Fixing The Game
Roger L. Martin
(Harvard Business Review Press, 249 pages, $24.95)
The National Football league doesn't condone gambling. It evicts any players or coaches found to be betting on games. But business does more than condone gambling. Business encourages top executives into high-stakes betting. And until business learns from the NFL, Rotman School of Management dean Roger Martin believes, we will have increasingly frequent bubbles and crashes.
In Fixing The Game, which brings together his provocative writings since the recent financial debacle, Mr. Martin distinguishes between the real market and the expectations market. In football, the real market is what we see on the field. Real touchdowns and real field goals are scored. There is a winner and a loser, determined by who scores the most points.
But there's also an expectations market, in which gamblers place bets according to how they think the games will turn out. To keep activity strong, bookmakers offer a point spread to compensate for the apparent strength of teams. So it's possible for a team to win on the field, in the real market, but lose in the expectations market, failing to make the spread.
In business, there is also a real market: how companies perform - sales, expenses, profits, and return on investment. But Prof. Martin notes there is also an expectations market - the stock market - where collective expectations give way to the ebb and flow in stock prices.
"Unlike American capitalism, the NFL looked thoughtfully at the relationship between the real game and the expectations game and identified a serious danger," Mr. Martin notes. The league recognized that the expectations market could unduly influence its personnel. After all, a player who bet on his opponent could make a deliberate but seemingly errant throw or fumble that would still result in a victory for his team in the real market but a loss in the expectations market - failing to make the point spread. So gambling has been banned, and that ban policed strenuously, to avoid such dire influences.
But in business there's a deeper problem, endemic to capitalism, than the possibility of a CEO doing the equivalent of shaving points. The danger is that a CEO so caught up with the expectations market - and the ability for personal gain within it, through stock options - will pervert the company, and its long-term chances in the real market of operations, for a quick buck. (Well, actually, lots and lots of bucks.)
Mr. Martin points to the 2007 New England Patriots, who went unbeaten, winning all 16 games in the real market. But they didn't fare so well on the expectations market. They covered the point spread in only 10 out of those 16 games because expectations ran away to unattainable levels. "The lesson is that no matter how good you are, you cannot beat expectations forever. Expectations will get ahead of anything you can actually accomplish, even with superhuman effort," he writes.
That applies in the executive suite, as well as the gridiron. Mr. Martin asks you to consider a company that could pay its CEO a $10-million salary, or split that into a $2-million salary and $8-million worth of phantom stock units. The second payment scheme is designed to encourage the CEO to raise shareholder value. But it means the chief executive has a clear and simple incentive to raise expectations of future performance from the current level. "One might imagine that improving performance in the real market would increase the stock price but this isn't the case. The dot-com bubble taught us that stock price and real market performance are not as closely linked as we would like to believe," Mr. Martin notes. And the recent bubbles - and the discovery that some prominent companies were backdating stock options to help their executives beat the expectations market - showed the danger of such gambling.
To fix the game, Mr. Martin argues that:
We must shift the focus of companies back to the customer - real performance for those customers - rather than on increasing shareholder value.
We must rethink our models of stock compensation, so that executives no longer have a powerful incentive to keep expectations continually rising. Stock-based compensation must be eliminated and new compensation models created to focus executives on real and meaningful goals for the company.
We must address board governance so that it is seen - particularly for the chairman - as public service, rather than personal gain.
We need to regulate and manage expectations market players more effectively, notably hedge funds, which he says create no value for society.
Business executives need to take a broader view of how their enterprise can contribute to society.
Fixing the Game offers a lively, intricate but accessible argument, neatly stitched together with references to the NFL and other sports when analogies are helpful.
Faced with a tailspin as the global economy collapsed, the president of a large company got rid of his public relations folk, because that was easy, and then the marketing team because they were expensive and their ideas no longer affordable. But with the recession unabated, he put this choice to his senior staff: "We can start cutting sales, which produces revenue; or we can really tighten our belts, cutting our own expenses, firing the executive chef, selling the plane, and that kind of stuff. What do you say?" The reaction was unanimous: "Cut sales, definitely." The moral of the story: There's a reason certain people make it to the top.
Fortune columnist Stanley Bing's updated version of Aesop's Fables, Bingsop's Fables: Little Morals For Big Business (Harper Business, 215 pages, $22.99) is filled with gems such as this one, as he offers a jaundiced, often accurate, and usually hilarious look at the games that business people play.
Special to The Globe and Mail