Bronte Media

James Surowiecki’s latest financial page in the New Yorker got me thinking about the root cause of management and financial excess of the past decade (oh how grand I sound).

And I think it boils down to this: For the vast majority of companies, the owners simply don’t care enough.

Why did seemingly smart people make a lot of bad investment decisions? The simple answer would be to say that they were paid for it. Valuations based on assumptions in the future allowed people to pay themselves large short term bonuses on long term investment products that were rigged to not fail in the short term (e.g. ARM mortgages).

Why did finance institutions allow this? Well for the most part they are publicly held corporations and not partnerships anymore. Goldman Sachs, one of the last hold-outs went public a decade ago.

Why does that matter? Primarily because the firm went from a small group of owners who deeply care to a large group of owners who don’t (public shareholders).

I highly doubt Merrill Lynch, Goldman Sachs, Lehman Brothers and Bear Stearns would have made as many bad decisions as they did if the owners were the employees themselves. I know, I know, the top level management and employees are all compensated to a large degree with equity but we are talking at least half as much as it was 20-30 years ago.

And the examples can be extrapolated out to the broader market beyond financials. Why do dipshits like Robert Parsons seem to land hundred-million dollar compensation agreements for running enterprises with an at best average competency? The owners of Time Warner and Citigroup let him.

Say what you will about Carl Icahn but at least he *cares*.

The vast majority of Time Warner and Citigroup shareholders are mutual funds. Mutual funds cycle their portfolios on average once per year. They simply don’t care about being a good owner for a particular company. It’s considered forward thinking if they outsource their decision making to corporate governance firms like Risk Metrics for god sake!

And that’s the reason I think startups and more generally small businesses are such an economic force and job creation engine. The owners in general care about their companies.

There is a paradox in that there is very real benefits to achieving scale and so naturally the corporate world will tend towards a landscape of a few very large companies. So having the corporate world full of more small enterprises is not a sustainable solution.

Which leads to the next step: Mutual funds must quite simply care about their investments. They must care enough to appoint directors who are properly compensated to be full time custodians of shareholder interests. They must care enough to make management accountable and push back on ludicrous requests. Management and employees ask, but ultimately owners/directors give.

One of the many reasons why there was a boom in private equity/hedge funds is because all those firms had to do is care a little bit (the bar was set so low by the mutual fund industry) about their holdings that investors were quite happy to be raped and beaten with 2% management fees and 20% of the carry.