Short-Termism, The Myth of the Rational Market, and Fire Fighting IROs : A Conversation With Bill George -- Part I

RiskRewardNews recently sat down with Bill George, former Medtronic CEO, current Exxon and Goldman Sachs board member,  best-selling author on leadership and teacher at the Harvard Business School. Here is a sample of what Bill had to say.

".... In an era of transparency, can corporations and their CEOs be honest with Wall St. without getting an overreaction? "

"There is no value that a CEO can create on Wall St. ..." 

"We all can hype the stock. We all know how to do it. That’s why it’s a myth that the market is rational."

To read the entire interview, click on the link below.

Bill George is a busy man -- Professor of Management Practice at his alma mater, the Harvard Business School; best-selling author (True North, Authentic Leadership, Finding Your Own True North, and his newly released 7 Lesson for Leading in Crisis); board member (Goldman Sachs, ExxonMobil); and non-profit trustee (Carnegie Endowment for International Peace, World Economic Forum USA, Guthrie Theater).

Promoting his newest book, the former Medtronic CEO moderated a ‘Summit on Leading in Crisis’ recently to a standing-room-only crowd in Minneapolis with prominent business leaders including Anne Mulcahy, Chair and former CEO of Xerox; John Donahoe, eBay Chair and CEO; Marilyn Carlson Nelson, Chair and former CEO of Carlson Companies; and David Gergen, former Presidential adviser, current CNN commentator and Director of Public Leadership at the Kennedy School of Government at Harvard.

RRN caught up with Bill the next day as he carved out time to share his views on a wide range of topics. He is a consistent promoter of long term value creation over what he decries as the ‘short termism’ that dominates the markets. In Part I of this edited interview, Bill talks about the financial market meltdown, the importance of leadership, the role of Investor Relations, as well as some of the lessons brought out in the Summit the evening before. Sitting in his office in Minneapolis on a beautiful late-September afternoon, Bill was relaxed yet animated, direct and candid in his views.

Part I

RRN: I’d like to start by reflecting on some of the comments last night. Anne Mulcahy recalled one of her first earnings calls when she had to tell investors that the business model Xerox was pursuing at the time was unsustainable, The PR and IR folks warned her she couldn’t say that. She did anyway, giving the street what she acknowledged in hindsight was a ‘negative sound bite’ as she’d been warned. And the stock dropped nearly 50 percent in a day. John Donahoe related a similar experience at eBay, where he had to reset the business model in his first few months as CEO and the stock lost almost 50 percent over three months. Clearly there was a lot of nominal value that disappeared in both instances. One could argue that that was going to happen anyway and both stocks eventually came back. But those stories crystallized the challenge that many corporations face when they need to recalibrate the financial community’s view of the company. As you look at the need to maintain credibility, integrity of management and transparency, how do you solve that formula in communicating with the financial markets?

BG: So it raises the question, in an era of transparency can corporations and their CEOs be honest with Wall St. without getting an overreaction?

I’ve always believed that there is no such thing as a rational market. In fact I got into a big argument with Myron Scholes at a conference where I said shareholder value does not represent the value of the company. My colleague, Michael Porter of Harvard, put up a chart that said:

“Shareholder Value ≠ Economic Value”

And he (Scholes) got quite upset.

I believe it’s the job of the leadership of the company and the board of directors to build up the economic value of the company with sound strategies and sound execution that can build the long term sustainability of the value of the corporation. In the end, shareholder value will follow.

I thought this approach was particularly evident in Anne Mulcahy's story. When she told the street her company's business model was essentially bankrupt, and there was a run on the stock, she didn’t spend her time with shareholders. She spent her time where the real value is created, with customers and with employees.

RRN: I wanted to ask you about that. You said most CEOs would go to Wall St. and you complimented her for going to the field. Can you expand?

BG: The value is created with your customers -- through your employees who are highly motivated to serve customers -- by coming up with innovative solutions for customers problems in terms of products or services.

There is no value that a CEO can create on Wall St. We all can hype the stock. We all know how to do it. That’s why it’s a myth that the market is rational.

Any of us can do that in the short term. It produces nothing for you in the long term… In fact you’ll be much worse off because you’ll get punished having done that. But a lot of people do it, because they’re trying to keep their jobs in the short term. Then they disappear in the long term and everyone blames the new guy coming in.

But I think CEOs and leaders of corporations who play the short term game are going to destroy the enterprise.

And the irony is that Wall St., who has been preaching that game, self-destructed. Take CitiGroup, They were so focused on short term fees and under pricing risk that it eventually destroyed the place. I mean, how else could you have to go the federal government for $306 billion in direct bailout money and the remainder in the coverage of toxic asset? And then lobby against mark-to-market accounting… just wanting to hide more bad news. They don’t want to face reality.

RRN: So the recent financial crisis was the result of…?

BG: Let me say, the root cause of the financial meltdown last year is leaders who focused on short term gain. They destroyed great institutions and they destroyed great value -- shareholder value. They destroyed a lot of other value as well, but let’s focus on those two aspects.

You can cite, in the past, AT&T, the old AT&T, … Sears, Kmart, Westinghouse as examples. Today, you can certainly cite CitiGroup and AIG right at the top of the list of culprits and formerly great banks, like Wachovia, Washington Mutual, Lehman obviously, Bear Stearns, Merrill Lynch… kind of a rogues’ gallery of failed leadership who failed because they focused so much on the short term and put their companies at risk.

So I would say that it’s incumbent on the leadership of the board and the leadership of the organization to always be focusing on the risk the organization should take and ascertaining whether it is producing sustainable results. And asking what is the possibility that it is taking actions that could destroy the entire company -- anything from putting out a bad product to creating too much financial leverage so that if things go way south the organization would fail.

RRN: You are on the record speaking out against quarterly earnings guidance that feeds into that whole game. What about annual guidance?

BG: Honestly speaking, analysts are bright people who should analyze -- not the IR department. OK? The IR department is there to communicate. In the case of Exxon, which gives no guidance at all, at the end of each quarter after the earnings come out, the IR department sits down with the analysts and describes where they missed Exxon’s actual numbers.

Now I know many CEOs fear that if you don’t give guidance then the analysts will go off the numbers and you’ll have to explain to CNBC why you missed the numbers. But you’re not missing your numbers; you’re missing someone else’s numbers. This is a bad game.

I think the analyst community is driven way too much by short term money on Wall St. -- primarily hedge funds -- which is where a lot of the money comes from today, and not enough on long term value. And it’s having a perverse effect on the businesses themselves, destroying far more value than it ever created.

RRN: This is very nuts and bolts for a lot of companies, particularly for small cap and mid cap companies. While it’s easier for an Exxon or a Coca-Cola to not provide guidance, it’s arguably more difficult for a small company that is searching for recognition or research coverage. Do you have any advice for CEOs, CFOs, and IROs of small cap and mid cap companies in navigating the guidance dilemma?

BG: Don’t play the game! Don’t play the game!

The only time it really matters in the short term is if you have to go to the markets to raise money. Because the rest of the time the stock price is just a morale thing, for employees, for management.

Small companies, midsized companies, growing companies are more at risk than the big companies. They’re the ones that have greater volatility. Coca-Cola has greater visibility and predictability of its earnings. Smaller companies don’t. So what the analyst community is asking you to do is predict things that are not predictable. They're asking you to commit to numbers that are not predictable. Then it becomes a big hedging game, you know?

RRN: I’d ask you to speak directly to the IR practitioners and your view of the role they should play. In your mind is most of the IR community feeding into this ‘short term’ game as enablers, bystanders? What role should they play? Why aren’t they, in your mind, playing that role? Is it lack of leadership on their part? Lack of management support?

BG: Well, I can’t blame the IR community, I can blame their bosses. But I think they (IROs) are playing the wrong game. They’re playing a reactive “How do I respond to the latest question from Wall St.?” There are an endless, unlimited number of questions you can get from the analysts. I see in a lot of companies the IR department is strictly like a firefighting department. Every time a fire comes up, they put it out.

IR has to serve as a buffer between management and the analyst community not to play that game. I think the analyst community doesn’t spend enough time analyzing value and so the IR community needs to spend more time showing them where the real value in the corporation is... not whether you are going to make 38 cents or 36 cents this quarter. That’s not the real value.

If you look at the great values creators of the last 25 years, they’re all companies that invest for the long term. I don’t know of anyone that’s played the short term game and created value in the long term – maybe Oracle.

IROs have got to think more long term… and guide the analysts to the long term value that’s being created by the organization. In other words, “Here is what the company strategies are. Here is what we are doing to create value -- in the research portfolio, in customer service, on the management and leadership side.” And communicate that to the outside world, to their shareholders. That’s really important.

RRN: The irony of this short term vs. long term dilemma in my view is that it does not create value for the economy as a whole, but it does create value for a few individuals. And you’ve cited some of the hedge fund managers who’ve been able to extract significant personal wealth out of that short term game.

BG: But for every gain there is a loss. So it’s not just the economy as a whole. This is not abstract. Take AIG. Look at all the money they made playing that game. But then they lost $153 billion. They’re bankrupt! Everything they created, they destroyed. It’s like a house of cards… and BOOM! It came falling down. So I’m saying it’s not a win-win, it’s a clear win-lose.

So we have to ask why is everyone ignoring Warren Buffet’s philosophies? He was asked a few months ago, 'Mr. Buffet, do you think it’s time to get back into the market?' And he said: 'I don’t buy stocks based on when it's the right time. I buy stocks based on when it's the right price.'

But in creating value, a company such as Intel, Medtronic, Google, those are companies that are creating long term sustainable value and that’s where the real value to investors is. I think a lot of investors sell out too soon.

I'd talk to people who'd say: 'I held Medtronic stock and I sold it.' And I'd say 'Oh! You just cost yourself a lot of money. Here’s a stock that’s continually going up and you sold. And why do you think you’re smarter than the market, so that you can get back in when it’s hit bottom? Maybe you’re not that smart to call it. Warren Buffet says he's not that smart. Why do you think you’re so smart?'

And they all think they can get out quickly. That’s the game. But not everyone gets out. In musical chairs, there’s always somebody left without a chair. And those losses can be very big. So I see a lot of people thinking they can get out in time, take the short term hit. “I don’t need to hold the stock. “ But somebody’s got to hold it. And to me, going long, going short, that's a zero sum game. In fact it can be a very negative game. In fact it’s a value destroying game.

RRN: What role can and should IRO play in a crisis both internally and externally?

BG: To communicate to the outside world honestly what’s happening and then to demonstrate where the long term value is today and where it is going to be created. Anyone who holds the IR manger accountable for the stock price is crazy. They can’t be held accountable for that.

RRN: As a follow on, while IROs have an obligation to bring an outside-in view to senior management: ‘This is what our shareholders are thinking’ sort of input, sometimes in a crisis, that can ‘raise the temperature’ for the management team, who then says: 'We’ve got to respond to that.' What’s your view?

BG: Well, I can learn, as CEO, a tremendous amount from the analyst community. They’re very insightful. I would love to hear from them, read all their reports. I wanted to hear everything they had to say. But that’s very different from spending a lot of time trying to influence them.

Everyone says 'Serve the shareholder.' And I say 'Which shareholder?' The owners? The founder? The employee shareholder? The long term shareholder that’s held your stock for 20 years? Or am I serving the people that bought it five minutes ago? Or worse yet -- am I serving the short sellers -- the ones making the all the noise? Or the security analyst who don’t hold any stock at all?

So I think we’ve become, as Jack Bogle says, an ‘Agency Society’. We listen too much to the agent. And remember, a lot of the security analysts get compensated by their firm for creating volatility. The analysts don’t make a lot of money following a stock that just goes up steadily, like Medtronic, from $5 a share to $50 a share. The people that make money are the holders. I think the analysts are acting against their clients best interests by trying to create churning in stocks. The clients’ best interests are in finding a good stock and holding it for the long term.

In Part II of our interview with Bill George, we discusses how the view of risk management has changed and needs to change in aftermath of the market meltdown, the importance of values-based management, the cultural divide in business schools, and more.

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