3 1 Why Value Value? The guiding principle of business value creation is a refreshingly simple con- struct: companies that grow and earn a return on capital that exceeds their cost of capital create value. Articulated as early as 1890 by Alfred Marshall,1 the con- cept has proven to be both enduring in its validity and elusive in its application. Nevertheless, managers, boards of directors, and investors sometimes ignore the foundations of value in the heat of competition or the exuberance of market euphoria. The tulip mania of the early 1600s, the dot-coms that soared spectacularly with the Internet bubble, only then to crash, and the mid-2000’s real estate frenzy whose implosion touched off the financial crisis of 2007–2008 can all to some extent be traced to a misunderstanding or misapplication of this guiding principle. At other moments, the system in which value creation takes place comes under fire. That happened at the turn of the twentieth century in the United States, when fears about the growing power of business combinations raised questions that led to more rigorous enforcement of antitrust laws. The Great Depression of the 1930s was another such moment, when prolonged unemploy- ment undermined confidence in the ability of the capitalist system to mobilize resources, leading to a range of new policies in democracies around the world. Today many people are again questioning the foundations of capitalism, especially shareholder-oriented capitalism. Challenges such as globalization, climate change, income inequality, and the growing power of technology titans have shaken public confidence in large corporations.2 Politicians and com- mentators push for more regulation and fundamental changes in corporate 1 A. Marshall, Principles of Economics (New York: Macmillan, 1890), 1:142. 2 An annual Gallup poll in the United States showed that the percentage of respondents with little or no confidence in big business increased from 27 percent in 1997 to 34 percent in 2019, and those with “a great deal” or “quite a lot” of confidence in big business decreased by five percentage points over that period, from 28 percent to 23 percent. Conversely, those with “a great deal” or “quite a lot” of confidence in small business increased by five percentage points over the same period (from 63 percent in 1997 to 68 percent in 2019). For more, see Gallup, “Confidence in Institutions,” www.gallup.com. 4  Why Value Value? governance. Some have gone so far as to argue that “capitalism is destroying the earth.”3 Many business leaders share the view that change is needed to answer society’s call. In August 2019, Business Roundtable, an association of chief executives of leading U.S. corporations, released its Statement on the Purpose of a Corporation. The document’s 181 signers declared “a fundamental com- mitment to all4 of our stakeholders.”5 The executives affirmed that their com- panies have a responsibility to customers, employees, suppliers, communities (including the physical environment), and shareholders. “We commit to de- liver value to all of them,” the statement concludes, “for the future success of our companies, our communities and our country.” The statement’s focus on the future is no accident: issues such as climate change have raised concerns that today’s global economic system is short- changing the future. It is a fair critique of today’s capitalism. Managers too often fall victim to short-termism, adopting a focus on meeting short-term performance metrics rather than creating value over the long term. There also is evidence, including the median scores of companies tracked by McKinsey’s Corporate Horizon Index from 1999 to 2017, that this trend is on the rise. The roots of short-termism are deep and intertwined, so a collective commitment of business leaders to the long-term future is encouraging. As business leaders wrestle with that challenge, not to mention broader questions about purpose and how best to manage the coalescing and colliding interests of myriad owners and stakeholders in a modern corporation, they will need a large dose of humility and tolerance for ambiguity. They’ll also need crystal clarity about the problems their communities are trying to solve. Otherwise, confusion about objectives could inadvertently undermine capital- ism’s ability to catalyze progress as it has in the past, whether lifting millions of people out of poverty, contributing to higher literacy rates, or fostering in- novations that improve quality of life and lengthen life expectancy. As business leaders strive to resolve all of those weighty trade-offs, we hope this book will contribute by clarifying the distinction between creating share- holder value and maximizing short-term profits. Companies that conflate the two often put both shareholder value and stakeholder interests at risk. In the first decade of this century, banks that acted as if maximizing short-term profits would maximize value precipitated a financial crisis that ultimately destroyed billions of dollars of shareholder value. Similarly, companies whose short-term focus leads to environmental disasters destroy shareholder value by incurring cleanup costs and fines, as well as via lingering reputational damage. The best managers don’t skimp on safety, don’t make value-destroying decisions just 3 G. Monbiot, “Capitalism Is Destroying the Earth; We Need a New Human Right for Future Genera- tions,” Guardian, March 15, 2019, www.guardian.com. 4 Emphasis added by Business Roundtable. 5 Kevin Sneader, the global managing partner of McKinsey & Company, is a signatory of the statement.