The Curse of “Short-termism” in America, Part I

GUEST: Ira M. Millstein
AIR DATE: 11/05/2011
VTR: 09/21/2011

I’m Richard Heffner, your host on The Open Mind.

And today’s guest first joined me here fifteen years ago after the Wall Street Journal approvingly categorized him as the eminence grise behind a major Board of Directors revolt at the even then ailing General Motors Corporation.

One angry GM Executive had called him “the snake in the grass” but the Wall Street Journal saw “a sweet and spectacular triumph in his quest to reform the way American Companies are run … too frequently with rubber stamp inside dominated Boards of Directors that in my guest’s words “Wait too long to respond to ongoing political, social and economic change”.

And ours was a pretty good Open Mind conversation. Look it up in our digital archive … December 4, 1996. Well, I waited another decade during which my guest came to loom ever larger as the figure many in America’s corporate life and high flying legal circles had come to call the Dean of Corporate Governance. Then I invited him here on the Open Mind once again to measure positive change in our corporate and financial world only to find it lacking rather than otherwise.

And now a pretty tough five years later I find Ira Millstein, my Columbia College classmate and hugely successful corporate lawyer friend, senior partner at the New York Law Firm of Weil, Gotshal & Manges, quoted as finding his views radicalized by the teaching he has done at Columbia and Yale, where until the recent crisis, almost every student planned on entering the financial sector but now he figures maybe only 30%.

What he has heard in virtually every class since the crisis began he says is “How could this happen and no one gets blamed”. These students ask where were the Boards, the auditors, rating agencies and regulators. Where was everybody else who was in the game? Why they ask is no one penalized?

And I would now ask my highly placed guest what in the world he tells them in response.

MILLSTEIN: What I would tell them in response is I think honest. Mainly that all the people you just reeled off were in the same bubble. There was no one looking at the consequences of what they were doing. They were simply doing what they do. Which is make a lot of money, give legal advice, do the auditing, run companies, sit on Boards and watch everything go up, up, up, in a seemly unending fashion and no body wanted to call the game.

Including me, including all the lawyers, including all the accountants, including everybody else who touched this, there wasn’t anybody who stood up and said “Wait a minute what are we doing here? What are the consequences of what we are doing?”

So I tell them that it’s very hard to finger anybody in particular. They’re all at fault. The lawyers were at fault, the rating agents were at fault, the Boards were at fault, the auditors were at fault. Everybody was at fault. They were all in the same game.

Everything was going beautifully. Who wanted to blow the whistle? Nobody. And I tell them that in order to change this we just going to have to change the way people are, some how. We have to change our culture. We have to change the way we look at success. We have to do lots of things but when you are in a bubble it’s very hard to stick a pin in it, if you’re gaining by it and everybody was gaining by it. Everybody was gaining by it. . The people who were taking terrible mortgages were gaining by it. They were getting homes they shouldn’t have been able to afford. Getting credit that they weren’t entitled to. Why did they do this? They did it because they are in the same bubble.

I could not for my students point to anybody and say there’s the villain. These are the people who really did it wrong. Could people have done better? You bet. There’s no question about it.

Could the rating agencies have rated … of course they could have, but they didn’t. Could the auditors have called it … absolutely. Could the Boards have acted? Certainly. Could the managers have done a lot better? Could the people who were wrapping up these terrible mortgages in packages and selling them? Could they have done this? Certainly. Did they … no.

So how now can I finger any of them? Every single one in the bubble was having a great time. Short-termism was rampant. They were all making a ton of money. Nobody blew the whistle.

Until the evil day showed up when the debts had to be paid and at that point there was no money to pay debts. Everything collapsed and it went right down the line. And everybody sort of wondered … well how did that happen? Well they knew how it happened. We all made it happen.

So that event I think really got me to think a lot about why did it happen. And why we are all in the bubble and why didn’t somebody call it. That’s, that’s I guess the beginning and that’s where my students picked it up. Because we talked a lot about what could have been done. When I looked at it with them and we went over the details it was hard to find criminal activity. In other words deliberate willful, malicious activity. That may yet be found. There yet may be cases. And some of them may be successful.

It may be that there were … oh, I’m sure there were frauds perpetrated … but nobody picked them up. But the basic reason I don’t think anybody will get criminally indicted to having caused the bubble … they may have implemented it or whatever. But they didn’t cause it. So the question which the classes raise is, alright if that’s true and nobody is going to go to jail, how, how do we fix this thing? There’re all terribly interested in fixing it.

HEFFNER: I should think so.

MILLSTEIN: I should think so and there we begin to hit a stone wall because not a stone wall but a very very difficult wall of trying to explain how you change human behavior.

There are some things you can readily fix. Dodd-Frank has done some of it. Others … there’s a law that has been passed and a lot of self regulation is going on. Things are happening to fix things. I don’t think the credit rating agencies will be as bad as they were.

I think there are reforms in the credit rating business which has changed. Jules Kroll has come along with a new model and other are going to follow it. There are things happening which may prevent the recurrence of I would say credit rating agency fraud. I don’t know. Or credit rating agency negligence. Or whatever they did. I think that can be fixed to a degree. Not completely because there are still problems with conflicts and so on which really Dodd-Frank doesn’t attack.

But around the edges things are … there are new laws … there are new regulations that may help things. For example in my corporate governance world there are provisions now which requires certain changes in the way the board acts and so on. Do I really think that’s going to change anything? No I don’t. There are new powers given to shareholders. Do I really think that’s’ going to do anything? No. And I hope we can talk about that a little later.

So I think all these changes around the periphery are simply around the periphery. The real changes I’ve seen and I’ve seen my class talk about was … how do we change the attitude of the people who are at the heart of making our country tick? And then we come up with this short-termism problem … and we begin …

HEFFNER: What problem?

MILLSTEIN: Short-termism.

HEFFNER: That’s what I’ve called this program because I know how you feel when I’ve read some of your speeches but I think we have to spell it out … short termism.

MILLSTEIN: Let’s segue into it. Short termism for me is nothing other than giving primary attention to the financial sector. I think the world became the tail on the dog of the financial sector in this, in this bubble era.

And what I mean by that is that everybody not everybody but almost everybody was being graded on how they did every quarter. Compensation, stock options, all the rest of it was highly dependent on the stock price climbing.

Now if you think of it that way, if you think of compensation being based on a short termism in the sense of quarterly returns …that’s how I would define short termism. An eye on the short term game and taking your eye off long term value sustainable growth … that’s the difference.

On one hand you have long term sustainable growth … on the other hand, you have meeting every quarter … they don’t match. You can’t really do both. You can balance them, but if you take as one polar extreme meeting the quarter then the other polar extreme namely long term sustainable growth you don’t do.

Now there have been lots of surveys and the one I like the best is McKinsey, which was done by some people … they go out and question CFO’s and they say, “Would you make a long term investment if it effected the next quarter?” No. 80% said no. That tells you the story. It tells you that in most corporations, most, during that period maybe even today they don’t look to the long term sustainability as the goal … they really worry about the quarter. They talk as though it’s the goal. What do they do? It’s a complicated story. I hope you don’t mind my rattling on on this matter.

HEFFNER: I want you to go on with it but I wanted you to explain why this disparity in looking at the long term and the short term produces this result.

MILLSTEIN: The reason is that the people who own corporations namely the shareholders … who are the shareholders today … pension funds, mutual funds not you and me we don’t count. We are just little people and our one or two shares in General Motors don’t mean anything. What does mean something is what the mutual funds own and what the pension funds own and that’s the huge part of the market.

HEFFNER: Are they the ones who are forcing short-termism?

MILLSTEIN: Basically yes. Basically yes because they profit by it and they forget the benefits that they are suppose to be rendering to the beneficiaries namely you and me who are holding pension funds or look to our mutual funds to produce what we need ten years from now to educate our children and to the rest. They forgot about us. And they are interested in how they are compensated. Most of them are in the hands of investment managers who make money on turnover and that’s life.

Now I can’t, can’t stop that that’s the way it is and that’s why they focus on the short term. That’s how they are compensated. That’s how they make money. That’s what it’s all about.

Now those are your shareholders. Now if your shareholders are all interested in quarterly returns or basically interested in quarterly returns. What is management going to do? Managements going to absolutely respond to their shareholders. And, therefore, they go short term.

If you talk to CEO’s as I do often, they’ll say I’d love to go long term. I’d to make an investment. I’d like to buy another company. I don’t know if my shareholders will reward me for doing that. We tell them have a credible plan. Go out and talk to your shareholders find the biggest 20% of the company tell them what you are doing and they will go along with you.

Well that is a great, great prescription but so far I haven’t seen it work too well. First of all you have to have a credible plan to go long term. You can’t go out and snow your investors. But somehow or other if you want to go long term you have to convince the people who own your company that they’ll be, they’ll be, they’ll be okay sticking with you.

HEFFNER: But that’s too difficult I gather.

MILLSTEIN: Difficult?

HEFFNER: Impossible.

MILLSTEIN: (Laugh) Difficult is hardly the word. It’s very difficult because these people on the other end are also being paid on the short term.

HEFFNER: Aha.

MILLSTEIN: So you have sort of like an unvertious circle here where everybody who’s being compensated and rewarded on the short term is, is going to be short term. And the question is somehow or other we have to break the chain.

So what we in corporate governance have been doing … or at least some of us have been doing … is talking to the shareholders and saying, “You’re the heart of the problem. You shareholders … big ones … mutual funds, pension funds and all the rest of you … you’re the heart of it. You own the companies and until you respond differently and send signals that you are willing to go long term what do you want management to do? Fly in your face and say I don’t care what you think I’m going to do the following even though my stock will drop?”

HEFFNER: You’re talking to them or you’re talking to their pocketbooks?

MILLSTEIN: I am talking to them directly because I don’t’ know how to talk to their pocketbooks. I really don’t know how to change that internal system of compensation.

If you read John Boggle who’s been in Vanguard since the very beginning and writes about the mutual fund industry …he’s outraged by what’s happening in his mutual fund industry.

He says they’ve disregarded completely their beneficiaries and are interested in nothing but short term gains. So the answer, Dick, is you have …I’m trying to simplify this … if you don’t have owners who are willing to go long term, either because you’ve convinced them that’s the thing to do or they just thinks it’s the right thing to do you never going to have management respond. So I don’t, I don’t look upon the managers and Boards as the villains of this piece. Short-termism. I see it at the other end of the stick. I see at the end of the stick where the owners are not willing to play anything but the short term game.

HEFFNER: And you’re saying the owners … not us.

MILLSTEIN: No.

HEFFNER: But really the big pension

MILLSTEIN: No not us. No. You and I don’t count. We’re irrelevant in this game. We are Irrelevant in this game. Our pressure doesn’t make any anything happen.

What makes it happen is what is a mutual fund director do. What is the investment manager do, what is the pension fund do, what do the banks do? What are the institutions do who own stock in most United States companies and foreign as well.

So there’s … the problem lies over here and I have stopped going to the meetings to preach to these people that they’ve got to turn around because I don’t know how to incentivize them to turn around. I don’t know how to incentivize them and to tell them “Okay, stop it and go long term and help these people do it.

But truthfully the only way to do it is to try to figure out what you need to do … so what I’ve tried to do say to the managers is “Okay you know what the problem is … you know you shareholders are your problem … “So you Boards … what you have to do … is if you have a credible long term plan … it’s credible … you can’t snow them you have to really have something that’s credible. Go see your 20%-30% owners, they’re, they’re there. You know who they are.

Every big company in the United States knows who owns 20%-30% of them. Calpers, New York State, so on. Vanguard. They know who their owners are.

And then go out and talk to them and say, “Look stick with me for the next five years and I can show you where I’ll be. Cash discounted backwards, say, see, see if I get where I’m going, what am I really worth. Stay with me. You’ll see what I can do.

Now what do you need to do that? (1) You need a credible plan; (2) you need a Board that will stick with you and not abandon you the minute the stock drops because something happened and is willing to go the 5 years and will back you with your shareholders and won’t abandon ship at the first bump in the road. Now if you have that, go out and talk to them.

McKinsey did a study which I though was great. They identified what they call the long-term shareholders – the intrinsic owners – and they said every company has intrinsic owners. And they said to the CEO and the Boards, “Don’t waste your time talking to the rest of them. They don’t care. They’re traders. They’re in; they’re out. They’re playing the market. They don’t really count.

You should spend your time talking to your intrinsic owners – to the people who are going to stick with you. They’re out there. There are lots of them if you try to attract them to buy your company.

HEFFNER: What percentage?

MILLSTEIN: Who knows. I mean this is a McKinsey . . .

HEFFNER: But your guess is 25% or 30%?

MILLSTEIN: 20%-25% of the stock market may be intrinsic owners. They have an association. You can look them up on the website. I didn’t know that. But McKinsey has them on the website and McKinsey estimates it someplace around 20%-25%.

HEFFNER: So get them on your side.

MILLSTEIN: Get them on your team if you can. But have a credible plan. Now the problem is …it’s tough. Because all the numbers are working against you. (Laugh) You know, the cash discounts for long-term are not what they used to be. They’re really tough. And so you’ve got to convince them that the discount is right in your favor and here’s the way it should work and you can have an investment banker with you. I’ve seen this done. I mean I’ve seen good CEOs get investments bankers who will vouch for – some say investment bankers will vouch for anything – but I don’t think that’s necessarily true.

(Laugh) Get an investment banker who will look at your numbers and vouch for the fact that your plan’s on target, it will produce results. Get your Board to say we’re 100% behind this. Do whatever you can to convince those intrinsic owners to stick with you and they just may stick because that’s what they’re in for. There are a group of investors who really are value investors in for the longer term.

And to the extent that we can convert more people into that intrinsic group, we may be able to break our attachment to this short-termism which basically has been caused by the financial sector. They do wonderfully by virtue of turnover and volatility.

HEFFNER: When you say they do “wonderfully” … you mean they put more and more money in their pockets?

MILLSTEIN: Yes.

HEFFNER: By “do” you mean profit.

MILLSTEIN: Profit.

HEFFNER: Personally.

MILLSTEIN: Personal.

HEFFNER: So, Ira, let me ask something …

MILLSTEIN: … that doesn’t sound terrible to me. You could … it can be done. I don’t mean put more money in their pockets.

HEFFNER: You mean “convince them”

MILLSTEIN: Yeah.

HEFFNER: … to take not a short-term but a long-term ….

MILLSTEIN: But a long-term view … provided it’s real. My problem is that you can’t let managers who are not really responsible pretend to have long-term plans in order to entrench themselves in their companies. A lot of people are suspicious of managers who run around talking about the long-term. They really may be hiding their inability to produce profits in the short-term.

Bear in mind, Richard, this is complicated because you can’t forego making a profit in the short-term. I mean the company has got to be profitable to survive. The question is how much short-term profit are you willing to sacrifice to go long-term. So you can’t … it isn’t a question of saying I will not pay any attention to making a profit in the short-term. You can’t do that. You have to have some idea of what you’re going to do in the short-term. And then say but I’ll sacrifice some piece of that.

HEFFNER: Now my friend Ira …

MILLSTEIN: Yes.

HEFFNER: … you’re a man of the world. You’re almost as old as I am. Tell me honestly – just between us . . .

MILLSTEIN: And a thousand of us.

HEFFNER: No, no. How much do you believe, really, that this is not just possible but in a practical sense likely to happen – this turnaround from short-termism to long-termism.

MILLSTEIN: I think – let me see if I can phrase this carefully because . . .

HEFFNER: Yes, but honestly.

MILLSTEIN: Well I’ll try.

HEFFNER: Well, you’re a lawyer.

MILLSTEIN: I’m not being careful in the sense of not offending anybody. That doesn’t bother me any more. I’m sure I’ve done enough of that in my lifetime. One more offense isn’t going to make any difference.

I think it can happen. And I think honestly that the current horror show recession is making people rethink where we are. And many people – not many people – but some people – have begun to think about resetting our goals.

In other words, all of us have to begin to think about – well, this didn’t work very well. This, this, this terrible situation that resulted in 2007-2008, didn’t work. So should our goals be short-term? Should our goals be just making money? Should our goals be just the quarter? Is that really what we’re after? Or are we trying to rebuild America to make it a growth country again and provide jobs and do the kind of things that we are fully capable of doing. This is a great country.

HEFFNER: May I though interrupt and ask – we just have a few more minutes. When you talk this way, don’t you have to put in to your calculations the fact that so many of these people that you’re going to speak with are still doing very well …

MILLSTEIN: Yes.

HEFFNER: … that we in fact are in a period when the middle class is suffering but when the people that you’re talking about are still raking it in – they’re not doing all that badly – we talk about bad times but not for them – why should they change? Why should they listen to you?

MILLSTEIN: Well, because I think, in a funny way I have some admiration of the Tea Party. I don’t really think that what they want is the right thing but that their fury is the right thing.

I approve heartily of the country being furious as to what happened and furious with the people who brought it about. And my feeling … sense is that if that lack of apathy …if the growing anger at what happened will continue to grow, maybe we can get Tea Party energies off in the right direction.

I mean, they’re crazy to be thinking about getting rid of government and no taxes and so on. That’s not going to solve the problem. But what will solve the problem is some really major reforms in compensation, some really major reforms in how the government spends its money and so on. All of that can be done but the apathy at the moment is enormous. The only people who are screaming is the Tea Party. And they’re screaming … they’re right in screaming. Things are bad. But they’re wrong in what they’re trying to do.

I wish the rest of the country would start screaming about what’s really wrong – namely, that our goal has been financial for much too long. That the goal of everybody is to get rich. That’s the goal of everything. We’ve got to change it. We’ve got to reset the goal. And I think if there’s enough anger out there we just may soon, after another few elections, put people in government who will begin to think straight about what needs to be done and how we go about resetting the goals.

HEFFNER: You mean if there are enough people who are saying “I’m mad as hell and I’m not going to take it any more?”

MILLSTEIN: You bet. That’s exactly what has to happen. To me it’s inconceivable that in this country with now 4 or 5 years on of not being able to get out of this mess and having the angry people arguing about the wrong thing, that the rest of us are sitting back and saying, “Oh, well, that’s too bad – Obama’s a bad guy, Congress is awful” … and we’re not doing anything. We need to put people in government who really believe we have to reset our goals, that we can’t be the tail on the dog of a financial sector, that we have to be thinking about growth, we have to think about rebuilding America. We’re not going to do it by producing short-term results.

HEFFNER: Ira … question …

MILLSTEIN: What?

HEFFNER: Do you see any credible sign on the horizon other than your wishful thinking that that’s going to happen?

MILLSTEIN: I don’t think it’s wishful thinking. I think I’m angry. And I think a lot of people are angry. And my, my thought is that we haven’t found a polarizing figure to talk this way. We need somebody who is a leader and who can talk this way and say “Wait a minute, this is wrong. We’ve got to go in a different direction.”

HEFFNER: I’ve got the answer.

MILLSTEIN: Who?

HEFFNER: Franklin Delano Roosevelt. And now you’ve got some ideas. Stay where you are and we’ll do another program for me to tease them out of you.

MILLSTEIN: Okay.

HEFFNER: Thanks, Ira Millstein. And thanks too to you in the audience. I hope you’ll join us again next time. Meanwhile, as another old friend used to say, good night and good luck. And do visit The Open Mind website at thirteen.org/openmind to reprise this program online right now or to draw upon our archive or 1500 or so other Open Mind and related programs. That’s thirteen.org/openmind.