OPINION: To understand why Lampert failed you have to admit that shareholders are not the most important part of a company. Wall Street can't handle that.
- Eddie Lampert failed at turning Sears around because the premise of his approach was flawed.
- Activist investors like him are the purest expression of shareholder primacy, the idea that shareholders are the most important part of a company and the only people companies have a responsibility toward.
- This philosophy often puts shareholders in conflict with customers and employees — and that can mean game over.
It would be nice if Wall Street could have an honest discussion about why Eddie Lampert's attempt to turn around Sears failed so spectacularly, and why he's now proposing to acquire what's left of the 125-year-old company's crown jewels.
But frankly, Wall Street doesn't have the stones for that.
Eddie Lampert failed because the premise of how he ran Sears was inherently flawed. Before he was consumed by Sears, Lampert was an activist investor. That meant he purchased shares in companies and then attempted to make changes to boost the company's stock price.
On the surface this sounds like a good idea — get a good operator running a failing operation and you can make it healthy again. When he started with Sears, which he merged with Kmart, this was the plan.
But the problem with the premise is who activist investors are turning a company around for. It's not for the customers or the employees, it's for shareholders — for themselves and for their investors. These are actors who care singularly about a company's stock price, but a healthy company and a healthy stock price are not necessarily one in the same.
Shareholders don't drive sales in a company. Customers do. So, putting shareholders first might lead to a high stock price for a while — but it won't last long if that means you're neglecting what matters.
Lampert was clear about this in the early days. Here's what he told investors in 2007:
"Unless we believe we will receive an adequate return on investment," he wrote in a 2007 letter to investors, "we will not spend money on capital expenditures to build new stores or upgrade our existing base simply because our competitors do. If share repurchases or acquisitions appear to be more productive, then we will allocate capital to those options appropriately."
Quick recap: no spending on store upkeep, or improvements aimed at keeping up with the competition.
Lampert kept his word by the way. If you're unsure of that, just go find a Sears that's still open and take a walk through.
Activist investing is shareholder primacy — the idea that companies have an obligation to shareholders and shareholders alone — in its purest form. And Lampert shows that it's a disaster.
Hate mail and rent seeking
Before you send me an angry e-mail delineating all the successful activist investor plays, let me clarify that sometimes the needs of the shareholder and the customer are in fact aligned. This is the ideal situation for an activist investor, and it's often the story they sell in interviews etc.
But it doesn't always happen this way. Sometimes the needs of shareholders and customers are not aligned at all. This is what we saw in Lampert's case over and over again. You can't make shareholders happy while driving customers away and expect success. You can't make shareholders happy while driving employees away and expect success.
Eddie Lampert did both.
Both employees and customers are far more important than shareholders when it comes to the health of a company. Say that to an average person on the street and they'll agree easily. It seems obvious.
Tell that to Wall Streeters and they'll look at you like you have three heads.
Some academics think this obsession with shareholders is actually hurting the American economy overall.
"One factor contributing to sluggish economic growth is short-termism, a corporate philosophy that prioritizes immediate increases in share price and payouts at the expense of long-term business investment and growth," wrote researchers at The Roosevelt Institute(RI) in a paper about shareholder primacy back in 2016.
The paper pointed out that since the 1980s, companies have invested less than 10 cents of each borrowed dollar. Meanwhile, since from 2003 to 2012, S&P 500 companies used 54% ($2.4 trillion) of their earnings for stock buybacks.
This has led public firms to become far more risk averse than private firms, even though public firms are responsible for roughly two-thirds of all non-government R&D expenditures. Often the C-suite would rather make their next quarterly earnings report than make a profitable investment longer term investment.
"In other words, the financial system is no longer an instrument for getting money into productive businesses, but has instead become an instrument for getting money out of them," the RI researchers write. "The sector overall is now predicated largely on seeking rents through payouts rather than increasing profits through growth."
Wall Street is cheering on this ludicrous short-termism, of course. An example: Last year Disney announced it would invest in its streaming service. In response, Guggenheim analyst Michael Morris downgraded the stock.
"While we are optimistic that the company's proposed direct-to-consumer video products will create long-term value, we expect the initial investment and long lead time into the launch of the Disney-branded offering will weigh on sentiment over the next 12 months," Morris said.
Oh. So Disney, a historic company with enough content to circle the earth many times over, should get docked for making a comparatively small investment that will bring it into the streaming age?
It wasn't always this way in America. Until the 1970s people generally believed that the purpose of the corporation was not solely to make money for shareholders, but rather to enrich communities by providing services and employment.
"The purpose of corporations used to be to innovate, creating universities, building railroads, designing self-driving cars, and looking into commercial space transport," Lynn Stout, a professor at Cornell Law School and the author of "The Shareholder Value Myth," said in an interview with Marketplace. "These are really big long-term projects ... and what corporations are supposed to do."
Instead, thanks to shareholder primacy, corporations are being forced to meet the Street's expectations (shout out to our friend Michael). More importantly for our purposes, they're being forced to do battle with activist investors — the purest expressions of shareholder primacy in the market.
The playbook should seem obvious by now. It certainly is to the companies fighting off activists plays. Guys like Lampert (or Bill Ackman, who famously tanked JC Penney) go into a company, ask for board seats, then pressure stock buybacks and walk away confused when it seems like things are going their way.
Lost in all of that, of course, are the people who really matter to companies.
Until activist investors start considering customers, employees, and communities in their playbooks (not just accidentally but as a rule) they'll continue to act as a swarm of locusts — a Biblical plague on companies that takes what it wants only to move on leaving nothing for the people who actually matter.
That's the truth, and Wall Street can't handle it.