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Saving Capitalism From Short-Termism: How to Build Long-Term Value and Take Back Our Financial Future
“As Rappaport keeps on speaking out for the realities surrounding investment and speculation, our society will profit as it builds on his keen insights.”
―from the Foreword by John C. Bogle, founder of the Vanguard Group “Al Rappaport brings insight and wisdom to the short-termism debate, fully demonstrating the way perverse incentives are undermining public companies and capital markets.”
―John Plender, Financial Times "In this rigorous, useful, and delightful book, Rappaport undresses short-term financial incentives for what they parasites that draw the value-creating innovation out of companies. And he shows how executives can align long-term value-creating investments with the right investors' expectations."
―Clayton Christensen, Harvard Business School “How to make managers focus on the long-run is one of the most consequential and difficult questions in corporate governance and is the subject of much debate and disagreement. Professor Alfred Rappaport’s insightful book is a valuable contribution to this important debate.”
―Lucian Bebchuk, Professor, Harvard Law School, and coauthor of Pay Without Performance “ Saving Capitalism from Short-Termism insightfully exposes the contradictions by which we incentivize money managers to require short-term focus by company managers. Again and again in rereading this book, I am struck with the author’s felicitous style in raising subject after subject in which I have long been interested―but, until this read, have not been able to resolve. Buy it, read it, and enjoy.”
―Robert A.G. Monks, founder ISS (Institutional Shareholder Services), Lens Governance Advisors, and The Corporate Library “Capitalism fails when corporate managers and professional investors prefer their own interests to those the true owners of businesses. In Saving Capitalism from Short-Termism , Al Rappaport shows how new incentives schemes can deliver shareholder value for the 21st century.”
―Edward Chancellor, author of Devil Take the A History of Financial Speculation and member of GMO's Asset Allocation team About the Book Business leaders today obsess over quarterly earnings and the current stock price―and for good reason. Corporate incentives typically focus on short-term profits rather than long-term value creation. Nothing is more harmful to businesses―and to the broader economy. Few business thinkers in recent decades have contributed more to this subject than Alfred Rappaport. As an author and educator, Rappaport is a pioneer in developing the principles of values-based management and is an acknowledged authority on how to make long-term shareholder value the essential driver of corporate strategy. His latest work, Saving Capitalism from Short-Termism , is a clarion call for conquering the addiction to short-term profit―and getting on the path to building long-term value. Rappaport’s solution to short-termism is simple but business leaders must align the interests of corporate and investment managers with those of their shareholders and beneficiaries. His plan
―from the Foreword by John C. Bogle, founder of the Vanguard Group “Al Rappaport brings insight and wisdom to the short-termism debate, fully demonstrating the way perverse incentives are undermining public companies and capital markets.”
―John Plender, Financial Times "In this rigorous, useful, and delightful book, Rappaport undresses short-term financial incentives for what they parasites that draw the value-creating innovation out of companies. And he shows how executives can align long-term value-creating investments with the right investors' expectations."
―Clayton Christensen, Harvard Business School “How to make managers focus on the long-run is one of the most consequential and difficult questions in corporate governance and is the subject of much debate and disagreement. Professor Alfred Rappaport’s insightful book is a valuable contribution to this important debate.”
―Lucian Bebchuk, Professor, Harvard Law School, and coauthor of Pay Without Performance “ Saving Capitalism from Short-Termism insightfully exposes the contradictions by which we incentivize money managers to require short-term focus by company managers. Again and again in rereading this book, I am struck with the author’s felicitous style in raising subject after subject in which I have long been interested―but, until this read, have not been able to resolve. Buy it, read it, and enjoy.”
―Robert A.G. Monks, founder ISS (Institutional Shareholder Services), Lens Governance Advisors, and The Corporate Library “Capitalism fails when corporate managers and professional investors prefer their own interests to those the true owners of businesses. In Saving Capitalism from Short-Termism , Al Rappaport shows how new incentives schemes can deliver shareholder value for the 21st century.”
―Edward Chancellor, author of Devil Take the A History of Financial Speculation and member of GMO's Asset Allocation team About the Book Business leaders today obsess over quarterly earnings and the current stock price―and for good reason. Corporate incentives typically focus on short-term profits rather than long-term value creation. Nothing is more harmful to businesses―and to the broader economy. Few business thinkers in recent decades have contributed more to this subject than Alfred Rappaport. As an author and educator, Rappaport is a pioneer in developing the principles of values-based management and is an acknowledged authority on how to make long-term shareholder value the essential driver of corporate strategy. His latest work, Saving Capitalism from Short-Termism , is a clarion call for conquering the addiction to short-term profit―and getting on the path to building long-term value. Rappaport’s solution to short-termism is simple but business leaders must align the interests of corporate and investment managers with those of their shareholders and beneficiaries. His plan
- GenresEconomics
256 pages, Hardcover
First published July 21, 2011
About the author
Alfred Rappaport
19 books17 followersMichael J. Mauboussin is Chief Investment Strategist at Legg Mason Capital Management. Prior to joining LMCM in 2004, Michael was a Managing Director and Chief U.S. Investment Strategist at Credit Suisse. Michael joined CS in 1992 as a packaged food industry analyst. He is a former president of the Consumer Analyst Group of New York and was repeatedly named to Institutional Investors All-America Research Team and The Wall Street Journal All-Star survey in the food industry group.
Michael is the author of Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) and More Than You Know: Finding Financial Wisdom in Unconventional PlacesUpdated and Expanded (New York: Columbia Business School Publishing, 2008). More Than You Know was named one of The 100 Best Business Books of All Time by 800-CEO-READ, one of the best business books by BusinessWeek (2006) and best economics book by Strategy+Business (2006). He is also co-author, with Alfred Rappaport, of Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business School Press, 2001).
Michael has been an adjunct professor of finance at Columbia Business School since 1993 and is on the faculty of the Heilbrunn Center for Graham and Dodd Investing. In 2009, Michael received the Deans Award for Teaching Excellence. BusinessWeeks Guide to the Best Business Schools (2001) highlighted Michael as one of the schools Outstanding Faculty, a distinction received by only seven professors.
Michael earned an A.B. from Georgetown University. He is also affiliated with the Santa Fe Institute, a leading center for multi-disciplinary research in complex systems theory, and is on the board of directors of Sermo, an online community for physicians."
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August 21, 2018
In the popular debate there is a growing consensus that short-termism in financial markets is a big problem. Is this actually the case? – And if so, what can be done about it? Alfred Rappaport, one of the founding fathers of what’s been dubbed the Shareholder Value Model and author of the trailblazing book Creating Shareholder Value, should be in a unique position to have a view on these topics. Rappaport’s view is that there surely is short-termism in corporate and financial processes but that this – contrary to mainstream discourse – is not due to the Shareholder Value Model and the solution is actually to return to the roots and original intentions of this model.
Some of the arguments for the model are utilitarian: pooling of resources to the highest return on capital investments allocates a society’s scarce resources to their most efficient use and thus is the mechanism by which economic growth is created; also, higher shareholder value means higher long term returns on securities which is sorely needed to give a decent living standard for retirees. The main argument however is in a way ethical. If you own something you are in lawful disposition of this property. The shareholders own the company so they should be in charge of it and decide on its purpose. Value is created by a company if it deploys capital into investments where the future incremental cash flow return on the investments are higher than the cost of capital of the funds needed to finance the investments. The value of the company, its shareholder value, equals the so called present value of all future free cash flows discounted by the cost of capital, net of net debt. The Shareholder Value Model simply states that it’s a company’s aim to maximize this net present value for the benefit of those who owns it. This is a model that looks at an eternal future. In contrast companies and investors are often trapped in a short-term rat race where the practice of maximizing quarterly earnings is sometimes dubbed as “creating shareholder value”, making this perverted model very easy to dislike.
Rappaport in the two first chapters gives an historical résumé of short-termism and looks at the recent financial crisis through these glasses – finding myopic behavior on all accounts: the finance industry, regulators and government, corporations and home buyers. Next the author probes deeper into the reasons for this behavior when it comes to corporations and investors.
As many of the problems in Rappaport’s opinion are caused by faulty incentives the second part of the book puts forward a number of solutions focusing on corporate managers and investment portfolio managers payment packages plus value creating practices in companies and in the investment process. The guiding principle for all this is a better alignment to the creation of long- term shareholder value as the concept was originally intended to be interpreted. The form and shape of the text follows a very natural pattern guiding the reader from start to finish line. This will obviously not convince the many vocal critics of (what they perceive as) “shareholder value”.
Apart from a section on corporate financial reporting that I find a bit of a dead end I basically agree with the author and I also think the topic is vitally important. Despite this the book cannot really get my juices flowing. For anyone that has followed this debate the last 15 – 20 years there is nothing new and for a person of Rappaport’s stature I also find the book rather shallow. To be fair the author states that the book is intended for a “broad audience”: “corporate executives, board members, institutional investors, and accounting standard- setters.” They might not be specialists in this matter but it doesn’t look like a group of people whose intelligence should be underestimated.
If you need a basic introduction to the topic, by all means read this book. However, although slightly dated, Rappaport’s 1997 book Creating Shareholder Value still offers a more comprehensive picture and should be in every investor’s bookshelf.
Some of the arguments for the model are utilitarian: pooling of resources to the highest return on capital investments allocates a society’s scarce resources to their most efficient use and thus is the mechanism by which economic growth is created; also, higher shareholder value means higher long term returns on securities which is sorely needed to give a decent living standard for retirees. The main argument however is in a way ethical. If you own something you are in lawful disposition of this property. The shareholders own the company so they should be in charge of it and decide on its purpose. Value is created by a company if it deploys capital into investments where the future incremental cash flow return on the investments are higher than the cost of capital of the funds needed to finance the investments. The value of the company, its shareholder value, equals the so called present value of all future free cash flows discounted by the cost of capital, net of net debt. The Shareholder Value Model simply states that it’s a company’s aim to maximize this net present value for the benefit of those who owns it. This is a model that looks at an eternal future. In contrast companies and investors are often trapped in a short-term rat race where the practice of maximizing quarterly earnings is sometimes dubbed as “creating shareholder value”, making this perverted model very easy to dislike.
Rappaport in the two first chapters gives an historical résumé of short-termism and looks at the recent financial crisis through these glasses – finding myopic behavior on all accounts: the finance industry, regulators and government, corporations and home buyers. Next the author probes deeper into the reasons for this behavior when it comes to corporations and investors.
As many of the problems in Rappaport’s opinion are caused by faulty incentives the second part of the book puts forward a number of solutions focusing on corporate managers and investment portfolio managers payment packages plus value creating practices in companies and in the investment process. The guiding principle for all this is a better alignment to the creation of long- term shareholder value as the concept was originally intended to be interpreted. The form and shape of the text follows a very natural pattern guiding the reader from start to finish line. This will obviously not convince the many vocal critics of (what they perceive as) “shareholder value”.
Apart from a section on corporate financial reporting that I find a bit of a dead end I basically agree with the author and I also think the topic is vitally important. Despite this the book cannot really get my juices flowing. For anyone that has followed this debate the last 15 – 20 years there is nothing new and for a person of Rappaport’s stature I also find the book rather shallow. To be fair the author states that the book is intended for a “broad audience”: “corporate executives, board members, institutional investors, and accounting standard- setters.” They might not be specialists in this matter but it doesn’t look like a group of people whose intelligence should be underestimated.
If you need a basic introduction to the topic, by all means read this book. However, although slightly dated, Rappaport’s 1997 book Creating Shareholder Value still offers a more comprehensive picture and should be in every investor’s bookshelf.
October 4, 2011
Intrinsic value created by corporate America is the bedrock of American Capitalism. This value is real and long lasting and provides strength to the growth of capitalism. Much has happened in recent years in the US - in corporations, in financial markets, in politics - to destroy this intrinsic value, making us worry about the future of US capitalism. While everyone is looking for the causes - in our greed, in the broken political system in Washington, in our engagement in wars overseas, in the reckless and parasitical behaviour of our financial institutions-, Alan Rappaport draws our attention to 'Short-termism' as one essential cause of American capitalism's breakdown. Short-termism is simply the addiction to short-term profit creation at the expense of creating long-term intrinsic value. The author says: "Investors expect corporate managers to allocate resources so as to maximize the long-term value of their companies and expect fund managers to construct portfolios that offer the highest risk-adjusted long-term returns. The incentives in place, however, typically reward corporate and investment managers for short-term performance rather than long-term value creation". The result of all this is the undermining of public companies and capital markets leading to economic crises.
The book comprises of two parts. The first part covers the rise of short-termism in general, how it works in corporations and Investment Management and finally, how it leads to financial and economic crises. In the second part, the author outlines a plan to overcome short-termism and reclaim our financial future.
Unfortunately, the first part does not contain any new insights. Most of us, who have suffered in the stock market through the first decade of the 21st century, are well aware instinctively of the tyranny of the quarterly earnings pressure and how one's money manager is influenced by it. We are also well aware of the conflict of interests that lie between investment managers and the client's money that they manage. My own personal experience was that my interests come a distant third, behind the manager's interests of earning more commission and then the investment firm's interest of earning income from my account.
The author's solution to short-termism in the second part is focussed on providing incentives to all employees - CEOs to the floor - for delivering long-term value, making senior management and the board to commit to long-term value creation as the main objective, modifying fees structure of fund management to take care of shareholder interests, and finally to provide real, transparent and valuable information on which investors can depend on.
As an ordinary citizen, I find it daunting that such a plan can be implemented in a society like ours. If a firm commits to long-term value creation and its competitors don't, then this firm may lose out market share in the short-term due to its lagging behind its competitors in earnings. All corporations must commit to long-term value creation together for it to work. But then, who will make it happen? The federal govt cannot force it in a democracy like ours. Additionally, I am skeptical that the System will rein in Wall Street and big business. After all, key Wall Street people like Tim Geithner, Hank Paulson, Robert Rubin, Larry Sommers etc have had key positions in the administration. What are the odds that they would do something against their Wall Street buddies and in favor of the common man? The failure of the Obama administration's efforts to reform Wall Street after 2008 is a case in point. Firms which were too big to fail have been allowed to get even bigger to fail. So, even though Alan Rappaport makes good suggestions in his reform plan, an ordinary citizen like me cannot wait for these reforms to take effect so as to secure my financial future.
So, what can the man on the street do towards his long term financial security? Living in Silicon Valley, if I look at the technology landscape, I find a few companies standing aside from short-termism. Companies like Google, Apple and Amazon seem to have the approach that they will just keep making great, innovative products for the consumer at great value and the rest - sales, market share, earnings etc - will take care of themselves. They are already implicitly doing what Alan Rappaport says. But not everyone is so creative. The broad tech landscape is filled with competent companies making incrementally better products and working hard to stay just ahead of its competition. These firms will have to worry about quarterly earnings. With the majority of the corporations committed to short-termism, how does one invest?
The author himself says: "...if we assume that in a given year, half of all the funds beat their benchmark and half underperform, the odds of a fund's beating its benchmark for six consecutive years are 1/64. The odds of 15 consecutive years are 1/32768". Given these odds and the complexities in evaluating fund managers' performances, one might simply invest in a set of index funds and be done with.
The book is easy to read. However, for me, it is not a 'must read'.
Disclosure: I received a free copy of the book from the publisher with a request for an optional review. However, my review would have been exactly the same even if I had bought the book myself.
The book comprises of two parts. The first part covers the rise of short-termism in general, how it works in corporations and Investment Management and finally, how it leads to financial and economic crises. In the second part, the author outlines a plan to overcome short-termism and reclaim our financial future.
Unfortunately, the first part does not contain any new insights. Most of us, who have suffered in the stock market through the first decade of the 21st century, are well aware instinctively of the tyranny of the quarterly earnings pressure and how one's money manager is influenced by it. We are also well aware of the conflict of interests that lie between investment managers and the client's money that they manage. My own personal experience was that my interests come a distant third, behind the manager's interests of earning more commission and then the investment firm's interest of earning income from my account.
The author's solution to short-termism in the second part is focussed on providing incentives to all employees - CEOs to the floor - for delivering long-term value, making senior management and the board to commit to long-term value creation as the main objective, modifying fees structure of fund management to take care of shareholder interests, and finally to provide real, transparent and valuable information on which investors can depend on.
As an ordinary citizen, I find it daunting that such a plan can be implemented in a society like ours. If a firm commits to long-term value creation and its competitors don't, then this firm may lose out market share in the short-term due to its lagging behind its competitors in earnings. All corporations must commit to long-term value creation together for it to work. But then, who will make it happen? The federal govt cannot force it in a democracy like ours. Additionally, I am skeptical that the System will rein in Wall Street and big business. After all, key Wall Street people like Tim Geithner, Hank Paulson, Robert Rubin, Larry Sommers etc have had key positions in the administration. What are the odds that they would do something against their Wall Street buddies and in favor of the common man? The failure of the Obama administration's efforts to reform Wall Street after 2008 is a case in point. Firms which were too big to fail have been allowed to get even bigger to fail. So, even though Alan Rappaport makes good suggestions in his reform plan, an ordinary citizen like me cannot wait for these reforms to take effect so as to secure my financial future.
So, what can the man on the street do towards his long term financial security? Living in Silicon Valley, if I look at the technology landscape, I find a few companies standing aside from short-termism. Companies like Google, Apple and Amazon seem to have the approach that they will just keep making great, innovative products for the consumer at great value and the rest - sales, market share, earnings etc - will take care of themselves. They are already implicitly doing what Alan Rappaport says. But not everyone is so creative. The broad tech landscape is filled with competent companies making incrementally better products and working hard to stay just ahead of its competition. These firms will have to worry about quarterly earnings. With the majority of the corporations committed to short-termism, how does one invest?
The author himself says: "...if we assume that in a given year, half of all the funds beat their benchmark and half underperform, the odds of a fund's beating its benchmark for six consecutive years are 1/64. The odds of 15 consecutive years are 1/32768". Given these odds and the complexities in evaluating fund managers' performances, one might simply invest in a set of index funds and be done with.
The book is easy to read. However, for me, it is not a 'must read'.
Disclosure: I received a free copy of the book from the publisher with a request for an optional review. However, my review would have been exactly the same even if I had bought the book myself.
October 15, 2011
Saving Capitalism From Short-Termism is not just for money managers. Although I admit having to ask my economist husband what author Rappaport was talking about here and there, for the most part it's understandable to anyone who follows the news and has thought about what went wrong in 2007.
Rappaport is a conservative economist, and his bias shows—but he's also an honest observer. And so, even though at one point early on he gives the requisite sound-bite that both overreaching government and greedy private sector players were to blame for the financial crisis, I searched in vain for examples of government overreaching in the pages to come. Instead, it seems pretty clear that government didn't reach enough. Here's the section on the Federal Reserve, in the chapter that lists all the guilty parties:
Part of this book seems to be a defense of Rappaport's own pet, "shareholder value." He says that shareholder value shouldn't be measured by quarterly earnings, but rather longer-term measures. That's a tough sell when shareholders typically hold stock for less than a year.
Beyond his own self-defense, however, Rappaport does have some insights into what needs to happen to save capitalism. (With the assumption, obviously that most of his readers believe it should be saved.)
He discusses perverse incentives for managers and offers alternatives that would lessen risks and improve long-term outcomes. He also gives a good list of what senior management should manage for (hint: it's not quarterly earnings reports). Rappaport also suggests an overhaul of corporate financial reporting. (You'd almost think he'd been sharing some late night tête-à-têtes with Rep. Barney Frank, who has been working to get reporting less manipulated by tricksters and instead more transparent.)
Rappaport isn't a big fan of the fund managers, who haven't shown either due diligence in protecting their clients from malfeasance. Nor does their expertise seem to justify their salaries. But his last chapter offers investors and managers some tips on how they can improve their odds.
I didn't finish this book feeling very hopeful about the fate of capitalism. Rappaport quotes Upton Sinclair, "It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" That goes a hundred-fold when your salary is in the millions. Rappaport's suggestions are for a casino industry that's actually doing very well just the way things are. So things might fall apart again? Tough luck for your kids, maybe, but if it really all falls apart, whose going to be better off - them or us?
Right.
Eat the rich.
(disclaimer! I won this copy through firstreads.)
Rappaport is a conservative economist, and his bias shows—but he's also an honest observer. And so, even though at one point early on he gives the requisite sound-bite that both overreaching government and greedy private sector players were to blame for the financial crisis, I searched in vain for examples of government overreaching in the pages to come. Instead, it seems pretty clear that government didn't reach enough. Here's the section on the Federal Reserve, in the chapter that lists all the guilty parties:
Where was the Fed when the signs of a looming economic disaster were flashing across the radar screen? Alan Greenspan, the Fed chairman, insisted that central bankers could not distinguish between an asset bubble and a tolerable price expansion. He therefore rejected the suggestion that the Fed fight the housing bubble. Ben Bernake, who succeeded Greenspan as chairman in 2006, shared this mindset.
Only after the bubble burst did Greenspan recognize the error of his ways. On October 23, 2008, he testified before Congress. Evoking a line from the classic film Casablanca, he conceded that he was "in a state of shocked disbelief" at the unanticipated meltdown of markets. "I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms." Regrettably, the interests of managers and shareholders often clash, and corporate governance systems do a poor job of handling the conflicts.
The Fed's models failed to account for how these conflicts affect both individual organizations and the global economy. As a consequence, the Federal Reserve relied on financial markets to self-correct, which allowed the housing market to spin out of control. Some commentators contend that a blind faith in free-market ideology trumped the obvious warning signs of an impending storm. Or perhaps Greenspan just neglected the advice of William McChesney Martin, Jr., chairman of the Fed from 1951 to 1970, who stressed that the Federal Reserve's job is "to take away the punch bowl just when the party gets going."
Part of this book seems to be a defense of Rappaport's own pet, "shareholder value." He says that shareholder value shouldn't be measured by quarterly earnings, but rather longer-term measures. That's a tough sell when shareholders typically hold stock for less than a year.
Beyond his own self-defense, however, Rappaport does have some insights into what needs to happen to save capitalism. (With the assumption, obviously that most of his readers believe it should be saved.)
He discusses perverse incentives for managers and offers alternatives that would lessen risks and improve long-term outcomes. He also gives a good list of what senior management should manage for (hint: it's not quarterly earnings reports). Rappaport also suggests an overhaul of corporate financial reporting. (You'd almost think he'd been sharing some late night tête-à-têtes with Rep. Barney Frank, who has been working to get reporting less manipulated by tricksters and instead more transparent.)
Rappaport isn't a big fan of the fund managers, who haven't shown either due diligence in protecting their clients from malfeasance. Nor does their expertise seem to justify their salaries. But his last chapter offers investors and managers some tips on how they can improve their odds.
I didn't finish this book feeling very hopeful about the fate of capitalism. Rappaport quotes Upton Sinclair, "It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" That goes a hundred-fold when your salary is in the millions. Rappaport's suggestions are for a casino industry that's actually doing very well just the way things are. So things might fall apart again? Tough luck for your kids, maybe, but if it really all falls apart, whose going to be better off - them or us?
Right.
Eat the rich.
(disclaimer! I won this copy through firstreads.)
Displaying 1 - 3 of 3 reviews