Businessweek has a interesting article written by Lawrence Mitchell that claims our obsession with finance over operations has put us on a dangerous economic course.
Fueled by headlines about top managers such as Home Depot (HD ) CEO Robert Nardelli, who received stratospheric pay even as his company's stock price stalled, shareholder activists this year took aim at executive compensation. Unfortunately, they should not expect much from those efforts, even if every corporation in the U.S. adopts "say on pay"measures that allow shareholders to vote on pay deals. That's because such proposals treat only a symptom, not a cause, of a more dangerous trend within American capitalism.
The real culprit is the growing preeminence of finance over operations. It causes stock market considerations to trump those that improve the actual workings of a business. And the quicker the stock payoff can be engineered, the better. Until that changes, don't expect CEOs to stop gaming the system.
This reward bias toward finance has been with us since the creation of the giant public corporation in the late 19th century. Almost overnight, U.S. business was transformed from making money by controlling costs and increasing productive efficiency, the way John D. Rockefeller and Andrew Carnegie did, to reaping instant riches from stock sales-such as the $1.5 billion stock fee (in 2006 dollars) that the J.P Morgan (JPM ) syndicate earned in 1901 putting together the factories that created U.S. Steel (X ).
I love this discussion, and Mitchell's analysis, but I think his solutions are short-sighted. Changing capital gains tax structures to a sliding scale that severely penalizes day traders seems like it would have many second order effects (like less liquidity). The traders don't bother me so much as the CFOs who patronize them. The problem is with the CFOs – giving quarterly earnings targets, using accounting tricks to smooth out earnings, and generally managing with a next quarter focus instead of a long-term focus. Not only that, but finance now encounters the same dilemma as production – it's more about marketing than it is about substance. In a world full of noise, it's hard to get your signal out, and that's true whether you are talking about a new product or an earnings release. It's a shame, but it's the way the game is played.