Picking winners at the top
While investment professionals love change at the top, usually the best person to be in charge of a company is a long-standing, loyal employee
Sometimes the obvious is blithely ignored. So people shrug off the pretty well-known fact that the interests of shareholders and the businesses underlying their investments are often different. Of course investment types pretend otherwise but it seems clear to me that investment specialists, not least those analysts who are given extraordinary amounts of airtime, really only know about investments and not much about business.
This gets problematic when they tend to like many things that do a lot of damage to businesses, such as takeovers, and they press for bigger dividend payments because they like cash flow regardless of whether handouts deprive firms of investment funds. They are also keen on dicing and slicing companies to create more investment opportunities because this provides ways of cashing out investments.
So far, so obvious, but if you really want to understand how little the investment community knows about running businesses, then look at the way share prices respond when companies change their chief executives.
A recent study by Saracen Fund Managers (yes, I know I'm quoting a bunch of people who I've maligned but you use the tools to hand even if you don't quite like the people providing them) shows that the share price of companies in London's FTSE 500 Index rose an average 41 per cent and outperformed the index by 34 per cent in three and 12-month periods following a change of chief executive.
Investors like the idea of change and they seem to think that bringing in people from outside is a good thing. But people who run businesses know that management stability is a key to success. Moreover, well-run businesses like to give top management jobs to people inside the firm, both to provide an incentive to employees and to make use of their knowledge and proven skills. Staff morale also tends to be maintained in firms that show they value employees by promoting them.
This is why, according to a 2012 study from the management consultant Booz & Co, 71 per cent of the world's largest companies choose current employees as chief executives. Moreover, those who think that new is always better might be surprised that this piece of research also found that a quarter of these top executives have worked for the same company throughout their entire careers.
I would like to be able to provide comparable figures for employment of top executives in investment companies but have failed to find research in this area. However, having been around this world for quite a while, I get the distinct impression that senior investment company employees move jobs a lot more than their counterparts elsewhere. Indeed it is not an exaggeration to say that the investment community has a built-in culture of change that has the effect of devaluing long-standing employees while showering lavish expectations on anyone from the outside.
My own experience of running companies is that the very best managers are long-standing employees who have shown their worth over the years and climbed up the ladder. Also, they have a depth of loyalty and experience that is difficult to replicate by appointing a newcomer. Like all sweeping statements, this one is subject to qualification but, overall, this is the experience of most businesses I know.
If this experience points so clearly in this direction, why are investors not aware of this? The simple answer is that stock markets and other financial markets are rarely bothered by business fundamentals. Shares move in response to new information. This is why investors like to see the appointment of new chief executives. They don't stop to ask whether Mr or Ms X is actually able to do the job better than the outgoing Mr Y because they simply assume that new blood is better blood. Investment specialists see themselves as being dynamic people and thus assume that anyone staying in a job for too long must lack dynamism.
This all gets a bit complicated in Asia, not least in Hong Kong, where most of the firms that matter are run either by their founders or their sons. Many of these people have a loyal following among the investment community, which believes their genius will bring home the goods.
Thus the general presumption of investors in North America and Europe is turned on its head, making Asian investors worry about new people running these companies. They will even tolerate dynastic successions even though the beneficiaries of this system float to the top by accident of birth rather than on the basis of proven talent.
So either way you look at this conundrum, you discover investment pundits have little knowledge to offer on how businesses are likely to succeed. But they do sometimes catch up with reality and ultimately everyone acknowledges the best measure of success is profitability.
This being so, why worry whether the investment community really understands how business works? Maybe it doesn't matter, but being lectured on business by people who are playing catch-up is really annoying.
Stephen Vines runs companies in the food sector and moonlights as a journalist and broadcaster