The Firm
Marvin Bower faced a critical choice. He had led McKinsey & Company from its earliest years, in the process helping to define the fledgling field of management consulting.1 Now nearing retirement age, it was time to hand the reins to the next generation of leaders. As the principal shareholder in the partnership, Bower’s ownership stake was a gold mine, appreciating to many multiples of its value since his joining roughly thirty years prior.
To cash out he could sell to a third-party buyer interested in taking over operations. Alternatively, he could require the current partners of the firm to buy out his stake at market value. This would involve significant indebtedness that could constrain future agility.
Bower chose a radical, nearly unprecedented path. When the time came for him to step down as managing director, he elected to sell his shares back to the partnership at their nominal book value instead of their true market price. In the process he would forego a massive windfall, while also setting an example that would reverberate throughout the organization for decades to come. For Bower, a one-time gain was not worth more than investing in the culture and health of the institution he had laboriously built up.
A few decades later, partners at upstart competitor Bain & Company were in a similar situation. By the mid-1980s the rival consulting firm was flying high, and its founding generation was eager to capitalize on what they built. Bain’s senior partners took a different approach than Bower, monetizing their stakes at a valuation that saddled the company with debt that junior partners were now accountable for.
A downturn in Bain’s business coupled with the general market slowdown later in the decade combined to put extreme stress on the company, to the point that its survival was in doubt. Its rising generation of leaders threatened to leave for more favorable situations elsewhere, and since human capital is the main asset of consultancies that would have left little of value. A complex series of negotiations ensued in which a former leader brokered a deal that kept the place together, lessening the ruinous debt load and placating disgruntled staff.
Barnyard lessons
Folk traditions around the world have produced many variations of a single story. In the canonical version, an impecunious peasant or farmer comes into possession of a goose that begins to lay golden eggs in lieu of the usual kind. The owner is surprised by this upending of the natural order but soon becomes accustomed to his good fortune. Each day a new lump of gold is added, slowly but steadily building his family’s wealth.
But this steady incremental growth is not enough. The farmer wonders if he might access the whole store of wealth at once instead of waiting patiently for each day’s deposit. The lure of massive riches becomes overwhelming, and in a fit of avarice the farmer slaughters the animal, hoping to capture the entire trove of golden eggs.
To his horror he discovers that his bird is the same on the inside as any other, and whatever alchemy it was that transformed a lump of calcium carbonate into gold has ceased permanently. Nothing can be done to raise the animal back to life. The gold it provided earlier is quickly spent, the chastened owner eventually reduced to his former condition. Thus many societies have codified hard-earned lessons against greed.2 Grasping too fiercely for a good thing can end up weakening or killing it off entirely.
Now imagine a profitable industrial concern that steadily produces widgets for heartland customers. It has been around for a few generations, and with good stewardship and steady investments in research and product development it might continue for a few more. Its owners are content with their profits, knowing they will have an enterprise to bequeath to their children, or some other members of future generations.
This widget maker is the analogue to the proverbial goose, and with the appropriate view towards long-term health it continues to thrive. This works if the owner considers her role as part in a chain that extends to a broader community, including those not yet born.
Modern capitalism adds an unfortunate twist, in that with the appropriate leverage and support from capital markets you can acquire a golden goose that belonged to many, or would provide for multiple generations, and squeeze out as much as you can for yourself right now. Whether it lives or dies need not trouble you, as long as you are able to cash out and move on.
If it is more profitable to extract more cash now and kill the enterprise, that is what someone will do. If loopholes exist, then an enterprising individual will assemble the talent and capital and figure out a way to plow straight through it, carrying out as much cash as possible until the money train derails.
Golden handcuffs
This is where the parable breaks down. In many cases trying to extract too much value too soon can destroy the engine of value creation. Yet in some cases it can leave one party enriched at the expense of an institution that would have benefited many others. Bower’s personal fortune would have been greatly multiplied had he followed the usual business practice when it came time to sell, and the senior Bain partners who brought their firm to the brink did quite well for themselves.
In 2001 the then-partners of the firm Accenture elected to float their company on the public markets, in the process personally reaping multimillion dollar returns. The business itself has since gone on to thrive by financial standards, growing substantially in headcount and share price. The loss is harder to quantify, since the future generations of consultants that would have grown up within and stewarded a private partnership never existed.
When establishing the ownership structure for investing behemoth Vanguard, Jack Bogle made the decision to eliminate private ownership of the fund company, giving these stakes to the mutual funds themselves. This implicitly made investors in Vanguard’s products the owners of the company itself, boosting their cumulative returns by billions of dollars. Bogle himself was no pauper, but his fortune was nowhere near those of creators of competing firms, like Charles Schwab or Fidelity. The gold he could have hoarded for himself was spread out among a much larger class of people, such that Warren Buffett viewed him as one of the greatest contributors to investors’ wellbeing in history.
What Bower gave up personally was far outweighed by the value captured and created by generations of consultants who developed within the McKinsey model he left as a legacy. Similarly Bogle’s losses were more than countered by the significant gains that accrued to the average, unsophisticated investor that chose his firm.
Taking as much as you can might be the rational thing to do, and profit-maximizing behavior might create the highest personal gains. Sometimes societal gain might be higher with a different approach.
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References
BuzzFeed News, of all places, has a rundown of the financial turmoil that nearly sunk Bain & Company in the 1990s.
