“Shareholder Value” Fetish Takes the Blame for the Crash

Roger Lowenstein is a rare commodity: a financial journalist with no apparent ax to grind, who seems to understand the people and institutions he covers, and is more often right than wrong on the big issues that matter. While most of us were trying to figure out how mere mortals could participate in the latest hot stock issue, his thoughtful columns in the Wall Street Journal and Smart Money warned of the overvaluation of the Internet, complained about excessive executive compensation and highlighted the need to revamp corporate governance. He has produced a respected biography of Warren Buffet and the definitive history of the collapse of the Long Term Credit Bank. In short, it would be hard to pick a better candidate than Roger Lowenstein to sum up the broader lessons of the most recent boom and bust–which makes one wonder why Origins of the Crash is so unsatisfying.

The main problem is that the book doesn’t know what it wants to be: a serious history; a scandalized litany of recent scandals; a practical guide for policy makers; or a sociological deconstruction of the culture that fed the boom. Although it may be possible to combine all these effectively in a single volume, in practice the attempt gives Origins of the Crash the disjointed quality of a work in progress. Rather than extend or deepen the themes raised previously in his columns, Mr. Lowenstein simply repeats them ad nauseam–then stretches to make connections where none logically exist.

Mr. Lowenstein begins by identifying the Leveraged buy-out (L.B.O.) boom of the 1980’s as the cultural moment when the concept of “shareholder value” became a pretext for enriching executives and promoters: “When an L.B.O. failed, society was poorer–jobs were lost, innovations were forgone–but the raiders simply went on to the next deal. The L.B.O. operators bore a moral hazard, for they had nothing to lose.”

This view of the world ignores the reality that the “raider” supplies the 25 to 50 percent of the capital structure that is equity, and that he has everything to lose (a number of them actually have lost everything). That’s why private equity funds that sponsor L.B.O.’s (all but a few of which are now barred from hostile “raids” under the terms of their fund agreements) also typically require their operating executives to invest equity. Also, if a good company has a bad capital structure it does not go out of business, but is instead usually restructured. Debt holders take a haircut, equity holders take a bigger haircut (or are wiped out) and life goes on; jobs and innovations are not necessarily forgone.

Never mind. Mr. Lowenstein is intent on his thesis that the fetishization of ever higher stock prices has lead to a culture in which shareholders and board members have given unwarranted and imprudent leeway to management to get share prices up. We should not be surprised, he argues, when executives who are given a “free ride” through exorbitant stock option grants increase a company’s risk profile or even fudge numbers to get a short term lift in the stock price. “The progression from L.B.O.’s to stock options to a market bubble was nurtured by a consistent ethos,” Mr. Lowenstein argues. Indeed, Mr. Lowenstein contends that absolutely everything about the boom and subsequent crash can be explained by this ethos of “shareholder value”: “Virtually every transgression flowed from this simple corruption,” he asserts.

But what should we do about this? Mr. Lowenstein doesn’t propose an alternative to the current share price as a way of calculating “value.” And rewarding managers on a different basis from shareholders raises important issues that are simply left unexamined. Saying that managers should concentrate on the long term is easier than structuring compensation systems to encourage long-term thinking. Mr. Lowenstein also fails to explore an apparent dilemma: Increased disclosure, which he lauds, is likely to aggravate the volatility of stocks, which he abhors. Beyond a very superficial discussion of the recent Sarbanes-Oxley corporate governance legislation, there’s no systematic discussion here of the policy implications of his views. Mr. Lowenstein tells us time and again that rules that focus on disclosure are not enough, but never tells us what broader rules he would propose. Instead we get chapters rehashing the already well-covered ground of the Enron and WorldCom scandals.

Mr. Lowenstein has set the bar high by inviting comparisons with the classic of the genre, John Kenneth Galbraith’s The Great Crash (1955), a brilliant anatomy of the 1929 debacle. Mr. Galbraith argued that the search for villains was misguided and that the 1929 crash was the “product of the free choice and decisions of thousands of individuals” who were “impelled to it by the seminal lunacy which has always seized people who are seized in turn with the notion that they can become very rich.” Of course he realized and documented with ferocious wit the extent to which “[t]here were many Wall Streeters who helped foster this insanity.”

One of the deficiencies of Mr. Lowenstein’s book is the complete absence of wit. Indeed, he has the slightly hectoring tone of someone trying to hard to make an argument he knows doesn’t quite hold together. Also missing from Mr. Lowenstein’s book is the sense of perspective that Mr. Galbraith brought to his book—which was written 25 years after the event. My guess is that the wounds from our latest bout of collective lunacy are still too raw—we may have to wait a quarter of a century for the definitive account.

Jonathan A. Knee is a Senior Managing Director at Evercore Partners and an Adjunct Professor of Finance and Economics at Columbia Business School. “Shareholder Value” Fetish Takes the Blame for the Crash