How Business is Like A Game of Cricket

Management expert Roger Martin says that maximising shareholder profit should stop being the raison d'tre for businesses

Published: Aug 23, 2011
How Business is Like A Game of Cricket
Image: Rotman School of Management
ROGER L. MARTIN, Dean of the Rotman School of Management, University of Toronto

ROGER L. MARTIN
Designation:
Dean of the Rotman School of Management, University of Toronto
Work: Author of several books including The Design of Business: Why Design Thinking is the Next Competitive Advantage, The Opposable Mind: How Successful Leaders Win through Integrative Thinking, and Diaminds (with Moldoveanu).
Education: Bachelor’s degree from Harvard College, with a concentration in Economics and MBA from Harvard Business School.
Next up: Co-authoring a book with ex-CEO of Procter & Gamble A.G. Lafley on how to think about strategy. “Most people make strategy about plans, not fundamental choices. Strategy is about a small number of very specific choices.”

 
Think of all the time you spend glued to the telly watching cricket. You cry yourself hoarse rooting for your favourite team through every nail-biting moment. But what if you discover that the game was fixed? That your team won not because it was the better team, but because the losing team took money and agreed to lose?

Roger Martin, dean of Rotman School of Management at the University of Toronto and a self-proclaimed sports buff, has been pondering this problem for a while. Martin says, “People who create the rules of the game have to enforce them so that it is played best for the fans.”

That’s what happened in the National Football League (NFL), the highest level of professional football in the US. In 1962, a scandal erupted in the NFL when two players betted on games — including the ones they were playing. Pete Rozelle, legendary NFL commissioner who was in charge at that time, punished them severely and in order to prevent future scandals, Rozelle established an agency that identifies and prevents player involvement in betting.

According to Martin, in sports such as football there is a real game and an expectations game, and it is when the two games start to intersect that problems happen. “In the real game, players go into the real field and play for 60 real minutes with real passes and real touchdowns, real scores and with a real winner and a real loser. Associated with that is this expectations game when people look forward to Sunday and form expectations about that and bet on that basis,” says Martin. On the basis of these bets, bookies constantly adjust the ‘point spread’, the forecast of the margin of defeat so that there is even money on either side. The pitch gets queered when the real game gets influenced by the expectations game.

What Rozelle did was separate the real game from the expectations game so that its integrity is maintained and fans get their money’s worth. That, says Martin, is the big lesson that businesses haven’t learnt. Businesses, too, have a real game and an expectations game, he says. The real game is one in which a company produces goods and serves the customer. The expectations game is played in the stock market.

In his latest book titled Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn From the NFL, Martin demolishes the long-cherished notion that businesses exist to maximise shareholder value, a theory that led to an obsessive focus on stock-based compensation for executives.

Considered one of the world’s leaders in design thinking — a particular approach that is becoming increasingly popular in management and engineering — this is the first time the consultant-turned-academic has attempted to offer a fix-all solution.

Most of his previous books are on business design and integrative thinking. Though the latest book reads differently from the earlier ones, Martin insists there is a common thread: “What characterises my work is that I tackle a commonly held theory that causes us to act in a certain way. When that theory does not produce the results you want, what’s a better theory?”  

The theory that Martin attacks in Fixing the Game was first proposed by academics Michael Jensen and Dean William Meckling in a 1976 research paper titled Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, which became the most frequently cited article in business academia. It said the best way to align the interests of executives with that of shareholders is to give executives stock-based compensation that makes them shareholders too.

It sounds logical. In such an arrangement, executives would act in the interest of shareholders and, thus, the company, right? Wrong. Says Martin. “Executives realised they couldn’t accomplish what shareholders want them to accomplish and so they figured out coping mechanisms for dealing with an impossible task in a way that benefited themselves.” Executives realised they had to get the market’s expectations up and, thus, the share price. They also figured this couldn’t go on forever as the market would become smarter about their earnings management. “So they concluded that all they need to do is jerk expectations up and get out before they come crashing down,” says Martin.

An obsession with stock-based compensation leads to a tight coupling of the real and expectations market as CEOs and senior executives end up having a single-minded focus on getting the stock price up. In reality, stock-based compensation misaligns the interest of the management and shareholders, it creates the incentive for management to create unrealistic expectations and create volatility. “In capital markets we are obsessed about protecting investors. In football the moral equivalent of investors are bettors. The rules are not in place to protect bettors, the rules are in place to make sure fans get a good experience,” says Martin. The moral equivalent of fans are consumers and that’s what businesses ought to focus on.

To correct this situation, Martin offers a radical prescription that most CEOs will probably hate him for: Scrap stock-based compensation and let business go back to its basic principles of serving the customer. Maximising shareholder value should no longer be an end in itself; it is an output of a company serving its customers well and building a good value proposition. “There are other things to maximise to make shareholder value maximise itself, such as maximising customer satisfaction. Apple has shown that having deliriously happy customers produces a high share price,” he says.

If discarding stock-based compensation is too drastic, Martin offers an alternative: Restructure the delivery of stock-based compensation. He suggests basing stock-based compensation on an initial grant at the start of the executive’s tenure instead of giving a grant every year. It should only vest three years or more after that executive retires. “Giving a stock grant every year is a licence to get them to manipulate expectations,” says Martin.
 
“If you get a grant every year, what you want is a valuable grant that you get when the stock is very low. You don’t even mind doing something to the company.”

 Will anyone buy Martin’s prescription? Maybe; the financial crisis shows that the system needs a shake-up. Maybe not; there is too much personal stake at risk here for CEOs and senior executives. And after all, as Martin says, people do not want to believe their beloved theory might not be entirely correct.

(This story appears in the 26 August, 2011 issue of Forbes India. You can buy our tablet version from Magzter.com. To visit our Archives, click here.)

Show More
Post Your Comment
Required
Required, will not be published
All comments are moderated
Rejuvenation: Rajasthan Patrika Gets Politicians to Behave
Examination: State Of The Nation Survey