Book review: The Outsiders

The book chosen for the debut deserves such a choice. Its name is The Outsiders, Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, written by William N. Thorndike, Jr. and published by Harvard Business Review Press in 2012. 

In addition to a foreword, an introduction, a concluding chapter, and an afterword, the book contains eight chapters, each devoted to a CEO noted for his or her abilities to efficiently allocate the available capital in their companies (capital allocation). The term capital is used in an economic rather than legal sense, since it corresponds not only to shareholder contributions but also to resources obtained from creditors or generated internally. Those elected to this corporate hall of fame, with their respective companies, are Tom Murphy (Capital Cities Broadcasting), Henry Singleton (Teledyne), Bill Anders (General Dynamics), John Malone (TCI), Katherine Graham (Washington Post), William Stiritz (Ralston Purina), Dick Smith (General Cinema) and Warren Buffett (Berkshire Hathaway).

These CEOs stood out for their ability to manage and allocate resources, both on the passive side, obtaining them by issuing debt, shares or internally generating funds, and on the active side, which involves allocating them, either by investing in existing operations, acquiring other businesses, paying down debt, paying dividends or repurchasing shares. In other words, asking: what is the best use for the next available dollar and what is its best source? Such a capital allocation task is far from simple; on the contrary, the failure or success of the company in question depends on the good design and execution of the strategy. That is why the book's foreword quotes Warren Buffett as stating that outstanding CEOs are so rare that when a company finds one it is almost impossible for his or her salary allocation to be unreasonable, a premise that goes against the grain of the criticism that has recently been generated both by the income of top company executives and by the rapid growth in the ratio between these and the average income of their employees. 

Among the characteristics that made these eight executives successful, three stand out. The first, when it comes to allocating available resources, is a propensity to buy back the shares of their own companies, a strategy rarely used in Colombia, for reasons that will be discussed later. Not infrequently a company's best investment opportunity is its own shares, especially when the market undervalues them. Thus, it has been common in the United States for companies with shares registered in a stock exchange to repurchase part of their securities when they consider that their price in the market is low and, when the opposite is observed, a high price, they will contribute them in kind or use them as a bargaining chip to acquire companies, whether in the same sector or in other industries of the economy.

Henry Singleton and his company Teledyne pioneered this strategy, which was rare before the 1970s. Teledyne repurchased 90% of its outstanding shares between 1972 and 1984. As an explanation of such buybacks, nothing better than the following conversation between Singleton and a Teledyne board member: "Arthur, I've been thinking about it and our stock is simply too cheap. I think we can earn a better return buying our shares at these levels than by doing almost anything else. I'd like to announce a tender - what do you think?"

Although there are financial reasons to justify them, share buybacks are not without controversy. Their large increase in the United States in recent years, due in part to tax reasons, has generated much criticism and even proposals for rules restricting their use (see Mariana Mazzucato, The Value of Everything: Who Makes and Who Takes from the Real Economy, p. 162-66).

The second characteristic is related to the first: some of the executives profiled in the book preferred that their companies never or almost never pay dividends, in order to finance themselves from their own resources. Again, Teledyne and its CEO, Henry Singleton, are a notorious example. Despite its good results, Teledyne paid no dividends for twenty-six years and made headlines when it did so for the first time in decades, in 1987, claiming to have found no better use for the company's money. More famous is the case of Warren Buffet, whose company Berkshire Hathaway has never paid dividends, and clearly it has not been for lack of success or profit generation, so much so that a single one of his shares is worth more than US$120,000. A third case is that of Dick Smith and his company General Cinema, which did pay dividends, but in minimal amounts, thus accumulating large amounts of cash while good investment opportunities arose. This decision could be criticized by shareholders who are financially dependent on a steady flow of dividends, but it is justifiable on the assumption that the company is better able to determine good investment opportunities than its associates and that this work should be done patiently, without making hasty purchases that could destroy value. The final example is that of TCI, a company that during John Malone's tenure did not pay dividends (1973 - 1996). This decision may have been influenced by Malone's libertarian disposition, who, according to the book, hated taxes and, to avoid them, accelerated the depreciation of his assets (which were abundant in his cable television company), preferred to finance himself with debt rather than stock, and only disposed of assets when the transaction in question had some tax advantage.

The absence of dividends did not necessarily mean bad news for shareholders. In some cases, as already noted, companies "distributed" their profits through share buybacks; in other cases, investors obtained profits through the valuation of their shares on the respective stock exchange and were free to decide whether or not to realize them through disposal.

The third characteristic is the emphasis on cash flow rather than book profits, a figure that the CEOs highlighted in the book considered to be of lesser relevance given the distortion to them generated by debt, investment, and tax levels. William Stiritz of Ralston Purina once stated that book value had no relevance to his business. His colleague John Malone, CEO of TCI, coined the term EBITDA, now widely popular both as a measure of a company's cash-generating capacity and as a useful indicator for determining its market value through the appropriate multiple.

Of the eight executives profiled in the book, by far the most distinguished figure is Warren Buffett, the so-called Sage of Omaha. Two of his phrases are relevant to conclude this review. The first reads: "Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks". The message is clear: in a company in crisis and without clear possibilities of recovery, it is preferable to concentrate efforts on a rapid liquidation and to use the resources saved in another company rather than to continue to be irrationally committed to rescuing an unsalvageable company. Viable companies should be saved, with the sacrifices that this implies, but for shareholders, stakeholders and society it is preferable for non-viable companies to be liquidated quickly, in line with Joseph Schumpeter's concept of creative destruction.

Buffett's second sentence will not be transcribed literally, suffice it to say that it is summarized in his preference for a low number of investments (limited diversification), significant stakes in the capital of companies and holding them for long periods of time. The tendency for concentrated investments is contrary to the widespread belief in the benefits of diversification, which minimizes risks when assets are negatively correlated, summarized in the aphorism "you should not put all your eggs in one basket" and which, explained with all the technical rigor, contributed to the Nobel Prize in Economics being awarded to James Tobin in 1981. Buffett's success does not undermine Tobin's theory; it simply shows that there are different investment styles whose outcome depends on who is at the helm.

 *Review courtesy of the Institute for Societal Analysis.