CEOs Decide To Adopt Appeasement

Appeasing an ideologue is never a good idea.  You might delay pain, but you are going to feel the pain at some point.  The most famous appeasement case is Neville Chamberlain and Adolph Hitler.  Coming off of WW1, the British didn’t have a stomach for war.  Neither did the rest of the world.  Hitler was a crazed ideologue who was hell-bent on getting what he wanted.  Appeasing him staved off a war for a year but in September of 1939, Hitler invaded Poland and the die for the next six years was cast.

Yesterday, the Business Roundtable led by Jamie Dimon decided to adopt a policy of appeasement.   It’s sort of a dumb idea that is built off of poor logic.

The Wall Street Journal goes so far as to call their action appeasement to the Socialists.  Socialism is on the rise in the US.  It’s because of our educational system’s failure, or deliberate actions to teach finance and business incorrectly.  We also teach the history of capitalism through the lens of Howard Zinn.  When you build your ideas of business off of the concepts forwarded by Bill Ayers and Howard Zinn, you aren’t teaching free-market capitalism.

Many Americans believe strongly that free enterprise left unchecked by a powerful government would lead to a race to the bottom on health care, wages, hours worked, and environmental damage.  Interestingly, all they have to do is go to China where the world’s most interventionist and powerful government over a large number of people has exactly that.

When people are free to choose and have opportunity, there is no race to the bottom.

I am reminded of a few things.  First, the US doesn’t have the most dynamic innovative economy with the most opportunity in the world because of government regulation or control.  It’s because we have free enterprise and free markets.  Where you see this most evident is in startups.  Venture capitalists raise funds, and capital gets allocated to the best ideas they see.  Those ideas only get .2% of all investible capital but create over 20% of new jobs.

I am reminded that most people in America truly don’t understand capitalism or even how to manage their own finances.  Heck, people I went to business school with at Chicago Booth are under the impression that if you raise minimum wage it’s good for profits and business.  That flies in the face of basic microeconomics and how markets work.  People don’t understand what opportunity costs are, nor do they have a clue as to how to calculate them.

I am also reminded of a public CEO that had his company brought private by a PE firm.  In the first board meeting, they put on a big presentation on diversity and things that the SEC mandates public corporations talk about at board meetings.  The executive said the PE firm pulled him aside and said, “That was nice but you never have to do that again as a private company.  We want to know two things.  1.  How are we going to make more money?  2.  How are we going to make more money?”  The focus was all about optimizing the business to create shareholder wealth.  Ironically, in the last fifteen years we have seen the amount of companies listed in the public market go down by about 50%.  Given what we are seeing in the broader society, I expect that trend to continue.

My old friend Professor Paul Magelli from the Gies College of Business used to tell his students if you didn’t make bottom line revenue what you were doing wasn’t a business, it was a hobby.  Milton Friedman also had some great ideas about business.   The point is to maximize shareholder value.  If you don’t do that, the business will have less access to capital as money flows away from the business and into assets where the return is expected to be greater.

One may not like the amount of pollution an oil company produces in the drilling, refining, transporting and burning of oil.  However, it’s awfully nice to be able to put gas in your tank and drive to work so you can earn a living for your family.  It’s nice to have that ease of transportation rather than boarding, feeding and cleaning up after a horse not to mention the maintenance on your buggy.  It’s a lot better to drive than ride a bike on very hot, very cold, or very windy days.  Since time is money, you get their faster too.  Oil companies can be viewed as social enterprises since they raise standards of living by solving problems for people every day.

When I was at the i7/G7 in Torino, Italy we talked about B Corporations.  If you are unfamiliar with B Corporations, here is a link.  It’s a newer trend that sort of echoes what Dimon and his Roundtable talked about the other day.  I have invested in a B Corporation, Nextspace.  They went bankrupt.  In our i7/G7 discussion, I made this point; I am not against B Corporations but what I want is an objective measurable standard exactly like I have with FASB and GAAP accounting rules so I can compare companies and calculate where I will get the best expected return on investment.  Absent that objective ability to analyze a company, I am left with no concrete way to evaluate.  That still is true today.  The concepts of decency and what’s fair are normative and not positive standards to judge and track companies performances by.

Cliff Asness of AQR did an analysis of social investing.  He starts his post off with this, “Negative screening is a common application of Environmental/Social/Governance (ESG) investing. It avoids “sin stocks” and divests from industries or firms deemed immoral or having poor or undesirable standards along one of the three E, S or G dimensions. 1  It’s promoted largely on the fact that it’s virtuous. While we may all define virtue differently, advocating for it in this way is fair and appropriate. However, employing these constraints is also often promoted as enhancing expected returns. That is, if you avoid certain companies, industries, and even countries, that are deemed non-virtuous, you should expect to make more money over time. 2  Do good and make the same return or more! This is mostly wrong and, more the point here, actually at odds with the very point of ESG investing. Pursuing virtue should hurt expected returns. Some have discussed this fact. 3  But, it’s still not widely understood or broadly accepted. This seems to arise from investment managers selling virtue as a free lunch, and from investors who very much want to believe in that story. In particular, and my focus here, accepting a lower expected return is not just an unfortunate ancillary consequence to ESG investing, it’s precisely the point (though its necessity may indeed be unfortunate). As an ESG investor this lower expected return is exactly what you want to happen and really the only way you can effect the change you seek.”

The pivot by Dimon and the Roundtable will decrease the returns of the businesses that decide to pursue the path they laid out in their commentary. All you have to do is look at Jeff Immelt’s record at running General Electric.

When businesses generate profits and maximize shareholder return they show evidence that they are solving a problem for someone.  When problems get solved and people are willing to fork over cash to get them solved, standards of living are raised.  Those profits and the rising standard of living allows people to pursue more innovation that further raises standards of living.  Those profits also create more individual freedom for people.   It’s a virtuous circle.

At board meetings in companies I am invested in, we talk about strategy, employees and things like that.  There is always a discussion about top line revenue and how to increase it.  Without increases in top line revenue leading to eventual bottom line revenue, the company isn’t sustainable.  Employees can’t have jobs.  Customers don’t get serviced.  Shareholders don’t get paid.

America isn’t perfect. We need to change many public policies to create more opportunity for more people.  But the ideas being brought forth by many people today will only speed the course to more government command and control of economic resources.  Some like Bernie Sanders and Elizabeth Warren are out of the closet socialists.  Those ideas have murdered millions of people in history and created lots of hardship for billions of people.

The problems with a lot of places in America isn’t racism.  It’s the breakdown of the American family and the policies that have been put in place that caused that breakdown.  Gary Becker did a lot of research on on this.  One parent households do worse than two parent.  People that don’t graduate from high school do worse.  This is a very difficult discussion to have.  It’s much easier to demonize capitalism and success.

I understand there is a lack of trust for free market capitalism.  I can appreciate that.  But, I’d much rather cast my lot with free market capitalists than a bureaucratic centralized government.  Heck, in Illinois and Chicago that’s what we have and despite all the nice parts of Chicago the city and state are the most corrupt in the United States.  Corrupt corporations eventually go out of business and that isn’t true for government.  They keep oppressing.

There is failure in capitalism to be sure.  But, accepting failure is also accepting the astonishing success that a lot of people have when they create a company that is valued by customers and shareholders.