Myth #2: Short sellers destroy companies
"Round up the usual suspects."
– Capitaine Renaud, Casablanca
When the real estate bubble burst in 2007, what were the short sellers in the risk committee and boards of directors at Lehman Brothers doing? Nothing. They did strictly nothing to prevent or remedy the situation because none of them ever sat on any of those committees. In the history of capitalism, no short seller has ever sat on the board of directors of a company whose stock they were selling short.
We can agree that fundamentals drive share prices in the long run. The driving force is the quality of management. Mark Zuckerberg is the genius behind Facebook. Warren Buffett turned an ailing textile company named Berkshire Hathaway into an industrial conglomerate. Jeff Bezos built Amazon. Steve Jobs 2.0 was the architect of Apple's renaissance. If top management is so eager to take credit for success, then it should equally be held responsible for failure. Steve Jobs 1.0 ran Apple into the ground. Kay Whitmore buried Kodak. The responsibility for Bears Stearns, Lehman Brothers, Merrill Lynch, and AIG falls squarely on the shoulders of those at the helm. Short sellers did not make any of the bad decisions that destroyed those companies. Bad management makes bad decisions that lead to bad outcomes, the same way that good management makes good decisions that lead to good results.
No one captured what happens at the highest echelon of companies better than Steve Jobs in his 1995 Lost Interview. He mentioned that "groupthink" amidst the rarefied atmosphere of top management in venerable institutions sometimes leads to a cognitive bias called the Dunning-Kruger effect. As an example, Kodak was once an iconic brand. Management believed they were so ahead of the game they could indefinitely delay innovation. They took a step backward to their old core technology when the world was moving forward. As tragic as it was back then, there is no flower on Kodak's grave today. The world, and even the 50,000 Kodak employees laid off, have moved on. Today, Kodak is a case study in the failure of management to embrace innovation.
Top management love to surround themselves with bozocrats, non-threatening obedient "yes-men," whose sole purpose is to reassure the upper crust of their brilliance, reinforcing a fatal belief in infallibility. Dissent is squashed. Innovation, branded as cannibalization, is swiftly buried in the Kodak sarcophagus of innovation.
Top management becomes so infatuated with their brilliance that they do not even realize they are detached from reality. Given sufficient time, their obsolete products destroy them from the inside. Short sellers simply ride arrogance to its dusty end.
The history of capitalism is the story of evolution. During World War I, the dominant mode of transportation was the horse. On the first day of World War II, the world woke up in horror to a German panzer division mowing down the Polish cavalry. The cruel lesson is that evolution does not take prisoners. Out of the hundreds of car manufacturers between the two world wars emerged a few winners. The rest of the industry went out of business. For every winner, there are countless losers. Today, everyone is perfectly happy with horse-carts running around Central Park, but no one sheds tears over the defunct horse-cart industry. Everyone has forgotten the names of all those small car manufacturers. The world has moved on.
We often see the S&P 500 as this monolithic hall of corporate fame and power, but we forget that since the index was formed in 1957, only 86 of the original 500 constituents are still in the index. The other 414 have either gone bankrupt or been merged into larger companies. Radio Shack did not go out of business because of short sellers. It went out of business because it could not evolve to face the competition of Amazon and the likes of Best Buy. Short sellers do not destroy companies. They escort obsolescence out of the inexorable march of evolution.
