Marko Jukic In a Twitter threat reported by reader DK, presents a succinct, plausible, and flawed theory. He correctly points out that the appointment of CEOs from the finance industry to such storied companies as Boeing, Intel, and Sony directly led to the adoption of policies that were destructive to those companies.
But he misses the point in attributing the decline to the replacement of engineering CEOs with finance/MBA CEOs across corporate America. While that is true in the very visible examples he gives, the trend towards financialization was already underway by the early 2000s that he portrays as the tipping point, and its leading practitioner was General Electric engineer Jack Welch, who was heralded as the pinnacle of modern management from the mid-1980s onwards. By the early 1990s, over 40% of GE’s profits came from its financial services division. McKinsey, like General Electric, was making a killing selling off manufacturing clients to beef up its financial services.1 One trend that was already spreading at the time was that large multinational companies had begun to run their financial operations as profit centers, often with disastrous results. 2
The second huge driver of the financialization trend was the rise and astonishing success of the acquirers of the 1980s. The acquirers changed names many times (leveraged buyouts, then private equity; of course they included other strategies, but leveraged buyouts still account for the majority of spending). The deals of the 1980s consisted overwhelmingly of financial engineering plays. There were a lot of over-diversified and undervalued conglomerates at the time. Fatten up the core of a company was fashionable in American business at the time, and even more so with these companies. These deals were exercises in financial engineering. The difficulty was that they were almost always hostile takeovers. Even after paying a merger premium, the acquirer could break up the company and sell the parts for more than the original whole was worth. This process didn’t break down until the late 1980s, when acquirers began buying up more and more marginal companies with increasingly expensive debt. The debt losses from leveraged buyouts were masked by the much larger savings and loan crisis. The fact that large foreign banks were the primary customers of the LBO loans helped to limit the disruption to U.S. regulators than it might have otherwise been.
Despite the collapse of LBOs, a group of academics, including Harvard’s Michael Jensen, enthusiastically defended the idea first put forward by Milton Friedman in a poorly-founded New York Times op-ed that corporations should be run above all else in the interest of shareholders. This runs counter to the legal status of corporations as residual claimants after all other obligations have been met. I can’t prove a negative, but I read quite a few guides for directors on corporate boards prepared by a major construction law firm, especially one focused on Delaware, a corporate-friendly jurisdiction despite Elon Musk’s ire. I didn’t find a single reference to prioritizing shareholder value as a board obligation. Instead, the unspoken first directive was “don’t go bankrupt.”
Jensen later retracted his idea after seeing the damage it caused, but too many people had benefited from it to let it go away.
Take Jack Welch as a case study and see how running a company for short-term results began long before financiers and MBAs became common CEOs. One of the reasons Welch was celebrated was because GE’s allegedly miraculously tight corporate controls allowed the company to hit projected profits like clockwork. For such a large company with exposure to many currencies, that should have been a sign of Madoff-like accounting fraud, if not fraud itself. GE achieved these results through a lot of financial maneuvering, including building and burning loss reserves and timing the recognition of divestitures from its large venture capital portfolio. From a post in 2021:
I am critical of Jack Welch not only for his disruptive expansion into financial services and the “celebrity CEO” that was very successful for Welch and General Electric during his tenure but had a destructive effect on American management practices in the long run. It is also because Welch’s success as a manager has been exaggerated, but it would be nearly impossible to pin down how much due to the rooting and omerta among departing executives. A colleague who worked for Reg Jones and later for Welch, who turned around a manufacturing company that is still a leader in its niche market, said Welch relied on the Jones brand. And some of the practices Welch promoted, such as Six Sigma, were all PR.
Jack Welch and General Electric had the good fortune to ride a financial market boom caused by a long-term trend of falling interest rates, and Welch inherited a well-run company at a time when America was still a manufacturing powerhouse, despite the advances of the Japanese and Germans.
To be sure, General Electric, like many other U.S. manufacturers, had some finance business in the form of loans to buyers, but by the late 1980s its role had expanded so much that it was taking a major hit from LBO financing (I know a former McKinsey partner who ran the company’s workout; he had two conference rooms, one named “Triage” and the other “Don Quixote”).
But by the early 1990s, GE Capital accounted for 40% of General Electric’s activities and was known for doing everything from venture capital to private label credit cards to credit guarantees. And General Electric got the best of both worlds: the company escaped the stigma of being considered a stale, old-economy manufacturer and, by the time Jack Welch retired in 2000, was classified as a Fortune 500 diversified financial company. And it could borrow at industry AAA interest rates, better than any AAA-rated bank or insurance company.
The giant GE Capital business gave Welch a second layer of shine, more than he deserved: It allowed GE Capital to play the profit game, consistently hitting quarterly guidance to the penny. Indeed, after Welch left, GE Capital continued to expand unwisely during the low-interest-rate dot-bomb era, raising leverage levels and re-entering the subprime mortgage business in 2004.
Here’s further evidence that financialization and sharttermism were established features of corporate America even before engineers were pushed out of CEO positions: In 2005, the Conference Board Review ran an article by us: Incredibly shrinking companiesIn it, we described how public companies were so fixated on short-term profits that a McKinsey consultant complained to me that they didn’t want to invest even if they could recoup the investment in less than a year because they still had short-term quarterly costs to make.Similarly, the anti-investment trend became so pronounced that across American business, companies were behaving in an unnatural way by becoming net savers during periods of expansion: they were slowly liquidating.
But this is not to downplay the importance of Djukic’s findings: In the early 2000s, companies were all about exploitation rather than growth, and they were staffed by people with spreadsheets and PowerPoint. His Tweetstorm There is completely righteous indignation involved.
You might think that companies that are being killed by their own CEOs would perform worse and investors would value their stocks lower, but in fact killing companies seems to boost profits dramatically and make investors more enthusiastic than ever.
The obvious conclusion, uncomfortable if not unthinkable to free marketers, is that MBA/finance thinking and decision-making is not only not conducive to running a successful, functioning enterprise, it is actively hostile and destructive.
How can this happen? If we accept that there is a trade-off between short-term profits and long-term viability, then in the above example we see that MBA/Finance dogma ruthlessly maximizes the trade-off in favor of short-term profits. Including killing the company!
But the change in leadership style was not new, but an intensification of a process that had been underway for some time. Differences in degree, however, can sometimes be differences in nature. A question to consider another day is whether the destruction of Intel and Boeing, companies that were not merely symbolic but too important to be allowed to go bankrupt, constituted plunder as George Akerlof and Paul Romer defined it in their classic paper. Plunder: An economic underworld that goes bankrupt for profit:
Our theoretical analysis shows that an economic underground can emerge when companies have incentives to go bankrupt (to plunder) in order to make profits at the expense of society. Bankruptcy for profits occurs when poor accounting, weak regulation, or low penalties for abuse give owners an incentive to pay more than their companies are worth and default on their debt.
To be clear, it’s unlikely that either Boeing or Intel will default on their debt, but it’s entirely possible that they could get government help before it gets to that point.
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1 The apex of this trend, of course, was Enron, which, under McKinsey’s gentle tutelage, transformed the company from being primarily an energy producer into the asset-light trading operation that McKinsey admired. The man solely responsible for destroying Enron, Jeff Skilling, was COO, not CEO, and originally studied engineering before switching to business administration. CEO and Chairman Ken Lay didn’t have an MBA, but he wasn’t an engineer either. He was an economist, and his rise through the energy industry seemed to depend on his expertise in regulation.
2 In the early 1990s, I was assigned to work with a strange client: a derivatives firm asked me to advise a new client, a Fortune 500 company that had just lost money on foreign exchange trading. My direct client, a derivatives trader partner, was actually not very keen on helping corporate clients. “This is really dangerous. You need to know what you’re doing so you don’t destroy yourself.” This job was just before the famous Procter & Gamble scandal, in which audio tapes revealed derivatives salesmen at Bankers Trust gloating about how easy it was to scam and rip off customers.
