A Wonderful Pipedream

Trying to recapture the days of “authentic” capitalism is praiseworthy but impractical

F ixing the Game: Bubbles, Crashes and What Capitalism Can Learn from the NFL is a deeply serious and important book wrapped in an ambiguous cover, intended, one presumes, to attract a wide audience. But anyone who picks it up expecting an easy read about business and American football will be gravely disappointed. It began life as a learned article in the Harvard Business Review and might easily be a series of lectures delivered at the University of Toronto’s Rotman School of Management, where the author is the widely respected dean—and, as he tells us, a football fan.

Roger Martin might also warn us that when it comes to conventional wisdom about U.S. business, he is a contrarian. For example, a business should seek to enhance value for its shareholders. Right? Wrong, says Martin. It should concentrate on “delighting” customers, and shareholders should expect no more than a reasonable return on their investment.

But first, that cute title. “Fixing” can mean either repairing something or arranging the outcome of a game for a dishonest purpose. But the game here turns out to be nothing less than modern American capitalism, which Martin finds in desperate need of repair. He begins by reminding us of market booms and crashes—recently in 2000 and 2008, “the aftershocks [of which] are still being felt”—which have wiped out billions of dollars in shareholder value, thousands of jobs and hundreds of promising new ventures. After each crash Congress has tried to discover what went wrong and to legislate corrections without, obviously, much success.

Then Martin offers his own analysis and solutions. I can only sketch and simplify—I hope not oversimplify—his analysis, but he focuses on two main villains. The first is Wall Street itself. There are, he says, two markets. The real market is where products and services are designed, produced and traded, and real profits show up on the bottom line of companies. Then another market takes over—the “expectations” market. “In this market, investors assess the real market activities of a company today and … form expectations as to how the company is likely to perform in the future. The consensus view of all investors and potential investors as to expectations of future performance shapes the stock price of the company.”

The problem with the expectations market is that prices can be driven up or down by hedge funds and other pools of capital managed by experts who dive in and out of the market, buying and selling to make a capital gain that is taxed at a lower rate than other income. In Martin’s words they are parasites because they add no real wealth but take wealth away in profits. Also, they create volatility in the market for their own purposes, and sometimes the speculative buying sparks a runaway boom that of course eventually crashes. Others may argue there have always been speculators in the market so hedge funds are nothing new and cannot be blamed for the turbulence of recent years. Possibly it is just a matter of scale, but my observation tends to jibe with Martin’s and he does have the support of some experts who should know. Paul Volcker, a former chair of the U.S. Federal Reserve, is quoted as saying that “market practices … have come to place American-style capitalism at risk.”

If one assumes Martin is right in his criticism of hedge funds, how are these monsters to be controlled? He suggests regulation and taxation can do the job. But would that restore sanity to the markets when even small investors now expect rapid gains rather than modest dividends? One answer might be to require that securities once bought must be held for, say, a month before being sold. But I can already hear the objections.

Martin’s second major set of villains are those CEOs and other managers of American corporations who have been given as part of their pay packet options to buy shares in their company. The argument is that holding shares will put the managers on the same footing as the shareholders, with the same interest in raising the value of the share. It seems reasonable, but Martin the contrarian argues that the result is the opposite. First, he cites evidence that the scheme has been riddled with fraud, recalling the 2005 scandal when thousands of corporations were found to be routinely issuing options at below market price, ensuring for the lucky executive an automatic profit at the expense of other shareholders.

But then Martin presents a more sophisticated case against options: “The illegal and unethical behavior of business executives over the past few decades suggests that something is seriously out of whack in the corporate world. . . . How is it that executives have come to act in ways that are so much at odds with what we would expect of them—and of what they should expect of themselves? They have fallen down the proverbial slippery slope, pushed by perverse incentives to behave in ways that are less and less ethical, more and more inauthentic.” Martin’s definition of authenticity is “the degree to which one stays true to one’s own character and morals while dealing with external forces.”

Options are perverse incentives because managers are led to concentrate on advancing their own interests rather than the interests of the company. They seek to run up the price of the shares in the short term so that they can cash out at a time that suits them. This they do by influencing the price of the stock in the expectations market, and even by collaborating with the hedge funds and other market fixers. In the process, Martin would say, they become inauthentic.

So what to do about it?

Here is where the NFL is dragged in. Some years ago the league recognized that players, coaches and others were betting on the outcome of a game they were in a position to rig. The league sensibly banned such individuals from betting—and has rigorously enforced the rule. Martin does not propose to ban financial incentives for executives, but insists they should be based on raising the real value of the company, and never on its value in the expectations market. It sounds sensible, but policing the activities of countless executives in thousands of corporations would be rather more difficult than policing a handful of NFL franchises.

Martin’s real goal, it appears, is to restore something like the model of capitalism that made the United States the envy of much of the world in the 1950s and ’60s. Corporations focused on “delighting” their customers rather than their shareholders and executives served not only their company but also their communities in which they were often leading citizens. They were, in Martin’s word, authentic. But the belief that this model can be restored is surely a pipedream. The U.S. is being challenged and often bested by other countries with earlier and less civilized models of capitalism more akin to the robber baron style that first made the U.S. rich and powerful. True, capitalism in China is controlled and directed to some extent by communist authorities, but, given the dynamism of capitalism, once unleashed it could easily wind up controlling the communists. In India and elsewhere in the developing world capitalism is booming—and stealing American jobs and profits. Learning to compete in global markets is the real problem facing American capitalism.

But this is not to say there is not much to be learnt from Martin. As I write, crowds of unhappy people are threatening to “occupy” Wall Street, and the protest has spread. They know that something is wrong with U.S. capitalism, but not exactly what, or what to do about it. Reading Martin would give them some ideas, although not, I fear, all the answers.