Bain just-released a study “Firm of the Future” which examines new company ownership and investment models evolving to better match long-term goals with the expectations of investors.
Here’s what Bain research predicts:
The line between public and private ownership will blur. Large public companies will pursue long-term anchor investors and adopt the governance practices of leading private investors, while larger private companies will trade in secondary markets that require enhanced investor protections. The line between debt and equity will also blur, as off-balance-sheet project-based equity becomes a significant funding source. Investors will invest in projects rather than companies, creating a new ecosystem of financial intermediaries to help them identify and gain access to the best projects. Activist investor techniques, both short and long term, will increasingly be adopted by traditional money managers in pursuit of alpha.
CEOs, CFOs and corporate boards have voiced increasing dissatisfaction with the current trend of investing less in their businesses; and many institutional investors such as Vanguard, BlackRock and Warren Buffett have urged greater long-term focus and reinvestment. Activist investors have become increasingly successful in applying shorter-term pressure to the CEO/CFO agenda, despite controlling only about $150 billion in assets under management (compared with the $30 trillion held by mutual funds).
Alongside the headlines from activists, a host of alternative models is gaining traction. Private equity firms have had to lengthen their investment horizons to create value with their portfolio companies, from 4.5 years in 2006 to 6 years in 2016; Blackstone, Carlyle Group and others have recently launched funds with longer target holding periods. Scale start-ups— the leading engine of job creation—are staying private longer, on average 11 years in 2014, and, in some cases, are even going straight from venture to private equity ownership to provide liquidity to early investors and employees. Nasdaq’s Linq platform now enables many of the functions of public markets (shareholder services, share registries, even secondary trading) for privately held companies.
More on the study below
In the world of the firm, something is changing. It’s not that your local bookstore went out of business. Or that your taxi driver now rates you on a 5-point scale. Or that anything can now be outsourced, allowing even the smallest firms to rent capabilities on demand. It’s more profound than these.
The prevailing paradigm that has underpinned business for the past 50 years is under review. The simplest version of that paradigm is that firms exist first and foremost to deliver returns to their shareholders’ capital—and the sooner they deliver it, the better. We will describe the challenges confronting this paradigm. But the first question we asked as we observed the changes was this: Is such a shift unusual? Has the idea of the firm been consistent over time, or has it changed before?
What we learned from looking back was that, similar to other human endeavors, the idea of a business has evolved slowly but profoundly through a series of what we can now see as definable eras: periods when particular strategies, corporate forms and styles of management became the dominant norm. We have observed five distinct eras since the industrial revolution. These eras include the current period, which we call the “shareholder primacy” era.
Transitions between eras play out over decades. The edges are fuzzy and often become clear only in hindsight. Some elements of the previous era remain in place, while others evolve into something quite different. The shareholder primacy era, for example, retained and enhanced several features of the previous period, including the importance of professional managers and the pursuit of scale to achieve leadership economics. But companies in the current period refocused on their core businesses, shed noncore assets, outsourced more and more functions, and made their remaining assets sweat harder. That focus, combined with a high rate of mergers and acquisitions, fostered increasing concentration within industries. CEOs and management teams, often holding significant equity stakes designed to align their interests with those of other shareholders, dedicated overwhelming attention to delivering shareholder returns. The ones who succeeded earned substantial rewards.
Today, the shareholder primacy era is under pressure from multiple sources. Technologies, markets and customer expectations are all changing rapidly. To cite just a few examples:
- As the economy has become more service-oriented and increasingly digital, the importance of speed has increased dramatically. Those who can’t keep up fall by the wayside. For instance, five-year survival rates for newly listed firms have declined by 30% since the 1960s, according to new research from the Tuck School of Business at Dartmouth College.
- Capital is superabundant. Global financial assets are now 10 times global GDP, making talent and ideas rather than capital the binding constraint on growth in most large companies.
- Industries have become more winner-take-all. A Bain study of 315 global corporations found that just one or two players in each market earned (on average) 80% of the economic profit.
- The pursuit of shareholder value itself increasingly focuses on the short term, driven by shorter management horizons and greater pressures from activist investors. Leverage, buybacks and dividends are up, while long-term investments in growth have lagged.
Within the firm, it feels harder than ever to translate strategy into rapid and effective execution. In our conversations with CEOs, we consistently hear how difficult it is to free up trapped resources to mobilize against important challenges and opportunities, despite the obvious and growing need for speed. Many companies are stuck in a resource-allocation doom loop that, despite best intentions, allocates next year’s resources more or less in line with this year’s revenue. It’s a formula for incremental improvement, not one for reacting to new competitive threats or new customer needs—or for proactively creating new demand.
Meanwhile, many younger employees, who now form the largest generational cohort in the workforce, are increasingly skeptical about corporate career paths. Some prefer the gig economy of Uber, TaskRabbit or Amazon’s Mechanical Turk. Others join corporations but plan on staying for only a few years. Though we can’t yet know how this generation’s work lives will play out, many of its members today place a higher value on new learning and new experiences than on traditional incentives such as moving up the corporate hierarchy.
Many of these younger employees, along with many older ones, also want to work for a company that pursues a higher purpose in addition to profits. CEOs have become acutely sensitive to this concern; in conversation after conversation with leaders, we are struck by how quickly the talk moves to how a company can engage and inspire team members with a vision of making a difference in the world. Jack Ma, founder and executive chairman of Alibaba Group, puts it clearly: “Customers are No. 1, employees are No. 2, and shareholders are No. 3.” Even Jack Welch, the shareholder primacy era’s greatest maestro as CEO of General Electric, has more recently reflected, “Shareholder value is a result, not a strategy…. Your main constituencies are your employees, your customers and your products.” A growing number of CEOs see a higher purpose not as a side issue or fluffy topic but rather as a central element of their culture, people and customer strategies.
Externally, governments and public opinion have become more activist, whether through regulation, the courts or simply exerting pressure on CEOs. Critiques of inequality