PROBLEMS WITH FINANCIALIZATION(#23)
23. But despite these positive developments, financialization has contributed to a whole assortment of negative trends and consequences. We will address only two—commoditization and short-termism. Financialization has tended to completely commoditize businesses, reducing the meaning of this human enterprise to nothing but a price. In particular, the financial sector has contributed to this commoditization trend by equating the purpose of business to shareholder wealth maximization. Shareholder value has become virtually the sole metric by which business leaders determine their performance and their worth. In the current climate, the call to “maximize shareholder wealth” remains dominant and is the leading theory taught in many business schools. Along with this commoditization have come short-term mentalities under which leaders are tempted to become fixated on the upside potential for short-term success, and to downplay the consequences of excessive risk-taking and strategic failure. It is not surprising that the opportunity to acquire enormous wealth in relatively short timeframes provides a strong incentive for dysfunctional behaviour. Pope Benedict XVI noted these dangers when he wrote: “Without doubt, one of the greatest risks for businesses is that they are almost exclusively answerable to their investors, thereby limiting their social value.... [I]t is becoming increasingly rare for business enterprises to be in the hands of a stable director who feels responsible in the long term, not just the short term, for the life and results of the company”.
Commentary: The financialization of a company focuses everyone's attention on shareholder return. All that matters is that number. So what's wrong with that? There are at least four major problems with this focus:
1) Catholic social doctrine teaches us that businesses exist to increase the dignity of the people involved with it: employees, customers, suppliers, shareholders, those in the community. The person should be the purpose of business, not shareholder wealth. Financialization abandons the person to the metric of shareholder return. Replacing a person with a number is a violation of the Church's social doctrine, and is at the root of Pope Francis' anger towards modern day capitalism.
2) "Short term-ism" is the focus of many public companies who are evaluated primarily on the basis of their quarterly financial results. It is difficult to do long-term planning in this environment because the required investment often reduces reported profits, free cash flow, or ROI and many companies are then punished by the market.
3) Innovation requires cash that is often invested in financial activities that drive "return on capital employed," rather than in new products or services. The capital required by a project with a longer term payoff will reduce ROCE. IBM became a darling of the financialization investment community. Its stock price has suffered greatly as innovation withered.
4) As the financial sector becomes a larger part of the world economy, fewer investor dollars are available to expand companies that actually produce something. The productive economy continues to shrink, along with the jobs that go with it.