Just What Do CEOs Get Up To?
By
Tim Price Jun 09, 2006
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'It must be galling for dumped executives,' we wrote earlier this year 'to see their former employer's share price rally on news of their departure.' Back then, the newsflow was all about Carly Fiorina and Hewlett-Packard. This week, the newsflow is largely about Morgan Stanley and Philip Purcell, who finally fell on his sword on Monday after a bitter three-month campaign with disgruntled former colleagues and a wave of high-profile departures.
The Wall Street Journal led with a rather brutal headline: 'Morgan Stanley To-Do List: Get Boss, Strategy'. Bloomberg's headline was even more damning: 'Morgan Seeks a Leader Outside; Purcell 'Killed Them All' Inside'. The $62 million in benefits the WSJ suggests Purcell will leave with, aside from being a direct transfer of wealth from shareholders, should cushion the blow. What's different between Hewlett-Packard and Morgan Stanley, we would suggest, is that unlike technology or manufacturing companies, investment banks are rarely associated with 'star' CEOs - rather, the better investment banks (outsiders would probably plump for Goldman Sachs, and formerly probably Morgan Stanley and Merrill Lynch) are associated in the mind of both the general public and their competition with an array of genuinely talented executives of assorted seniority.
These brands exude class, whether or not the perception is sharper than the reality. The chief executive of an investment bank may or may not be an indifferently recognised figurehead, but the chances are that his talents - essentially, of being a political animal - run counter to those of his most valuable underlings, in that personally creating meaningful revenue has no obvious positive correlation with being a good manager. The shares of investment banks still look like vehicles for putting shareholders at the mercy of employee cliques (much like listed football teams). But we ask the same question today that we did in February: is the ability of chief executives in any big business to direct the fortunes of their company now significantly overstated? We went on to ponder which companies and sectors are most immune to the vicissitudes of fate and executive vanity. (Our somewhat messy conclusion, on which the jury remains out, included the resources sector, commercial banking, retailing but most executive-proof of all, the utilities sector.)
Our lingering suspicion is that, particularly within the world's larger organisations, the ability of any chief executive to add demonstrable value is limited - or perhaps rather, that the best thing they can typically do is not to overmanage, but just to get out of the way of their better staff. The cult of personality seems to remain in the popular appreciation of corporate value, though, which may indicate that the benefits of what is subjectively called 'a good management team' are wildly overstated - and, conversely, that what is perceived to be 'a bad management team' might just be either terribly unlucky or cursed with particularly poor communication skills.
Reviewing 'The Only Sustainable Edge' (John Hagel III and John Seely Brown) for The Financial Times, John Gapper suggests that other popular perceptions of the way businesses work are ripe for radical review. Among them, that
'the growth in competition caused by lowered trade barriers and technological change.. not only makes it harder for companies to make high returns but also puts in question their reason for existence.'
Another apparent conclusion is that
'companies cannot simply outsource some labour-intensive activities and carry on as before. Instead, they must establish new ways of organising themselves and relating to others.'
Hagel and Seely Brown/Gapper cite the example of Toyota remodelling relationships with suppliers while its US rivals flounder. It seems evident that what works for manufacturing barely relates automatically to financial services, in which personal relationships come to the fore, but by the same token it seems increasingly difficult, given the pace of technological change and innovations like offshoring, to describe the modern fundamentals of either sector with any degree of certainty. The business world may or may not be changing practically before our eyes, but sometimes it definitely seems to be. BusinessWeek, for example, this week in a similar vein runs with 'The Power of Us': how mass collaboration on the Internet is shaking up business, and cites amongst other disintermediators Skype, Linux, and investment managers Marketocracy Inc. And a number of weblogs have been speculating about a Yahoo / Skype tie-up.
On the topic of challenging previously easy assumptions, John Hussman in his Weekly Market Comment for Hussman funds neatly addresses misperceptions with regard to the valuation of 'growth' stocks. The full article can be read here. His first observation is that value is not a timing tool:
'To identify a security as overvalued does not imply a decline in price over the near term, or even over a short period of years. Rather, overvaluation implies only an unsatisfactory trade-off between the current price and future cash flows. Overvaluation implies that given the current security price, the stream of future cash flows delivered by that security is likely to result in an unsatisfactory long term investment return. Similarly, “fair value” is not a target price. Rather, it's a price that would most probably result in reasonable long-term investment returns, given the likely growth and risk of the future cash flows being purchased. We like to think that markets tend to move toward “fair value” over the long-term, but it's essential to remember that this “mean reversion” can take 5 years, 10 years or longer.
'If you spend any time at all studying valuation models, you'll quickly discover that you can justify nearly any price you want for a security, provided you're willing to assume fast enough growth and low enough long-term returns. In order to transform these models from algebraic curiosities into useful investment tools, the crucial step is to make sure – and this is essential – that your assumptions are reasonable.'
From the general to the specific. Using the examples of the George Foreman Grill and the Apple iPod, Hussman points to cases where investors see extraordinary adoption of products but where they may be using unreasonable assumptions and overestimating the sustainable growth attached to sales of those products. (Writing as someone who bought a Foreman Grill for a friend for Christmas and who just acquired an iPod, I can confirm the popularity of both but also, perhaps sadly, my status as a very late stage adopter indeed.) Equity analysts writing about Apple Computer have started banging on about something called 'the halo affect', whereby iPod sales are supposed magically to transform sales of all of Apple's other products. With all due respect to equity analysts, i.e. none whatsoever, this sounds like just another coinage of the dotcom era - used to substantiate exactly whatever wondrous fairy story happens to be spraying uncontrollably from the sell-side.
Hussman's argument has, of course, a particular relevance to the shares of one company in particular: Google, which may enjoy a fantastic brand (we use it too - but we don't pay to do so), but which also has 'no high-cost obstacle to entry aside from smart statistical and computing algorithms'. There is, however, a certain delicious irony in Google's market capitalisation overtaking that of Time Warner, as Google's recently did. Because Time Warner (note how fast they dropped the AOL tag) itself represents, in retrospect, the absurd pinnacle of internet mania-related folly. And that brings us neatly back to what in February we called the risk of value-corrosive corporate executives. Both running a successful business and successfully investing in a prudent, risk-adjusted way given the vagaries of the post-web, 'post-globalized' world is many things right now, but easy isn't necessarily one of them. For those focusing solely on investment, this gives rise to another suspicion: if you don't have an easily articulable strategy or an identifiable edge, you are going to get carried out of here.
Tim PricSenior Investment StrategisAnsbacher & Co Ltd
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