Donald Chew, "The Making of Modern Corporate Finance: A History of the Ideas and How They Help Build the Wealth of Nations" (Columbia Business School Publishing, 2025)

Summary

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Podcast Summary: New Books Network – Donald Chew, "The Making of Modern Corporate Finance"

Episode Date: February 18, 2026
Host: Alfred Marcus
Guest: Donald H. Chew Jr.
Book Discussed: The Making of Modern Corporate Finance: A History of the Ideas and How They Help Build the Wealth of Nations (Columbia Business School Publishing, 2025)

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Overview

This episode explores the evolution of modern corporate finance as traced in Donald Chew’s new book. Chew draws on his decades as editor of the Journal of Applied Corporate Finance to explain how a handful of foundational ideas—capital allocation, leverage, governance, and risk management—reshaped the American corporation. The conversation delves into the intellectual history of these concepts, their impact on the structure and accountability of firms, and the ongoing tension between long-term value creation and short-term pressures.

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Key Discussion Points and Insights

Chew’s Background and Why He Wrote the Book

• Academic Shift: Chew transitioned from a PhD in English (studying self vs. society) to finance, bringing a broad view of organizational conflict between self-interest and societal order.
  Quote:

  “I was concerned with...the conflict between what people want to accomplish for themselves and then what they want to see in their...community. They want stability and order, and they want freedom.” [02:30]

• Corporate Finance Transformation: At the University of Rochester and later with Joel Stern at Chase Manhattan, Chew encountered the “Chicago school” of finance, emphasizing maximizing shareholder value (stock price) over traditional measures like earnings or dividends.

• Mantra of the New Era:

  “Earnings per share don't count and dividends don't matter. What mattered was earning high rates of return for your shareholders...” [04:20]

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The American Model of Corporate Finance: Why Is It a Success?

• Productivity as the Key: Chew positions corporate finance as the engine that allocates capital efficiently to fund productive, innovative growth, referencing Adam Smith and Schumpeter.

• Provocative Comparison:

  "American style corporate finance is on par with advances in medicine and information technology." [05:15]

• The ‘Visible Hand’ of Markets:

  “Corporate finance is the visible hand of Schumpeter’s creative destruction...We get rid of failing technologies and funnel the money into new ones.” [06:20]

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Problems and Limits: Short-Termism and Misalignments

• Potential for Abuse: The system can pressure companies into prioritizing short-term returns.

  “Corporate managers may be shortsighted, but markets are farsighted.” [15:12]

• Historical Critique: Adam Smith doubted that public corporations could align managers’ interests, a concern addressed in the 20th century by incentive mechanisms like hostile takeovers and stock options ([07:12]–[08:43]).

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The Conglomerate Era and Its Demise

• Conglomerate Movement: Corporations diversified heavily from the 1960s to hit steady earnings targets, often sacrificing genuine value creation ([02:24], [08:20]).

• Mechanisms for Change:

  • Hostile takeovers, leveraged buyouts, and activist investors dismantled poorly performing conglomerates.

  • “Hostile takeovers...the reassertion of investor control.” [09:50]

• General Electric as a Case Study: Once a star conglomerate, GE lost its way post-Jack Welch. Value was restored only when it was broken up into focused companies.

  “Larry Culp...recently separated the company into three public businesses. That company is now worth double what Jack Welch had it at at the end of the 1980s.” [13:30]

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Modern Value Creation and Investor Discipline

• Two Ways to Create Value:

  1. Growth (Amazon)
  2. Eliminating unprofitable growth (Private equity’s role)

• Private Equity’s Role:

  • Intensive ownership, focus on operational discipline, and aligning incentives
  • Private equity now applies less debt and more active management than in the past ([31:36]–[34:15]).

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Notable Examples and Contrasts

• Amazon vs. Intel:

  “Bezos does a great job of creating confidence...he almost challenges [investors]...we’re not in this to make immediate profits.” [17:38], [18:14]

• Short-term vs. Long-term: Mistakes occur when managers cut investment for earnings targets (Heinz Kraft, Intel), whereas visionary leadership (Bezos) attracts patient capital.

• Host on Shareholder Structure:

  “You can change the value of the company by improving the quality of your investors by getting longer-term investors.” [19:39]

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Intellectual Schools of Corporate Finance

• Chicago School (Merton Miller):

  • What matters is investment policy, not how you finance it ([25:01])
  • “Leverage does not matter...But what matters is investment. Are you earning adequate rates of return in your capital?”

• Jensen and Meckling (Rochester):

  • Leverage controls managerial behavior; too much capital without investment opportunities promotes waste ([25:50]).
  • “Leverage in that situation can increase the value of the firm as a control device.”

• Stuart Myers (MIT):

  • Warns of “underinvestment problem”—too much debt makes companies turn down good projects ([26:58]).

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Private Equity and Public Companies

• Rising Role of Private Equity:

  • Many public companies are larger, but fewer; private equity offers more intense oversight and better performance in certain eras ([34:27]–[36:00]).
  • Caution: Not all private equity is positive. In sectors like healthcare and education, value-maximization motives create risks ([37:23]).

• Limitations:

  “If regulators do a bad job, private equity will find them out and they will exploit these regulatory loopholes...” [37:23]

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Global Perspectives: US, Europe, and Asia

• European and Asian Models:
  • European firms often have family or foundation ownership (Novo Nordisk); prioritizing stability over returns ([40:25]–[42:41]).
  • Chinese, Korean, and Japanese companies can sustain losses longer due to less investor pressure but have lower long-term returns ([43:09]–[46:54]).

  • “You can’t build a system in which companies don’t make money because they will run out of...that’s not sustainable.” [46:23]

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Innovations and Critique in Finance

• Private Debt and Credit:

  • Private lending is more flexible and profitable than traditional banks but comes with increased risk ([49:32]–[52:10]).

• EVA and Stern Stewart:

  • EVA (Economic Value Added) attempts to connect capital costs to performance pay; rarely implemented comprehensively ([52:59]–[54:31]).

• CEO Pay and Incentives:

  • CEO stock options have not always aligned pay with performance; recalibration and competitive benchmarking often dilute incentives ([54:49]–[57:57]).

  • “The worst US CEOs get paid way too much, but the best US CEOs get paid way too little.” [57:15]

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Enlightened Value Maximization and ESG

• Jensen’s Later Views:

  • Advocates “enlightened value maximization,” where taking care of all stakeholders serves long-term shareholder returns ([61:09]–[62:44]).
  • Milton Friedman’s views are often misunderstood; long-term "value" means serving all claimants effectively.

• ESG Investing:

  • Value-increasing ESG (environmental, social, governance) initiatives persist, but many companies have destroyed value by misapplying them (e.g., BP). [65:08]–[65:53]

  • “My book tries to distinguish between value increasing and value destroying ESG, and again, I believe value increasing ESG is alive and well.” [65:53]

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Notable Quotes & Memorable Moments

• On Capital Allocation:

  “Corporate finance basically takes money and allocates it to promising technologies and it takes it out of failing technologies. And America does that better than anybody else...” —Donald Chew [06:05]

• On Investors as Change Agents:

  “This is the glory of American capitalism. When something is not working, investors step in...they bring about change.” —Donald Chew [16:21]

• On Private Equity Discipline:

  “The intensity of the scrutiny of the managers by the investors...is very different from our public companies.” —Donald Chew [33:30]

• On China vs. America:

  “You can’t build a system in which companies don’t make money because they will run out of...that’s not sustainable.” —Donald Chew [46:23]

• On Value Creation:

  “There’s good growth and bad growth. If you’re not earning your cost of capital, it is your duty to get out of the business...” —Donald Chew [22:45]

• On Stakeholders:

  “You have to take care of everybody who can affect the value of the firm, because you’re the residual claim holder.” —Donald Chew [61:37]

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Timestamps for Key Segments

• [02:24] Chew’s background and shift from humanities to finance
• [04:20] The shift from “old fashioned” to “modern” corporate finance
• [06:20] American corporate finance as a productivity driver
• [13:30] The General Electric story and the fall of conglomerates
• [17:38] Amazon’s investor relations and long-term vision
• [25:01] Three intellectual traditions: Chicago, Rochester, MIT
• [31:36] What private equity gets right and its limitations
• [34:27] Shrinking number and rising size of public companies
• [40:25] European and Asian ownership models and their implications
• [49:32] The rise and risks of private debt/credit
• [54:49] CEO pay, stock options, and performance
• [61:09] Jensen on enlightened value maximization and stakeholders
• [65:08] The fate of ESG: differentiating value-increasing and value-destroying initiatives

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Closing & Future Work

Chew hints at a return to his philosophical roots and fiction, inspired by John Gardner's call for moral seriousness in narrative ([66:29]–[67:25]). He also considers continuing the debate on the social benefits of activist shareholders—possibly with host Alfred Marcus.

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Final Thoughts

This episode is a masterclass in the history and mechanics of corporate finance, blending academic theory with real-world stories and critique. It explores how financial incentives, governance structures, and investor vigilance shape the modern corporation, ultimately impacting economic growth and social wealth.

For listeners interested in strategy, governance, or the social role of the corporation, this episode—and Chew’s book—offer an indispensable guide to the ideas that built the system we have today.

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Transcript

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Welcome to the New Books Network.

[A]

Welcome to the New Books Network. I am Alfred Marcus and this is on the cusp between strategy and ethics, where we explore how organizations navigate the tensions between performance, innovation and responsibility. Today I'm speaking with Donald H. Chu Jr. Longtime editor of the Journal of Applied Corporate Finance and author of the Making of Modern Corporate Finance, A history of the ideas and how they helped build the wealth of nations. Published by Columbia University Press in 2025, the book traces how a relatively small set of ideas about capital allocation, leverage, governance and risk management helped move U.S. corporations from the conglomerate era of the 1970s to the more disciplined, market driven system we see today. So, Don, thank you very much for joining me. To begin, could you tell listeners a bit about your background and why you decided to write this particular book? Now, how did your work at the Journal of Applied Corporate Finance shape the way you tell this history? By the way, this is a great book and it tells a very important history and it's quite unique. I've been looking for this book for a long time. A book like it.

[B]

Well, thank you Alfie, for all the kind words and for taking the trouble to actually read my book. I found very few readers have been few and far between and it was a wonderful summary of the book which you gave. So I don't often encounter that as well. So again, thank you very much for listening to me. Now if I remember what the question was. Oh yeah.

[A]

Why did you decide to write this book? Name?

[B]

Yeah, well, yeah, I mean some, well, I think I was some 50 years ago I did, I did a PhD in English on self and society in Melville, Conrad and Faulkner and I and I was concerned with the topic of it was really about the conflict between what people want to accomplish for themselves and then what they want to see in their surrounding the order, the local community. They want stability and order and they want freedom. And so but people didn't seem interested in this topic 50 years ago when I was trying to get my launch my career. So I moved over to the business school at the University of Rochester and did an MBA in corporate finance and from there I was hired by a man named Joel Stern at the Chase Manhattan bank that had an internal financial consulting group that was based on University of Chicago training and principles how to apply the Chicago theory of finance to the modern corporate enterprise. And so we developed what we call the principles of modern corporate finance to apply to businesses which were being run according to what we saw as old fashioned corporate finance. Old fashioned corporate finance was the idea that the shareholders were one of many constituencies you had to take care of. And the way you took care of them was by reporting steady, steady increases in earnings per share, you kept your debt ratios low. And you just, you basically, and you, you, you made sure you reported enough earnings in order to keep shareholders behind you. But what this led to was the conglomerate movement in which corporations, they turned themselves into all weather growth companies. They wanted to be all things to all people. So they, they diversified like mad and this allowed them to make their earnings target, but they really didn't create much value for shareholders. And so we thought of ourselves as kind of helping initiate this new era of modern corporate finance. And the mantra of our firm was earnings per share don't count and dividends don't matter. What mattered was earning high rates of return for your shareholders and doing lots of it investing where investments look good, but also cutting back on investments where they were bad. I'm going to take a breath now because I think I've gotten way off the rails, but tell me where I can take this for peace.

[A]

Yeah. So you argue early in the book that American style corporate finance has been a great success story. So what you mean by that is American style is this Chicago principles where we're looking at growth in the price of the stock as opposed to dividends or earnings per share, I'm assuming. And where there's greater agency accountability to management.

[B]

And.

[A]

And you say it's on this American style corporate finance is on the par with advances in medicine and information technology, which is an amazing claim.

[B]

No, I meant to be as provocative as possible, but let me explain what I mean by that. The book starts with Adam Smith. Adam Smith said that private sector productivity is really a source of all economic and social wealth. All the good, all the health, education and welfare that we value most comes out of the ability of our private sector, and this includes nonprofits, to actually do more with less. In other words, and what drives this productivity is advances in technology that then get commercialized. So it's commercialized technology that ends up leading to productivity which ends up putting the. Again, it pays for the health, education and welfare. And corporate finance is actually the process of directing that productivity. Corporate finance basically takes money and allocates it to promising technologies and it takes it out of failing technologies. And America does that better than anybody else because we have investors breathing down managers necks saying if you don't produce we are going to take the capital out of your companies and put it into companies where they can use it. So corporate finance is the visible hand of Schumpeter's creative destruction in which we get rid of failing technologies and funnel the money into new technologies. And that's why we have our world leading growth sector. But it's all based on productivity gains and productivity.

[A]

Can you imagine any abuses in this system in a sense of pressures on corporate corporations to make short term gains as opposed to long term gains?

[B]

I guess that's they're there all the time. In fact, Adam Smith said that the public corporation could not work. In his view. This is one of the great failings of Adam Smith. He thought no business could become larger than a small partnership because they the system could not keep managers from spending money on their own purposes rather than serving their shareholders. So this is 250 years ago. Adam Smith said the public corporation, the joint stock company will not work 200 years later. In 1976, Michael Jensen and Bill Mechling write a paper in which they show how and why it is the corporation has become the dominant organization in the world. And it's about ways to control managerial's behavior and decision making so that it ends up serving their shareholders. But it obviously works some places better than others.

[A]

But yeah, yeah, yeah, so that's that system. It wasn't working in the United States in a maximizing way for shareholder wealth. And Jensen there were a. Hostile takeovers were a part of the process that then occurred. And then we also had the managers getting stock options is a higher percentage. Those were two of the ways of control that were introduced. Why don't you tell that story? When did it happen and why?

[B]

Well if you go Back to the 20s, JP Morgan owned huge chunks of stock and sat on boards. And it was really an investor founder driven capitalist model in which the owners were in effect the managers or they controlled them tightly. Then we had the Great Depression and we had Glass, Steagall and a whole set of regulations that basically said we do not want bankers on our boards, we do not want investors controlling our companies. So the next 40 or 50 years under the auspices of Adolf Burrell was to basically separate managers, actually separate investors and shareholders from Control of the corporation. We were again, the shareholder was viewed as one among many constituencies to be served. And the managers basically became the de facto controllers of corporations, professional managers in tandem with regulators who protected, you know, the US was kind of. There was not much competition for American industry until the 70s. So we flourished and prospered. We had growth in middle class wages that was the envy of the world. And these were the golden years. But once global corporate, global competition set in, then the companies were no longer able to compete and they conglomerated in part because of antitrust rule. Antitrust basically prevented companies from acquiring near horizontal acquisitions. So they bought unrelated businesses. And this created this massive loss of value which then cried out for the rise of active investors. Hostile takeovers, leverage buyouts, the reassertion of investor control.

[A]

So what brought it to an end? How did it end? Was it just poor performance on the part of companies, the hostile takeovers? Was it Jensen's famous papers that brought this to an end?

[B]

It was all bub. I mean at one point the s and P500 lost half its value in the mid-70s. So, so investors were looking at these conglomerates saying, you know, if I add up the pieces outstanding alone they, they're probably, they're probably twice as valuable as the market value the companies. So this provided clear incentives for active investors to take positions and competate them over and then just separate the pieces, sell them all, spin them off. And leverage was a tool in that.

[A]

It'S still going on with private equity today.

[B]

Absolutely. Now this. I argue in my book that the 80s set off a 45 year period of continuous restructuring. America continuously restructures. It's called the. Jensen calls it the third industrial revolution. But that's. There is a theory, Rick Reeder at BlackRock has a theory that, that we no longer have recessions economy wide because active investors actually go around creating mini recessions in a variety of different industries. Our tech industry had a mini recession in 2023 when they had massive layoffs. And our tech industry is now in the midst of a mini recession where they are pressing companies. They over hired, they over acquired. And so through this continuous process of restructuring, our active investors sort of reduce the need for an economy wide recess.

[A]

Why are conglomerates a poor generator of value?

[B]

Because they misallocate capital. In other words, if you have a core business that's suffering, your temptation is to feed that business, to get it back on its feet. But what means is all your growth businesses end up getting starved. All your new promising technologies end up Sitting there waiting for money which never comes because they're not run by the heads. One of the great stories in the last two years or so, which I've read almost nothing about is General Electric. Electric under Jack Welch was probably the greatest old fashioned corporate finance corporation ever created. That was a conglomerate and it was based on meeting your earnings target every quarter and using the profits and flexibility from your financial businesses to, to, to invest in God knows what. Anything, Anything. Welch wanted NBC. If it was glamorous, he could make it work because he was kind of an accounting magician. He was also a very good manager. But then the next two or three guys that inherited the company couldn't make that work. Jeff Immel just staggered under the, the weight of this conglomerate. So finally Larry Culp after, after GM almost went out of business, there was the guy that called the Madoff scandal, said that he called a press conferen, was bound to fail about three years ago he said he was taking a short position and telling everybody on Bloomberg that GE was about to fail. Well, Larry Culp has since he got rid of all the finance businesses, capped the long term care liability and he recently separated the company into three public standing businesses. And that company is now worth like double what Jack Welch had it at at the end of the 1980s. I mean it is a magnificent feat of value creation. And if you read Bill Cohan's book, he doesn't foresee it coming. He actually disparages Larry Culp as a manager. And in the past I think GE increased its value by 50% a year ago. So this is undoing, it's happening a lot right now.

[A]

These divestitures like Johnson and Johnson is also split up into three and Kellogg's has basically Dupont and Dow came together and then split up.

[B]

This is I believe technology.

[A]

Yeah, yeah, yeah, I think we can, there are like maybe 10 examples of this right now. But yesterday I read in the newspaper, in the Wall Street Journal that Heinz Kraft, they were originally going to split up and they decided that they could stay together and get more value. At least the current CEO he reversed that.

[B]

Well, Heinz Kraft is a great illustration of short sightedness. That's a company that actually did it cut back on investment to meet its earnings targets. And the great irony of all, and this was discovered, they were outed and they lost a ton of value because they were underinvesting in their future. But the great irony here is that one of their largest holders was Warren Buffett who was the spokesman for Long term value investing. And here he's invested in this Heinz company which is just basically trying to create value by cutting out investment. And that is not a prescription for value. And that's one of the biggest lessons in my book. Corporate managers may be shortsighted, but markets are farsighted. So managers may think they have to meet an earnings target, but if you keep holding up earnings targets and cutting investment to meet them, you're going to be short lived.

[A]

Well, like a company like Intel, I think also was hurt a great deal by short term market pressures which didn't allow it to invest. Make the long term investments that could.

[B]

Have made it Place no faith in Pat Gelsinger. I mean, they did not trust him. So you have to earn the market's trust so that you can make investments. But if people don't think they're going to pay off, you're not going to get credit. But if you noticed what happened under the new owner who was on board, the company is suddenly turned around because this is like an active investor, but also an insider who steps in and changes the whole course of the company. And again, this is, this is the glory of American capitalism. When something is not working, investors step in and they bring about change and it's change from the outside. Although this was guy, this was guy who was actually on the board. So it's, he's an insider and an outsider at the same time.

[A]

What about Gelsinger? Why didn't the board, why didn't the market have faith in him?

[B]

I don't know enough about the business, but he had been, he had been begging for public funds and you know, and everybody wants public funds. Talking a great game, but, but it was never paying off. There was never, you know, there was never, the investment never paid off in a visit. Whereas Jeff Bezos could keep investing for years without any profits. But then suddenly, you know, he showed that the payoffs were coming all the time.

[A]

You know, coming right to the contrast. The first two chapters in the book that I'm about to write about intel and Amazon and I think that's absolutely true, that Bezos does a great job of creating confidence. That in Wall street he was very transparent. He actually wrote his own letters to his shareholders. Yeah. Which I read many of them. And he would say right up front, he said to his shareholders, he would say things like, you know, we're not in this to make immediate profits. You can be a fool and not invest in us. But he really, he almost challenges him like that.

[B]

No, he does. He says, if you care. We don't. We care about gap earnings. But, but given the choice between gap earnings and doing the right thing, we will always forego the earnings. We will. You know, we really, really don't want you as a shareholder if that's all you care about is earned. The next quarter's earned. You know, we're investing for the long term and that's, that's the kind of people we want.

[A]

He almost insults the shareholders in some of these letters.

[B]

Well, but that's, but some investors deserve to be insulted. In the GE book by Bill Cohan, there's a scene where Jeff Immelt, when he first steps into the, into the job, he goes around and meets the institutional investors and he finds out that they don't even know what business easy in. I mean he thought his investors were stupid. You know, and that's, and that's my, my theory is the GE attracted a bunch of earnings groupies who followed Jack welch around for 20 years and said as long as he meets his earnings targets, we're going to give him the benefit of the doubt. But they never understood how the business worked. You know, and you know what, what was driving it. And that's what active investors are informed investors. They get involved and that's the kind of people you want to attract to your company. That's one of the lessons of you can change the value of the company by improving the quality of your investors by getting longer term investors.

[A]

But Welch's formula, I don't know if it would work today because some of many of his. Well, Culp was his student. I guess Culp was worked for Welch. Is that true?

[B]

Are you sure about that?

[A]

I could be wrong about that came.

[B]

Out of Danaher which is an incredibly successful.

[A]

Right. Yes, Danaher is an amazing conglomerate. It's a conglomerate runs a conglomerate like.

[B]

A private equity firm every. So does Warren Buffett, by the way. Warren. I view Warren Buffett as a very well run private equity firm in which, you know, every manager has a large equity stake in his or her business. And, and the, and they determine their own investment requirements. If the business needs capital, you know, they have access. So this is again, it's not like a conventional conglomerate which subsidize each other, but it's, it's and, and it's right. You always find the right manager first and then you give that manager a lot of equity.

[A]

I think Kufft was originally achieved. It doesn't matter if the Danahy. The Danahy part is even more interesting. I wanted to give to McNerney who was a 3M and then went to Goy and was an acolyte of Jack Roch. And he was a total failure in my opinion. He destroyed two companies, great companies, 3M because he took away the engineering culture at 3M and at, at Boeing. And he also hollowed out Boeing's capabilities by farming everything out.

[B]

But was he also always in pursuit of earnings as well? He was always concerned to guide earnings and make the earnings target and.

[A]

Right. He was obsessed with that instead of really creating value. I don't know, do you have any con. So I guess the, my question is like the Welch formula. Is, is Welch really an example of what you would say is modern finance or is he.

[B]

Oh no, he is old fashioned corporate finance. Well, I'm going to confuse you here. His financial management principles are old fashioned.

[A]

He believed he's a conglomerate guy.

[B]

Well yeah, but the thing is he believed that he had to produce earnings per share every quarter. He, unlike see Bezos, freed himself from that constraint. So Welch said, okay, how do I get earnings every quarter? Well, I buy finance companies because I can manipulate the hell out of those earnings. I can any earnings I want. And so he viewed, and I mean he was also a great manager. He turned NBC around. He's shown himself he has a great ability to run companies and get the most out of people. But at the same time he had a flawed financial model and which, which limited what you can do. And that's why nobody else could run it because they weren't, you know, he was a management genius.

[A]

So the old school is really about earnings per share. The new school's about growth and the value of the company. It's, it's the growth. It's the growth. The growth company versus the dividend giving company in a sense.

[B]

Well, no, no, you could. No, no, no, that's wrong. There are two ways to create value. You can create growth like Amazon, but you can also eliminate unprofitable growth, which is what a lot of private equity is. A lot of private equity is cutting back on bad growth. I mean that's one of the principles of my book. There's good growth and bad growth. If you're not earning your cost of capital, it is your duty to get out of the business, to pay the capital out, pay it in dividends or stock buybacks so that, that money can be recycled into the economy. See, and that's to me, I mean this is what people don't understand about the role of finance in taking out companies that have outlived their productive lives. Finance takes them out by Reducing their share prices, then having them taken over, leveraged up or eventually dismantled and that capital gets released to fund the growth our great world leading growth sector.

[A]

So the raiders are the heroes.

[B]

Yeah, the raid. I mean, as ugly as they are, you know, as, as, you know, as people that we all love to hate and they repeatedly embarrass themselves, they are nonetheless performing an incredibly socially productive service by again eliminating waste, excess capital. You know, the RJR Nabisco story is really remarkable. I mean that just says it all. What Ross Johnson, he was this, he ended up, the company was selling at 12 billion. 12 billion market cap. And KKR ended up paying 25 billion for that firm because he was just wasting capital and he was hiding it. He would instruct managers to waste capital on promotions for Oreos so that the raiders would not see the profitability of the firm. I mean, the extent of corporate waste is hard. That's why Michael Jensen said that the barbarians were really inside the gates. They're not the outsiders.

[A]

Why don't you talk a little bit about Jensen, the other greats in three intellectual schools you talk about that come from Chicago. Merton Miller from Rochester, Michael Jensen and William Meckling and MIT with Stuart Myers. Why don't you give a gloss on all three of those?

[B]

Did you know any of those guys or did you know Merton Miller?

[A]

No, but I certainly knew. I know their work, but I don't know them personally.

[B]

Merton Miller at the University of Chicago is viewed as the father of modern corporate or finance. And you know, the, the Miller and Modigliani propositions basically say that leverage does not matter. How you finance a business doesn't matter. But so he, he said, so earnings per, you know, finance, leverage and debt don't matter. But what matters is investment. Are you earning adequate rate, rates of return in your capital or not? And if you are, then the more investment the better. But if you're earning less than your cost of capital, then it's your duty to get rid of the capital and give it back. So that's, it's really, that's the Chicago's theory of value in a nutshell. You know, leverage does. Leverage is not a first order determinant of value. But what matters is the investment decision. What you do with the capital. Do you earn the cost of capital or not? Michael Jensen came along and said, well, leverage actually does matter because it affects the decisions that managers take. So if you're a mature company and you don't have any debt, you don't have any growth opportunities, but you don't have any debt, you're going to waste that capital, you're going to keep doing what you did and your value is going to get lower and lower. So leverage in that situation can increase the value of the firm as a control device. The debt forces managers to pay out the excess capital. That's the theory. And it keeps them from doing diversifying acquisitions. And then now on the other hand, Stuart Myers came along and said, well, okay, if that were, if everything, if Mike had told the whole story, then you'd want every company levered up 99 to 1. If leverage is so good, then why don't we have all leverage? And Stu said, well, if you have too much leverage and you're a growth company, you're going to turn down valuable growth opportunities. That's called the underinvestment problem. So Jensen was concerned primarily with the over investment problem. Stuart Myers was concerned with the underinvestment problem. How do we keep companies from investing in all? The duty of management is to take all NPV increasing opportunities, but to walk away from all the value reducing opportunities. So that's the theory in a nutshell. Merton Miller said all that matters is taking the right investment opportunities. Jensen said, okay, use debt. If you have, if you have too much capital and no growth opportunities, you got to get rid of the capital. The importance of exit, which again, nobody, nobody in the newspapers focuses on the value of exit. And, and, and then the underinvestment problem, which everybody focuses on is what Stu Myers, you know, showed us in, in, in the MIT school.

[A]

So you, if you have too much debt, what, what is what, how does it discipline managers? What is, what is, what does that lead to? I mean, it would seem that you, there's a, there would be profitable opportunities you couldn't follow up on. If you have too much debt, let's.

[B]

Say, well, no, if you haven't, yeah, if you have them. But the question is for, for a company, you know, like IBM, even to this day can only use about half the cash flow that it throws off. So it, it's, and some theorists say you have, you have to pay that out. That capital is going to fester, it's got, managers are going to be tempted to waste it once it's there. So you've got to pay out the capital that you have no foreseeable use for. And if you need the capital, you can always go back out and raise it again. I mean there are models like REITs of some kind where you actually, and utilities do this too. They give the Capital back every period, and then they go out and raise equity every two years. And what that does is it basically you have to go back to your investors and ask for permission to get.

[A]

The new capital and to give it back. You mean in form of dividends?

[B]

Stock repurchase.

[A]

Yeah, right. Stock repurchases is just another way.

[B]

And debt, because, see, debt. Debt has a contractual return of principal and interest. So that is. It's. Jensen calls it cash disgorgement. You have to, you know, companies usually pay out pretty low levels of dividends. Now, you know, before 1958, you're right.

[A]

Before, they couldn't do it. They couldn't repurchase.

[B]

In 1958, the market would not put a high enough price on your shares, so they wanted a higher dividend payout than your debt coupon rate. So in other words, they didn't trust managers to use the capital productively, so they insisted on the dividend. They would not put your price high enough to get you. You had to have a dividend yield of 5 or 6%. And so you ended up. The limits on price. Earnings ratios were about 10, you know, in the 50s, if you were a.

[A]

Mature company, stock repurchases become common. Have dividends gone down generally, though?

[B]

No, but they're on a par. I think repurchases surpass dividends, but they're about the same. And the best story I've heard about dividends versus repurchases is that dividends get paid out of your normal earnings. So if you look at a corporate earnings stream and you take the trajectory, you're going to pay out, say, 2/3, 3/4 of that. And then the stock repurchases are used to pay out the windfalls, all the deviations around that normal level of earnings. So abnormal earnings gets paid out as stock repurchases.

[A]

You talk in the book about private equity and stock, Stephen Kaplan's work, and no, not personally again, but I definitely know about his work. So. So what does private equity get right about ownership incentives and operational discipline that public companies still struggle to match? And then what are the. And then you can go on that. You know, you don't romanticize private equity. So what are your critiques of private equity?

[B]

Everybody else thinks that I am so over the top.

[A]

That they do.

[B]

Thank you. Yes, that I say, yeah, because what.

[A]

They call me on private equity, on.

[B]

Corporate finance in general.

[A]

Okay, so. So what about private equity? How would you. Where would you, you know, what are the pluses and the minuses, I guess, of private equity? And Kaplan is a big, he's a, he's a celebrator of private equity.

[B]

No, he, he's, he, I would call him the, the world's foremost scholar of private equity. And he, and Mike Jensen's disciple. He, he worked for him at Harvard. He did his PhD dissertation for Jensen at Harvard. On the first wave of LBOs, he looked at their operating performance and he discovered they, you know, they basically increased the, the operating earnings about 10% a year and they doubled the enterprise value, debt plus equity of these companies in a short period of time. And, and the argument is that they concentrate ownership. They, you know, instead of this fragmented ownership where nobody controls managers, they buy the whole firm. They give management. Actually, I think the average private equity Firm owns about 60% of the companies they invest in. And they, and the managers own maybe 10%. And then they, so, and they, the owners sit on the boards, these companies, companies, and they, they have board meetings, you know, monthly in some cases. So the, the, the intensity of the scrutiny of the managers by the investors. And this also, this is also true of venture capital, by the way. LBOs, private equity and, and venture capital have the same capital structure. They're just applied to different. You know, venture capital is pure growth, so they use no debt, whereas LBOs are slow growth to middle growth, so they use large amounts of debt. You know, the first LBOs had 90% debt because they generated so much cash. So this was a way of limiting corporate waste and focusing managers on generating cash flow and inefficiency because again, they weren't worried about growth opportunities. Now, over the last three or four decades, LBOs of the private equity firms have acquired more operating and managerial expertise and they've bought firms with more growth opportunities. So they've used progressively less debt to the point where I'd say the debt ratio today of private equity firms, private equity owned companies, is about 50%. So they have really moved from the extreme cost cutting edge of the spectrum sort of to the middle. And they can run companies like Silver Lake can manage growth firms and they do it with very little equity. But again, the story is concentrated ownership and intensive oversight of the investors over their managers. And the managers have huge equity stakes as well. And all this is very different from our public companies.

[A]

The number of public companies actually has been going down, as I understand it. Yeah, it's about half what it once was. And private equities is growing very rapidly in the region.

[B]

But the public company, average public company is something like eight times the size of the average private company. And that gap has actually been growing over time. So even though there are half as many public companies, there's a study by Espen Ekpo at Dartmouth that shows that if you take all the large mergers that were done inside some of these largest companies, you would actually get back to around that 8,000 number. So there are certain companies that know how to run companies that have just gotten larger and larger, but there's fewer of them. So I, you know, private equity is 10% of public equity, if you want.

[A]

To, in terms of how large it is in the larger economy. But even so, the, the, the companies that are still listed are getting bigger and that private equity is, is. But the performance of private equity when Kaplan did his study was at least he could show that it was outstanding.

[B]

As he just said, outperform public equity. I mean, for the first, you know, first, it was from 1989 to 2003, I say, or 2023. And only now are doubts arising if this can be.

[A]

Yeah, I think the last couple of years they've had really bad returns to private equity.

[B]

Well, they have not about half of the public.

[A]

Yeah, it's about, I mean, it's, on average, there's so many. I guess the, the problem is that there's so many companies that have. New private equity companies have entered. So you don't have to.

[B]

Oh, yes, that's right. That's right. So if you are an institutional investor and you're lining up for your private equity allocation, you, you don't go to the new firms. You, you go to the Blackstones and kkrs. And I, I believe those firms have continued to outperform, but maybe not by as much. But the other problem is comparisons to the S and P over the last few years are really. The S and P has just done so incredibly well. I mean, just amazingly well, you know, so it's almost, it's an unfair comparison to private equity because you have all these remarkable growth companies that have, that have sort of pushed the S and P return upward. And so, you know, I don't think you're going to expect, you know, you know, if private equity continues to do its 15% or whatever, they're doing a great job. And there's no shortage of people who want to invest in private equity.

[A]

I think that's true, but I think the number is lower than that. It's not 15% today.

[B]

That's right. Okay.

[A]

I think it's like, I think if this is based on memory, but I think it's eight or nine actually. The last year.

[B]

Last year?

[A]

Yeah, last year. I think that that's true, but I could be wrong. You also have a critique of private equity. So what's your critique of private equity?

[B]

Well, you know, the critique is that any. There are lots of businesses where government plays a huge role as, as the funder and regulator, such as health care, education and, and the problem with private equity is that they can, if regulators do a bad job, private equity will find them out and they will, they will exploit these regulatory loopholes like the, the private for profit college business, for example. Private equity found ways to, you know, extort government. Extort's the wrong word. But get government money for their students in ways just not productive. And some of their nursing homes didn't work out. Well, some, some of the lesser, less reputable private equity firms did a bad job with nursing care. So the whole industry gets tarnished by what I would call what Steve calls the transients, these new private equity players that come in and out and yet they do a bad job because they don't have a reputation to protect. So any business where value maximization has problems, which again, education is one of them, health care, if the government is the main payer in healthcare, you just know you're not going to get, you're going to create problems. So.

[A]

You know, on the other hand, private equity, because they have freedom from public markets, you can also find conceivably a lot of corporate social responsibility in, maybe not in private equity itself, but in private ownership. That because there's. The owners can do more of what they want without the pressure of the group.

[B]

No, but that, no, that would be true of a private family owned business.

[A]

Yes. Private, family owned private equity.

[B]

No. Yeah, private equity has, you know, on the end that are, yeah, they're limited partners, expected, paid. But on your own business you can do whatever you want. Which is, which is why, you know, you can have the lovable owner of the private family business that never, never laid off a person. And the problem with that, although, you know, it's wonderful and people who do that are to be completely commended, but if they start to have lots of relatives and large families, then they're going to push for more efficiency. And if you want to go public, you know, and get really rich, then you're going to meet outside owners. But which is, that's what happens in Europe, by the way. You know, in America, family businesses, if they get large enough, most of them tend to go public just because they have so many heirs that need to be fed. But in Europe, the governance systems are so bad that the family owned businesses can't get a high enough value that they're tempted to sell because they just. There won't be enough reward for all the family members so they stay private. And this is true of Germany, this is true of Italy.

[A]

I've been told recently that Novo Nordisk is owned by a foundation. And is that, are you aware of that? And then that, that really affects their, the whole operation. I mean it's, it's not completely. It's publicly traded. I, I own shares in the minority.

[B]

Okay, you own.

[A]

But, but the.

[B]

Who is. The. Who is the majority holder.

[A]

Yeah, it's, it's a foundation. A charitable foundation is the majority owners. I think it owns. That's what I was told recently and in a podcast I did. The 60% of Novo, or 60%.

[B]

Okay.

[A]

60% is owned by a, a foundation, a char. And the argument that was made was because of that ownership, it's going to be able to get through this rough period very well because they have long term goals in mind. They've made such outstanding mistakes recently. You would think that Novo would be.

[B]

Set up for how the foundation let that happen. Is this controversy over the pricing of insulin?

[A]

Yes, well, it's wegovy. You know, they were the first with the diet, the weight lossing drugs, but then they didn't have. When the demand shot up, they didn't have the supply to meet it and him and hers came in and they walloped them and the price just felt Lilly took off and Lilly's product is somewhat better. So anyhow, that's a whole other story.

[B]

Oh, but you would agree with me that Eli Lilly is much more promising for its investor shareholders than Novo and our disc, right?

[A]

Yeah, absolutely.

[B]

Novo Nordisk will survive, but I don't think it's ever going to earn huge rates of return. And yes, they perform a social function, but I think Eli Lilly is going to have much more capital to grow and that's would be the place.

[A]

Certainly. Certainly been this story so far. As an investor in both of them, I thought weight loss drugs would be the biggest, biggest boondoggle in history. And I went big for both of them. And I'm being. My Lilly investment has been great in my.

[B]

No, not, not so good.

[A]

Not so good at all.

[B]

Yeah, no, well that's. That is the story of America versus Europe in a nutshell. European companies are not run for their investors, they're not run for shareholders, they're run for their.

[A]

Would you say that's true also? Let's say of Chinese, Korean companies, Asian companies. And does that, I mean, in some ways does that provide them with an advantage over American companies or not?

[B]

It allows them to take losses for as long as they want.

[A]

Right. And they don't have to return as much to investors.

[B]

They rarely do return any. Yeah, they don't. They don't. They don't. They. In fact, you know, Donald Trump is actually now, he's, he's demonized shareholder returns. Returning capital is an act of unpatriotism. But it's on the contrary, it's an act of, you're, you're saying, you're acknowledge, acknowledging your commitment to your investors to be efficient. And sure, China can invest forever in developing certain technologies and they will throw massive amounts of both government and maybe some investor money. But I don't expect these companies to become profitable. And their stock market, as I say in my book, actually has negative rates of return since 1993. And so the Chinese people do not as a rule invest in their own stock market, nor do the Germans. The Germans were burned by their neue marked scandals in the 90s. And so Germans don't trust their market. The Japanese people really have not. They had no returns for 30 years and now they've had a couple good years in recent times. But that's in part because Warren Buffet took a large stake in Japanese companies about a year or two ago. And then about a year ago, the spokesman for the Kaiden Ren, which is the Japanese Business Roundtable, made a public announcement. He said, we recognize our companies have been in a slumber for 30 years. We are inviting American shareholder activists to come over, take positions in our companies and help them become more efficient. And I said, you know, why was this not emblazoned in large bold letters on the front of every newspaper in America? And nobody carried it. Japan has acknowledged their governance system as.

[A]

A failure and seem that the relationship between national economies, growth and vitality isn't perfectly correlated with the type of shareholder governance system that's in place. Because we do have examples of the so called Anglo Saxon model, which is our model as opposed to the other model. We have examples like our economy has been pretty vital, but the Chinese economy arguably is outperformed our model in the last, let's say 10 years.

[B]

See, I don't agree with that at all. Okay, just. Yes, they have, I mean they've raised a lot of people out of poverty, but their GDP per capita is about a quarter of ours. The poverty and the, their labor market is terrible. Companies, you know, Even their. The most famous electric vehicle maker in the world just declared record losses last week. You know, so this is the company we're all being taught to emulate. And it. It's lost half its market value.

[A]

You're talking about BYD.

[B]

Yeah. And they have 90 of them. How can you. How can an economy support 90 EV makers? They're all losing money. So. And I would argue that that can't work.

[A]

You can't.

[B]

You can't build a system in which companies don't make money because they will run out of. That's not sustainable.

[A]

Endless subsidies from the government and support. That's local.

[B]

Local municipalities actually subsidize their failing and even bankrupt businesses. A municipality will beg a company out of bankruptcy to employ more people. You can, you can't. You're going to run out of money if you keep doing that. And I believe that. I believe that's what's going on.

[A]

So.

[B]

But. And that's what Carl Walter said, the guy featured in my book.

[A]

Yeah. So we should worry less about China.

[B]

I think they are in very deep trouble.

[A]

And I mean, they have other. There's so many potential crises that could occur.

[B]

The demographic cliff value go down by 75%. How would you feel? Yeah, multiply that by, you know, 80% of Chinese householders watch their. The equity in their houses, the housing. So the story I saw was this port town where all the nightclubs were empty. I mean, this was a thriving port, you know, center of culture and music. And the reporter goes in and nothing happening. There's no lights. Yeah. And there's 20% unemployment among college graduates right now and no opportunities. You know. Did you read Dan Wang's book Breakneck?

[A]

I think that's. I didn't read the book, but I definitely know about the. Okay, the argument's tremendous. Why don't you repeat the argument for our listeners? Or I can repeat it. You know, that the.

[B]

America is not correct.

[A]

America is a country of engineers and China is. I mean, America's company of lawyers.

[B]

China.

[A]

And China is a country of engineers and an engineer. For any problem that occurs, engineer builds more. And so you have tremendous trains in China and the cities. I heard this statistic that 90% of Chinese live in dwellings that have been built since the 1950s. Tremendous amount of new housing built. But in America, the answer to all problems is let's slow it down and see if it hits.

[B]

Yeah, but he's comparing the Chinese government to the American government. Completely. The American government is lawyers. Yes. It's completely inefficient you know, so it's, my book is about the US private sector and the US private sector in my book is so much more efficient and valuable than the Chinese. The comparison is almost laughable.

[A]

I'm going to ask another question. What about private equity? I mean private debt, a lot of debt has been privatized recently and I get very nervous about that because, and there have been some calls now that this is perhaps problematic. So what is your view of that?

[B]

Well, the success of private credit reflects in part the limitations of our bank system. That bank just have never, it's, it's disaster prone technology. I, I believe it. They, you know, contributed greatly to the global financial crisis. And it wasn't the entire, it wasn't the bank's fault. They were basically required to make bad loans and they didn't put up much of a fight. And so they ended up, they were issuing mortgages at 100 cents on the dollar that were only worth 90. And if you have $4.6 trillion of bad mortgages on your bank balance sheets, that's why the government had to pump in $500 billion to plug that hole. And Steve Kaplan has done a wonderful survey of bankers versus private credit. And he's determined that bankers actually lend against assets. Private credit lends against cash flows. So that is why a company can lever up. If you know the cash flows, you can lever a company up to 60, 70, 80%. If you're lending against assets, your leverage is going to be a fraction of that. But the private credit people charge more. So they make much larger loans and they charge more. And I'm told they earn something like 400 basis points more than banks do on a return on assets, which is just an astonishing gap, profitability gap. But the bankers just don't have right now actually. And the regulations after Dodd Frank penalized banks penalized banks for making loans. So the banks were hamstrung. Even if the good bankers ended up, they all moved over to private credit. And I view private credit as an extension of Michael Milken's high yield business. Michael Milken had the insight back in the 80s that you could make a lot of money by lending to non investment grade credits, but you had to be prepared to reorganize them. In other words, he knew he was lending high against cash flows, he would charge a lot of money and if they got in trouble, they were prepared to change the debt into equity at the drop of a hat. He knew all the investors. So they were lined up and if Mike said, okay, this is over leveraged. We now need to, we need to kick in some more equity. You could reorganize these companies. It's a different business model. And private. Michael Milken is, is the intellectual father of private credit. You know, you could say everything private credit has done could be laid up to his private.

[A]

It's sort of the private equity model too that he invented.

[B]

Well, yeah, but, yes, but that's, but Mike, Mike wasn't really an equity holder. But you're, but he certainly played a critical role in any funded LPOs. Yeah, no, I mean Michael Jensen and Michael. Michael Jensen and Michael Milken are the two. You know, he's the, the academic hero is Michael Jensen. The practitioner hero of my book might be Michael Milken.

[A]

Yeah. And it's, there's so much that I want to cover. But what about EVA and Stern Stewart? You talk about that. It looked like a coherent way to connect capital charges, incentive pay and value creation. Yet you describe it through Eisenhower. Yeah, I once wanted to use Stern's EVA in my research and I don't know, I sort of gave up. I don't remember why.

[B]

That is probably not very good. And there were only, you know, there are only 160 Some companies who are actually EVA clients. But, and the eva, you know, people just don't calculate eva, you know, the statistics keepers. But the basic insight of EVA is that equity capital has a cost and it's not reflected on the, on accounting statements. You don't, there's no accounting item on the P L for cost of equity capital. And so that manager. That led managers to believe that equity is free. And that's how the Chinese view equity, by the way. They have openly said we raise capital from foreigners, it's free, we don't have to return any money. We know that and we're quite open about it. But American managers behaved as if equity were free. So they would waste capital just to produce growth enough to produce earnings, but they were actually earning a substandard rate of return. So we put equity back on the balance sheet. Now that works well for mature companies that are throwing off a lot of cash flow. But it wouldn't work for Amazon because Amazon, there's no real EVA left because they're actually spending so much money faster than they're taking it in that you can't, you, you would have be hard pressed to get an EVA calculation to make Amazon work. You could capitalize all their expenditures, you know like R and D and, and maybe get something close to it.

[A]

But CEO pay and Jensen and CEO pay and, and stock options and as a way pay for performance. Essentially that's what stock options mean for top management. For top management.

[B]

They don't necessarily mean that, but they, if well structured they can.

[A]

But it, but it always seems like the, you know, the Wall Street Journal will publish and say X s the highest paid executive his companies. The return to shareholders was negative 30%. You know, there's always that headline. So does it really work? And even Jensen himself has kind of said that some of this had gone, has gone too far. What's your view on it?

[B]

Well, back in the 80s, Jensen wrote this article saying that US CEOs are paid like bureaucrats. I mean they make less money than, you know, well, certainly far less money than top law firms and athletes and things like that. You know, some people say that's fair enough. But the problem was there was no, there was no payoff for huge performance. Which is what, that's what private equity does. Private equity gives the manager a large block of stock on day one and says let's see what you can do. And whereas, and so over time US companies started to, you know, they listened to Jensen, Jensen what became an authority on the subject. Even, even the New York New Yorker, the New Yorker called Michael Jackson great apologist for CEO pay and blamed it on him, of course. But the problem is that the, the, sure the, the options work to some extent, but the way they got ended up being given out was very different from private equity. There, there, there are, it's the, it's, it's competitive pay practices involve this. They recalibrate every year. So if your stock price goes down, you actually get more stock to ensure that you have the same level of stock in the beginning. And if you go way up, you actually get fewer shares. And this became incredibly widespread practice. So my friend Steve o', Byrne, to which my chapter on whom my chapter on CEO pay draws said that, you know, this is, it actually ended up reducing pay for performance, this tendency of companies to do this. Before that, before the 1950s or before the 1970s, that profitability was what drove CEO equity pay. But after the 70s, the payout started coming for growth. So you end up just getting more, you get higher rewards for producing growth and size. And again the way the stock was paid out ended up reducing the pay for performance correlation. And some of the largest companies you could end up, you could get paid just for, you could preside for five years, watch the price go way down and then just bring it back to the normal level and get a massive Payout. So the result of all this was that the worst US CEOs get paid way too much, but the best US CEOs get paid way too little, and that's way too little for their performance.

[A]

What they actually, it's out of whack right now?

[B]

Well, I'm not sure, but I think they've learned some of the lessons. But no, you, but you know, there have to be, there have to be rewards for success. And the question is large enough and, and I think it's, they're still, they're still still not as large as they are for private equity. And then are there costs for bad performance? And they're not big enough. You can still, I mean, the average CEO, that CEO turnover is much higher today. So if you're, if you do a bad job, chances are you're not going to be there very long. It's almost, you know, it's not as bad as a pro football coach, but, you know, if you're, if you're a CEO that's not performing, you're just not going to be there very long, which is good. And that's the way it should work. But they still get, you know, what do they call these things? The gold golden something, golden parachutes? Yeah, yeah. Those things are still, they still have so much control that the worst CEO still get paid way too much money. That's not how people frame the discussion. They say all.

[A]

Is that, is that what Jensen ended up criticizing or making something of a mea culpa on his early work? So how did his thought, thinking evolve?

[B]

Well, he came to see integrity as a factor of production. Integrity is the quote saying you're going to do something and if you fail to do it, then you explain why immediately. So that is a key to say, improving the share, the management shareholder dialogue. So you say you're going to do something. Did you do it? No. And then if you don't, you have to. And that, that builds trust and confidence. He said the system, he hated earnings guidance. Earnings guidance to him was probably a criminal practice practice. And he said that led to, it was a game in which managers would feed information to stock analysts and they would sort of play a game where they would manage the forecast back to the right level. And so he said this was ruining corporate America and that that was his real claim about the system being broken. And so stock prices could get too high because of this complicity. And so he said we have to. And I think earnings guidance has been going down and, you know, since he made those Criticisms that he has had a profound influence on, on the way. You know, annual earnings guidance is okay, and projections, but this idea that you're holding up a target and then if you don't, you know, a lot.

[A]

Some companies now are trying not to give guidance.

[B]

No, that's what, no, that's been. No, we, I did a whole series on that when I first joined Morgan Stanley in 2005. We did, we did a diatribe against earnings guidance and said, you know, this is, this is a bad practice. This is a form of collusion that conceals the earnings potential of the firm. You know, this back and forth between analysts and managers.

[A]

Many, most companies meet their guidance. I think in the end. Is that true?

[B]

They do, yeah. Yeah. But I guess how they. I think far fewer companies are doing quarterly earnings guidance. I think they did in the past. I haven't followed it closely enough.

[A]

And Jensen now has this idea of enlightened value maximization. What does he mean by that and how do you make it make sense with what he said earlier? Is it consistent? Is there?

[B]

Absolutely. It's a form of value maximization, but it takes into account all the stakeholders in the firm that are not investors, all the other people, the regulators, tax collectors, environmental spokesman, employees. And what he says is that you have to take care of everybody who can affect the value of the firm because you're the residual claim holder. You only get what's left over. So to succeed, you have to minimally, at least minimally take care of everybody. And ideally, to be a great manager, you want to inspire people. You want to earn their allegiance and trust. But he said you devote a dollar to every stakeholder, but only as long as you expect a dollar in return at some point, way down the line. And what this means, you know, is hard, very difficult. But it explains sustainability programs by Walmart. You can buy Exxon, you know, companies like that.

[A]

It's a little bit of a movement back to the old conglomerate theory, although it's also a movement back to. I mean, I think that was Milton Friedman's essential view of shareholder maximization. It wasn't like you abandoned your stakeholders, but you. That's right. For benefit.

[B]

Misunderstood. Milton said the purpose of the corporation is profit, but that's not what he meant. He meant it was long run. Value maximization. Yeah, no value, the value of the debt and the equity is really what you mean. That's the enterprise value of the firm. So you can't screw your creditors. So some people go around, oh, it's okay to screw.

[A]

Okay no.

[B]

And then. But Jensen's. Jensen basically elaborated the Friedman theory and said, you know, employees are part of the firm. You have to inspire them, you have to treat them well, you have to hold out a future for them. And I believe private equity does all those things. I mean, studies have shown. There was a study of Dutch private equity that looks at what happens to people, their career trajectories, and here's what it finds. It finds that, that if you are a young and rather healthy person at the beginning of your career, private equity is much better than public equity. But if you are sort of in the senescent or declining phases, you're not going to do as well. There's not going to be enough of a safety net for you. But the government will also. The government steps in and pays part of that, which I believe is an appropriate system. But there, but there's a gap there. So. But I've answered like too many questions. But I really do buy Jensen's model of enlightened value maximization. And one of the beauties of it is, as I argue in my book, is that companies get credit for. If they spend more money on employees or communities than they have to, I argue that they get a lower cost of capital. There are enough investors out there that like what they're doing that will actually take that as a substitute for earnings. They will say, I like you so much that I will put a higher price earnings multiple on your earnings.

[A]

It's reputational capital, which is reputation for.

[B]

Good governance, but for taking care of other people. And you know, I think Warren Buffett would agree with me. Yeah.

[A]

I mean, but at this point in history, with all the attacks on ec, ESG and the loosening of government programs, is it still, Is this an enlightened form of.

[B]

It'S alive and well, it's just, it's going underground. Yeah. I mean, look at even Exxon guy like Darren woods kind of pushed back on Trump and said like, we'll do Venezuela if Venezuela works for our shareholders. And we're going to do carbon sequestration, we're going to do blue hydrogen, we're not going to do renewables and solar. That's BP did that and destroyed half its value. Okay, so BP has failed esg. That's why ESG has a bad name because it led so many companies in destroying their value. But that's not what Exxon's doing and that's not what Walmart's doing. So my book tries to distinguish between value increasing and value destroying es, ESG and again, I, I believe value increasing ESG is, is alive and well.

[A]

It's a very important factor. And, and if we lost it, that's just my personal opinion. That would be very bad. We, I don't want to hold you any longer. This is a bit, this has been a very great conversation and I'm sure we could go on and on. There's so many loose ends here that I would love to pick up on that. I think we should probably bring it to an end because we have to have pity on, on, on the poor listener.

[B]

That's right, absolutely. Yes. I feel for him.

[A]

Yes. So done a great job, Alan.

[B]

Thank you.

[A]

The last question is, what are you working on now? Do you have any major.

[B]

Going back to my old PhD thesis and again, it's Self in Society only. I'm going back to literature, what literature has. And my hero is John Gardner, if you've ever heard the name.

[A]

Yeah, he was a writer and fiction writer, right?

[B]

Yes. He wrote a book called On Moral Fiction.

[A]

Oh, yeah.

[B]

He said modern contemporary fiction writers had lost their way. They had lost sight of the big moral issues that inform great fiction like Dante, Tolstoy and Homer. And what we need is fiction that takes people seriously from all vantage points. Conservatives, liberals, they all have to get in the same room and, and joust and talk it out, talk through their problems. We have to treat all these people with deep respect and, and get out of our own narrow, siloed views of reality. And we will, you know, we'll, we'll, you know, it'll make life much more.

[A]

Interesting through fiction conviction. But you're continuing it to the journal, right?

[B]

You're, I, I, I put out the last issue of my journal, mercifully this past December may be continuing a short form jacf. Now we will take out an old article, reprint it, and then append a commentary about its relevance to current issues, like activist shareholders, for example, hedge funds. What does Paul Singer of Elliott Management do for the world in spite of his.

[A]

Wouldn't it be great to have a book debating these issues, like about hedge funds and activist shareholders and private equity and private debt at this in time? Do you think that would be something valuable or.

[B]

Yeah, I thought my book already did it. Go back and read my chapter four, Life by Sentence.

[A]

Yeah. Well, continuing with this debate.

[B]

Would you.

[A]

Think there's room for another for more work?

[B]

Absolutely, yeah. That's the book I probably should write. In fact, maybe I will write that instead of the other one. So let me know if you want to write A book with me, that.

[A]

Might be something I would think about.

[B]

Let's talk about it.

[A]

Okay.

[B]

It's a great topic though. No, no. Are activist shareholders good for society?

[A]

Yes, I think that's tremendously important. I wrote my book coming back and I wrote about a lot of companies and every company almost this activist shareholder ends up playing a role. And I wasn't even winner generally constructive role. Yeah.

[B]

Well, not old.

[A]

Right, right. But they come in Disney, Pepsi, fair enough.

[B]

Southwest Airlines.

[A]

That's what I'm Southwest Airline. Yeah, that's a, that's another.

[B]

Hasn't that company had a remarkable turnaround in the one year?

[A]

I, I think that I, I, I agree with you. When I look at some of these other attempts at turnarounds like Nike, I don't know if that's going anywhere. Starbucks, I don't know if it's but Southwest, I think is it amazing that Half west really turned around? You look at the stats were in the Wall Street Journal about on time rival, which is considered a great stat and they were like almost on top again. And you're right. I don't know if I would have really thought that was going to happen when they started moving this and anyhow we should bring this to an end. The book is the making. Maybe there'll be another book called Chu and Marcus about these proceeds.

[B]

Are activist shareholders good for society? Marcus and Chu.

[A]

Yeah. Okay, we got it. The book is the Making of Modern Corporate Finance, A history of ideas and how they help build the wealth of nations from Columbia University Press. For listeners who think about strategy, governance and the social role of the corporation, it offers a rich match of how financial ideas have shaped the world we manage in today. Thank you all for listening to on the Cusp on the New Books Network. If you have comments or suggestions, you can reach me at amarcusmn.

[B]

Edu.

[A]

Amarcusmn.

[B]

Eduardo.