shift in CEO compensation affect long-term business strategies and the focus on short-term gains?

The shift led CEOs and other senior executives to focus on short-term gains to increase stock prices and secure their bonuses, often at the expense of long-term business strategies, safety controls, and development.

What are some examples of companies that have taken significant risks or engaged in unethical practices in the name of maximizing shareholder value?

Examples include Silicon Valley Bank with a terrible risk management department, Lehman Brothers with subprime mortgage bonds, Boeing with safety control cuts, and HSBC providing financial services to international criminals.

How did Jack Welch's strategies as CEO of General Electric impact the company, its employees, and shareholders?

Welch's focus on shareholder value led to mass layoffs, selling off divisions, and investing in financial and media arms of the business. While the stock price rose during his tenure, it has since fallen by about 70%, and the company's reputation for quality products and employee satisfaction declined.

What is the connection between the average holding period for stocks and the focus on short-term gains in corporate America?

As the average holding period for stocks has decreased, investors have become more focused on short-term gains rather than long-term value, which aligns with the short-term focus of CEOs trying to maximize shareholder value.

Outlines

00:00

📉 The Downfall of Maximizing Shareholder Value

The concept of maximizing shareholder value has led to detrimental outcomes such as mass layoffs, environmental disasters, corporate frauds, and increased workplace inequality. Even its early proponent eventually criticized it as a harmful idea that could destabilize capitalism. Although executives often feel a fiduciary duty to prioritize shareholders, the long-term benefits of this approach are questionable. The text highlights the ongoing debate about the true purpose of corporations and suggests that maximizing shareholder returns is no longer the primary goal.

05:01

🏭 Ford's Revolutionary Yet Controversial Business Strategy

Henry Ford’s business strategies in the early 20th century, including using surplus cash to expand operations and significantly raising workers’ wages, angered minority shareholders who preferred profits over Ford's vision of industrial welfare. This tension led to a landmark court case that established the precedent for shareholder primacy in American corporate law, mandating that executives prioritize shareholder interests. However, this ruling also upheld the business judgment rule, allowing executives to act in what they believe is the company’s best interest, even if it doesn’t directly benefit shareholders.

10:02

💼 The Shift in CEO Compensation and Corporate Norms

The 1990s saw a shift in CEO compensation structures, with stock options increasingly aligning executives' interests with short-term stock performance rather than long-term company health. This change led to CEOs making risky decisions to boost stock prices, often at the expense of the company’s future. The text highlights various corporate failures resulting from this short-term focus, emphasizing that this approach is detrimental not only to the companies and their workers but also to shareholders in the long run.

🔧 The Decline of General Electric Under Shareholder Primacy

Jack Welch’s tenure as CEO of General Electric exemplifies the dangers of prioritizing shareholder value above all else. Welch's aggressive strategies, including mass layoffs and outsourcing, initially boosted GE’s stock price but ultimately led to the company’s decline. The text discusses how Welch's approach, widely emulated by other CEOs, prioritized short-term gains over long-term stability, leading to GE's loss of market dominance and reputation. Despite his eventual criticism of shareholder primacy, Welch’s methods have had a lasting impact on corporate practices.

📊 The Unsustainable Focus on Short-Term Gains

The decreasing average holding period for stocks reflects the growing emphasis on short-term gains over long-term investments. This shift, driven by electronic trading and financial insecurity, pressures CEOs to prioritize immediate profits to satisfy shareholders, often at the expense of long-term company health. The text argues that this short-term thinking is unsustainable and harmful to both companies and their investors, urging a reconsideration of current corporate practices.

🏥 The Deadly Consequences of Shareholder Value Obsession

The video concludes by linking the obsession with maximizing shareholder value to severe consequences in industries like nursing homes, where profit-driven strategies have led to the deaths of thousands of vulnerable individuals. It serves as a call to action for more responsible business practices and encourages viewers to engage with content that explores these critical issues further.

Keywords

💡Shareholder Value

Shareholder value refers to the economic value created for the owners of a company, often measured by the market capitalization of the company. In the video's context, it is the central focus of corporate strategy, where decisions are made to maximize this value, sometimes at the expense of other stakeholders. The script criticizes this approach, suggesting it has led to negative outcomes such as layoffs and environmental issues.

💡Fiduciary Duty

Fiduciary duty is the legal obligation of a CEO or board member to act in the best interest of the company and its shareholders. The video argues that this duty has been misinterpreted to mean a sole focus on maximizing shareholder value, which the script suggests is a mistake and not actually mandated by law.

💡Corporate Fraud

Corporate fraud encompasses a range of illegal activities that a company may engage in to deceive stakeholders, often for the purpose of inflating stock prices or hiding losses. The script implies that the pressure to maximize shareholder value can lead to such fraudulent activities, harming the company and its stakeholders in the long run.

💡Inequality

Inequality in the workplace refers to disparities in pay, benefits, or opportunities among employees. The video suggests that the pursuit of maximizing shareholder value can exacerbate such inequalities, as companies may cut costs or benefits to boost profits and stock prices.

💡Risk Management

Risk management is the process of identifying, assessing, and controlling risks to minimize harm to an organization. The script uses the example of Silicon Valley Bank to illustrate how neglecting risk management in the pursuit of shareholder value can lead to catastrophic failures and financial losses.

💡Creative Accounting

Creative accounting is the manipulation of financial reports to present a more favorable view of a company's performance. The video mentions General Electric's Jack Welch as an example of a CEO who allegedly used creative accounting to meet financial goals and boost the stock price, which ultimately did not reflect the company's true health.

💡Outsourcing

Outsourcing is the practice of contracting work to external entities rather than performing it in-house. The video criticizes the practice, suggesting that Welch's focus on shareholder value led to outsourcing, which resulted in lower product quality and customer dissatisfaction at General Electric.

💡Stock Options

Stock options are a form of compensation where executives receive the right to buy company shares at a set price, often used to align their interests with those of shareholders. The script argues that this practice incentivizes short-term thinking and risk-taking, as executives may prioritize immediate stock price increases over long-term company health.

💡Golden Parachute

A golden parachute is a large severance package given to executives when they leave a company, often after a merger or acquisition. The video implies that executives may make decisions that benefit themselves in the short term, securing their golden parachute, even if it harms the company and shareholders in the long run.

💡Short-Term Gains

Short-term gains refer to profits or benefits realized within a short period, often at the expense of long-term sustainability. The script suggests that a focus on maximizing shareholder value can lead CEOs to prioritize these short-term gains, neglecting the development and safety measures necessary for the company's future success.

💡Dividend

A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits. The video mentions dividends as a way that companies might try to appease shareholders in the short term, potentially at the cost of reinvesting in the business for long-term growth.

Highlights

Business decisions focused on maximizing shareholder value have led to mass layoffs, environmental catastrophes, corporate frauds, and record inequality in the workplace.

The concept of maximizing shareholder value, once championed, is now criticized as the 'dumbest idea in the world' by the same CEO who pioneered it.

Managers and CEOs have a fiduciary duty to shareholders, but this has been misconstrued as an exclusive focus on the bottom line.

The 1916 Ford Motor Company case set a precedent for shareholder primacy, influencing corporate governance to prioritize shareholder value.

Henry Ford's approach to business, focusing on employee welfare and market share, was challenged by minority shareholders seeking immediate dividends.

The misconception that CEOs have a legal mandate to maximize shareholder value is debunked; executives have flexibility in business decisions.

The minority shareholders who influenced Ford's business strategy were the Dodge brothers, who later became Ford's competitors.

Three reasons are presented for why the belief in maximizing shareholder value is flawed and leads to corporate failure.

The shift in CEO compensation from salary to stock options in the 1990s realigned their interests with shareholders, often at the expense of long-term business health.

CEOs motivated by short-term stock performance may take excessive risks, as evidenced by recent corporate bankruptcies.

Cutting costs in areas like risk management and safety controls can lead to increased revenue in the short term but poses significant long-term risks.

Examples of corporate scandals, such as Silicon Valley Bank and Lehman Brothers, demonstrate the dangers of prioritizing shareholder value over ethical business practices.

Jack Welch's tenure at General Electric saw a focus on shareholder value that led to massive layoffs, division sell-offs, and a shift towards financial services.

Welch's strategies, while initially successful, ultimately led to a 70% decline in GE's stock price and a loss of customer loyalty and employee morale.

The pressure to meet financial goals led to creative accounting practices that eventually resulted in legal trouble for companies like GE.

The decline in the average holding period for stocks reflects a shift towards short-term investment strategies, impacting how CEOs are evaluated and compensated.

The focus on short-term gains has been detrimental to sustainable business practices and has led to a misalignment of interests among stakeholders.

Alternative business strategies that prioritize long-term growth and stakeholder value are suggested as a more successful approach.

The video concludes with a call to action for business and leadership teams to rethink their approach to shareholder value and consider the broader implications of their decisions.

Transcripts

business decisions made in the interest of  maximizing shareholder value have caused Mass  

layoffs environmental catastrophes an endless list  of corporate frauds and record inequality in the  

workplace the very same CEO who made millions of  dollars by being the first champion of maximizing  

shareholder value in the' 60s called it the  dumbest idea in the world and something that  

could Rock capitalism to its core but worst of  all maximizing shareholder value isn't even good  

for the shareholders indeed um managers  the CEO have a they have a fiduciary duty  

to their shareholders to be concerned only with  the bottom line we think this is wrong a serious  

mistake but continue to create the capacity to  be able to reward our shareholders as we have  

done in 2023 and as we hope to continue to do in  20124 Roundtable today sparking a debate about  

the purpose of a corporation and why maximizing  shareholder returns is no longer the main goal  

if you hate your job here is a history lesson for  you that might make it start to make sense in 1916  

the Ford Motor Company had revolutionized the  automobile industry with the Ford Model T Henry  

Ford the founder and majority stockholder of the  company wanted to use the Surplus cash they had  

accumulated to build additional plans and hire  even more workers to build even more cars Ford  

had also famously and controversially raised  factory worker wages significantly and offered  

benefits like the 40-hour work week in press  interviews Ford spoke about his plans for the  

company my ambition is to employ still more men to  spread the benefit of the industrial system to the  

greatest possible number to help them build  up their lives in their homes to do this we  

are putting the greatest share of our profits  back into the business this angered minority  

shareholders in the company that just wanted him  to lower wages again raised the price of the Model  

T and keep paying them a regular dividend since  Ford was the majority shareholder in the company  

though their options were limited so they took  him to court but the court sided with the minority  

shareholders Ford was forced to consider the best  interest of shareholders above his other business  

Ambitions this was the case that set the precedent  for shareholder Primacy in America meaning the  

board of directors and Executives in a company  must always try to maximize shareholder value  

to the best of their ability some have mistaken  this ruling to mean that CEOs and the boards that  

appoint them have a legal mandate to maximize  shareholder value but the reality is that this  

simply isn't true the case was awarded in favor  of the minority shareholders but it upheld the  

business judgment rule which means that Executives  can do what they believe is in the best interest  

of the company even if it doesn't make the number  on a stock chart go up Ford himself wasn't paying  

his workers more and making new jobs because he  wanted to be nice he was a ruthless businessman  

who wanted to control a larger share of the  growing automobile Market by paying his workers  

better and offering them higher wages he was  just denying his competitors a Workforce and  

by pricing his model T's just above cost he made  it almost impossible for any other manufacturer  

to sell a profitable budget automobile the biggest  irony of all of this is the minority share holders  

that took Ford to court were John and Horus Dodge  they owned about 10% of the company and used their  

special dividends to fund growth of their own  company Dodge a car maker that would eventually  

become one of Ford motor's biggest Rivals so this  Court ruling was bad for the company's leaders bad  

for workers bad for the country and bad for the  shareholders in Ford who sacrific market dominance  

for a quick payday but there are three reasons  why people still believe in maximizing shareholder  

value and three reasons why companies that operate  this way are almost guaranteed to fail so it's  

time to learn how money Works to find out how  the worst idea in business history became the new  

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Cod hmw Corporate America didn't always have the  dangerous obsession with shareholder value that  

it does today and even after the Landmark Dodge  versus Ford case in 1919 companies were slow to  

change between the mid1 1960s and 1970s American  Stock markets traded mostly sideways corporate  

CEOs still had a duty to do what was best for the  company but they were paid a normal salary and a  

small bonus just like every other normal employee  according to the economic policy Institute and the  

National Bureau of Labor Statistics CEOs at this  time made around 20 times as much as the average  

employee of their company so they were still rich  but not so rich that they could retire after one  

good year their motivation was primarily to keep  the company running safely so they could maintain  

their well-paid jobs for as long as possible by  the 1990s a small group of financiers got the idea  

that in order to grow to get better returns from  their companies they should align the interest of  

their CEO with their own interest of getting the  stock price as high as possible they did this by  

paying the CEOs a smaller cash salary but added  stock options that directly tied CEO bonuses to  

stock performance in the 1990s CEO compensation  went from 60 times average worker pay to 380 times  

average worker pay my friend Patrick Bole did a  great video on how this small change in corporate  

Norms eventually led to people like Elon Musk  demanding $50 billion in compensation for one  

year's work now that there was so much money to be  made CEOs and other senior Executives were happy  

to go along with with the lie that it was their  legal duty to maximize shareholder value even if  

it would destroy their companies in the long  term the first strategy they used was picking  

up pennies in front of a steamroller it won't  surprise you that some of the biggest companies  

in the world have taken dumb risks we have seen  some of the biggest corporate bankruptcies in  

history happening just the past 24 months and  it's becoming more common if you are a CEO with a  

multi-million doll bonus package on the table you  are going to do everything in your power to tick  

the boxes you need for the board to Grant that  bonus a top priority for you as a CEO is going  

to be to increase your company stock price pay  a big dividend or both most bonuses are awarded  

year-to-year and according to Fortune Magazine  the average tenure of a Fortune 500 CEO is now  

only 7 years for you big projects that could pay  off over decades are effectively useless unless  

their announcement could drive up your stock  price but even that's unlikely investors rarely  

care about long-term business strategies because  they so rarely come come true anyway your best  

strategy is to control bad publicity and focus  on next quarter's financials an easy place to cut  

expenses is in areas like security auditing risk  management safety controls long-term development  

and training if you cut these enough you might  even increase Revenue at the same time because  

sales staff and revenue centers can operate more  freely without pesky compliance departments making  

sure things aren't being done illegally Silicon  Valley Bank one of the largest bank failures in  

American history had a risk manager Department  that Regulators described as terrible that's  

about the harshest thing that Financial Regulators  say about anything Leeman Brothers went bankrupt  

because it couldn't say no to the revenue  it was making from subprime mortgage bonds  

Boeing's repeated string of Airline failures has  been blamed on a push to get new planes into the  

air by cutting down on safety controls and testing  HSBC one of the biggest banks in the world made  

billions of dollars in Revenue by providing  Financial Services to International criminals  

people have lost their jobs lost savings and lost  their lives in these scandals but worse than all  

of that the shareholders lost billions of dollars  from scandals like these and others that are too  

numerous to list but the CEOs that ultimately  oversaw the companies making these terrible risk  

trade-offs already made their enormous bonuses  and some of them even got a golden parachute  

on the way out business departments like Risk  Management and cyber security have tough jobs  

if everything is going well people question what  good they are doing for the business if things  

are going badly people question what good they are  doing for the business you can make a little money  

by picking up pennies in front of a steamroller  but if something goes wrong you get smushed all  

for a few dollars the short sighted nature of CEOs  mandated to maximize shareholder value is also the  

second reason it's one of the worst ideas in the  history of business it guarantees that businesses  

become worse Jack Welch was the chairman and CEO  of General Electric from 1981 to 2001 he worked  

his way up in the company from an entry-level  position but upon stepping into the top job he  

radically reshaped the company in the name of the  shareholders Welch made 72,000 of ge's 400,000  

employees redundant he sold off entire company  divisions and he invested heavily in financial  

and media arms of the business GE Capital became  the primary focus of an engineering company that  

made consumer appliances commercial machinery and  Aerospace Parts Welch also pioneered Outsourcing  

and bragged about it on CNBC a News Network  he created to focus on business news after GE  

acquired MBC his ruthless strategy worked and  during his 20 years as CEO GE stock price Rose  

from $6 a share to a high of almost $370 a share  a year before being asked to walk away from the  

company he did but not before being awarded an  exit package estimated at $417 million other CEOs  

who are now getting paid mainly with stock options  saw this Maverick CEO talking about his strategies  

on his own News Network and they figured they  couldn't argue with the results according to  

data from the economic policy and Institute the  year that Jack Welch took over as the CEO of  

General Electric was the last year when increases  in worker productivity kept pace with increases in  

wages make of that what you would Welch's focus on  shareholder above every other stakeholder in the  

business worked well for a long time but since he  was pushed out of the company the stock price of  

GE has fallen by roughly 70% from its all-time  high even during a record bull run where the  

market is up by 400% GE used to make high quality  products that customers were highly loyal to ge's  

Outsourcing delivered worst products to the market  leading customers to buy from other brands GE used  

to be one of the most attractive companies to work  for because they were stable paid well and let  

employees like Jack Welch himself work their way  up the corporate ladder GE CEO proudly boasting  

about Mass layoffs and firing the bottom 10% of  Staff every year meant it became one of the least  

desirable companies to work for so top talent went  elsewhere by sacrificing customers and employees  

to appease shareholders they made it worse for  them too Welch himself even said in an interview  

that maximizing shareholder value was stupid a  high stock price is the result of doing everything  

else correctly why didn't he follow his own advice  well because he made too much money by keeping the  

people that paid him happy during Welch's tenure  as CEO GE was almost suspiciously good at meeting  

financial goals Roger Martin the dean of the  rotman School of Business at the University  

of Toronto said in an interview with Forbes that  GE met orb analyst forecast in 46 of 48 quarters  

between December 31st 1989 and September 30th 2001  a 96% hit rate even more impressive in 41 of those  

46 quarters GE hit the analyst forecast to the  exact Penny 89% Perfection of course this wasn't  

amazing management it was good old fashioned  Creative Accounting a practice that got GE and  

hot water with the SEC and was part of the reason  why welch was eventually asked to nicely leave the  

company despite his tarnished record Welch's  business practices are still common in a lot  

of corporate boardrooms across the world okay  so you might ask if encouraging CEOs to pursue  

short-term gains has shown to be bad for everyone  including the shareholders who appoint the board  

who employ the CEO why are companies still doing  this well that's because the third reason why  

maximizing shareholder value is a terrible idea  for everyone the short term is all that matters  

according to data from the largest stock exchanges  in America the average holding period for stocks  

has been consistently declining for decades in  1975 investors held on to stocks for an average  

of 5 years in 2021 they held on to them for less  than one year electronic brokerages have made  

buying and selling shares much easier and people  are generally in financial situations that are  

much less secure where selling shares becomes a  way to cover an unexpected expense that's not how  

long-term investing should be done but staying  ahead financially these days is hard the largest  

dips and shareholder holding periods happened in  2001 and 2008 during down markets and job losses  

where people were probably selling out a loss on  their Holdings but needed to cover their expenses  

one way or another long-term capital gains tax  laws also encourage people to seek profits from  

buying and selling year toe rather than a dividend  strategy which can be less tax efficient the  

result is that if people are holding on to shares  for less time then they also only care about short  

term wins so a CEO that delivers a profitable  fourth quarter will be more popular than a CEO who  

reinvests company earnings into training R&D or  safety that won't pay off for years this kind of  

short-term thinking is not sustainable but that's  another shareholder in CEO's problem but this  

isn't the only way I am going to ride an oped on  business and Leadership teams that I have worked  

with in the real world that are doing things  a little bit differently to great success on  

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