In September 2009, Kraft, a company perhaps best known for its macaroni and cheese, made an unsolicited offer for Cadbury, the creator of the iconic Cadbury Easter Egg. Cadbury’s board of directors gave the offer a direct cut, and the U.K. public also proved very resistant to the idea of a U.S. firm buying a brand so closely aligned with the very essence of Britishness.
Kraft ignored the rejection and launched a hostile takeover, citing substantial synergy with Cadbury. The investment community, however, wasn’t convinced the buyout created value. Warren Buffett, a large Kraft shareholder, opposed the deal. Even as Kraft’s share price dropped, they pushed Cadbury to accept.
Much to the dismay of Anglophiles everywhere, the Cadbury board agreed to terms in 2010 and consummated the deal with Kraft. Even then, the markets remained unpersuaded. Though Kraft’s stock rose five percent from the time of its initial proposal to the final agreement, Kraft’s shares trended down while the S&P 500 rose 15 percent over the same period.
Kraft’s more active investors, including the hedge fund Pershing Square Capital, pushed for a strategy revision. Only 18 months after the Cadbury acquisition, Kraft announced that it would split the stable, but slower-growing products, like Oscar Meyer, Jell-O, Maxwell House, and the famous Kraft Macaroni & Cheese into a separate business from the faster-growing snack brands. Kraft moved to “unlock value,” and the capital markets were predictably happy with the split.
With each of these strategic moves, who was in charge of Kraft’s strategy? Was it managers using their superior knowledge to create a corporate theory and execute strategy? Or were investors in charge, pushing managers to forgo what investors perceived as empire-building, value-destroying moves?
A fundamental question underlies the tension in this example and many others: Who should ideally set strategic direction — expert managers with deep knowledge of their industries and resources, or an independent “crowd” of investors and their advisers? The answer is not obvious.
On the one hand, managers as experts have access to information often unavailable to the market, including extensive knowledge of the resources available and opportunities present in their own organizations. On the other hands, the capital markets aggregate a vast array of disparate opinions of investors (and potential investors) about a firm’s proposed actions.
Moreover, if an organization’s task is to maximize enterprise value, there is clear wisdom in taking strategic actions consistent with investors’ beliefs and theories. After all investors, establish the value of the enterprise. Why not give them what they want?
Essentially, the issue that underlies these divergent paths is a problem of agency. Managers are hired to act in investors’ interests because they possess information and skills that investors lack — information vital to composing a valuable corporate theory that may diverge from the simple value-maximizing motives of investors. So the choice for owner-investors is to either allow managers — with their self-serving incentives, but presumably better information to choose the theory, or to maximize their own control by shaping managers” incentives to simple attend to investor signals and feedback, in some sense crowdsourcing the selection of strategic action from the beliefs of the investors.
As a result, we face two very different philosophies about the motivation and roles of managers in the value-creation process. Understanding their difference is vital to understanding the manager’s role in sustaining value creation.
This excerpt comes from Beyond Competitive Advantage. Published June 14, 2016, by Harvard Business Review, enter your email below to download the first chapter.