The Six New Rules of Business

Creating Real Value in a Changing World

Judy Samuelson

• Publisher: Berrett-Koehler Publishers
• Year: 2021
• ISBN:
  9781523089987
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Produktion

The rules of business are changing dramatically. The Aspen Institute's Judy Samuelson describes the profound shifts in attitudes and mindsets that are redefining our notions of what constitutes business success. Dynamic forces are conspiring to clarify the new rules of real value creation—and to put the old rules to rest. Internet-powered transparency, more powerful worker voice, the decline in importance of capital, and the complexity of global supply chains in the face of planetary limits all define the new landscape. As executive director of the Aspen Institute Business and Society Program, Judy Samuelson has a unique vantage point from which to engage business decision makers and identify the forces that are moving the needle in both boardrooms and business classrooms. Samuelson lays out how hard-to-measure intangibles like reputation, trust, and loyalty are imposing new ways to assess risk and opportunity in investment and asset management. She argues that “maximizing shareholder value” has never been the sole objective of effective businesses while observing that shareholder theory and the practices that keep it in place continue to lose power in both business and the public square. In our globalized era, she demonstrates how expectations of corporations are set far beyond the company gates—and why employees are both the best allies of the business and the new accountability mechanism, more so than consumers or investors. Samuelson's new rules offer a powerful guide to how businesses are changing today—and what is needed to succeed in tomorrow's economic and social landscape.

CHAPTER ONE

Rethinking Risk

RULE #1
Reputation, Trust, and Other Intangibles Drive Business Value

To create a fairer economy, one where prosperity is more broadly shared and is therefore more sustainable, we need to reinvigorate a serious discussion about the nature and origin of value.
—MARIANA MAZZUCATO, THE VALUE OF EVERYTHING

ON A WARM SEPTEMBER AFTERNOON under a brilliant blue sky, a group of finance scholars were fighting to hear one another over the sound of the Roaring Fork River where it winds through the campus of Aspen Institute in Colorado. It was 2010. The meltdown in the financial markets—from the failures of Bear Stearns and Lehman Brothers to the bailout of major banks—was still reverberating on Wall Street, but especially on Main Street where the value of homes plummeted and the real effects were still felt a decade later.

The purpose of the gathering was to consider what role the finance academy might have played in the turmoil that roiled the markets and defined the early days of a new presidency. Nineteen faculty members drawn from influential business schools—Stanford, NYU, Wharton, the University of Chicago, and Darden at the University of Virginia among them—had accepted our invitation to dialogue. What had we learned—and what were the consequences for how finance is taught?

David Blood had left a leadership position in asset management at Goldman Sachs in 2005 to start a new company called Generation Investment Management. David waved his hand at the rushing stream that tumbled 15 feet below on its journey to the Colorado River and asked the scholars a provocative question: “How do you put a price on the fish?” One of the scholars took the bait: “You can’t,” he said definitively. It was clear from his quick dismissal of the idea that he thought, “What’s more, you shouldn’t.”

Trying to value the fish in the stream—or the water we drink and the air we breathe—is an abstraction. Yet as we pull back from the river and consider the consequences of an ecosystem at risk, it becomes more than an academic exercise on a warm afternoon in the Rockies. As we consider the livelihoods of communities and quality of life for future generations, we experience challenging questions and very real costs, albeit largely unmeasurable by the traditional tools of finance.

Economists and their colleagues in finance use the label externality for a cost imposed on a third party who isn’t part of the transaction. In business terms, this might mean the cost of a decision made inside the gate on the community that resides outside the gate—for example, the unintended consequence of a product with observable social ramifications, such as the public health costs of alcohol abuse or soda consumption; or how work, structured for maximum efficiency, affects home life or commitment to education. Externalities, by and large, are viewed as a distraction by managers committed to profits and growth.

Social and environmental impacts of business decisions sit outside the frame of financial analysis—until they don’t. When we step away from the classroom and observe the world that students enter upon graduation, the need for change in how we invest and how we measure value becomes clear.

Risk analysis is bending to embrace the full life cycle of products. It connects us with the effects of business decisions over time—and is widening in scope to include perspectives of those who help create the product or who feel its effects downstream. Both shape our definitions of value.

These ideas are hardly new. The contemporary framework of the circular economy, given visibility by the Ellen MacArthur Foundation and a score of aligned thinkers, has traditional roots; it is part of a conversation about value creation and what to measure and how to measure it that has been evolving since the time of Adam Smith. The idea of thinking in systems echoes a core principle of the Iroquois Confederacy formed by five Native American tribes over 500 years ago. The name of the eco-friendly consumer products company Seventh Generation recalls the Native American ideal of considering the impact of decisions today on generations far into the future. The thesis behind David Blood’s successful investment company Generation Investment Management draws from the same philosophy, translating business norms and impact on living systems into investment theory and analysis.

Lorraine Smith, a creative thinker and gifted adviser to our work at the Aspen Institute, weaves together the worlds of business and finance to put nature at the center of the bull’s-eye. Maybe because of her Canadian roots, she gets away with questions like “What if the Colorado River were the board of directors—what if the fish owned the business?”

Welcome to the front lines of business, where the game of finance is changing in real time.

Teachers and scholars in management schools are insulated from the pace and chaos of markets and business decision-making. Their job is to observe, interpret the data, and build knowledge, which requires some distance from the day-to-day. In their search for clear decision rules for managers and investors working across a range of industries, they employ both large data sets and case studies.

The tension between theory and practice can be a healthy one. The principal ideas and analytical frameworks that are taught in finance classrooms—and shape the attitudes and frameworks in professional domains like consulting and finance—may lag behind what’s current today, the thinking goes, but they stand the test of time.

But what do financial analysts and scholars in finance do when the key assets of the enterprise are unmeasurable?

The simple frameworks that dominated business classrooms in the decades leading up to the turmoil of 2008 were the last gasp of a world ring-fenced by rules about capital formation and valuation. They fail to make the most obvious connections between the real long-term health of the underlying corporation and that of the society and natural systems on which the enterprise depends.

A WAKE-UP CALL IN FINANCE

An early-warning signal of the need for fundamental change emerged early in 2007, in a boom market, before the 2008 collapse. Texas Power & Light, then known as TXU, was one of the most profitable utilities in the country, its growth and prosperity a mirror of the economy of Texas. When the influential private equity firm Kohlberg Kravis Roberts & Co. and its partners, Texas Pacific Group and Goldman Sachs, prepared to take the publicly listed company private, they offered a window into the failure of the old rules of valuation. TXU became a Yale School of Management case study of the need for risk assessment to adjust to new realities and the influence of new voices equipped to go head-to-head with Wall Street.

The deal was ultimately consummated at a valuation of $44 billion—the largest leveraged buyout recorded at the time. Valuations are part art, part mathematics. They are derived from estimates of the market value of current assets of the company plus projections of future asset values, profits, and cash flows—all of which must be stress tested against the competitive environment and future risks to the business model, then discounted back to the value in today’s dollars. Citibank, Morgan Stanley, JPMorgan, and others led the placement, and virtually every asset manager and investor of scale on Wall Street, and, by extension, every pension fund in the country, contributed capital—hungry for high-yielding junk bonds at a time of relatively low interest rates.

But that’s only part of the story. At the most crucial moment, with the required capital fully subscribed and syndicated and the fees all but booked, the architects of the transaction returned to the drawing board—forced by a network of environmental activists to reexamine assumptions about the future of coal in the state of Texas.

In time, a more environmentally friendly deal went forward, but the wall that insulates the valuation and investment game on Wall Street from the real consequences of investment decisions had begun to crumble. Assumptions about business in the volatile energy sector have continued to morph. We have come to understand brand and business risk in new ways.

We are no longer taken by surprise when B-to-C brands are hijacked by dogged activists determined to make the real costs of operations and the so-called externalities material. What was once outside the scope of the interests of profit-seeking investors blurs the lines between tangible and intangible; the contributors to real value are being redefined, and the central theorem of value is being shaped by critical thinking about the material relationships between and among firm value, human systems, and the biosphere. The simplicity of the single-objective function of maximum profit is no longer deemed superior—or useful.

Within five years after the deal closed, TXU was in shambles and headed toward bankruptcy; the expected cash flow needed to retire massive levels of debt had been undermined by the shift from coal to cheap natural gas. Along the way, TXU was renamed Energy Future Holdings, perhaps in the hope of a better future, and the game started anew.

Welcome to Finance 2020, where pension funds, state controllers, institutional investors, and even the investors’ investment bankers have begun to redefine real value and seek a more complex—and useful—understanding of risk.

TXU and the Future of Financial Analysis

In February 2007, at the 11th hour—with the deal doers and bankers and debt syndicators and their clients poised to commit funds for the leveraged buyout of TXU, the Texas utility—a group of scrappy, determined environmental campaigners shot a gaping hole through the spreadsheets, blowing apart the core assumption that another 11 carbon-emitting coal-fired plants would be built to supply energy to the fastest-growing state in the union.

The campaign to thwart the utility’s plans began much earlier. As the intention of leading private equity firms to purchase TXU became public in the spring of 2006, a network of local and national environmentalists moved from direct engagement with company executives to a ground game of building public opposition through every means available, from TV ads to swamping the state legislature with letters and petitions. By February 2007, the deal was on ice. When it reemerged a month later, the projected debt was still staggering, but assumptions about the source of energy for the citizens of Texas had changed dramatically. The number of proposed coal-fired power plants had been reduced from 11 to three—a massive scaling back of the utility’s plans and a signal of things to come. A number of critics thought even three new carbon-emitting plants was too many; the head of the Rainforest Action Network commented that if the utility was really serious about climate change, it would not build any new coal plants, a sign of further challenges ahead.

The managers of the largest leveraged buyout in history had missed an obvious and tangible risk, leaving egg on the faces of the titans of Wall Street. It was what an investor would consider a material risk—one that could produce losses due to a failure to perform under contract.

Ultimately, the chief architects of the campaign against TXU, the Environmental Defense Fund and Natural Resources Defense Council and its affiliates and partners in Texas, backed up by at least some regulators and opinion makers, dropped multiple lawsuits brought against the utility. In exchange, TXU agreed to cancel plans for eight planned coal-fired power plants in Texas and several more in Pennsylvania and Virginia. TXU also agreed to support federal cap-and-trade legislation to regulate CO₂ emissions and to invest $400 million in conservation and energy efficiency.

SIGNS OF CHANGE IN ASSET MANAGEMENT

Thomas Kamei, an investor focused on the Internet sector for Morgan Stanley Investment Management’s Counterpoint Global fund, is a member of the Aspen Institute’s First Movers Fellowship class of 2015. First Movers meet in cohorts of 21 fellows per class to hone skills and build their know-how about creating change from within companies. The fellows are drawn from every corner of the business world—from heavy equipment manufacturers to consumer products, finance to retail. They are selected for their commitment to the complex task of aligning business decisions with the long-term health of society—a complicated endeavor that depends on new business models and metrics.

Thomas was born to investment. At age 10, he began an annual pilgrimage with his mother to sit at the feet of the Oracle of Omaha, Warren Buffett. In 2019, he and his colleagues at Morgan Stanley Investment Management began to test a model for assessing risk that Thomas started working on during his fellowship year. The model offers a clear-eyed view of both risk and rewards when the rules no longer support walls between business and society. Long-term investing demanded a fresh approach, and Thomas was offered the chance to experiment.

The fund that employs Thomas Kamei seeks superior long-term returns for patient investors. Counterpoint Global is designed to identify and invest in undervalued stocks for the long term. Counterpoint is one of the most successful long-only funds in the market, and Thomas’s job was to study companies and understand risks and opportunities now and into the future in order to pick stocks that have a long-term competitive advantage.

With a doggedness that is both admirable and the key to systemic change, Thomas has helped widen the lens at Counterpoint Global to consider material, yet difficult-to-measure, disruptions from unusual places. In one example, Thomas and his colleagues aligned with Lonely Whale, an NGO working on eliminating plastics in oceans, to engage Starbucks on the use of plastic straws. Thomas considered Starbucks’s iconic green straw for frozen drinks a “gateway plastic”—not by any measure the key to protecting ocean ecology yet an obvious target for campaigners seeking massive change in norms around producer responsibility. Following a series of conversations in 2018 highlighting the material risks of inaction around plastic waste, CEO Howard Schultz responded to the call from his early and important investor Counterpoint Global and put a process in motion to eliminate the straw. By the end of 2019, Pepsi and Coke had announced the decision to drop out of the Plastics Industry Association and to double down on investment in alternatives to plastics in packaging.

As Morgan Stanley’s Counterpoint Global fund began to test Thomas’s framework, it became not only an analytical tool but also a guide to engagement with company management. The framework features a dashboard of data and a series of questions designed to unlock the attitudes, embedded incentives, and mindset of the target enterprise.

The quantitative measures on the analyst’s dashboard help provide insight into a company’s alignment with long-term value creation. The methodology that Thomas scoped out and continues to develop employs questions to take the measure of leadership and commitment—what Thomas calls agency. Do the executives have the bearing and aligned incentives to take a long-term view? Is the culture equipped to understand the collision of changing expectations among investors and the shifts in social norms and environmental trends that are on the horizon—and that could rebound to the firm? Is management awake to the opportunity that the trends present, as well as the risk?

This kind of thoug...