Session 4: Externalities, Alternative to Shareholder Wealth Maximization and the End Game

What do you say about it? Uh quick quick quick question again. If you haven't or quick comment about the groups. I was checking through the master list. I'm glad to see more companies starting to show up on the master list. But I wanted to remind you again, once you pick your company, put it on the master list, at least I can get a sense of what you know, what you what you're tracking. So, when you talk about in class, I can at least pull a company off that list and talk about that company in context. Okay? So, today I want to complete you know, at least complete the most of the rest of the discussion of what the end game in a business is. If you remember the last session, we talked about markets. And let's face it, most of us don't trust markets. Whether that's built in you think we Let me take that back. We don't trust financial markets. And the reason I find it ironic down the screen on you. The reason I find it ironic when people say, "I don't trust markets." is our entire lives are run by markets. Take an example. Now, how many of you sat down to watch Netflix yesterday? Right? But if you sat down to watch Netflix, most of the shows they don't come with with reviews because Netflix removed that a few years ago. You've no idea what you watch, right? So, anybody help me out here. When you get on Netflix and you don't know what to watch, what do you fall back on? I'm sorry? Or you you first is you fall back on names. There is a reason Suits was the most I mean, this was a pretty average show when it was on broadcast TV. Now, don't take it as an insult if you like Suits. It's a good show, but it's no no it's not a supernatural show. The fact that Suits is watched more than Stranger Things, that you go to the familiar. So, that's one thing you do. What's the other So, what's the other second play you try? Recommendations for I don't even Is there Is there a way to actually see that on Netflix? I'm not a So, you actually call your friends and family before you watch a show. I don't have that much that many friends and family, so I can't do that. You look at the top 10, right? Every single streaming network now gives you Okay. Every single streaming network now gives you the top 10. Used to be just Netflix, but you go to Max. You know why they do it, right? Because they know if you're confused, you're going to go where everybody else is gone. It's a little bit like letting the market guide. Or my favorite device is to go to Rotten Tomatoes. You been Rotten Tomatoes? Basically, you get the reviews. You get the critic reviews, which I completely ignore because they're I don't think they have their heads screwed on straight. I look to the audience reviews because I When you want to pick a restaurant to eat in a strange city, think of how you pick a restaurant. Do you pick up the New York Times or the local newspaper restaurant reviews? I haven't read a restaurant review in years. What do we do? We go to Yelp. Four and a half stars, it must be a good restaurant. It might not be, but we've turned our lives over to crowd choices, right? And there's a big basis for that. It's called crowd wisdom. And the reason it's crowd wisdom is the argument is the collective view of hundreds, thousands of people is better than one person telling you what to watch, what to eat, where to eat. In fact, we built an entire currency on crowd checking the currency, right? The way currencies were built is you have a central bank in a fiat currency. What am I Which currency am I talking about where the crowd checks to see? It's Bitcoin. How does a Bitcoin transaction get checked? A crowd of Ukrainian miners or whoever they are get on a computer, check a number. They So, while we complain about markets being irrational, increasingly we're letting crowds drive our choices. And it is only going to get worse because with big data, you will know instantaneously what the rest of the world is doing. And you follow along because much of the time they're right. In fact, I've run an experiment for the last 3 years since COVID. And the experiment is we have experts telling us what's going to happen. And you have the market giving you its own sense. March of 2020. Now, they were in sync. Both markets So, March 23rd, 2020, markets had collapsed. Experts were saying the end of the world is here. But there's something that happened. This is the thing about markets. You don't realize what causes markets to shift. March 24th, markets opened up and all of a sudden everything got upbeat. And over the next 6 months, markets came back fully. And what were markets saying? It's going to be okay. But if you go back and read what experts were saying then, "It's not going to be okay. There will never be a vaccine in the next 2 or 3 years. Vaccines cannot be developed this fast." And in hindsight, markets were right, experts wrong. If you don't trust me, go back and check every single time in the last 3 years where markets have given one message and experts have given Last year, what were experts saying about the economy? Start of 2023. Recession. Not a question of whether it's when it's going to happen, how severe it's going to be. And markets said, "Don't worry about it. There's going to be no recession. I don't care what the Fed is doing." And a year and a month later, it looks like the market is closer to the truth. I'm not just saying market's always right. We know that the same crowds that give us wisdom also give us madness. In fact, one of my favorite books is called The Madness of Crowds. It was written 150 years ago. It looked at how bubbles got formed. The South Sea bubble basically talked about how crowds can sometimes do irrational things. So, I'm not going to throw myself at the mercy of markets and markets are always right. But I'm saying when I doubt markets and when I question markets, I always have to double-check my own numbers, my own assumptions to make sure it's not me that's wrong rather than markets. So, don't be too quick to throw away market prices and markets are irrational, markets are crazy. All of those things might be true, but you need an alternative. And what's that alternative? Are you going to trust managers? Are you going to trust regulators? Somebody's going to be making the decisions. And the question is who's least likely to make mistakes. And I'm going to come back and give you one more reason I think markets beat experts. And we'll talk about it in a few minutes. Which brings me to to the the final link. So, if you look at the links we've talked about so far, we've talked about how shareholders have little power over managers. Annual meeting doesn't work very well. Boards of directors are ineffective. So, what do managers do? They put their interests over shareholders. If lenders don't protect themselves and lend to companies, you get an Enron scandal. Markets you know, managers don't reveal information to markets honestly or on time. And markets sometimes do crazy things. Which brings me to that final link. If you remember in the original utopian world, what do we assume about social costs and social benefits? There are none. Nice convenient assumption if you're an economist. But the truth is you cannot run a business without creating social costs. And sometimes your business creates social benefits. But let's be clear on what a social cost or a social benefit is. Economists call these externalities. Basically, they're things you create for society that cannot be traced back and charged to you as a company. So, not all environmental costs are social costs. If I can trace an environmental cost and charge it to you as a cost, it ceases to be a social cost and it becomes an economic cost. So, the nature of social costs and benefits is really you cannot put a number on them because if you did, you could attach it to the company and say, "You pay that cost." So, the the the reality that businesses face when they make decisions There're all these externalities. And this has become the big debate over the last This is actually not just the last 20 years. This is as is as old as private business is what do we do about those externalities? And one extreme scenario is let's not have private business. This was the experiment of socialism in the last century of private businesses create too many externalities. Instead, we will let the government run things and have no private businesses. And of course, that experiment ran a century. Okay? It's still a continuing try. People try. But if you stay with private businesses, the reality is there are social costs, there are social benefits. And you when you make decisions have to think about what do I do about those. I'll tell you the challenge here. When you look at social costs and benefits, you assume that when you make a decision, you know what the social costs are. It's not always true. Company called John Manville in 1950s invented a product that made construction so much easier. Asbestos. Asbestos when it first came out was viewed as an amazing product because you no longer were carrying heavy stuff. It was a lightweight product. It was durable. Until people discovered it caused cancer. In hindsight, you say why did Manville consider that cost when they created the product? The truth is when they created the product, they did not know it was going to cause cancer. If you go back to the 1940s or even the 50s, look at tobacco ads. They actually encouraged it for health. Now, the problem with tobacco companies is once they knew they created cancer, then you say you know what there's a social cost, but initially it was viewed as a great thing. Coca-Cola which originally contained actual cocaine. Pep you up, not surprisingly. And the you know, when you look at the late 1800 ads, drink Coca-Cola, it's good for you. So, when you think about social costs and benefits, you think about bad companies creating social costs and good companies not doing it, but that is not necessarily true. What do we find out one day that smartphones make us stupid? It's an experiment we're running, right? Maybe it'll lower IQs. I can't read a physical map anymore because I've used GPS for so long. I'm losing skills I used to have. And there are people who've never had those skills because they've never had to use a map. But yesterday I saw uh you know, video of four college students being interviewed and asked what's 4 * 15? And every one of them got it wrong. And in a sense, we create this when we have calculators, right? You no longer have to do I mean, who remembers the multiplication tables? You know, who cares? I can check it out. I have a calculator. If smartphones make us stupid, think of the social costs that Apple and Samsung have created for society. And then ask yourself, how do you get those costs back? So, the view that good companies don't create social costs and bad companies do is too black and white for me. It's shades of gray here that make it difficult. Second, the nature of social costs and social benefits is in the eyes of the beholder. This is at the heart of why I have issues when you try to measure goodness. I'll wager if we go around this room and I ask you to describe what goodness means to you, we're going to get very different definitions reflecting where you grew up, what religion you're in, what culture you're coming from, what your family life looked like. And when we look at social costs, those views you have will come into play. So, you can I mean, I always ask people to put themselves in a decision-making room at a company, right? You're a retailer, you're trying to decide whether to open a new store. And ask how social costs and benefits are going to enter the discussion and get resolved. Because you go around the room, there are nine people with very different perspectives on what's good or bad. How do you put a number around it and make a decision based on it? And in fact, if you carry to extremes, you will never decide. You get into what I call decision paralysis because there things we don't know. It could be costly for society. So, let's talk a little bit about social costs and benefits. Cuz for better or worse, companies have chosen to say, "Look, we're good companies." You look at pick up an annual report for a company now, and many of you once you pick a company, you should print off the annual report, you're going to be surprised at what percentage of that annual report is a company telling the world how good they are. Excuse me. Or how much good they do. I'm okay with that. But here's the reason I'm skeptical. It's easy to sound good. But doing good might cost money. So, I'm going to put you on the spot. Let's say you buy into the notion that companies need to do good for society. And let's say you work for Disney. Excuse me. Disney is a company that has always prided itself on you know, on on being so a good corporate citizen. So, you decide, okay, this the annual report, we'll spend 20 pages telling the world how good we are. And you decide to act on that. You say, "Look, we're a good company." And you're a decision-maker. And here's the decision you're facing. And uh Disney doesn't have too many Disney stores left anymore. There's one in Times Square. There used to be hundreds of Disney stores. They've closed a lot of them. Let's say that you decide to open a Disney store in downtown Oakland. Oakland is having all kinds of issues now. The city is emptying out. But you're doing it, and I'm going to cut off all the excuses you can give for building the store cuz often people say, "If I build the store, can I can I advertise it and use it as PR?" Let's say you cut off all those, and you're looking at opening the store, and you know you're going to lose money on the store. $200,000 a year as long as the store is going to But it's going to do good. It's going to revitalize that area. It's going to provide employment. Hey, if I believe what you said in your annual report, this is what you told me you're about as a company, right? So, here are my questions. There's no right or wrong answer, but I want you to start thinking through you You're working at a publicly traded company how this decision would play out. First, would you open the store? How many of you would open the store? Let's say you work at Disney. You've got all this thing about, you know, social responsibility. How many of you would open the store knowing that you would lose money? None of you would? Then please stop talking about ESG or sustainability. Because if you're not willing to lose money, this is all talk. And that's why I took away all those options. What if I can use it in advertising? Then you're doing it for PR. This has nothing to do with social good. So, you said you would open it, right? Okay. Exactly, what is the benefit from a marketing side? Oh, see, you're looking for So, you say, "Can I make The question I'm asking is if I take away any potential benefit you can get, would you still do good?" And if you say no, then take those 20 pages out. Put it into the advertising section and call it whatever you want, special kind of advertising, look good advertising. But if this is about doing No, this is unfortunate because none of you said you'd open the store because companies sometimes spend money on things where you don't get a benefit. I don't have a problem with this if you can follow through. Here's the second, and this is what I mean by following through. It's not your money. Companies don't have money. It's your shareholders' money. Would you tell your shareholders that you'll open the store and will lose money? I think you need to carry this through, right? If you're going to be a good company, you tell the shareholders how good you are, you need to tell them how much you're spending on being good. You can't hide behind, you know, we it's it's it's it's not your job to find out what that is. So, if you're going to do good do good as a company, be willing to spend money. And second, be willing to be open about how much you're spending. And at least collectively, you need to give a shareholders a vote on Remember we talked about how companies that do well can do good? If you get in front of shareholders, if Nvidia CEO got up in front of a shareholders and said, "You know what, guys? This year Nvidia's planning to give away half a billion dollars to doing good." Do you think anybody at Nvidia I think that vote would pass with a 99% yes. Why? Because over the last year, you know how much Nvidia's added to its market cap? A trillion dollars. When you add a trillion dollars to market cap, and you want to give away a half a billion, people say, "That's okay." GM gets up, Mary Barra gets up and says, "I'd like to give away a half a billion." I'll wager not a single person in that room is going to go along saying, "We lost half our market cap last year, and you want to give away a half a billion?" That's not going to happen. Trust your shareholders. If you truly believe in doing good, trust your shareholders to give you the okay on it because why talk about it if you're not going to act on it. So, let's summarize. All of the utopian assumptions break down. Shareholders have little power over managers. Managers put their interests over shareholder interests. Lenders, if they aren't protected, get ripped off. Markets are irrational and inefficient, and managers feed them information, if not fraudulent information, not often on a timely in a timely fashion. And companies do create social costs and social benefits. They have externalities. This is the world we live in, not the utopian world. So, I've actually I'm in a very precarious space for maximizing value because I've taken away its underpinnings. So, the question is, what do we do in this world that we live in? And I'll give you the three choices you have. The first is, maybe you can replace the shareholder-based corporate governance system that I just described, that corporate finance is built on, with a different system. So, I'm going to talk about alternatives that have emerged to shareholder-driven corporate governance, some more benign than others, and some pretty successful. Second, I'm going to talk about maybe we can pick a different objective. Maximize revenue growth. Maximize market share. Maximize number of subscribers. Let that kind of fester in there for a while because for a decade, users, subscribers, platform numbers. Maybe a different objective. Or third, maybe we can revert back to maximizing value, but put guardrails on so that you don't have these side costs that we talked about to other stakeholders. So, let's start with the first choice. What about a different way of running companies? 1945, the Second World War ended. The German and Japanese economies were nonexistent. They were in shambles. And over the next 40 years, by the mid-80s, in true economic miracles, the two countries had built themselves back up. Germany was the second largest economy, and Japan was the third largest economy. And they built it around a corporate governance system very different from the shareholder-based system that I talked about. When I say shareholder-based, the the responsibility for replacing bad managers in the system I described is shareholders need to get together, vote them out, move them out of the way. That's not the system that Germany and Japan picked. What the Japanese picked was what's called a keiretsu. A keiretsu is a cross-holding company. There are 100 companies bound together in the group. And here's how corporate governance works in a keiretsu system. If one of the companies is badly managed and badly run, the remaining 99 managers in the cross-holding group get together and replace the bad manager. In other words, we've replaced shareholders with managers of other companies and put the responsibility for changing bad management in their hands. The German system is similar, built around cross-holdings, but not as many companies. So, at one point in time, Allianz was the largest single stockholder in Deutsche, and Deutsche was largest single stockholder in Daimler, and they were supposed to keep an eye on each other. Already, you can see this is kind of an elitist system, right? In a sense In a sense, you're saying managers are better educated, they're more informed. I trust them to make the right decisions. In fact, Japan elevated There's a Ministry of Finance in the 1980s that was viewed as the premier job in the country. You got to the Ministry of Finance, you ran the economy. You decided where growth should be and where investment should happen. And as long as it worked, people said, "Why can't we be more like the Germans and the Japanese?" So, as you look at these alternative corporate governance systems that sounds attractive, especially when it's working. I remember Michael Porter in the 1980s. You heard of Michael Porter, right? The strategy guy from Harvard. 1987, he wrote a book saying, "US companies need to be more like the Japanese companies. They need to focus, you know, have these cross-holding systems." And it sounded awfully good in '87 because Japanese companies ruled the world. And then you got to the 1990s, and you saw the downside of these systems. You know what the problem with elitist systems is? Elitism. And here's what I mean by that. In 1992, both Japanese and US banks were about as equally exposed to bad real estate loans. Why? Because real estate prices had been high, they'd collapsed. So, in the US, here's what happened. Chase and City and pretty much every big bank had to take big write-offs for those loans. They got punished by markets. City lost half its market cap that year. You think that's terrible. But they were able to move on. You know what Japanese banks did? They surrounded the wagons and said, "What problem?" No. Essentially, they acted like there was no bad loan problem, and since there's no shareholder pressure, the problem stayed in the banks. I know it's There are lots of other things in Japan that can explain what's happened to the Japanese economy over the last 30 years, including demographics. But I think one reason the Japanese economy went into deep freeze in the early '90s and has never quite recovered is because those problems stayed on bank balance sheets and kind of prevented banks from doing the right thing. Elitist systems work, and in the good times, you don't notice that everything is stopped down. But when they don't work, here's the problem. Elitists hate to admit that they've made mistakes. Markets have no egos. They can adjust the market price by 80% overnight, and markets move on. Elitists stay and fight the fight because you can't I mean, you you went to the best schools, you were the smartest kids. I mean, all the way through your life, everybody's looked up to you. And now you've made this horrendous mistake. Your first inclination is, "How do I hedge? How do I keep this going? How do I cover it up?" So, if you're tempted to go with alternative corporate governance systems, look at the downside of how these systems because the keiretsu system was imitated in Korea with chaebols, a very similar. And in the late '90s, those systems had the same problem. This is not a one-time deal. Anytime these systems get into trouble, they have much more difficulty recovering because of the way they're structured. Now, two or three years ago, the question I would get asked is, "The Chinese corporate governance system is not built on shareholder power, and it's working really well. Why can't we more be And my response was, "In good times, you don't notice the weakness of systems." And when you're growing 10% a year, as the Chinese economy was growing, you have buffer built into the system. Nobody notices the weakness of the system. And I said the real test will come when the Chinese economy slows and the system is put under stress. I think we're there. This decade is going to be the test of how the system responds to bad times. That's really the test of a system. And we're going to see it play out. It's going to be interesting to see, nothing else. But it could be painful. If systems don't respond, you extend the pain. So, when you look at these alternative systems, one choice, which is the Japanese and the German is I call it managerial corporatism. Why do I call it managerial corporatism? Shareholders have nothing to do here. Basically, the managers decide. They They kind of self-decide when things don't work right, and they fix things. And in good times, that might be a more efficient system than the US system. No takeovers, no hostile acquisitions, no replacements. Managers essentially fix problems. But unfortunately, in bad times, those same managers are running the company, and they're unwilling to admit their mistakes. That's the more benign version, the Japanese. There is a more malignant version of what happens in an alternative I call this crony capitalism. Or crony corporatism, they're pretty much the same thing. In crony corporatism, what happens, you still have publicly traded companies, but they're controlled by family groups or insiders with connections. Connections to whom? Regulators, governments. Effectively, they've cooked the the system in such a way that you really can't challenge them. With crony corporatism, again, it's you you you get the plus of, you know, these companies are able to grow because they don't have any of the roadblocks that traditional companies do. That's the good news. The bad news is, you can't compete against these companies if you're not part of that group. There are consequences, and the consequences in countries which have had crony corporatism is you get corruption, you get all the side costs. And then every time a government shifts, the entire economy goes into all kinds of contortions because the connections get broken, and new set of connections come in. You get these zigzags in the economy depending on who's in power. So, if you're going to pick a different corporate governance system, go ahead, but think through how that system will deal with weakness, not with strength. Any questions on alternative corporate governance system? So, this is a work in progress. Maybe there will be another corporate governance system, but somebody's got to be in charge of changing bad management. The question is, who's going to do it? So, let's look at the second alternative. Maybe instead of maximizing value, we can maximize market share, maximize revenue growth. Or if you call in a consultant, they'll come up with an acronym. C C F R O I E V A, whatever, because each consulting firm has created its own acronym. For for selfish reasons, because once you have that acronym, you need them to come in and compute it. But their argument is this, maximizing value is so complicated, just maximize E V A, maximize C F R O I. It's a And there's usually a little R in in in with a circle around it. Drives me crazy whenever I see that on something that is so self-evident that everybody knows it. It's a registered, you can't use this this acronym. It's our acronym. Again, the appeal of these is it seems simpler. I'd maximize market share, it's so much simpler than maximizing value. But here's the downside. I call these intermediate objectives. And the reason they're intermediate is maximizing market share by itself is a terrible objective. And here's why. Do you want 100% market share of a market? Go along with me. Yeah, of course, right? But what if the only way you can get 100% market share is by selling below cost? Do you still want it? I don't. What's the point of having 100% market share if I'm going to have to sell below cost? And when you maximize market share, that becomes a driving force in your decision-making. I'll give you an example. 1981, American Airlines got a new CEO. A guy called Robert Crandall. Came in. First, you know, I think he called a press conference and he announced his intention. He said, "I want to make American the number one domestic US airline." Notice how Notice how he's framed his mission. Number one domestic US airline. By 1989, it succeeded. American was the number one domestic US airline in terms of number of passengers flown. But in in 1989, there were only two airlines making money and neither of them was called American. One was Alaska Air. I guess nobody else wanted to fly to Fairbanks. And the other was a very young Southwest Air. You know in 1989 what the Southwest Air routes were? Dallas to Houston and back again. They went back, you know, they didn't care about you know, national flights. So, basically, they said, "We'll fly where we can make money." The exact opposite of the American objective. When you focus on an intermediate objective, that's going to drive decision-making across the firm. So, middle managers, lower managers, all recognize, "We want market share, we want more flights." And it's not just market share, right? We talked about users and subscribers. We've spent a decade where companies were built around the premise that the objective of the company is to maximize the number of subscribers you have, maximize the number of users. Let me ask you a question. If you work at a company like that, how do you increase the number of users, subscribers? You give stuff away for free. It works really well. And I valued this company called Paytm, the Indian payment processing company, a couple of years ago at the time of its IPO. I'd never used Paytm, so I I made the mistake of downloading its app onto my phone because I wanted to see what it looked like. And I can't stop the notifications from this. Every day, they offer me more free stuff. Paytm has 330 million people on its platform. That's its big sales pitch. Look, hundreds of billions of people on our platform. But it's a payment processing company. How do payment processing companies make money? How does MasterCard make money or Visa make money or American Express? Every time you use it, they take a slice. American Express takes about 4%. MasterCard and Visa are about 2 and 1/2 to 3%. PayPal is around 2 and 1/2, but it's dropping because of competition from other You know what Paytm makes? I That's called a take rate. 0.4%. No wonder you have 330 million subscribers. You're giving stuff away for free. But this, you know, it's saying that's irrational. No, it's completely rational. From the top, you were told, "Your job is to go find more subscribers, more users." Everything you do as a company is going to be driven by that objective. So, if you want to pick a different objective, be my guest, but think through what that will mean in terms of decision-making in your company and whether you're building a healthy business with that objective. Now, I've talked a little bit about stakeholder wealth. You know what's coming, but the argument for stakeholder wealth goes back to that original page page I showed you about all the different stakeholders in a company. Shareholders, lenders, employees, society. And the basis for stakeholder wealth maximization is that it's the fairest thing to do, right? There are all these stakeholders, why do you focus just on shareholders? Everybody needs to be taken care of. Who can you know, really contest that? That seems like a sensible thing, something good to do. So, born out of fair born out of a fairness, and it seemed like an easy fix, right? Because we talked about how stockholder wealth maximization creates all these externalities. By doing stakeholder wealth maximization, it looks like we're taking care of the problems. So, the appeal at least at the surface level is this is a bigger objective, therefore you won't have the side costs. And for many companies and many CEOs, this became in something that was more politically defensible because especially in the last decade, even in the US, you've had companies being attacked for not caring about society. And this way, you could talk about how much you cared about stakeholders. And it must have registered because in I think 2019, and this was the first, you know, puzzle the the weekly puzzle that I sent out. The Business Roundtable, which is composed of the CEOs of some of the largest companies in the US. I think 171 CEOs, so all of the largest companies. Jamie Dimon is on it, Jeff Bezos is there. Put out a statement that effectively seemed to buy into stakeholder wealth maximization. They said the objective of a company is to take care of shareholders, take care of So, if you look at each statement by itself, it You think it's That sounds good. And I remember reading this saying, "Do you really want to put this out as your view on how companies should be run?" Can you really I mean, hey, put yourself in the shoes of I mean, around the table for that decision you're making. Should I open the store? Ask yourself, "How do I convert this nice-sounding objective into practice?" How do you keep everybody happy? Because that's effectively what stakeholder wealth maximization is. So, when you think about stakeholder wealth maximization, it sounds good, but my view it leads to what I call confused corporatism. Why confused? Because you have no idea which particular stakeholder you should be looking at at any particular point. Now, I mean, different decision-makers pick different stakeholders. So, you could be sitting around a table with four other people and you can't even con- converge on a decision because each of you is holding onto a different stakeholder group. It's great for CEOs. And I'll tell you why. If you're accountable to everyone, you're accountable to no one. I used exactly these words in a Financial Times op-ed last year. And people said, "What are you talking about?" I said, "Here's how it works. I'm a CEO of a company. You're my shareholders, the stock price is down 15%. And you get up and say, "Wha- Why? You know, what's what's happening?" And I say, "You know what? This year, I had to take care of the employees." I had other stakeholders. Then the employees say, "Look, our benefits have been cut. What's happening?" "You know what? We have society to take care of, you know, there's another interest to be served. Every time a stakeholder group challenges me, I point to another stakeholder group saying, 'That's why I can't deal with you.'" It's a great way to not accountable. And that's exactly where you end up with stakeholder wealth maximization. If you're attracted still by the notion, I'm going to give you two real examples of of entities that have put stakeholder wealth maximization at the top of how they run the company. And I want you to ask yourself whether your business you want your business to look like one of these. One is the old government-owned company. This is not a public company with the government. This is a company that's 100% owned by the government. When I grew up in India, lots of companies were entirely government-owned. You talk to the CEO of one of these old government-owned companies. They say, "What is your mission?" He'd say, "You know what? The minister said we need to make money, okay? We need to produce a product. We need to open factories in parts of the country where employment is low because an election might be coming up. Oh, by the way, while we do all of this, they'd like us to also do something for the towns we live in. Now, have some community centers." Basically, a list a mile long. And then at the end of the period, look at it and say, "Why are these companies run so inefficiently?" Of course, they're going to be run inefficiently because at any point in time, you're saying, "Whose interest am I serving?" That's one entity. Here's another one, and you're sitting in a room run by this entity. The modern research university. If I asked you what the mission for a university should be, what should your answer I mean what you know what what are universities supposed to do? What is their end game? They're non-profit, so it's not to make money at least. So what what's the mission? Think it's education, right? You think university it's education? But we need to collect tuition. So if we define education as our mission and we define stakeholder groups in here, who should be on top of the list? Our undergraduate students. Let's face it, without those 45,000 people paying tuition, there is no NYU. Do you think at a modern research university, I mean you were undergraduates in college, did you ever feel that you were put first at the university? If you did, you were incredibly naive. You're not even in the top 10. I describe universities as asylums run by lunatics. The lunatics are the tenured faculty. And we set the rules to make our life simple. Easy. Three courses a year, that sounds like a lot to do. 4 and 1/2 hours a week, I don't think I can do that. Let's make it two courses a year. And because I work so hard, let's take every seventh year off, call it a sabbatical. And I don't even feel like teaching, let's get adjuncts to come in and teach our classes and we can just do research. That nobody reads, but research. If you're wondering why there is so much flab and cost in universities, this is exactly what happens when you have no idea what your mission is. I sit on committees, I absolutely hate sitting on committees. And I always start with what what are we trying to do here? What's the end game? It's amazing how confused people are around the table about what are we are we trying to save money? Are we trying to improve the MBA? I don't know, I have no idea. And when you don't know, of course your decision-making is going to reflect it. If every company were run like a modern research university, God help us. Have you ever heard of a research university running a surplus? No matter how much money we raise, we spend it plus 10%. It's almost a built-in system. And that's always going to happen when you have no sense of what your end game is. So I don't care if you pick shareholders as your stakeholder group, but pick a group. Somebody's got to be on top of this hierarchy. And if you decide it's going to be employees, I'm okay with that. But that group then has to drive all of your decision-making and you have to figure out how you survive as a financially healthy company and where you raise capital if you do that. But you might find a solution to it. But don't give me this will keep everybody happy objective, it's not going to work. Which brings me the topic that I could go off on a rant for an hour, but I won't. Which is the issue. You know when the issue was born? Anybody know? Well, 2005. It's born out of a UN document. A UN document that talked about companies doing the right thing, primarily driven around climate change. So after the document is put together, Kofi Annan, who was then, you know, head of the UN, called together 50 executives from different companies that were self-selected because of their social purpose. And they wrote out this this original document, the birthing of ESG. You can see the document list out this is what companies should do. I encourage you to read that document because I did. Because it tells you where ESG was born out of a desire to do good. But ESG was not the first now acronym to do that. This is something that's as old as time. There was a fund in the 1990s called the Anno Domini fund. It's a fund there for religious Catholics and it invested only in companies that met met So this is old as time. Now, Islamic finance has been around hundreds of years, where usually it's driven by a view of what's good and that But the difference is when you have a religion, it comes with a thousand 5,000 500 2,000 years of this is good, this is bad. But ESG was a new religion. It was writing its own Bible as it was being built. This is good, this is bad and the Bible was built around climate change. I've already talked about why goodness is difficult to measure. So starting point for ESG, you're already on shaky ground because you're going to say, "Look, we're going to define good and bad and we're going to hold companies accountable." Who's we? That's always my question, who's we? Is it a group of people in London getting together in New York getting to Who are these people who decide what's good or bad? Second, and this was Larry Fink's biggest mistake, was in the last part of the decade, he said, you know, ESG is good for value. My reaction is why? Where does it show up? And I'm going to talk about you know, so I'll open I'll open I'll approach with the open eyes saying, you know, let's look at where it can be good for value. I think, you know, it's it's questionable and that I'm being, you know, kind when I say the use the word questionable, whether it's good for value. I told you ESG was born out of goodness. Somewhere along the way people realized people selling ESG realized that goodness was not selling that well, so they replaced it with alpha. You know alpha is? This is when you tell investors they can beat the market. So for a long period in the last decade, ESG was sold to investors on the notion of you can be good and you can earn an alpha. You can earn This sounds like you can be you know, the best of both worlds. And finally, the argument is if not even if you don't agree with any of this stuff, it's still good for society. So why are you fighting? And that I think was the weakest link in ESG because by making it about goodness and virtue, they got no pushback. In fact, in 2019, when I look back at anybody who'd written a paper critical of ESG, I couldn't find any. Cuz nobody wanted to be on the other side of a debate where you are taught. In fact, I I started my first post in ESG in 2019 by saying, you know, I know you're going to view me as a moral troglodyte for doing this, but I have some questions. So let's take each of the premises of ESG and why I think the truth is so difficult to deal with for ESG advocates. First, I'm going to argue that ESG is not just difficult to measure, but ESG services actually keep changing their minds on what goes into a score. If you don't believe me, go back and look at Sustainalytics' definition of ESG. You know, Refinitiv, one of the services that measures ESG, retroactively changed ESG scores. That's That's almost unconscionable. Can you imagine if Moody's said, "We're going to retroactively change bond ratings for the last 100 years to make them work better?" You can, right? Retroactively you can fix everything. You can fix that Enron rating in 2000 in 1996 saying, "Look, I could see it coming." They keep changing their mind. They started with goodness, they moved to alpha. And that worked until 2021. What happened in 2021? Russia invaded Ukraine. And all of a sudden ESG stopped delivering alpha. We'll talk about why. So alpha wasn't working. So they moved on from alpha. I have I've saved the documents along each way, so they can't say we never did that. So goodness to alpha. Then they said, "No, no, it's not about alpha, it's about measuring risk, that if you have a low ESG score, you're more exposed to risk." I said, "Okay." In fact, the CFA in a in one of its most feckless moves, actually created what's called a CFA ESG certification. And one of the multiple choice questions, it's actually a 100 multiple choice question, you don't even have to prepare, that tells you how little substance there is in ESG. You can go take the exam, pass it without preparing for a day. One of the questions they asked was multiple choice question is, improving ESG scores reduces cost of capital, does nothing to your cost of capital, increases your cost of capital. The right answer according to the CFA was it reduces your cost of capital. My reaction was stop making up stuff. It It turns out that you look at the numbers, there is no correlation between ESG scores and cost of capital. There is no correlation between ESG and whether you have a catastrophic crisis. So they moved on from goodness to alpha, alpha didn't stop working, they moved on to risk, risk stopped working. And then they said it's really about disclosure. What do you have against disclosure? Companies are just telling you all this stuff, investors can use it. And I have a whole set of things about disclosure and how it's evolved over the last 40 years, which I call disclosure diarrhea. If you don't believe me, pick up a prospectus for an IPO in the last two or three years, compare to the prospectus that Microsoft and Apple had 40 years ago. And you tell me whether the 400-page IPO prospectus you get for Airbnb tells you more about the company than the 48 pages Apple took in 1981 to tell me about the company. But the measure keeps evolving. What are you measuring? And if you if you're not sure what you're measuring, then why are you asking me to put trillions of dollars in it you keep changing your mind? The notion that ESC always increases values absurd. It's absurd because nothing increases value all the time. Everything is a trade-off. Are there some companies where being good could increase your value? Yes. Why? Because you have a customer base that cares about goodness. They're more likely to buy your products. Are there some companies where being good is going to cost you value? Absolutely. Partly because your customers couldn't care less about being good. So you're spending money to be good. ESC can increase value, do nothing for value, decrease value. Is ESC good for alpha? No, that cuts against everything you know, we've heard learned as human beings. Go back to the start of humanity. And you think about the two paths you can take. You want to be good? You want to be bad? Which one's the easier path to take? Is it easier to be good or easier to be bad? If it were easier to be good, you wouldn't need religion, right? There'd be no need for the 10 Commandments. It's always been easier to be bad. And to be good, what do you have to do? You have to sacrifice. You have to give up something. That has always been the history of goodness. How in the last 15 years did you come up with a way of turning that, you know, thousands of years of history on its head? It never made sense even when the numbers look like it made sense to tell me that I could adopt this ESC constraint and end up with a higher alpha. It took 10 years for it to kind of blow up. But it was always there. And finally you're saying, is ESC good for society? I'm going to push back. Is it? Can you name one dimension on ESC where we're better off now than we were in 2008? You say, what about climate change? What about climate change? Was it a problem in 2008? It's gone away now? What about diversity? Are we a more diverse, welcoming, you know? So you take every dimension say, okay, you spend money on it, but where's the outcome? So if you think about each of these, let me kind of back it up. First, here's the easiest evidence to see that services don't know what they're measuring. When you look at bond ratings, you can look at Moody's, you can look at S&P, you can look at Fitch. The correlation is 95, 96, 97%. You never see a company triple A rate Moody's and triple B rate. You might get a single notch off. Why? They're measuring something where they know what they're measuring. They're measuring default risk. They back it up with tables. You can see that it's correlated. The correlation across services on ESC scores is not 0.9, it's not 0.8. It's like 0.3, 0.4. There is a huge amount of divergence between what Sustainalytics attaches to a company like BP and what Refinitiv attaches to a company because each comes up with its own scoring. Yeah. I wonder if that is a function of the fact that it's only been around for 10 That's what I'm told is we'll converge, right? First, let's assume it converges. What are we going to converge on? It terrifies me on what we'll converge on because you're going to converge on some least common multiple, right? But I don't think you're going to converge because each service will have to decide what to weight more. I'll give you right now, ESC includes environmental issues. You know, BP has one of the highest ESC scores from Sustainalytics. You say, how can that be? Because in Sustainalytics, environmental scores have received the background. They put social and governance scores first. Refinitiv it gets lower scores. So within each group, there is a divergence on which and that will always be there. This is not like the fortress where we learn more, we converge. The convergence will not happen. And if it does happen, it'll be on a score that nobody can really use. Secondly, you think about ESC and value. I'm old fashioned and value. In the valuation class, I use what's called the it proposition. If it's going to affect value, it's going to show up either in the cash flows or in the You're saying that is so narrow-minded. Valuation is narrow-minded. Why? Because I've got to collect cash flows. I would look at the risk and the growth. So here's what I did when I 2019, I wanted to ask a question, does ESC increase value? For ESC to increase value, here's where it's got to show up. It's got to show up as higher growth for companies with higher ESC scores. Or it's going to show up as higher margins for companies with higher ESC scores. Or maybe less reinvestment for companies with higher ESC scores. Or maybe less risk, either as operating risk of failures. So basically I went back and looked at, you know, all of the ESC research out there. And this is perhaps the area with This is the worst research I've ever seen. Because research is not written by research, it's written by advocates. You know the differences, right? Advocates want to So basically, so I looked across the research and I looked to see what the evidence was. So here's what I saw in the collective findings. On growth, going for higher ESC actually made it less likely that you could grow faster. Let me give you an example. One of the companies that I'm often offered as an example for country ESC for by ESC advocates for a companies can do good. It's a company called Patagonia. What does Patagonia do? Make extremely overpriced outerwear for guilt-ridden younger people. I think around you say, I would want to do good for society. I'll wear a Patagonia $400 jacket. I'm sure hungry people around the world are now eating. Okay? And Patagonia is actually owned 75% by Yvon Chouinard who's run the company. It's his company. And you know what? I give him all the credit. He puts his conscience where his money is. It's his money that he's basically spending. But I'm going to ask you a question about Patagonia revenues. And if you're an ESC supporter, I'd like you to try to guess what the number is. You know how much revenues Patagonia had last year? About 1 billion in revenues. When you have 1 billion revenues, you're a niche company. You're a niche company, you can afford to kind of pick and choose and say, I want to be good. I want to What Patagonia can do, Nike cannot. Why? You're a $40 billion company, you can't say, look, you know, I'm not going to do business in China. You can't do that. It's a big market. So if you want to be good, it comes with a cap on growth. You have to be okay being a smaller, you know, Etsy ran into this problem because they were started as what's called a social benefit corporation. You know what a social benefit corporation is? You don't have to be accountable to shareholders in the Delaware courts, you can't get into trouble. But they discovered that as a social benefit corporation, they could not grow very much because they had all these different stakeholder groups. Remember the way Etsy operates is craftsmen put their products on Etsy. So when Etsy makes more money, craftsmen either craftsmen or consumers have to pay the price. And the fight came to fruition at with the CEO being pushed out. They replaced their social benefit with a for-profit. I'm not saying it's good or bad, but I'm saying you have to make a trade-off. Do you want to be good and small, or do you want to accept small compromises to be a bigger company? So growth, ESC actually works against you. You're saying, what about margins? I'll give you the good news. If you look at the overall evidence, high ESC score companies have higher margins. This is good. Being good as a company gives me higher profits. To show you why you should be wary of that finding. You know that shopping at Whole Foods makes you richer? Sounds like a stupid thing to say. I'll back it up statistically. I have a correlation of how much people spend at Whole Foods and how much money they make. You know what the correlation like 94%? But what did I get wrong in my finding? Do people get rich by shopping at Whole Foods? Do they shop at Whole Foods because they've they're better off? The answer is the causation runs the other way. So with ESC, the question is, are you making more money because you're good, or are you able to do the stuff that ESC services ask you to do to get a higher score because you're making money? Third, ESC and alpha. You know, why ESC looked good on an alpha basis for much of the last decade? Early on was climate change was the big focus. All the companies high ESC scores in 2013, 14, 15, early in the process used to be tech companies. You see where this is going, right? Last decade was a great decade for tech companies. You In a In a sense, you rode the wave. You say, I call these accidental alphas. Accidental because you It's not your ESC score that's delivering the alpha. It's the kinds of companies that you kind of tilted towards because of ESC. That's why the the Russian invasion of Ukraine kind of upended it because now fossil fuel companies became the best performing. You know, ESC scores have underperformed over the last year and a half cuz somewhere along the way they decided to bring in the S part of the ESC. So now tech companies have scored lower. So in fact, many of the ESC the many the mag seven, you know, what the mag seven are? Facebook, Apple. Many of them have lower ESC scores because of the way scored. So now ESC scores were not able to even take advantage of the tech boom that happened in 2023 because they've changed the score. But I think you're selling a false picture to begin with. Don't tell me that I can be good, have constraints, and earn a higher return at the same time because I have to give up something to be good. And finally, on the on the issue So, when you look at alphas and this table stuff to read, basically what this table does it cleans up for the tech skew. And when you take out the tech tech effect from ESG, even in the last decade when it looked good, there was no residual ESG effect. There was no alpha from ESG specifically. So, let's see where we are. ESG services, don't know what they're measuring, and they never will. ESG cannot be good for value for every company. That doesn't make any sense. Could be good for some companies, bad for others. And if it's good for your company, why the heck did you need ESG in the first place? Do what you did when you opened the store, right? You You used this advertising, increase your revenues by all means. Do it because it's good for you. ESG has to be associated with either a mild negative alpha or a big negative alpha, right? And you know in your operations research class, now you you you optimize, you know? Is a can a constrained optimal ever deliver a better result than an unconstrained optimum? Even if you've never taken an OR class. A constraint always costs you money, right? The question is how much? ESG is a constraint that you're adding to the process. And finally, on ESG and society. And this is where I think it gets really tricky. You say, "But I'm doing good. I'm changing the world. I'm making the world a better place." Are you? But 6 months ago, I wrote a piece on impact investing. That's come into my radar because I thought about ESG and all these other things start to swim in, right? Sustainability, impact investing. And I looked at how much and I looked at impact made successful if you define success as how much money has been invested in impact investing. But the ultimate measure of impact investing is actually having an impact. Now, I might have mentioned this before, but I'll mention again. When impact investing took off, it began it took off in the middle of the 2000s, 2005, 2006. We got 82% of our energy collectively, you know, both globally and the US, 82% from fossil fuels. 16 years later and 5 and 1/2 trillion dollars spent, we get roughly the same percentage of energy from fossil fuels. You say, "But what about all the green energy that I'm reading about?" The green energy has doubled from like 3 to 6%. But it's been offset by the fact that nuclear energy has become a much smaller source. If the measure of impact investing is impact, not how much you spend, where's the impact? And here's the reason both ESG, impact investing, sustainability are all going to run into a brick wall. They're selective in where the pressure is. You know who feels the pressure about not investing in fossil fuels? Publicly traded fossil fuel companies in the US and Europe primarily feel the heat. ExxonMobil felt the heat. Act You know, this small activist fund called Engine No. 1 got them to divest themselves of their oil reserves. Huge celebration. But the keyword is divest. When you divest, question is who you divesting it to? You know who they sold their reserves to? A private equity firm in Australia. In the last 15 years, while we've been putting pressure on publicly traded companies to put in these self-constraints, private equity has invested a trillion and a half in fossil fuels. And the question I have for you is, you went in saying you were trying to do good. So, is your definition of doing good taking reserves out of the hands of ExxonMobil where you have a chance at least of putting some influence in how those reserves get developed, and putting them in the hands of Carlyle, one of the least scrupulous people on the face of the earth? And then you wonder why aren't things changing? You cannot have selective pressure. Because when you put selective pressure, all you do is move things behind the curtain. And that's what ESG has done. It's selective pressure where CEOs of companies decide, "We're not going to do that because that is bad." That's fine, but then somebody else does it because you've sold it to them. It's, you know, if you want to make change, it's got to come the old-fashioned way. You got to have rules that apply to everybody. You got to change So, you got If you're a democracy, you got to vote governments that change So, that's We We've given up on that. And that's I think one of the one of the most negative things that came out of 2008. We lost faith in governments and regulators to do it. We elevated these CEOs, especially tech companies, to be supernatural human beings. And especially the middle of the last decade, it was kind of scary how we thought about these CEOs. And then we gave them the power to decide what's good for the world. And that story never has a good ending. So, I know you will have sustainability classes, ESG classes, impact investing classes. I'm not saying go into the negative view, but ask questions. Now, because it's too facile to say we're doing good, so we should keep doing it. You can actually do damage trying to do good. I think impact investing has had the perverse impact of putting money into alternative energies that are not viable. Now, I asked you to pick a company that makes money, and some of you might have picked energy companies to look at. I challenge you to find me one healthy green energy company in the world. One. I can't find one. What does that tell you about green energy? We've built a system built around subsidies and allowing companies to lose money without business models. It's not a sustainable system in term You can't keep throwing money into it. But that's exactly what happens when how much money you spend becomes a measure of is this good or bad. So, with ESG, I started in 2019. I was curious. By 2020, I was cynical. Cuz I said, "I I can see there's nothing here. So, why do keep people people keep pushing?" And the answer is surprisingly easy to get. In In lawyers often ask, "Cui bono? Who benefits?" And when you ask that question with ESG, you start to see why ESG is not going to leave quickly. This is a a swamp that feeds on itself. Here's the starting point for the swamp. You start with a scoring system. Sustainalytics, Sustainalytics, they make money on these scores. To get the scores, what do you need? You need disclosures. Right? So, who makes money with those? Ernst & Young, KPMG, they've got to come up with these 100 pages of disclosures. So, disclosures feed into scores. The scores get sold to investment managers who sell funds with ESG in its name. For a while, that sold, right? And you charge three times BlackRock actually had two funds. One was called, I think, the carbon transitions fund, and the other was the regular S&P 500 fund. So, carbon transitions fund was marketed as a sustainable good fund. So, the Wall Street Journal actually looked at what stocks went into the funds. And it turned out that 497 of the 500 stocks were in both funds. The carbon transitions fund was just an index fund disguised as a goodness fund. But at a three times the fees. Investment managers. And finally, companies then get worried if we have a low ESG score, what do consulting. Call in McKinsey. McKinsey had an entire arm dedicated to ESG. Talk about feckless. An institution that did all kinds of things in South Africa, and you can go read with talking to the world about how to do good. I mean, how the hypocrisy in this space is just mind-boggling. So, you can see I don't like ESG. But you will run into people saying, "Corporate finance is so narrow. It's so focused." So, I'm open to ESG if I can feed it into my numbers, and you can show me that those guardrails work. But those are guardrails that you have to show me actually work for me. So, I'm going to go back to my original objective and talk a little bit about how do we fix this objective? I accept it's got all kinds of weaknesses. Why is maximizing value still a good objective? I'm going to argue it's the only self-correcting objective. What that means is when whenever a group overreaches, this is a system that's got a built-in backlash. Take the first leg. What did I say managers do is stockholders have little power, managers take advantage of them, right? And if you're a stockholder in a company, every time managers take advantage of you, you feel a little more pissed off. Initially, you not much you can do. But there's a critical mass of piss off at which you say, "I'm going to do something about this." And that's when you get the activist investors, hostile acquisitions kicking. There's a reason Disney is in the target zone for Nelson Peltz. People are not happy at Disney. Nobody is. Employees are not, shareholders are not. Nelson Peltz is just a messenger who's trying to take advantage of backlash So we talk about how that backlash plays out. Second, we talked about how you get you can get in a biscuit. You know you know when you borrow lend money and you're not protected, people take it. We'll talk about how markets try to stop protect themselves against getting in a biscuit. What happened to corporate bonds and lending after the Nabisco fiasco? We talked about how managers sometimes lie but often try to delay or defer news. We'll talk about how markets start to adjust to that. And finally, we talked about social costs and social benefits. We'll talk about what happens when companies ignore the guardrails and create large social costs. What happens to those companies? I'll use the sad but true tale of Valeant. A Canadian pharmaceutical company built on a story that you could never say to your you would never mention if you're at Thanksgiving dinner and you worked at Valeant and somebody says, "What does Valeant do?" The story you're going to have to tell is going to be so unappetizing you probably won't tell it. We'll talk about what happens when companies push the limits of what's legal but create social costs. So let's start with with the the mechanism of market discipline. With each one, I've listed out what what the what the pushback is. With stockholders, it's activist invest. Carl Icahn, the Bill Ackmans of the world. And the US used to be the only market with activist investing. The rest of the world used to have pushback against them. You did not have funding. Now it's spread across the world. And I'm not going to tell you activist investors are nice people. In fact, I don't like Carl Icahn. I won't have dinner with him. I'm afraid he'd eat me. But we need the Carl Icahns and the Bill Ackmans of the world. And you're not going to like this this this analog. I think of activist investors as the laxatives that keep markets moving. Otherwise, markets get constipated. Europe was an incredibly constipated market. It remains one still. Japan I don't think they passed a motion in like 20 years. What happens when you have nobody pushing back? So I'm not saying you have to agree with Nelson Peltz, but I'm glad he's there pushing back against Disney management because when I push back, nobody notices. Maybe his directors will and maybe they won't, but the process of pushing back is healthy. And in extreme cases, if you truly take advantage of your shareholders, you become targets for hostile acquisitions. I'm going to show you the typical company in a hostile acquisition and it's not a well-managed well-run company. It's a badly managed company that's pissed off everybody around them. you're going to get protections built in. We'll talk about the protections that started to show up post Nabisco. Bonds became putable. What does that mean? If somebody does an LBO like KKR did, you can put your bonds back to the company and say, "Give me my $1,000 back. You've changed the rules of the game." Protection. Too late to protect your Nabisco, but people learned. We'll talk about what happens when managers mislead markets. Let's talk about it now. They get away with it for a while, right? Prices move. Eventually, the truth always comes out. And when it does come out, first what happens to the stock price? Every every accounting fraud scandal First it's it's going to go down. I mean, I've never had an accounting fraud where managers would come say, "You know what? We made five times more money than we told you we did." The the mistake is always on one side. The price goes down and it stays down. Why? Because you've lost all credibility as a management. Nobody believes you anymore. And with social costs and benefits, you don't want to be the company that starred as a bad company. Talk to the management of tobacco companies who've had to live for 30 years in that space. They've learned to live in that space, but it's not a great place to be and you can't have growth plans. Everything you do, people are going to try to stop you. So let's take each of these these these mechanisms of correction. As I said, with stockholders you'll know when stockholders are getting more and more pissed off. Annual meetings you're going to see more shareholders pop up and more of them try to talk because they just don't like the way the company's run. Usually it coincides with the fact that your stock price is down 40%. You're also going to get more activist investors. The typical target company for an activist investor is usually a company that underperformed its peer group and has done badly in terms of its stock price. And hostile acquisitions are to me the extreme scenario because in every hostile acquisition, here's what you see. You got two groups. So you have the shareholders. The first group are the hostile acquirers. And what are they telling you? Don't trust the managers. They don't have your best interests at heart. What are the managers telling you? Don't sell to the hostile acquirers. We care about you. And you for the for one of the few times in your lifetime, you are at the center of attention. You get to decide which side to trust. We tipped the scales. Your stock price is down 50% over the last 5 years. Who are you going to trust? Probably the activist investor. Your stock price is up 80%. Nobody's going to try to do a hostile acquisition of Invidiot. They're not going to It's not going to work. First, you got to come up with a trillion and a half. That's kind of difficult, but even if you did when you try to do a hostile acquisition, the shareholders have to be receptive and that happens because they feel taken advantage of. So let's go back to Disney. Remember I showed you the Disney board in 1997? Imperial CEO, rubber stamp board. 97. I went back and looked at analysis of Disney. Nobody was pushing back. Nobody was complaining about the board. Why? Because the company had been doing reasonably well. He had just completed the ABC acquisition. In fact, Eisner boasted about the fact that he arranged the terms of the acquisition privately in a meeting with Thomas Murphy who was the CEO. He said, "We met outside in a some place in Aspen." And which tells you a little bit about where he got and we arranged the whole thing. 18 and a half billion dollar acquisition after a ski trip you did. And it terrifies me, but he thought it was a good thing. And and then things started to slip at Disney. First now when he bought when Disney bought ABC, its biggest show was Who Wants to Be a Millionaire. It had just come out, big hit. And at one point, I think 2 years later, it was the only show they had. They said it's Who Wants to Be a Millionaire every day, every show is a Who Wants to Be a Millionaire. It kind of fell apart. Disney stock price collapsed. And you could tell that that Eisner was starting to feel the heat because you started to see investors speaking up. Their annual meetings started to get more vocal, more aggressive. There was pushback. But I think the tipping point for Disney was in 2004. Comcast announced a hostile acquisition bid for Disney that in my view was the most insulting hostile acquisition bid I've ever seen in my lifetime. Usually the way you announce a acquisition bid is you take the stock price and you announce a higher price. You know what Comcast did? They took the stock price and they said, "We'll buy you for $10 less." You say, "Who would sell it back?" It was never meant to be a serious bid. It was really a shot across the bow saying, "Your shareholders hate you so much they will sell their shares to me for $10 below the current stock price." And it kind of reflected where Disney was in 2004. People were upset. And you could see Eisner kind of woke up to it and he started to make little changes. His board got rejuggled, less insider focus than it did in '97. He removed himself as chair of the board. He said, "I'm doing this for you as shareholders." Truth was he was terrified of what shareholders would do to him. George Mitchell became the chair. He put out a corporate governance statement about how much Disney cared about corporate governance. He listed all the things that Disney was going to do. Usually when you see this happening, it's a sign of fear. Managers are seeing change coming and they say, "We're going to preempt." The case of Disney, it didn't work. In 2005 Eisner was pushed out. He said he left for other reasons, but the reason he was pushed out by the the same board. That tells you how much shareholder anger there must have been because this board that he handpicked basically told him, "You got to leave." And a new CEO coming came in. Man called Bob Iger. And Bob Iger was the exact opposite of Eisner in many ways. Small ego, cared about corporate governance. And initially, the things he did were really well received. He made the board much smaller, more independent. And between 2005 and 2011, he was playing the role of a great CEO, listening to shareholders, doing the right things. Disney stock price, everybody's happy. And in 2011, you started to see things start to change. First Iger when the board announced that Iger was going to go back to being chairman. Remember that Eisner had removed himself. No. So Disney stock price was starting to level off. And you could see shareholders start to get a little more impatient. But in 2011, Iger also did what I thought was a very good thing, which is he said, "I'm going to leave in 4 years and I want a the plan." This is what good CEOs should, right? Plan the transition. So, 2011, if you still ask me about Iger, what I thought about him, I'd say, "Well, good CEO, cares about transition, succession. He's not an imperial CEO." But, here's where I Remember the board I the current board for Disney that I talked about and why I think it's one of the worst boards ever? Here's where the story takes a turn. In 2015, Disney's board goes to Iger and says, "You can't leave." Why can't you? Because you're too indispensable to the firm. Have you ever seen the Shakespeare version of Julius Caesar? Julius Caesar is a senator that time the Roman Senate ran Rome. And then, a bunch of senators go to Caesar and say, "You have to be king." The first time they ask him to be king, he said, "No, no, no, no, I'm not worthy of you." Second time, "No, no, no, I'm not that good." And third time, he said, "Okay, you know what? I'll be king." Iger probably did "No, no, no, I'm not worthy. I'm not that indispensable." Third time they offered it, "Okay, I think I'll stay on." And it set in motion a series of events that Disney is still paying for today. Iger stayed on as CEO. Once he decided to stay on as CEO, Thomas Staggs, who was actually the person waiting in line to become the next CEO, said, "I'm not waiting." He leaves. It In fact, it emptied out the entire succession group for Disney. Which basically meant there was nobody to take over. In February 2020, ultimately, Iger steps down right as COVID is hitting. I don't know what the timing there was. And turns over Disney to a guy called Bob Chapek. Bob Chapek is a finance guy, and I'm using finance in an insulting way here. It's a numbers He's a numbers guy. He's a theme park guy. He's the guy who decides you should pay $5 for a Coke in Disneyland because that'll be a dollar more in margin. So, he thinks in those terms. You need people like that in a company, but not at the top of a company like Disney where you have all these different groups. A lot of creative people you got to cater and keep happy. He was a terrible choice for Disney. When he came in, he made some choices that changed what Disney did for the He He invested big time in Disney Plus, hundreds of millions of dollars going into it. And of course, the rest, as they say, is Disney history. Two years later, the board goes back and says, "Iger, you need to come back." Iger comes back, and now we're where we are now. Where Nelson Peltz has said, "Look, the company's in trouble, and it's got a corporate governance problem. I don't think anybody can contest that notion. It does have a corporate governance problem. But, that problem was born the day in 2015 when the board went to Bob Iger and said, "You are the key to this company. You have to stay on." Cuz that decision is still coloring what Disney's doing. You know who's next in line at Disney? Nobody knows. It's a bad place for a company. Iger said he's leaving in 2026, but what if there's nobody around in 2026? Iger would be 97 years old and still hanging on there because there's nobody in the But, this is self-fulfilling. So, when we start on Wednesday I'm sorry, next Monday, we will complete this last stretch, but then we're going to get into the meat and potatoes part of corporate finance. But, I'd encourage you to pick a company and start looking at the corporate governance section for your company. I guess what I know you're points on So, I was I read the paper of Michael Sandel That's really Well, actually, fossil fuel investments. points out what you're doing. You're saying it's now People have to start really examining what ESG investment or investment fact is. How much Well, there's nothing The whole problem with this thing I want to do this. As long as you accept the fact that it'll come with a cost, right? Don't say you want to do good and you want to make 2% more, right? That is the pitch that has always struck me as If right from the beginning you had said, "This is about doing good." We want you to avoid investing in fossil fuel or investing in whatever you want. And by the way, when you do that, you will leave money on the table. I would have much more respect for them because they had to put their cards on and say, "That's what I mean." Catholic funded in 1990, they said, "Look, we'll invest only in companies that follow the 10 Commandments." And by the way, if you look at their actual prospect, it says that'll cost you. It cost you about 50 basis points to do. We're going to try to do the best we can under constrained offer. But, that is speaking the truth. That is selling the truth, not selling a lie. And here's the problem came from the fact that they stole the life of trillions, and there was no way to walk it back. That is the problem. The BlackRock is an investment fund with a fiduciary responsibility. You know what you invest in BlackRock? Not substantial companies put their pension So, you're BlackRock, you have a fiduciary responsibility. If you're investing in in ESG constraint and not telling them, you are in serious legal trouble. That's why we noticed BlackRock has stopped talking about alpha for the last 3 years because there's no alpha. They can't even talk about ESG because there's no alpha, and ESG's actually costing you alpha. You've exposed yourself completely to your fiduciary responsibility. It's different to start a fund that says, "I'm in I'm just going to be an ESG fund." You know, I'm going to invest only in good companies, and this is the constraint. Then you're walking in with open eyes. If pension has invested in that fund, all the more power to them. But, you can't be BlackRock, take state pension fund money, invest it in ESG without letting people have a choice in it. That's a violation of fiduciary responsibility. So, this has a ripple effect because that original sales pitch dug a hole that these the all these sales people went into, and they can't get out of that hole they're in. It created the hole they're in. I know it's in theory more than also cuz I was in theory more than in fact. Uh we had a unit unit for ESG investment. It's my money, right? Everybody who had an ESG unit, because why wouldn't you? Because it's a it was an easy way to make money.