The Man Who Broke Capitalism

I initially started my share portfolio in mid 1996 with 110 shares in Mayne Nickless. I had just bought my first home, read a book about share market investing for the first time, and saw an ad in the Australian Financial Review about endowment warrants.

I made an enquiry with a stockbroking firm trying to sell such warrants who then blithely informed me that Mayne Nickless was about to divest themselves of their 25% holding in Optus, and that the likely capital return would cause such warrants to pay themselves off in no time at all.

I decided I would rather go with the shares than the warrants, given that I was curious about obtaining Optus shares through this divestment.

Over the three years or so I held my Mayne NIckless shares (a $1000 investment), I learned a lot more about the share market than one could from reading a beginner’s guide. Firstly, the shares had spiked when the Optus divestment was announced, so I had bought them at about a 50% premium to where they had been previously. Secondly, the divestment (which came to involve a float of Optus) was significantly delayed by a major unexpected lawsuit involving disagreements over Optus’ pay TV arm, Optus Vision. These developments taught me a fair bit about the exuberance that investors such as yours truly allow to lead us astray when making decisions on buying and selling shares.

A few other more mundane lessons followed – such as participating in the dividend reinvestment plan (something I no longer opt into for any company), and taking up my entitlement offer to buy the shares in Optus eventually (again, something I think carefully about before I participate in these days). Finally, selling my Mayne Nickless and Optus shares at a time when buying and selling shares was not quite as easy as it is now.

It was still, in the mid 1990s, a time when share certificates would be physically issued when you bought shares in a company, and then would need to be sent back to the broker when it was time to sell. A pity I did not wait a while longer, as I might otherwise still have those share certificates as a souvenir.

Mayne Nickless was transitioning as a business at the time. It had been a logistics giant with an ancient lineage in Australia, but had encountered regulatory head winds in the early 1990s when some sharp business practices were discovered. Aside from selling out of Optus, it was rather listlessly divesting itself of various of its logistics businesses and putting the money into other operations. At the time I was a shareholder, nursing homes were the new direction for Mayne Nickless. This did not seem to be going that well for them.

Enter a new CEO. I am not sure whether Peter ‘Pacman’ Smedley became CEO before or after I sold my shares, but he did come both with a formidable reputation and considerable drive. He had gotten his nickname as CEO of Colonial, where he had undertaken many deals, buying up and merging many businesses to build Colonial First State.

Mayne Nickless became Mayne Group, and then started to focus their attention on pharmaceuticals. These days, it exists as Mayne Pharma, and I don’t think it has any real resemblance to the company I bought those 110 shares in almost three decades ago.

I know now years later that Pacman’s principal management focus of acquisitions and divestments was not unique to him (neither was his nickname), and nor was it necessarily effective, but was one of the three main tiers popularised by Dr Jack Welch, CEO of General Electric between 1981 and 2001.

Welch’s management approach has become known as ‘Welchism’, and I just finished reading a book all about it, David Gelles’ The Man Who Broke Capitalism. Welch took the value of GE from $14 billion in 1981 to $600 billion by the end of his reign.

He did this through three main techniques:

. treating staff as a cost rather than an asset – resulting in retrenchments, outsourcing, and offshoring

. dealing making – continually acquiring new businesses and selling others, regardless as to whether they fitted into the company or were profitable

. financialisation – engineering the financial reports each quarter so as to make it appear that the company was continually growing its profits.

Such techniques, as the manager of a large business, can sometimes be compared to sweeping dust under a carpet to make it a problem in the future. That GE is no longer a significant company is one of the legacies of ‘Neutron Jack’ Welch, but not the sole one, nor the major one.

Even though GE was a profitable and well run company, Welch sought to cut employees ruthlessly from the time he started as CEO. Outsourcing and offshoring soon followed. GE went from a company where it was a model employer with lifelong and even intergenerational loyalty to the company to one where employees were seen as a liability, and a ‘war on loyalty’ followed, one where ‘rank and yank’ was a major part of the staff management policy.

This has had a lasting and devastating impact on middle America, marking the start of the erosion of the lower middle class in America in recent decades.

The dealing making that followed often approached absurd. GE Capital, originally created to help consumers afford to buy electric goods from GE, became a major financial institution, and one which often was exposed to high risk financial markets. Some core business units, not being the top ones in their field, were divested. General Electric, which was started as a factory by Thomas Edison to make light bulbs, no longer has a light bulb division. It bought the NBC network. Content creation, rather than TV creation, seemed to matter more suddenly.

The financialisation, which involved juggling numbers to create the impression that profits were going up every quarter, has had significant consequences. Aside from creating a short sighted management focus on short term gain rather than long term planning, it also has created a management culture in corporate America where creative accounting to make numbers that fit the results has from time to time resulted in outright fraud, such as in Enron.

Putting these matters together, Welchism has led to the sad state where the CEOs of major listed companies are paid obscenely high ratios of remuneration compared to the average employee of their companies.

Australia is not immune to Welchism. Alan Joyce, the now widely reviled former CEO of Qantas, enjoyed a remuneration package very Welchist in its scale, whilst employing Welchist techniques.

His ruthlessness in dealing with Qantas staff, combined with his pursuit of outsourcing and offshoring, both damaged relations with employees and the general reputation of Qantas.

The outrage which emerged from the way that Qantas benefitted from massive taxpayer support during the pandemic and then gouged a major profit immediately afterwards is reminiscent of the way Welch manipulated financial results.

So too is the scandal which resulted from the discovery last year that Qantas had knowingly been selling tickets on flights which had already been cancelled. To say nothing of the obtuse way that people could claim and use credits from flights cancelled during the pandemic, and the declining value of frequent flyer points.

I am a believer in free market capitalism, and I am not prepared to agree with one of David Gelles’ underpinning arguments, that is, that Welch and his ilk were able to thrive because of an intellectual revolution arising from the thinking of Milton Friedman and similar advocates for free market capitalism.

The Friedmanite idea that the interests of the share holders in a business are the primary concern of the directors was the major one which Gelles blames for Welch’s actions as a CEO.

I however do not think that this idea necessarily leads to the atrocious outcomes that arose from Welch’s management techniques. Shareholders do not benefit from short term thinking which results in the long term destruction of shareholder value, nor from irresponsible decision making which allows CEOs to operate with impunity and to enrich themselves regardless of whether they run a company well or into the ground.

What I think is the cause of the behaviour of Welch, other such CEOs, and company directors generally is a lack of general decency or ethics, combined with a lack of an informed and active investor class able to confront and challenge management misfeasance.

Until the culture changes and we come to expect our CEOs to behave with more decency and less greed, it is well enough to blame Milton Friedman for his ideas, but that won’t fix anything.