McKinsey’s Ian Davis: Maximizing Shareholder Value Doesn’t Cut It Anymore

Shareholder value is growing increasingly irrelevant as government and society take a larger role in shaping business and industry, according to Ian Davis, managing director of McKinsey, the global management-consulting firm.

In a Wharton Leadership Lecture, Davis said new societal pressures, such as regulation and environmental sustainability, are now joining the list of long-standing issues — including growth, globalization and technology — that weigh on the minds of CEOs.

In much of the world, government, labor and other social forces have a greater impact on business than in the U.S. or other more free-market Western societies, Davis said. In China, for example, government is often an owner. “If you’re talking in China about shareholder value, you will get blank looks,” said Davis. “Maximization of shareholder value is in danger of becoming irrelevant.”

Davis predicted large multinationals would continue to consolidate, growing to such massive size that they will increasingly bump into political and societal conflicts. In Europe, successful businesses are often viewed with suspicion — an attitude Davis worries is growing more prevalent in the United States. “Big businesses have to be forthright in saying what their role is in society, and they will never do it by saying, ‘We maximize shareholder value.’”

Regulators will “whack” companies that take such a stance, he said. Companies must take control of defining themselves and explain their approach to regulators, staff and the community in a moral sense, not just as a profit-making enterprise. As private equity deals grow increasingly large, those firms, too, will need to be much more open with regulators and society. “You can’t buy a $20 billion dollar company and then say, ‘We’re secret. We’re managing value for the shareholders.’”

Davis suggested that any discussion of shareholder value should be placed in the context of a timeframe, or it has little meaning. Are the company’s actions designed to boost shareholder value in the next quarter or 20 years from now? “Asians understand this very well. All plans are on a 20-year timeframe,” he said, adding, “Shareholder value for me is a very lazy concept.” He doesn’t even like the term, preferring the phrase “economic profit” instead.

“Don’t Screw Up”

Born in Britain, Davis studied philosophy at Oxford University and worked for a paper company before joining McKinsey 25 years ago. He was elected managing director in 2003. Davis pointed out that he, and about half the staff at McKinsey, do not hold MBAs.

Although he is based in London, Davis travels extensively, often to Asia, and is in frequent contact with CEOs of the world’s largest multinationals. In addition to increased pressure from governments and societies, Davis went on to describe other issues he said chief executives have been worrying about for two or three years. Barring a major unforeseen global crisis, these concerns will probably continue to preoccupy CEOs for several years, he predicted.

The first concern is growth. While growth is obviously not a new business issue, the pressure to grow must be balanced against the risks inherent in a growth strategy. “The real dimension is risk,” he said, adding that it comes in many forms: business risk, financial risk and government risk, such as new regulatory scrutiny put in place after the scandals at WorldCom and Enron.

“The psychological impact of Sarbanes-Oxley cannot be underestimated,” said Davis. The legislation, which makes executives personally liable for corporate misdeeds, has caused boards in the United States and Europe to become increasingly risk-averse. “CEOs are under tremendous pressure to grow, but the attitude of the board is, ‘Whatever you do, don’t screw up, at least not on my watch.’” Executives need to develop a much greater understanding of risk, and new frameworks to gauge its impact on growth, Davis said, adding that “insufficient emphasis has been placed by academics, consultants and clients on understanding the panoply of risk.”

A second major topic is globalization. Davis noted this, too, is not a new subject for CEOs, but one that is evolving in unexpected ways. “I’m talking about Mach4, second- and third-order consequences of globalization,” he said. As globalization began to take off 10 to 15 years ago, managers approached world markets with a simple export mentality. Now companies are being required to integrate more fully into foreign societies, a development that creates new challenges, particularly when it comes to managing people.

“The license to play requires companies to be insiders. That places huge challenges on the organization,” said Davis. He told the story of a Silicon Valley chief executive with a modern-day dilemma over hiring a new finance chief. He could promote one candidate from headquarters at a salary of $750,000 or give the job to an employee based in India, who was actually more qualified, for $25,000.

Law is another area where globalization is having unexpected consequences. For example, Davis pointed out that Western executives often complain that China does not respect intellectual property rights, yet an understanding of China’s past would show that the concept of property rights is not part of the country’s history. Chinese authorities know they will need to develop intellectual property protections, but at the moment, there are only eight judges to try that kind of case. There is a need for 800, said Davis. “These are the second and third-order consequences that are not very well understood by Westerners going to Asia. I think the Asians, when they come to the U.S. — and they will come — will struggle as well.”

Technology is the third major concern Davis discussed — again, not a new issue, but one that is now having greater impact as it begins to seep deep into business organizations. The Internet is probably the most important technology transforming the human dimension of organizations, he said. Technology is huge. You don’t have to be a techie, but you do need to understand the technology and what it can do in terms of organizational effectiveness.”

Fourth on executives’ minds is organizational capability. Talent is only one component of capability. “If talent is not trained or relevant to the task at hand,” it won’t have an impact, he said. Capability comes in many forms: emotional, psychological and intellectua. Sometimes even physical capability is important in business. “Intellectual can be dominant, but often human capability, like the emotional stability to deal with stress, can, in certain circumstances, be crucial.”

In most companies, talent is misdirected close to 70% of the time, according to Davis. Often the mismatch between an employee’s capabilities and his or her assignment is most obvious from the CEO’s vantage point. One CEO told Davis that his main job — his definition of strategy — is matching managers’ capabilities to the work that needs to be done.

Davis was asked how companies should balance matching individual capabilities with specific tasks, and still be able to develop management talent when new challenges arise that might be beyond an employee’s capabilities. He said it is possible to do if top executives have a clear strategic view of what they need and a sense of the people who could ultimately fill senior leadership roles. Then top management should be prepared to invest in those people and tolerate some mistakes.

Business today, he said, is unwilling to accept any degree of failure, even small mistakes that might help future leaders avoid catastrophes in the long run. “We’re in a culture that says, ‘If you fail, you’re gone.’” He argued that most people learn more from their mistakes than their successes. Often CEOs are fired for a mistake, just as they are becoming strong and wise executives. “It’s tragic,” said Davis. “My general experience is that if you have highly capable, motivated people in the right place, most other problems go away.”

The “Usual Suspects”

How do these themes bear on leadership?

Davis said one word captures what is necessary: diplomacy. He defined diplomacy in the business context as “the ability to influence events through the force of personal and moral character…. I think business, NGOs (non-government organizations) and public sector leaders are all going to have to learn the useful skills of diplomacy to explain in a positive way what they do and why they do it.”

He bristles at the concept of corporate social responsibility, or CSR.”I don’t like the way the C is put before the S and R,” he noted, adding that individuals, media, NGOs and governments should all share in social responsibility. “Of course corporations should be socially responsible, but so should a lot of other people,” he said. “Why should corporations be the primary vehicles for social responsibility?”

Corporate giving programs are acceptable if they have shareholders’ approval; otherwise executives are giving away other people’s money, said Davis. Owners of a privately held company can donate as much as they like. “If Google wants to do it, that’s fantastic.”

Davis stressed that the issues he focused on in his speech go beyond the “usual suspects” of CEO concerns — such as costs, corporate structure, customer relationships and strategy. “These subjects matter a lot, but they’re starters. You’ve got to get them right.” Even companies that do get the “usual suspects” right don’t necessarily thrive, he said. To differentiate themselves in the future, companies will need to build strategies taking into account the larger themes of society and government.

The new demands on business are changing the consulting industry, too, said Davis. Companies like McKinsey can no longer get away with offering only analytical solutions. Client firms are now filled with MBAs and former consultants who can do much of that work in house.

Companies still need consultants, however, to provide an independent, objective analysis, according to Davis. Successful consultants must also continue to provide specialized expertise but with a fully integrated approach. Finally, he said, consultants should begin to develop teaching skills to reach their clients.

The future of the consulting industry is secure, he added. The profession has been around for centuries, with consultants performing the same job under other names, including courtiers, academics or lawyers. “I think there is a deep human need for advice,” said Davis. “If I have a personal problem, I talk to a friend.”

As a consultant, Davis is the one companies turn to for advice. “Other people’s problems are easier,” he said.

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