The Finance Curse

There were 57.8 million people in the United States over the age of 65 in 2022. Let’s conservatively assume only five million of them, less than ten percent, own stocks or stock funds that they will gradually liquidate for retirement income once each month. That’s about 400,000 sales of stock a month, or 20,000 each trading day. Let’s suppose, meanwhile, there are younger investors who are in accumulation mode, seeking to purchase stocks each month to add to their stock portfolios.

Do we really believe that with 20,000 retirees seeking to sell stocks or funds in the market each day, these accumulators will not be able to buy at a fair price, and the sellers will not be able to sell at a fair price? Is it really necessary, in order for the price to be fair, for there to be 74 million trades a day rather than 20,000? Would the price be fairer if there were 74 billion trades a day, or 74 trillion? Is that much “liquidity” actually needed?

But everybody says you need all those trades to ensure liquidity, including putative experts like Fama.

Except for Sir John Anderson Kay. Kay is a prominent Scottish economist who has written many columns for the Financial Times, and several books, most of which I have read, and I’ve reviewed two of them for Advisor Perspectives. In his book Other People’s Money (which was — I love this — shortlisted for the Orwell Prize in 2016), he says

“Nothing illustrates the self-referential nature of the dialogue in modern financial markets more clearly than this constant repetition of the mantra of liquidity. … [E]nd-users – households, non-financial businesses, governments – have very modest requirements for liquidity from securities markets ... these needs could be met in almost every case if markets opened once a week – perhaps once a year – for small volumes of trade.”

Then what is the purpose of liquidity? Kay says, “The pursuit of liquidity often seems to mean little more than the facilitation of trading activity as an end in itself: trading is to be welcomed because it promotes trading.”

This is just one example of Kay’s views about finance — many of which are far out of the mainstream of conventional finance wisdom, but with which I completely agree. I enjoy reading his books not only because of that, but because they are so full of interesting information.

John Kay’s New Book

I was delighted to notice a few months ago that Kay had a new book out, The Corporation in the Twenty-First Century: Why (almost) everything we are told about business is wrong. I hastened to get it and read it and, after arranging a Zoom interview with him, to review it. The book is, as with his others, replete with views with which I heartily agree, but more importantly, with fascinating facts and stories.

The title of the book is based on his view that while corporations of today are much different from the corporations that prevailed in the industrial age of the mid-twentieth century — the General Electrics, the General Motors, the IBMs, the AT&Ts — corporate theory hasn’t changed enough to recognize this change.

In the 1960s, the iconic corporation was a manufacturer; the iconic image was an assembly line. The corporation was typically hierarchical, vertically integrated, and top-down. Its physical capital was machines made of iron and steel. The corporation unmistakably owned that physical capital.

The iconic U.S. or U.K. corporation of today is knowledge based; the iconic image is of individuals at desks operating computers. Today’s corporation is a “hollow corporation.” Kay gives a good description of a hollow corporation in the form of Amazon. In a chapter titled “The Myth of Ownership” Kay explains: “The business of Amazon requires large warehouses, vehicles and stocks of goods. But Amazon owns few of these things. Its property assets are largely rented from real estate investors, and most of its mechanical assets are leased from financial institutions.”

Stakeholder, Not Shareholder

Much of Kay’s book is occupied with an extended critique of the shareholder value movement, which was spurred by a famous article by Milton Friedman in The New York Times in 1970, “The Social Responsibility of Business is to Increase Its Profits.” (Friedman used the term “stockholders” rather than “shareholders.”) Kay has long written about stakeholder capitalism, at least since former U.K. Prime Minister Tony Blair embraced the concept in a speech in 1996 and Kay was called upon to explain it.

Kay's advocacy of stakeholder value rather than shareholder value may be considered "woke," but virtue signalling is no part of it. Many corporate executives may believe (though they have not actually read the theoretical law) that it's legally required that a corporation's foremost goal be to maximize shareholder value. It's not. Kay says, “within every legal framework, the actions of all but the most tone-deaf executives and directors must be sensitive to the culture and expectations of the society in which they operate.”

Not only is it necessary for corporate executives to be sensitive to the society in which they live, they must pursue real objectives, such as to create and sell products that consumers believe add value to their lives, rather than only a nebulous financial objective like shareholder value.

The sole pursuit of shareholder value — i.e. of maximizing stock price — leads not to a focus on creating the greatest possible value for the firm’s customers, but to a focus on financial metrics and financial engineering. Kay gives a myriad of examples of firms that failed after diverting their efforts to enhancing financial metrics, including Enron and WorldCom, AOL, Sears, Citibank, and numerous others.

He calls this the “finance curse”: “… the elevation of the achievement of financial metrics over satisfaction of the needs of the stakeholders – a priority that has often worked to the long-run detriment of all stakeholders, including shareholders themselves.”

And, of course, this elevation has been facilitated by the financial industry, which grew enormously during the shareholder value age. “But the financial sector,” says Kay, “is primarily rewarded by fees from facilitating transactions, not for the consequences of these transactions.” This financial sector, it could be noted, includes the liquidity mavens who applaud the “liquidity” provided by the maximum number of transactions, which enriches only the financial sector.

Kay quotes approvingly the view that Jack Welch, the famous former CEO of General Electric, expressed in 2009, years after his stint as CEO of GE: “Shareholder value is a result, not a strategy … Your main constituencies are your employees, your customers and your products.”

The Real Modern Corporation

The real modern corporation, Kay says, is not merely a “nexus of contracts,” negotiated in arms-length transactions among “rationally” self-interested transactors, but a web of informal relationships and accumulated intellectual capital out of which emerges a corporate personality. Kay spends many words in his book elucidating this concept, one that cannot be subsumed by simple models or quantitative theorizing.

One way in which Kay and I strongly agree is in our aversion to excessive financialization, quantification, and the substitution of mathematical and computer models for the real world — something expressed in superlative manner not only in his new book but in his other writing as well.

He cites a comment from former Chicago economist Frank Knight, a teacher of Milton Friedman, in which Knight quotes Lord Kelvin’s dictum about research in the hard sciences: “When you cannot measure, your knowledge is meager and unsatisfactory.” But Knight suggested, at a 1939 symposium, that Kelvin’s dictum be amended in its mistaken application to social sciences such as economics to “if you cannot measure, measure anyhow!” (At the same symposium, according to one report, another economist, Jacob Viner, suggested an additional amendment, “If you can measure, your knowledge is still meager and unsatisfactory.”) The quantification curse — the “tyranny of metrics” — is a sometime partner of the finance curse.

Kay said that while he was writing The Corporation in the Twenty-First Century, he realized it was going on longer than he expected. So he decided to make it a two-volume set. The second of the two volumes will be forthcoming later. I look forward eagerly to its publication.

Economist and mathematician Michael Edesess is an adjunct professor and visiting faculty at the Hong Kong University of Science and Technology. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, was published by Berrett-Koehler in June 2014.

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