In 2007, Chuck Prince, then the CEO of Citigroup, made a notorious
comment about the subprime mortgage market: “As long as the music’s
playing, you’ve got to get up and dance. We’re still dancing.” Soon
after, the financial system crashed, and that remark came to be seen as a
cavalier justification for excessive risk taking by the bank. But
authors Martin and Kemper raise another possibility: Prince may have
been painted into a corner, because Citigroup’s stock was indefensibly
overvalued. The only way the bank could earn the unrealistically high
returns shareholders expected was through ever more dangerous
activities. The overvaluation trap was first identified by Michael
Jensen in a 2005 article examining the dot-com bubble. He noted that it
often affects entire sectors and that in response to it executives tend
to adopt two strategies: investing in hot, hyped technologies (as Global
Crossing did with fiber-optic cable) and glamorous acquisitions
(Nortel’s downfall). And when investment opportunities start to dry up,
firms may turn to financial manipulation (think WorldCom) to prop up
their overpriced equity. Martin and Kemper point out that today
companies in the pharmaceutical and oil sectors are caught in this same
trap. Their market caps are spectacularly high. But massive spending on
R&D is not producing more new drugs, and ever greater investment in
oil reserve exploration is only exacerbating the glut of supply. The
dance may be ending for both industries, and their executives need to
figure out new and more-realistic narratives for value creation.
[ABSTRACT FROM AUTHOR]