Fixing the Game

Fixing the Game: Bubbles, Crashes, and What Capitalism can Learn From the NFL by Roger L. Martin

In one line: Misalignment of management incentives has caused many corporate executives to manage the financial markets' short-sighted expectation of share performance, rather than focusing on customer satisfaction.

Incentivizing managers with stock options leads them to manage a company's share price. If company performance falls below market expectations, sunken share prices hurt them financially. If performance exceeds expectations, share price rises, but the bar of expectations is raised and harder to achieve, making future under-performance more likely. As a result, managers try to match expectations, sometimes to the detriment of corporate health and long-term growth.

Using a sports analogy (specifically, from the NFL), this is akin to professional coaches being compensated on whether they covered the point spread, instead of whether they won the game. The point spread arises from the expectations of bettors. Regulations prevent players and coaches from betting on games, to remove any incentive connected to the point spread, allowing them to focus solely on quality performances to win games; i.e., give the fans (customers) a good show (product).

Five things can be done to fix this problem:

1) Shift companies' focus from shareholder value to customer satisfaction.

2) Restore authenticity to the lives of executives.

3) Address board governance.

4) Regulate and manage expectations markets more efficiently.

5) Business executives need to take a more expansive and positive view on the role of for-profit companies on society.

My comments:
Companies exist to make money for their owners (shareholders). Companies cannot exist very long without profits, and profits cannot exist without customers. The best way to ensure long-term profits is to build an adequate base of happy and loyal customers. A view of shareholder value that depends only on short-term results and the next quarter's earnings is myopic at best. Instead of ignore shareholder value to focus on customers, companies should focus on customers to maximize shareholder value. It is easy to maximize customer satisfaction with no eye on shareholder value: give the product or service away for free. Just as with a myopic view on shareholder value, this does not work very long.

The book poses an intelligence issue is as a moral issue. To increase long-term shareholder value (the purpose of stock options for executives and employees), a company needs happy customers to keep returning and spending money. While some executives are surely greedy and parasitic (as are many politicians), this is not the overall problem. The myopic incentives of playing to short-term expectations come from market participants and analysts dramatizing corporate performance (think any TV financial news programs).

The NFL analogy is apt, but not for the reasons given in the book. NFL regulations on betting prevent a game from being treated as a gambling business, but dramatization of markets and business performance (especially under the guise of giving an edge to the average investor) treats business like a betting game.