I’m starting to get some thought convergence on this subject. An early seed is my interest in socially responsible investing (SRI). At a first level, it started as mutual funds doing filtering, refusing to buy stocks of companies deemed socially irresponsible – however you choose to define it. In truth, I don’t believe that does anything and many other folks have already come to that view. What happens in the stock market is really only tangentially related to a company’s finances. They only make money off the stock when they make new offerings. Sure, having the stock do well lets them make acquisitions with it or compensate employees with it, but when you buy stock in a company, that money is not going to the company, it’s going to the last holder of the stock. So the theory of starving a company by reducing the tradability of its stock is a weak one, not to mention that it would take participation of a huge percentage of the market to actually create that impact.
SRI has more interestingly moved on to what I’ll call level 2, Shareholder Activism: the act of deliberately investing in ill-behaved companies and using that status as shareholder to try and influence their behavior. What’s going on in shareholder activism is a blog entry in itself that I want to write, so while I still feel some enthusiasm for that approach, I’ll skip here directly to my disappointment with it. Currently shareholders don’t actually have all that much power, particularly not small ones.
From there I move to, well, what really is this whole stock-market thing? What is it about the magic that lets you invest 300K in a company, go public and be worth a million? Is that a good thing? The markets encourage risk-taking and they provide liquidity. But it’s becoming a bit too derivative from actual economic activity when investment managers are running funds that trade based in psychological behavior models applied to the market. I’ve been getting interested in private equity – the process by which companies get early direct funding before they’re public. Basically you can get money two ways: 1) debt- where you borrow it and owe it back with a pre-determined return; or 2) equity – where someone makes an investment in your company and you owe it back with a uncertain return. With equity, they’re taking the risk with you, if it goes bust you all lose. Equity in this simple sense is collaborative.
But equity investing in practice is not at all collaborative. Equity investors in practice work to own you, and in our current capital-rules-all society, they can. The archetypical model is venture capital – groups of investors whose goal is to make big money, usually on a short time frame like 5 years. Because markets and business change, the short time frame is a way for them to control their own risk, by getting theirs while it’s still a high-probability thing. VCs follow a “blockbuster” model that is high-risk but theoretically high-reward. To make it work, you only look at companies that have a possibility of a 35+ percent return in the short term. You invest in 8 or 9, knowing that odds are only one or two will actually hit, but those that do have the potential to make enough money to cover your losses on the others. It’s very much a gambling business model. However, VCs don’t just gamble, they work to minimize their risk by taking controlling stakes in their investments. In any company there are hundreds of decision making opportunities that define what kind of company it will be. The VC is there to ensure that making the most money possible is the highest priority. This is about maximizing, not satisficing.
Companies making profit maximization their highest priority are in a bind now when it comes to making good decisions about their other stakeholders (employees, suppliers, local communities) or their environment. VCs don’t have a standard by which they can say something is “good enough”, the standard they’re evaluated by is competition with everyone else, and the measurable standard they’re all competing on is profit dollars.
By this very system of funding, we create and build companies that are unsustainable. By that I mean they prioritize short-term profits over their long-term impact on stakeholders (including shareholders) and the environment. This early investment cycle ends when the company goes public or is bought out, thus cashing-out the VC investment but by then the groundwork is laid. Going public is a continuation of this process. Who owns you now? Shareholders officially. But it’s not the average folks that get listened to, it’s the folks with sizable holdings – brokerage houses and hedge funds. Now the company’s leash is held by investment analysts who again evaluate them purely by financial standards and who more and more look only at the short term. I went to a CEO panel talk at Seattle U. on corporate turnarounds. One of the CEOs talked about meeting with analysts after getting his company on a firm footing; in an entire season of meetings only once did someone ask him about next year. Everyone else was focused on next quarter. He said that the trouble now is that they’re all speculators rather than real investors.
This is a terrible standard by which to run our society. And it is our society: the profits may not trickle down but the standards of treatment do. Costco was famously publicly criticized by an analyst for having employee benefits that are too generous. Not CEO benefits, we’re talking about that friendly person who scans your card and boxes your year’s supply of toilet paper.
(see: http://reclaimdemocracy.org/articles_2004/costco_employee_benefits_walmart.html) or http://www.businessweek.com/magazine/content/04_15/b3878084_mz021.htm)
The backlash against Wal-Mart and the attention paid to the Costco-analyst incident show that a sense that we need to make some fundamental changes is building. There is something wrong with the role the market is playing in our economy. This morning a friend of mine pointed me to the blog of billionaire Mark Cuban, where I found a good capture of the difference between investors & speculators.
It’s interesting that he categorizes investment as win-win and speculation as zero-sum (win-lose). I once had an investment manager suggest to me that the market is a zero-sum game. What did his company do? Arbitrage. One of the replies to Mark’s blog captures it perfectly. “Scott” writes: “It’s unfortunate that raising capital for a startup is directly related to the exit strategy.” I’m not sure I’m impressed with Mark’s tax incentive solution, but he’s onto the right problem.
So what are the solutions? Well, I think we’re still in a phase of convincing enough folks that we have a problem, but experimentation is already starting on the cutting edge. Corporation 2020 is an organization formed to bring people together to think about problems and solutions. One of the founders is Marjorie Kelly, editor of Business Ethics magazine and author of The Divine Right of Capital.
I’m investing in a new fund that is about investment, not speculation. It will buy and hold socially responsible companies while they grow. It’s called Upstream 21. Written into the corporate charter is the axiom that it is responsible to all stakeholders: shareholders are not more equal. Unfortunately, to invest you need to be an “accredited” (or “sophisticated”) investor – yet another layer to this onion: many folks are restricted by SEC regulations, designed to protect them, from doing the kind of direct company investment that is about building your own community. However, I think this too may be exaggerated – if you’re not planning to get big or raise big money (max 2 million), this isn’t quite as prohibitive as it seems. If small companies can get help with financial reporting instead of hoping for “dumb money” that will invest and go away, I think this can be overcome. Certainly that would be less painful than selling your soul to the profit counters.