Author: Roger L. Martin
Publisher: Harvard Business Review Press, 2011
ISBN-13: 978-1422171646, 249 pages
Roger L. Martin, dean of the University of Toronto’s Rotman School of Management and a life-long sports enthusiast, writes that the 2008 mortgage meltdown was only the most recent crisis in the chronically ill U.S. economy and that another setback is inevitable unless American business leaders change their approach. He traces the U.S. economy’s problems to the mid-1970s, when corporate philosophy shifted from serving consumers to placating shareholders. He calls for a return to the old business model of paying executives based on real achievement not on meeting or missing projections. He cites the U.S. National Football League (pre-referee strike) as the perfect illustration of how well a real-rewards model can work if executives put their customers first. “It isn’t about how profitable a company wants to be,” Martin says, “It is about in what way the company becomes profitable.” getAbstract believes that his playbook can help corporations get back in the game.
Ineffective temporary fixes
The dot-com meltdown crippled the American stock market in 2001 and 2002. In response, Congress enacted new regulations, such as the Sarbanes-Oxley Act, to prevent a similar financial crisis in the future. Yet less than a decade later, the mortgage bubble exploded, spurring a worldwide recession that saw the demise of many firms, including such financial stalwarts as Lehman Brothers and Bear Stearns. The U.S. is likely to enforce additional regulations in hopes of avoiding another crash. Unfortunately, a new crisis is inevitable because of a failure to address flaws in the theories that underlie U.S. capitalism.
The U.S. economy labors under mistaken ideas about the “real market” and the “expectations market” in terms of their relationship to executive compensation. The real market is the tangible array of products, services and revenues. For a sports team, the tangible product is the win. The expectations market focuses on investor activity in reaction to predicted results. For a sports team, that’s the gamblers’ point spread.
Traditionally, boards of directors tied CEO compensation to real market results, just as coaches make more when their teams do well. Corporate salaries and bonuses used to hinge on performance. That changed in the mid-1970s when University of Rochester finance professors wrote an influential paper suggesting that executives would perform better if boards based compensation on stock-price results in the expectations market. As a result, for example, Larry Ellison of Oracle and Ray Irani of Occidental Petroleum earned most of their 2009 compensation from stock options.
In corporate America, the line between the real and expectations markets is often blurry. But that distinction remains crystal clear in the National Football League (NFL). In the real market, football games determine winning and losing teams, players and coaches. Gamblers trying to predict — and betting on — the games’ outcome create the expectations market. Las Vegas odds-makers calculate point spreads that anoint favorites and underdogs. Gamblers heeding these spreads bet hundreds of millions on games weekly. Point spreads compare to stock prices in that bettors (in essence, short-term NFL investors) affect value and price. The NFL works tirelessly to separate the real and expectations markets. That commitment distinguishes the NFL from most businesses. The NFL forbids players, coaches and officials from betting on games and strongly proscribes them from associating with known gamblers. Conversely, corporate CEOs frequently straddle both the real and the predicted markets in an attempt to meet expectations while boosting their firms’ perceived value on Wall Street…