It would be presumptuous of me to act as defense attorney for outgoing Teva CEO Shlomo Yanai. Or as prosecutor either. However, it is hard to ignore the reaction of investors to the announcement that Yanai is stepping down, for more than it tells us about Yanai’s contribution, it tells us about the bizarre nature of the capital market. Teva’s share price has jumped by more than 12% since Yanai announced his resignation, of which 7% came on the day of the announcement itself. There are those who will argue that the capital market foresaw the move, so that the effect of the change of management is closer to 20% of the company’s market cap.
The elated response of the investors signifies two things about their outlook. One is that they see the the CEO, even in a company the size of Teva, as a dominant factor, decisive for its economic value. The second is that they believe that Yanai did not deliver the goods. The first view is certainly worthy of discussion, but the more acute question, which for some reason no-one is asking, relates to the second: what exactly are the goods that Yanai failed to deliver?
The answer to such a question generally lies in the company’s performance, but the worrying truth is that is this instance is lies elsewhere: in the performance of the stock. It’s hard to find cause for complaint to Yanai in Teva’s results, but since according to capital market doctrine the graph doesn’t lie, he is the one who is answerable for the trough that the share price finds itself in. But that’s just it, he isn’t. A CEO is responsible for the company’s profits, not for its share price.
This perverted view has become so strong in recent years that it has ceased to be that of financial investors alone, and has steadily taken hold of the real markets and the companies themselves. So it comes about that, unfortunately, more and more CEOs devote their time to managing the stock, at the expense of managing the company.
The best example of this is the well-known metaphor employed by former Citi CEO Charles Prince to explain to the “Financial Times” why he was continuing to finance leveraged deals aggressively: “As long as the music is playing, you've got to get up and dance…”
The music Prince referred to was the strident tune played by Wall Street, which demanded that he should continue to generate unreasonable returns on equity to justify the unreasonable pricing that it had itself given the bank. This absurd mechanism collapsed of course, and with it Citi and the investors.
There are other examples of distortions encouraged by the capital market: companies that insist on continuing to pay dividends even when the business is going downhill (because the capital market likes cash…); companies that buy back shares simply to boost earnings per share (instead of increasing the numerator, they reduce the denominator…); companies that invest in PR instead of buying fixed assets and infrastructure (because it’s more effective not for the company, for the stock…); and the list goes on. Many challenges lie in wait for Teva in the future. The expectation that the CEO, however talented he may be, will overcome them all is unrealistic; to a great extent, it’s an illusion. The rise in Teva’s share price is justified, but not because of Yanai’s departure.
The bottom line: it is characteristic of the capital market that it simplifies reality to the point of absurdity and pushes it to the extreme. This is exactly what happened with Teva recently. The share price fell for the wrong reason, and rose for the wrong reason, which made it a clear buying opportunity when it touched $35, and will make it much less attractive the day it crosses the $55 threshold, irrespective of the identity of the CEO. The attempt to see the outgoing CEO as the explanation for the low to which the share price sank is a childish excuse to my mind, the product of a kind of desire to find a rational explanation for irrational behavior. That’s how the capital market is sometimes.
The writer is head of equity research at Bank Leumi.
Published by Globes [online], Israel business news - www.globes-online.com - on January 19, 2012
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