Competing with shareholders

Excerpted from Transcompetition, by Harvey Robbins & Michael Finley, McGraw-Hill/Business Week Books, 1998

(c) by Harvey Robbins & Michael Finley

There is a fable about a scorpion who talked a frog into helping him cross a stream. The frog demurred, certain the scorpion would sting him. The scorpion assured him that it would be irrational to sting the frog, because then he would drown. You know the rest. The frog gets halfway across the stream and the scorpion stings him. The convulsing frog is just able to ask Why? and the scorpion can only answer that he did what he did because it was in his nature.

Now, you would think it would go against a company's nature to compete against its shareholders. After all, what is the number one thing companies get grief for? It is their determination to reward first-line investors more than other constituent groups -- workers, customers, the community they do business in. That is the purpose of businesses -- to enrich the owners.

Every business has "sacred" constituents whose interests the people in that business are supposed to put above their own interests. The Hippocratic oath circumscribes medicine's reach. In real estate the prime constituent is the seller. In corporate life, it is the stockholder. Corporate management is no more likely to betray the interests of investors than government, say, can ignore the interests of the everyday citizen.

In theory.

Choking the chicken

But it happens, and it happens because management's supercompetitive traits lead it forget about corporate profit being a team sport. When managers withhold information about losses from stockholders, for instance, they are stealing from them. The Boston Chicken restaurant chain was one of the fastest growing in recent years, and it stock was for many months one of Wall Street's favorites.

But the company's rapid expansion came at the expense of numerous franchises that were financially unequipped, or simply incompetent, to handle the responsibilities of running a restaurant. The chain showed very little diligence in identifying weak franchisers, and even less diligence in informing investors that the value of their rapid growth was suspect. While the company's stock inflated like a rubber chicken, the chain squeezed out reliable information to investors. Over the course of two quarters, the company's stock fell from $41.50 a share to a low of $15.67.

According to a lawsuit file by one shareholder in June, 1997, at no time did the company lay it on the line for investors that its franchise base was thin. By the time the fat hit the fryer, the company had reduced its workforce by a third. Investors? Caveat emptor, seemed to be the company's policy -- a policy that runs afoul of SEC regulations.

Insider Trading

When managers take advantage of insider information in their own investing, they are stealing from their own shareholders. That insider trading is wrong is implicit in the exchange-encircle-exact dynamic -- because information is not circulating as it must. Too often, the sacred constituency gets screwed on the altar.

Take a case from the Twin Cities that went all the way to the Supreme Court. A respected attorney at the firm of Dorsey & Whitney, James O'Hagan had an interesting meeting with a client, Grand Metropolitan PLC of London, in which he learned that Grand Met was planning to make a tender offer for all shares of the Pillsbury Co. Grand Met soon left Dorsey & Whitney, but the inside info stayed in O'Hagan's head.

O'Hagan, despite his grandfatherly appearance, was the sort of reckless individual who liked to play games with other people's money, and imagined that since he was clever, he would never get caught. A trickster's trickster. He decided to become a player himself, and over the next year parlayed $4.3 in gains, using client moneys to buy at a low price shares he knew would soon skyrocket in price. They did.

O'Hagan was eventually tried in local courts and found guilty of swindling his law clients and ordered to serve 30 months in jail. Then a federal court indicted him and found him guilty of 57 counts of mail fraud, securities fraud, and money laundering. Sentence: 41 months. O'Hagan, lawyerly to the end, appealed his conviction at every level until it was turned down by the Supreme Court, which found his defense, that he couldn't be guilty of insider trading because he didn't actually work inside Grand Met, to be a little light on the merit side. It was a breathtaking legal precedent, which held for the first time that a swindle is a swindle, even when the swindler is a member of the bar.

Takeover mutinies

During corporate takeovers, management often mutinies against shareholders, because their interests (keeping the company under their control, or seeking acquisition terms favorable to them) and the interests of shareholders (windfall returns) have bifurcated. The brute cycle kicks into high gear very quickly, since shareholders swivel rapidly to the new management in order to get rid of the old management. But even then it comes at horrific high cost.

Managers like Ross Johnson of RJR Nabisco show what happen when they put their own interests ahead of shareholders. Johnson sought in 1987 to buy the company away from investors at a bargain price, primarily to enrich himself and other top management. But Johnson, RJR Nabisco's CEO, learned a painful lesson, that one does not initiate a stealth operation with a hog call. As soon as its leveraged buyout plans became public, a bigger hog, Kohlberg Kravis Roberts (KKR) moved in, outmaneuvered Johnson, and took the company away from him, installing American Express's Louis Gerstner in his place.

This particular tale of damn-the-stockholders took several more years to play out, however. KKR, which took such delight in stealing Johnson's company from him, wound up enriching RJR Nabisco's investors, and punishing their own. The massive debt the buyout incurred, plus the fading appeal of the companies' many brands, resulted in a final stockholder profit of only eleven cents a share.

It cuts both ways

Shareholders, for their part, exert a collaborative drag upon a company. When all 99% of investors want from a company is to keep the cream coming, a great fear of action sets in, and management feels that fear like a cold hand around its throat. Many companies have met untimely deaths because stockholders were unwilling to see the companies plunged into the bath of change. No managers have ever been let go while the company kept delivering regular dividends, even while those payments masked structural and strategic problems that spelled long-term doom.

Can a stock exchange cRy?

It may seem that we have wandered far from the customary pastures of industrial psychology. But the higher you go into our institutions, the greater the role played by the supercompetitiveness ethos. Eventually you come to the holy of holies, the free market system itself, where men are men and dogs eat dogs and the devil take the hindmost.

Look down upon the frantic goings-on in the pit of the New York Stock Exchange and you perceive a competitive arena that puts the Olympics to shame. For a sixteenth of a point over an hour's time, grown men trained in the philosophy of a rational marketplace will push their grandmothers down the stairs, sell their children into slavery, and dress in women's underwear.

At first glance, cannibalism is the law of the free market: for every winner (buy low, sell high) there must be a loser (buy high, sell low). Buying a share of stock is always your gamble that the stock will do better for you than the person selling that same share. And a definite star system is at work: the Wall Street Journal holds ongoing contests with top brokers, headlining the stockpicker who finishes the quarter with the highest gains. There are short speculators whose mission in life is to achieve short-term gains by betting against the market. Their role appears unsavory at first, but they play a vital ecological role in clearing the street of carrion.

To overlook this pressurized supercompetition betrays the whole concept of transcompetition.

But times are changing. The colorful world of the trading pit is a relic of an earlier time. Before another ten years passes, we expect to see it replaced by a system of almost pure information. Instead of buzzers, markers, tickers, and exhausted men in damp shirt sleeves, the system will be run by computers, following the NASDAQ model, but worldwide and round-the-clock. All the stock markets and bourses will feed into one large system, a kind of financial Internet.

Our sense is that this streamlining of the world of investment will have a powerful transcompetitive effect. When it is in place we will have moved in less than a century from a series of national economies where a handful of diamond-stickpin brutes with inside information feasted on the wealth of others to a transglobal economy where information and opportunities are available to all.

Already, our thinking about money and wealth has undergone a major transcompetitive shift. The very concept of a bull market meets that description: a market that is good for everyone, "a rising tide that lifts all boats." The diversification and low-entry costs of investing via mutual funds and large group investment pools like pension and 401k funds allow us to find an above-average profit while running below-average risk. Pool investors are like armed warriors, protecting one another with their very numbers. There are even pools for pacifists, the so-called "ethical funds" that seek to invest in companies that do not pollute, that treat workers well, and aren't involved in tobacco, liquor, or guns.

We have evolved from a market on the lookout for a fool to buy at the highest price to a community that invests at stages intervals, stays in the market for decades at a time, and roots for everyone's success.

Many of the competitive practices of Wall Street are less competitive than they appear at first glance. One of the habits of fundamental analysis is to view companies only through the lens of how they are faring against other companies in their category. Thus everyone in the aerospace industry is considered to be competing against one another, even though only a select few vie for the same contracts. From the art of nichemanship, we know that listed "competitors" are not always competitors. Yes, Arco and Chevron compete against one another, especially in some regions. But does Encyclopedia Britanica really compete against Simon & Schuster? Does Cray Research (now part of Silicon Graphics) compete against NCR? Does Glaxo Wellcome compete against Johnson & Johnson? No, no, no and no. The competitive is in mostly our minds.

And a surprisingly collaborative force, the Federal Reserve Bank, is trying to protect all Americans from the go-go enthusiasm of a few. Sen. Daniel Patrick Moynihan made the observation in a television interview that Americans live in "earthshaking economic times" because only 14 months of the 30 years from 1960 to 1995 saw negative economic growth. Under the tutelage of Alan Greenspan, the Fed has buffered a nation undergoing rapid change with an economy that knows when to cut the throttle and glide. There are no guarantees that we will not see a crash or panic at any time. But there is a clear intention to guide the market so that the largest possible number of people benefit from it, for the longest possible period.

In Albert Brooks' 1983 comedy, Lost in America, he quits his job and invests his savings in an RV to travel around the country experiencing life. The very next day he and his otherwise sensible wife, played by Julie Hagerty, squander their life savings at the craps tables in Las Vegas. Desperate to undo the damage, Brooks beseeches the casino managers to return his money and to start a new era, as the "casino that cares."

It was asking too much of Las Vegas, but it may not be too much to ask of Wall Street. Indeed, with the decline of the billionaire class and the rise of pooled investments, a market that looks out for its participants is the only one people will participate in.

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