EG Corporation had sales of just over $3.5 billion in 1998. The company was in three main lines of business— consumer products, food service, and furniture—with its Consumerco, Foodco, and Woodco divisions.
Consumerco manufactured consumer products and sold them through a direct salesforce to grocery and drugstores throughout the United States. It had a dominant market share (more than 40 percent) in the majority of its product lines, all of which had a strong branded consumer franchise.
Woodco was a mid-sized competitor in the highly fragmented furniture business. Woodco had been created through acquisitions and consisted of eight separate smaller companies acquired over 10 years. All served the mid- to lower priced end of the market with complementary product lines. The Woodco companies sold their products under their original brand names. As of early 1999, the companies were still operated as autonomous units, but EG had begun to combine the companies into one unit, consolidating separate administration, sales, and production functions to the extent feasible. EG also planned to establish an umbrella brand to tie together the wide range of Woodco product offerings and establish a base for adding new lines.
Thus far, the Woodco businesses had turned in uneven financial results. Management capability in the eight businesses varied widely. Moreover, Woodco’s business performance was to differing degrees dependent on keeping up with the latest in furniture styling and fashion. Some of the companies were skilled in this area, but the disastrous consequences of missing the trends had been brought home over the years by their uneven performance. Despite this, Woodco’s management was convinced that EG could build a large and successful business. The managers believed consolidation would reduce Woodco’s operating costs significantly and strengthen the company’s management control over the businesses. They thought the new common sales and marketing thrust would lead to increased volumes and higher margins. The Woodco management’s convictions were lent some credence by the existence of several other players in the industry that earned consistently high returns, achieved in part by rationalizing less-efficient companies that they had acquired.
Foodco, EG’s third main division, was in the food service business. Foodco operated a small chain of fast-food restaurants, as well as providing food service under contract to major corporations and other institutions around the country. It had been essentially built up from internal growth plus a few small acquisitions over the last five years. The former CEO had viewed Foodco as a major growth vehicle for EG and had backed aggressive expansion plans and the associated capital spending. As of early 1999, EG’s Foodco unit was earning a profit but was still in the early stages of its development plan. It was a small player in the restaurant business and had only a few institutional food service accounts. In both businesses, it faced formidable competition, but management believed that its operating approach and EG Corporation’s Consumerco name recognition, which was being used as the branding proposition for Foodco, would establish Foodco as a major factor in the industry.
Beyond Consumerco, Foodco, and Woodco, EG Corporation owned a few other smaller businesses: a property development company (Propco), a small consumer finance company (Finco), and several small newspapers (Newsco). No one currently employed by EG could recall why EG had acquired these businesses. They had been added to the portfolio in the 1970s. All were earning a profit, though they were small by comparison with EG’s three main divisions.
We doubt that the strong economic performance of the United States since the mid-1980s would have taken place without the discipline of shareholder capitalism and an increasingly sharp eye by many participants in its economy on creating shareholder value.
The U.S. corporate focus on shareholder value tends to limit investment in outdated strategies—even encourage divestment—well before any competing governance model would. Schumpeter’s ”creative destruction” is fostered by a bottom-line focus. Moreover, it is hard to claim (as many have at times, albeit often managers of poorly performing companies) that the capital markets are shortsighted compared with other corporate governors—the high number and value of technology and internet companies going public in recent years attests to this. Foolish maybe, but shortsighted? Certainly not.
But what about actual economic performance? Economists widely agree that the dominant measure of an economy’s success is GDP per capita. The United States—the world’s most capitalist, shareholder friendly economy—has a lead of more than 20 percent over other major countries. Up to 1975 other countries were catching up, but this convergence has since stopped. If anything, the lead of the United States has been widening. From 1994 to 1997, the McKinsey Global Institute carried out a series of research projects to analyze the differences in GDP per capita between the United States and other countries. The research, which focused on the United States, Germany, and Japan, attributed the U.S. advantage to much higher factor productivity, especially capital productivity. How can the United States be outperforming other countries with a savings rate that is often deplored as wholly inadequate? The answer is what happens to those savings. In the United States they are invested in more productive (i.e., economically profitable or value creating) projects than in either Germany or Japan. Financial returns in the corporate sector in the United States between 1974 and 1993 were dramatically higher than in Germany or Japan.
This is not to say that the shareholder value system is always perceived as fair. Job losses from restructuring disrupt lives. At the same time, one can argue that an economy’s ability to create jobs, or its lack thereof, is the better measure of fairness. On that score, the track record of the United States compared with the other countries speaks for itself. Two centuries ago, Adam Smith postulated that the most productive and innovative companies would create the highest returns to shareholders and attract better workers, who would be more productive and increase returns further—a virtuous cycle. On the other hand, companies that destroy value would create a vicious cycle and eventually wither away. In today’s terms, we believe that a company that focuses on building shareholder value is served well by being a good corporate citizen. Why? Simply because such a company will create more value for its shareholders. Consider the employee stakeholders. A company that tries to fatten its profits by providing a shabby work environment, underpaying employees, and skimping on benefits will have trouble attracting and retaining high quality employees. With today’s increased labor mobility and more educated workforce, this kind of a company will be less profitable. While it may feel good to treat people well, it’s also good business.
The empirical record also strongly supports the conclusion that shareholder wealth creation does not come at the expense of other stakeholders. We analyzed the relationship among labor productivity, increases in shareholder wealth, and employment growth across a range of industries in the United States, Japan, and Germany. Our conclusions are that companies with higher labor productivity are more likely to create more value than those with lower productivity, and that these gains do not come at the expense of employees in general. Companies that are able to create more value also create more jobs.