From Owner-Managers to Baby Boomer Executives: continued
The Evolution of Executive Motivation
Yesterday's Loyal Servants
Individual executives should not be blamed for the ethics of their class.
The decay in professional conduct has been slow and often unperceived by the people involved.
The decay in managerial ethics is the inevitable consequence of democratic capitalism
Each of us comes to the world knowing nothing.
Those who teach us when we are young, shape our attitudes.
Consequently, as corporations have evolved, the concept of a manager's job has changed slowly with each generation.
The gradual dispersal of corporate ownership by taxation, merger, public sales, death, bankruptcy, gift, inheritance, and court action has driven social change in large corporations.
The decay in managerial ethics is the inevitable consequence of democratic capitalism, paralleling the corrupting influence of Big Government.
When stockholders ran most corporations, hired managers were directly beholden to them.
The owners would promote faithful servants and sometimes pay then well.
They promoted managers who showed loyalty and the ability to run production or sales.
Sometimes, they took loyal servant-executives into the firm and offered them a partnership.
Owners would allow employees to buy stock, with the understanding that the stock must be sold back, if they left the company
Some owners would allow employees to buy stock with the understanding that they would sell the shares back at par, should they leave the firm.
Because closely-held companies often paid liberal dividends, a manager who owned enough stock could sometimes become wealthy on dividends alone.
In those days, hired executives wanted to increase profits so that their share of dividends would grow. Restricted from selling stock, they had little interest in share prices.
Organization Man in Grey Flannel
One hundred years ago, newspapers did not usually advertise management jobs.
Commonsense taught that employees should start at the bottom, learning the details of business before exercising managerial power.
Besides, nineteenth century owners were secretive.
They were tight-lipped about technical expertise and trade secrets. They would be suspicious that competitors might infiltrate the business.
The traditional 'good master' would offer steadily increasing remuneration and periodic bonuses to those who were loyal and who could get the job done.
Large companies still followed the 'good master' model long after any single shareholder or group held enough stock to control the enterprise.
The 'good master' offered lifetime, stable employment
By the 1950s, many companies on the New York Stock Exchange had thousands of shareholders, with no one having control.
In such cases, there were no owner-managers, only employee-managers. Most of these professionals had been promoted from within and were schooled under the 'good master' model.
This was time of the Organization Man and the Man in the Gray Flannel Suit.
The 'good master' offered lifetime, stable employment.
Few managers held credentials as Masters of Business Administration.
Most executives in the 1950s had business ethics inculcated by their bosses, who in turn had acquired their ideals in the early decades of the twentieth century.
An Autobiographical Note
As evidence of the change that has occurred in managerial culture over the last half century, I can cite my own experience as an Ivy League graduate in the 1950s.
My first permanent job was as a management trainee with the First National City Bank of New York in 1955. In return for loyalty and earnest endeavor, the bank promised young trainees lifetime employment and enough pay to raise a family and afford an upper middle-class lifestyle.
Each trainee had a career path that was as clear as in the civil service. The only way to the top was through the training program. Managers were never hired from outside and were rarely fired. If one left the bank, there was no return.
A Senior Vice President would take trainees to the window on a high floor at Fifty-five Wall Street and point to a worker with a hard hat on the girder of a nearby construction.
'Do you see that worker?' he would say. 'He probably makes more than I do. If you want to make money, work somewhere else. We only offer decent pay and security.'
MBAs were rare and given no preference. Contacts, reputation among peers, and personal skills were more important than credentials.
Management training lasted two years and consisted of working in each department, including the mailroom, collections, foreign exchange, check sorting, internal auditing, and credit. Trainees had to write reports describing the workflow in each section.
The President of the bank would draft a personal note as a trainee completed the program and earned his first title (there were no female trainees).
The First National City Bank of New York (Citibank. today) at that time was protective of young managers and tried hard to find the right spot for everyone. There were no budgetary goals to meet, only the concept of being a good banker. No one expected to become a millionaire.
In the 1950s, professional managers served the organization and in turn, the organization tried to protect its managers.
Consistent with this social compact, companies sought to retain capital to withstand economic downturns and to avoid the need to fire key employees.
To ensure expanding opportunities for promotion, companies invested in new areas. The loyal executive looked forward to a lifetime of steady employment and a comfortable old age.
Few thought that this cozy world would ever change.
Transition in the Seventies
Government regulation, which accelerated with the Great Society legislative binge, had a negative impact on industrialization in the United States, discouraging the reinvestment needed to ensure steady employment for the growing number of executives.
By the 1970s, the Jimmy Carter Recession with 'stagflation', the turmoil in the energy market, and the downgrading of the space program forced many companies to fire executives – especially those in middle management.
This ended the dream of lifetime employment.
A new breed of Masters of Business Administration came forward.
MBAs learned about business from college professors, rather than from on-the-job training
This new class saw themselves as independent professionals, like engineers or doctors, capable of going anywhere and managing any task.
Rather than on-the-job training under people with practical knowledge, the MBAs learned about business from college professors who had never held a managerial position and from their young, inexperienced peers, in classroom debate in accordance with the ubiquitous 'case method'.
The MBA degree became a passport to gain entrance to the largest corporations.
Fees of top schools, like Stanford or Harvard, amounted to several years' wages of the average American worker.
With an onerous indenture to work off, and having postponed entrance into the class of wage earners, young executive needed a high starting salary.
They could not accept the modest pay of the prior generation.
The Baby Boomer MBA
By 1980, the Organization Man was gone and the public corporation had evolved into something different.
The clubby, men's world of the 1950s had disappeared.
It used to be that a respectable company would not lure executives from a competitor.
Now, a new profession of 'head-hunters' had arisen, allowing firms to sidestep the polite rule against stealing executives by going through a broker.
The ideal of company loyalty suffered.
The oldest Baby-Boomers were now thirty-something and were taking on middle management responsibilities.
This generation turned away from the steady, dull life of the Organization Man and instead sought quick riches and the fast track.
Senior executives found that with democratic capitalism, they could control their own contracts and benefits.
As time passed, compensation of senior executives grew faster than in other countries, adding many new 'perks', from private airplanes to executive dining rooms and saunas.
By 1985, a new kind of manager arrived: Baby-Boomers with MBAs.
By 1985, a new kind of manager had arrived.
Baby-Boomers with MBAs held important positions, with no sense of company loyalty and with self-serving, relativistic business ethics learned from professors at business school.
This generation knew that lifetime employment with a single firm was unlikely.
Without the continuity of owner-managers, corporations became transitory stations on a career path.
The MBA could not trust the boss to keep promises, because the boss might not be there tomorrow.
The smart executive had to make money as fast as possible, at any opportunity, no matter what this might mean to the corporation or its shareholders.
Like their fellows in the medical and legal professions, MBAs demanded higher and higher pay, even if the patient died or the client went to jail for life.
Ethics of Professional Managers
The new management ethics were the result of a culture in which widely-held public corporations left no one in charge for long.
At the top, tenure was short and there was little time to get rich slowly.
Unlike owner-managers, the new professionals had no incentive to build a company for the long term or to provide employment for their descendents.
Executives learned to seize the moment, take the cash, and run.
Executives learned to seize the moment, take the cash, and run
In the 1990s, the budding executive reconnoitered the road to the top through case studies at business school and soon learned that credentials, contacts, and a positive record of accomplishments would be essential.
The smart MBA took care, early on, to land a visible job in a fast growing, profitable division of a thriving company.
Assiduously 'dressing for success', the MBA would massage performance statistics, trying to attract someone higher in the organization.
It paid to know an executive recruiter, for victory might hinge on a string of jobs with a half-dozen companies.
The clever MBA knew how to escape from a collapsing division, a bad boss, or a company that was about to implode.
The wise MBA would create an impressive resume and would be assiduously subservient to those in power.
It was important to be bland and politically correct, taller than average, lean, with a certain gravitas that suggested that one would be at home in a boardroom.
The rising executive would need to avoid controversy.
Skill was required to forge temporary alliances and to trick competing executives into taking impossible assignments, while accepting credit for work done by others, avoiding blame for one's mistakes, and covertly eliminating rivals by undetectable maneuvering.
Finally, nearing the top, the greediest executives would break anonymity, using public relations professionals and press interviews to create a cult of personality, seeking flattering magazine articles that seemed to justify multi-million dollar remuneration.
The trick was to get a contract with a severance agreement that would allow one to retire with riches in just a few years, no matter what happened to the company, its employees, clients, or suppliers.
Numbers, Not Virtue
Numbers run modern corporations.
There can be no 'management-by-walking-around' or personal knowledge of the workers and operations of a giant corporation with several hundred lines.
Financial targets are set at the highest level, and are broken down into goals by division, section, and unit.
Executives need to meet performance targets.
To succeed, MBAs became adroit in disguising and doctoring reports to their benefit, usually without breaking the law and within the broad latitude of accepted accounting standards.
The modern corporate bureacracy brings to the fore the same type of people who succeed in government
They get away with this because large corporations are complex and often unknowable with tens of thousands of employees and hundreds of products, divisions, and branches.
The bosses are always changing.
Computerized accounting is complicated and mysterious. Few people, even at the top, fully understand what is going on.
The modern corporate bureaucracy brings to the fore the same type of people who succeed in government.
An annual report of a government agency has the same kind of slick half-truths, distracting inconsequential details, politically correct sidebars, and misleading inferences that are found in annual reports of public companies.
Smarmy photographs of 'our team', with happy faces intentionally diversified by race and gender, do not show the ten thousand employees fired after the merger used to justify increased management remuneration.
Dog Eat Dog
The tactics required to succeed, although distasteful, are the logical outcome of American culture and history.
An MBA must put up a lot of money to buy the credentials needed to enter the race. There is no guarantee of success.
Companies, as legal abstractions with ever-changing captains at the helm, are unfair to executives and do not deserve their loyalty.
Corporations dismiss competent executives every day to cut costs
There are many dangers on the way to the boardroom.
A company will fire an executive with outstanding performance for being on the wrong side of a merger.
Corporations dismiss competent executives every day to cut costs.
Many careers are destroyed when a business collapses due to someone else's stupidity.
The fate of Arthur Andersen is a case in point.
Thousands of blameless professional accountants had their careers thrown off course by a politically motivated prosecutor, a biased judge, and an incompetent jury.
The final decision hinged on a request by a recently hired, in-house lawyer to re-word a single memo, which, in any event, was unrelated to professional malfeasance by anyone in the firm, or even to the obstruction of justice.
The cynical lesson of the Arthur Andersen case is that life is not fair
The partners of Arthur Andersen had made a fatal mistake in cooperating with the prosecutor by openly and unnecessarily offering documents that the government later used against them.
The lesson for accounting firms and their lawyers is not to trust the government.
It is safer to stall, like President Clinton.
The Andersen accountants that lost jobs must have known of thousands of executives who were lawfully looting shareholders.
The cynical lesson for executives is to fill one's pockets when one gets the chance, because life is not fair.
It is also clear why executives have developed an exaggerated opinion of their worth.
American society pays millions to reward sports heroes with trick reflexes, teenagers that scream dirty words to ear-splitting cacophony, and to fund a library that honors a President who is a perjurer and trafficker in pardons.
Over the last half century, the rise of state and local lotteries that distribute millions by chance signaled the decline of meritocracy.
The executive, seeing others become rich with far less claims of merit, might easily say, 'If they deserve so much, why not me?'
Not Everyone Is A Crook
Not all professional managers have the shortcomings described.
Hundreds of thousands of good-hearted middle managers have their heads buried in daily tasks, paying little attention to the Machiavellian tactics of corporate climbers.
Most executives earn only a fraction of what the few at the top are able to plunder from corporate reserves.
There still are companies run by owner-managers.
There still are companies run by traditional owner-managers, and there are even some widely held companies that hang on to ideals of the 1950s, maintaining reasonable salaries, and a sense of duty to other stakeholders.
However, Capital Flow Analysis reveals a generation of managers that perpetrated over one trillion dollars in stock repurchases to jack up the value of their options.
This suggests that, by the millennium, less ethical managers dominated American public corporations.
Executive Power and America's Future
In the 1950s, individuals owned ninety percent of the stock of U.S. corporations.
All other kinds of owners – mutual funds, pension plans, foreigners, state and local governments, and financial corporations – held less than ten percent of outstanding corporate stock. The pattern gradually changed over the next fifty years.
Over time, the percentage of stock held by individuals fell by half – from ninety percent in the 1950s to forty-two percent in 2000.
In contrast, the percentage of stock controlled by portfolio managers quadrupled.
Mutual funds, closed-end funds, private pension plans, and state and local government pension plans held over forty-three percent of the stock of U.S. corporations in 2000 .
The shift in corporate control from individuals to institutions modified the behavior of public companies.
In 1959, three young stockbrokers founded a company that made them rich by noting a significant shift in the sociology of the American capital market.
While old-line firms, like Lehman Brothers, were still catering to the white-shoe crowd – the blue blood aristocracy of wealth that hung out in country clubs – these young men, William Donaldson, Dan Lufkin, and Richard Jenrette, noticed that the buy-side of Wall Street was being taken over by institutional investors.
Furthermore, young MBAs, like themselves, were running the institutional funds.
Accordingly, they set up an investment bank in which MBAs on the sell side could talk with MBAs on the buy side – a logical and effective marketing scheme that was copied throughout Wall Street.
Now there are MBAs on all sides of the equity market – issuers, fund managers, and investment bankers – all speaking the language of Modern Portfolio Theory.
Portfolio managers exercise the controlling votes of many public companies.
They are ultimately responsible for the behavior of large corporations, since they elect the directors.
Portfolio managers are ultimately responsible for the behavior of large corporations
The message that they send to these directors, in many ways, is more important than the President's State of the Union Address to Congress or the pronouncements of the Chairman of the Federal Reserve Bank.
They set the guidelines for investment and, in so doing, determine the job market in the next generation and the thrust of American progress.
The allocation of their portfolios determines what America will be like in the future.
Some economists tell us not to worry – the Invisible Hand will take care of everything.
If fund managers see greater opportunities for short-term gain in casinos than in steel mills or education, it will all be for the best.
Surprisingly, despite the portent of decisions of fund managers, Congress, the SEC, and the Federal Reserve Bank take little notice as to how institutions exercise their fiduciary responsibility.
Although a person with commonsense might want to know what motivates fund managers and how they make decisions, government did not seem to care throughout the 1990s.
Investors: Beware the Fiduciary Gap
Savings for retirement make up eighty percent of money managed by these professionals.
Fund owners' investment time horizon is, on the average, fifteen to twenty years.
The strategy of fund owners should be long-term.
However, Modern Portfolio Theory is essentially a short-term technique.
The multi-layering of fiduciaries has created a fiduciary gap
There is no corresponding methodology for long-term investment.
The short-term outlook of corporate executives is a consequence of the role of portfolio managers, the workings of open-end mutual funds, and Modern Portfolio Theory.
Furthermore, the multi-layering of fiduciaries — fund managers, fund directors, 401(k) trustees, and 401(k) plan administrators — has created a fiduciary gap, where it is difficult to say how the real interests of the ultimate investors can be correctly conveyed to the management of major corporations.
Portfolio managers earn fees that are a small percentage of the value of a fund, often less than one per cent.
For the average American, with less than ten thousand dollars invested in a particular fund, the manager's fee is less than ten dollars per month – a modest payment for the services provided. Because the fee is variable, costs are reasonable even when portfolio values decline.
This fee arrangement is even more attractive to the fund manager.
The costs of portfolio management do not rise in proportion to the size of the fund.
The expenses of managing a one hundred million dollar portfolio are not one hundred times greater than the costs of managing a one million dollar portfolio.
In fact, most costs are just about the same.
The income of a portfolio manager is highly leveraged.
When the volume of funds increases, income rises much faster than cost.
In a perfect world, the remuneration of a portfolio manager would be determined by the fair value of the manager's time and, perhaps, by performance measured in a way that was relevant to investors' interests.
For long-term investors, a fee tied to market values does not meet these criteria, since managers are rewarded for higher stock prices, rather than for improvements in the intrinsic worth of the portfolio.
Fund managers face many conflicts of interest.
Fund managers face many conflicts of interest
Should they vote for directors who will focus on intrinsic value (dividends, asset value, market leadership, product quality, and productive capacity) or for directors that focus on stock prices?
Intrinsic value presumably benefits long-term investors, while increased market value although transitory, yields higher fees for fund managers.
Free research from stockbrokers presents another potential conflict.
One would expect fund managers to use their own due diligence when selecting stock, or, at least, to pay for research from an independent source.
It would not be prudent to rely on brokers who are trying to sell securities to the fund and elicit transaction volume.
However, a portfolio manager can increase profits by cutting expenses, and it costs less to base decisions on recommendations of brokers that are promoting issues or even trying to unload bad trades.
Efficient Markets Grant Absolution
The Efficient Market Hypothesis seems to absolve fund managers from allegations of conflicts of interest.
This conjecture conveniently equates market value with intrinsic value.
If this is so, there is no conflict of interest and portfolio managers are justified in charging fees based on market value.
The Efficient Market Hypothesis seems to absolve fund managers from allegations of conflicts of interest
Since the 1980s, institutional portfolio managers have come to hold a major stake in American corporations.
Their objective has been to select management that will do what is necessary to maximize market capitalization.
The most direct way to do this is through programs in which a company buys back its shares on the market and pays management in options linked to stock prices.
And so we see that, at the end of the day, there is no one to blame for management excesses of the 1990s.
Everyone was just doing their job and looking to the bottom line as they were taught to do in business school.
No one is really responsible for the overall health of the capital market — not the Federal Reserve Board, not the SEC.
What we find is only the Invisible Hand moving mindlessly in a relativistic, secular society in which, as the IRS commissioner said in the quote at the opening of this essay,
'there is a very high incentive to cheat. That is, of course, putting aside honor, duty, and patriotism'.
