Picture this: New England Patriots quarterback Tom Brady gives a press conference before the big game against the New York Jets. The Las Vegas line that week favors the Pats by 6½ and Brady is confident. “I think we’ll beat that spread,” he says. “In fact, right now we’re projecting a win by eight points.” Later, after the game, Brady again talks to the press, this time apologetically. The Patriots have won by only four, so bettors who wagered on them lost money. “We didn’t anticipate the headwinds we would run into,” he confesses, referring to the Jets’ secondary. “I’m sure we’ll do better next game.” He himself, he acknowledges, lost a substantial amount of money when his team failed to beat the spread.
Such is the scenario one imagines after reading Roger L. Martin’s superb book Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL. The book—published by Harvard Business Review Press—is now seven years old, but it’s worth a read by anyone concerned with restructuring ownership. Though couched in the measured language of a well-respected business school professor and management consultant, it is in fact a devastating indictment of the Anglo-American style of capitalism.
After all, Martin points out, what we (absurdly) imagine Brady doing is pretty much what CEOs of publicly traded companies do every quarter.
Martin’s argument is nuanced, but the basics are easy to understand. They run like this:
- For various reasons—historical and political—more and more of a CEO’s compensation today comes in the form of corporate stock. The theory is that stock-based compensation aligns senior executives’ interests with those of the shareholders. The top team will make serious money only if their companies perform well, as measured by an increase in the stock price.
- This approach has had “the unfortunate effect of tying together two markets: the real market and the expectations market,” writes Martin. The real market is the one where companies produce goods and services for customers. The expectations market is the stock market, where investors try to assess a company’s prospects and place their bets accordingly. The consensus view among investors about the business’s future performance essentially determines its stock price.
- But here’s the thing about this linkage: it’s perverse. A company can do very well in the real market and still lose in the expectations market just because it hasn’t lived up to expectations. Microsoft, Martin points out, nearly tripled its revenue and profit between 2000 and 2010. But its stock went nowhere. “The market expects Microsoft to perform pretty much spectacularly in the real market, and so doesn’t reward it in the stock price for doing so.”
- So here are the CEO’s choices if he wants to increase his compensation. (Martin nicely uses the pronoun “she” in reference to CEOs, and there are certainly more women in corporate corner offices than there used to be. But the vast majority are still men, so we’re sticking with “he.”) He can invest in the real market, developing new products and serving new customers, hoping that the investments will lead to higher profits and a higher share price. Of course, the investments will take a long time to pay off and may or may not boost the stock—it all depends on expectations.
Alternatively, he can raise expectations right now by hyping the stock, by touting some new product that happens to be a few years down the road, or by using various accounting techniques (legal and illegal) to make the company’s performance today look better. Or, in an increasingly common move, he can buy back shares on the open market—a particularly popular move after the recent tax cut. These measures are likely to have immediate effects on the share price and thus on his compensation.
This is where Tom Brady and his imaginary press conference come in. The National Football League, Martin argues, runs things a whole lot better than the American version of capitalism. The NFL goes to great lengths to separate the real market (games played) from the expectations market (bets on those games). Players and team staff aren’t allowed to wager on the games. The point spread affects only the bettors, not the outcome of the game. The Las Vegas line has nothing to do with the compensation of anyone in the league. The expectations market in football is thus a sideshow to the main event.
If the NFL worked like modern capitalism, the press conference imagined in the opening paragraph might not be so far-fetched: Tom Brady giving “earnings guidance” to the investors—sorry, bettors—and apologizing for not meeting their expectations. Contrariwise, if capitalism were more like the NFL, corporate executives wouldn’t be paying so much attention to the stock market. In this contest, the NFL wins by at least a touchdown.
Does all this matter? A lot, says Martin. “The real market produces a positive-sum game for society. Everyone can be better off as more and more value is created for customers. In contrast, the expectations market produces a gigantic zero-sum game. In trading, by definition, for every dollar won, there is a dollar lost. It therefore pits players against one another to split up a defined, finite pie.”
And that’s not the only difference. The real market is long term and relatively stable, the expectations market short term and volatile. The real market produces “meaning and motivation”; the expectations market “is all about gaining advantage.” John Maynard Keynes himself was concerned about the fact that the stock exchanges “absorbs otherwise productive capital in the function of speculation,” points out David Ellerman, a visiting scholar at the University of California, Riverside. “Keynes saw no problem when speculation was but a bubble on the stream of enterprise, but it was quite another matter ‘when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.’” That’s more or less the situation we’re in now.
Martin’s book offers a menu of modest reforms that might attenuate the link between the real market and the expectations market. But as he noted in a recent e-mail, not many people have jumped onto his bandwagon. “I can’t say that [Fixing the Game] has had a big impact…. I believe that it is too frame-breaking. Folks in the system are inclined to say that my view is too extreme and executives don’t do what I say they do—even though there is such strong evidence that they do.”
Employee-ownership advocates may wonder whether the whole system of ownership by absentee investors—investors who jump into or out of a stock purely on the basis of today’s ephemeral expectations—shouldn’t be thrown out and replaced by something else. Ellerman is one scholar who argues that ownership should always reside with the people who work for a company. Investors would be free to buy and sell “variable income debt-like instruments that are still liquid,” but they wouldn’t be owners of the enterprise.