Guest Post: A Physician Rebels Against Micromanagement by "'Leadership-Trained' Management Extenders"

Health Care Renewal presents a guest post by Dr Howard Brody, John P McGovern Centennial Chair of Family Medicine, Director of the Institute for Medical Humanities at University of Texas - Medical Branch at Galveston, and blogger at Hooked: Ethics, Medicine and Pharma.

I recently heard from a physician whom I knew well in an earlier stage of her training—I’ll call her Pauline. She completed her training at one of the top children’s hospitals in the US, and served in several capacities in academic medical centers before her most recent job with a physician-owned for-profit practice. She called me to express her frustrations and to ask if the right course for her was to quit doing clinical medicine.

Pauline had become skilled in her earlier jobs in providing primary care for children with severe chronic conditions. Her reputation was such that when she was settled in her current post, pediatric subspecialists started to refer their difficult cases to her for follow-up. This patient mix did not suit her current employer for two reasons. First, these children were hard to take care of and even though they could have their visits “up-coded” to reflect their complexity, the practice much preferred to see healthy children with colds and earaches that could be moved through quickly and who did not demand much staff time and attention. Second, most of these children with special needs were on state insurance, which did not pay as well (even after up-coding) as the private insurance the practice coveted.

Pauline found herself constantly struggling with her co-workers and superiors in order to deliver all of her patients—not just the special-needs kids—the quality of care she had been trained to demand. As far as the practice was concerned, it was Pauline, and the medically complex kids she was attracting into the practice, who were the problem.

One recent incident had especially concerned Pauline. She had set up a visit to see a new medically complex patient and had blocked off 40 minutes, the amount of time she felt she needed to do a good job. The child had a complex genetic disorder, cerebral palsy, and heart, lung, and kidney problems.  Both the cardiologist and the nephrologist had called asking her to take this patient.  She agreed.  After she had scheduled the visit, a manager called her and told her that she was being allowed only 15 minutes to see that patient. After some fruitless discussion with him, Pauline finally said, “Okay, I guess that means that you’ll be seeing the patient instead of me, right?” The shocked voice at the other end of the phone line replied, “What do you mean? I don’t know how to take care of patients.” “That’s exactly my point,” Pauline put in.

Pauline explained that this manager assigned to her office is not even a college graduate. Physicians cannot access the schedule electronically and have no control over scheduling. These functions are controlled by the office manager and (amazingly) by some of the medical assistants who have received some “leadership” training. These medical assistants are even allowed to evaluate the clinical competency and skills of the physicians.

Now, at this stage, I can imagine a response from a management-trained person. Pauline is obviously one of those starry-eyed idealist physicians who believe that money grows on trees and that costs should never be a factor in caring for patients. Somebody who actually knows what it means to make a payroll and keep the lights on has to step in and rein in these physicians. There has to be somebody in the system someplace with a head for business, who can recognize the stark realities of what today’s practice demands from all parties. Physicians should get off their high horses and stop imagining that they can give orders to everyone else.

So let me add a further nugget about Pauline’s background. In one of her previous jobs, she was made the manager of a pediatric outpatient center within a county hospital caring for a largely indigent population. This center had been running in the red for a good while. Pauline took over and within 28 months she’d streamlined the place and had them running well in the black, while still administering a quality of care that Pauline and her colleagues could be proud of. In short, Pauline could probably tell the managers of her current practice a thing or two about how to optimize patient scheduling without compromising care or cost —if they’d listen.

Pauline probably has a nearly-unique skill set in her community and has put in a lot of years of training and experience to get there. Due to the present state of American medicine, and those who want to run it as if it were an industrial operation to make a profit, Pauline is thinking about leaving clinical practice altogether despite her relatively young age – and she has several colleagues, who trained in the same way that she did, who are considering this option.

Fortunately, Pauline has at least for now postponed any final decision about leaving clinical medicine entirely. Here’s what she last told me:

I am leaving the organization - I cannot remain in an organization where profit comes ahead of quality - and as a former medical director who had financial accountability/responsibilities, I know it does not HAVE to be a choice.  I do not know what my next steps will be from here.  For me, working with integrity, compassion and a desire for excellence is not negotiable.

Physicians MUST become better advocates for our profession.  For too long, we have been asleep at the wheel while insurance companies and corporations shaped the environment in which we practice.  We cannot allow this to continue.  We are professionals, not vocationally educated medical automatons  who need every moment of work day micromanaged by 'leadership-trained' management extenders who have no idea what it means to take responsibility for patients.  

Dr Howard Brody

Tales of the Wayfaring Generic Manager - from Ritz Carlton Hotels to Henry Ford West Bloomfield Hospital to Cancer Treatment Centers of America

In 2006, we wondered what a former hotel manager, Mr Gerard van Grinsven, admittedly known for putting the "wow" back in the Detroit Ritz-Carlton, would be doing as a hospital CEO.  This seemed at the time like a real "wow" example of how generic managers were taking over health care.  Mr Grinsven had extensive experience in the hospitality field, but no known background in health care. 

Organic Local Produce, "Wellbeing Centers," Gourmet Dining, Wedding Receptions, and Corporate Functions

Over the next few years, Mr van Grinsven's Henry Ford West Bloomfield hospital did make a name for itself.  In 2009, Becker's Hospital Review reported on some of Mr Van Grinsven's innovations. 

First, he lead an apparent change in the hospital's mission from acute care to recreating:

the hospital experience into one focused on promoting wellbeing and healthy living. The hospital has already begun to realize its mission statement, which reads 'to take health and healing beyond the boundaries of imagination.'

The new hospital apparently was designed to look like a luxury hotel:

The hospital is located on 160 acres of woodlands and is designed to resemble a Northern Michigan lodge. The facility also features a retail 'main street' which looks like an actual main street in a Northern Michigan town and includes stores focused on sleep, pregnancy, organic food and healthy cooking as well as a pharmacy.

Apparently it is now a favored site for weddings:

The hospital also holds free concerts for the community and has already received nine wedding inquiries. 

It had a "wellness center"

Henry Ford West Bloomfield also features a unique, integrated wellness center called Vita. Vita offers acupuncture, therapeutic message, yoga and relaxation classes, an aqua therapy suite, a spa and health coaches who provide lifestyle and exercise consultations. In addition to offering one-time services, the hospital offers memberships to community members to encourage frequent use of the center.

What really stood out was its food service:

Henry Ford brought in top Michigan chef Matt Prentice to transform traditional hospital food service. The hospital features 24-hour room service for patients, all of which is served by the hospital's on-site gourmet, organic restaurant, Henry's. All food served in the hospital is organic, promotes sustainable agriculture and, in many cases, is procured from local farmers.

A 2011 article in Fortune noted that

the hospital is on track to generate millions of dollars a year hosting and catering functions for companies and community groups.

It all sounds great, if it were describing a luxury hotel.

The Fortune article ended with the gushing summation:

While it will be years before anyone can say whether this model works, there's no question that it captures a spirit of innovation that just might be a cure for what ails so many organizations. We are living today through the age of disruption. You can't do big things if you're content with just doing things a little better than everyone else or a little differently from how you've done them in the past. In an era of intense competition and non-stop reinvention, the only way to stand out from the crowd is to stand for something special. Originality has become the acid test of strategy.

Neither it nor the Becker's rather uncritical discussions dealt with what any of this had to do with the fundamental mission of a hospital, to care for the sick, what it has to particularly do with quality of care, especially care of severely acutely or chronically ill patients, traditionally those whom hospitals were meant to serve.  Would a patient desperately sick from a myocardial infarction (heart attack), stroke, sepsis (bacterial blood stream infection) or the other major ills that bring people to hospitals really care that if he or she were to survive without major sequelae, organic, locally grown food would be served in the hospital's fancy restaurant?  Is there any evidence that provision of any of these fancy hotel amenities would affect important clinical outcomes for such patients?  Could the funds needed for all these fancy hotel services be better spent to improve patients' the the population's health?

On to a More Ethically Challenged Environment

We may never know.  But what we do know is that Mr van Grinsven, having brought "wellness" centers and organic, locally grown, gourmet food to an acute care hospital, is now moving on.

Crain's Detroit Business just reported:

Henry Ford West Bloomfield Hospital President and CEO Gerard van Grinsven has resigned from the position effective June 1, according to an internal email sent Friday to employees from Henry Ford Health System President and COO Bob Riney.

Van Grinsven is leaving the hospital to become the president and CEO of Chicago-based Cancer Treatment Centers of America, Riney said in the email. He will oversee the CTCA's five hospitals and medical centers in Illinois, Pennsylvania, Oklahoma, Arizona and Georgia. The CTCA is expected to announce van Grinsven's new position later today.

Henry Ford Health System CEO Bob Riney saluted van Grinsven thus,

'Gerard's leadership talents and his tremendous global experience made the transformation of this innovation and distinctive vision a reality,' Riney told employees in the email.

He did not apparently mention anything about the quality of care for acutely and chronically ill patients.  The press release from CTCA proclaimed

'Gerard's arrival is an exciting and dramatic step in the evolution of our leadership that will herald new opportunities for all of our talented Stakeholders and the thousands of patients we serve,' said [executive chairman and former CEO Stephen B] Bonner. 'Our expertise in Patient Empowerment Medicine® and track record implementing change is unparalleled. Nothing we do today is the same as we did two years ago. Gerard is uniquely qualified to provide the leadership required to advance our commitment to patient-centered care in all we do,' concluded Bonner.

Of course, there was nothing about how van Grinsven's expertise in wellness centers and organic produce would be useful to an organization supposedly devoted to cancer patients, whose care may involve risky treatment choices and who may become desperately ill.

There was also nothing about how van Grinsven's background would help CTCA to avoid new ethical misadventures.  Earlier this year, we posted about issues involving CTCA making unsubstantiated survival claims; promoting "integrative" treatments that are unsupported by evidence; and manipulating survival statistics, in part by turning away patients with poor prognoses.  Of course, it is not clear that given van Grinsven's background he would even understand why such behavior is unethical. 

Summary

As a physician, it is hard not to laugh at all this, at least to keep from crying.  As we have noted frequently, health care has been taken over by generic hired managers.  At best, while well meaning, many of them seem clueless about the nature and context of health care, and health care professionals' values.  At worst, the manager's coup d'etat has turned managers into manager-kings, queens and nobles, while driving up health care costs, and sacrificing the health of patients and the public.  The depth of this phenomenon is demonstrated by the absolute lack of skepticism about the worthiness of a former Ritz-Carlton executive to run either a community hospital or a system of cancer treatment centers.

I say once again that true health care reform would put in place leadership that understands the health care context, upholds health care professionals' values, and puts patients' and the public's health ahead of extraneous, particularly short-term financial concerns. We need health care governance that holds health care leaders accountable, and ensures their transparency, integrity and honesty.

BLOGSCAN - An Ex-Pharmaceutical Company CEO to Run the American College of Cardiology?

Marilyn Mann's blog discussed the appointment of a former pharmaceutical company executive, most recently at Actelion, and previously at Hoffman La Roche, Abbott Canada, Nordic Labs and Marion Merrill Dow (now known as Aventis), as president of the American College of Cardiology.  Although Mr Jacobovitz, who boasts a bachelor's degree in biology but no obvious experience in direct health care or biomedical science, was touted by the ACC as having "developed a strong patient- and customer-centered corporate strategy," Ms Mann provided documentation that his trajectory at Actelion seemed more money- than patient-centered.  

During his watch, Actelion was cited for not reporting 3500 deaths of patients taking two of its drugs to the US Food an Drug Administration (FDA).  Actelion blocked availability of samples of one of its drugs to generic drug companies, an action that the US Federal Trade Commission (FTC) alleged violated anti-trust laws.  Actelion purchased a company that was working on a drug that could have become a competitor to Actelion's most remunerative product, and then shut down development, possibly preventing a drug that might help patients from reaching them.  Finally, Acetelion's marketing practices seem to be currently under investigation by a US Attorney.   

One wonders why cardiologists would want such an individual representing them as leader of their premier organization? 

(Dr Wes wondered as well.)

More Reasons to Doubt How CEOs are Chosen and Paid

Health Care Renewal is about problems with the leadership and governance of health care organizations.  Since the global financial collapse/ great recession began in 2008, it became evident that the problems we saw affecting health care leadership were similar to problems affecting other large organizations, notably financial firms.  Recently, I spotted a series of articles that raise more questions about how business leaders, and by extension, leaders of health care organizations are chosen and paid.

Doubts about Generic Managers

We have often questioned the wisdom of having health care organizations lead by people with little if any direct health care experience, little knowledge of health care on the ground, and little commitment to health care's core values.  We have called such leaders generic managers.

A New York Times article by Gretchen Morgenson from September, 2012, cited new academic work that questioned the abilities of generic managers.  The source article was Elson CM, Ferrere CK.  Executive superstars, peer groups, and overcompensation - cause, effect and solution.  Ms Morgenson summarized,

Mr. Elson and Mr. Ferrere conclude, contrary to the prevailing line, that chief executives can’t readily transfer their skills from one company to another.

Furthermore, Ms Morgenson interviewed Mr Elson, who said,

But we found that C.E.O. skills are very firm-specific. C.E.O.’s don’t move very often, but when they do, they’re flops.

Also,

But there is little evidence, according to Mr. Elson and Mr. Ferrere, that a hot market exists for interchangeable chief executives. First, they note numerous academic studies indicating that C.E.O.’s selected from within a company perform better than outsiders, especially in the creation of long-term shareholder value.

'There is no conclusive empirical evidence that outside succession leads to more favorable corporate performance, or even that good performance at one company can accurately predict success at another,' the authors conclude. 'In short, executive skills cannot pass the most basic test of generality: transferability.'

To be sure, this flies in the face of the widely held view that skilled managers have become generalists and are therefore far more interchangeable than in previous years. Proponents of this thesis argue that top managers today can accumulate a broad knowledge of economics, finance and management science, giving them the ability to manage any type of company effectively. Technological advancements also give chief executives access to untold amounts of data about a particular company that in previous times would have taken years to amass and synthesize, this view holds.

But the data on actual C.E.O. moves raises questions about just how portable C.E.O. skills really are. The Delaware paper cites several studies indicating that relatively few chief executives land new top jobs elsewhere. One study, a 2011 analysis of roughly 1,800 C.E.O. successions from 1993 to 2005, found that less than 2 percent had been public-company chief executives before their new jobs.

This data and these observations seem to broadly apply to business executives, but there is no reason to think they do not apply to executives of health care corporations.  Furthermore, given that on its face, health care is less like making automobiles than, say, the restaurant business is, there is no reason to think doubts this raises about the abilities of generic managers should not be even bigger in health care, and should apply not just to for-profit, but to not for profit corporations.  Yet the trend in health care seems to increasingly favor generic managers of not just for-profit health care corporations, but also hospitals and hospital systems, non-profit health insurers and managed care organizations, health care charities, disease advocacy groups, and even medical associations, medical schools, and their parent universities.  

Doubts about Executive Compensation

Peer-Group Benchmarking

We have often posted about amazingly generous compensation given to top leaders of health care organizations.  Health care corporate CEOs can make tens of millions of dollars, occasionally even more.  While CEOs of not for profit health care organizations make less, they still now can makes millions of dollars.  Ms Morgenson called the usual justification for these huge amounts of compensation the "pay-'em-or-lose-'em" myth.

Corporations are forever defending big executive paydays. If we don’t pay up, the argument goes, our sharpest minds will jump to our rivals.

This notion, or myth, depends on the argument that generic managers are the best managers, which appears to be largely unsubstantiated, as we noted above.

 In other words, the argument that C.E.O.’s will leave if they aren’t compensated well, perhaps even lavishly, is bogus. Using the peer-group benchmark only pushes pay up and up. 

Furthermore,

Importantly, the study disputes the notion that executive pay today is a result of an efficient bidding process for finding and retaining a scarce and valuable commodity: managerial talent. 'In essence, this process creates a model of a competitive market for executives where it otherwise does not exist,' the authors wrote. 'Through the operation of a market, it is argued, wages are bid up to an executive’s outside opportunities.'

Instead, as noted above, since the skills needed to run one sort of company or organization may not readily transfer to other companies and organizations, even seemingly similar ones, such a market does not exist. 
 
 Incentives Based on Short-Term Financial Results

We have also previously discussed (look here) how contemporary economic dogma suggest that the only measure of success of a for-profit corporation is "shareholder value," which has come to mean the stock price over the short term.  There is reason to think that this focus on short-term economic performance has also become the major measure of success of health care organizations.  Another word for this phenomenon is "financialization."  

An op-ed in the UK Independent questions this focus because of its economic effects.  Anthony Hilton wrote about the views of Andrew Smithers,

His starting point was that the economy was floundering because of inadequate demand. Personal spending is flat for obvious reasons but the real culprit is the companies who are hoarding cash and refusing to invest.

Others have noticed the cash hoarding but explain it away by saying we live in uncertain times and companies will start investing again once they become more confident about the economic outlook. Smithers disagrees fundamentally with this. He says companies are not investing because executives are bonused to deliver short-term profits. Costly spending on investment projects is therefore anathema to them. Investment may deliver long-term prosperity but by that time they will have left the company. It also depresses short-term profits while they are still there.

We have in the last two decades, under the mantra of shareholder value and aligning the interests of management with shareholders, created a new breed of management incentivised to believe that what is good for them is good for the business. They dislike investment because it reduces their bonuses .

They don't invest surplus cash. They hoard it or they use it to buy back their own company's shares.

When the majority of the managements in publicly quoted companies start behaving this way, as they now do, we have a serious problem. They are sitting on cash which is the equivalent of six per cent of GDP. This deadweight of unused resources prevents lift-off and threatens to leave the economy forever trapped in the mire.

Smithers says this behaviour by management is a structural change — meaning it is something which won't go away. It makes this down- turn different from all that have gone before.

There is no reason to think that health care corporations are not hoarding money in the sense described above.  If so, they may be failing to invest in drugs or devices that would have helped patients in the future.

Because of the limited reporting required of large health care non-profit organizations in the US, it may be very hard to tell if they are similarly hoarding money, but if they are, the effects again might be to fail to provide patients long-term benefits they might otherwise have enjoyed.

The Ultimately Self-Destructive Outcome

Meanwhile, writing in the New York Times, Chrystia Freeland, the author of Plutocrats: the Rise of the New Global Super-Rich and the Fall of Everyone Else, explained why picking the wrong leaders  and paying them too much may be bad for everyone.  We have noted that an increasing fraction of the wealthiest one percent of the US are current and former corporate executives.  Ms Freeland wrote how domination by an increasingly wealthy and powerful elite usually dooms the countries they dominate.

what separates successful states from failed ones is whether their governing institutions are inclusive or extractive. Extractive states are controlled by ruling elites whose objective is to extract as much wealth as they can from the rest of society.

So

it is the danger America faces today, as the 1 percent pulls away from everyone else and pursues an economic, political and social agenda that will increase that gap even further — ultimately destroying the open system that made America rich and allowed its 1 percent to thrive in the first place.  

Furthermore,

It is no accident that in America today the gap between the very rich and everyone else is wider than at any time since the Gilded Age. Now, as then, the titans are seeking an even greater political voice to match their economic power. Now, as then, the inevitable danger is that they will confuse their own self-interest with the common good. The irony of the political rise of the plutocrats is that, like Venice’s oligarchs, they threaten the system that created them.

So it is not merely that overcompensating generic executives has likely been one of the major reasons our health care is so expensive, inaccessible, and mediocre.  The larger problem of overpaying under skilled executives threatens to destroy our whole society.  How cheerful

Summary

The way forward seems clear.  It is just blocked by the interests of the rich and powerful elite which our current foolish policies have created.

In a health care context, leaders of organizations should only be those with clear knowledge of, experience in, and commitment to the values of health care.  Their compensation should be reasonable, and based on their ability to uphold these values first, with financial goals clearly second, and short-term financial goals probably not at all.  Pay should not be bench-marked to compensation of leaders of other organizations, especially not of vastly different kinds of organizations.

Whether there is any chance of such changes happening while corporate boards of directors, and non-profit boards of trustees are dominated by executives of other organizations is doubtful.  Thus we also need to change the governance of for-profit health care corporations to clearly reflect the long-term interests of the stockholders, who will only prosper if in the long run their companies provide products and services that help patients at a fair price and with minimal risks.   Thus we further need to need to change the governance of health care non-profits to reflect the needs of patients, their communities and other key constituencies.  That should keep us all busy for a while. 
 

Health Care Dysfunction Explained by the Fallacy of "Maximizing Shareholder Value"

Over the last two weeks, the Naked Capitalism blog ran a multi-part series (1-4) on what has gone wrong with US public for-profit corporations.  Although not targeted specifically on health care, the series included several themes we have discussed on Health Care Renewal, and suggested some important new ones.  So let us review the most relevant topics.

"Financialization," and the Exclusive Ostensible Focus on Shareholder Value

In the first post,(1) William Lazonick explained how corporations gave up their devotion to societal values to ostensibly focus only on the interests of shareholders: 

What went wrong? A fundamental transformation in the investment strategies of major U.S. corporations is a big part of the story.

A generation or two ago, corporate leaders considered the interests of their companies to be aligned with those of the broader society. In 1953, at his congressional confirmation hearing to be Secretary of Defense, General Motors CEO Charles E. Wilson was asked whether he would be able to make a decision that conflicted with the interests of his company. His famous reply: 'For years I thought what was good for the country was good for General Motors and vice versa.'

However, then(1)

the U.S. business corporation has become in a (rather ugly) word 'financialized.' It means that executives began to base all their decisions on increasing corporate earnings for the sake of jacking up corporate stock prices. Other concerns — economic, social and political — took a backseat. From the 1980s, the talk in boardrooms and business schools changed. Instead of running corporations to create wealth for all, leaders should think only of 'maximizing shareholder value.'

This was formalized in the the scholarly management literature,(1)

But in 1983, two financial economists, Eugene Fama of the University of Chicago and Michael Jensen of the University of Rochester, co-authored two articles in the Journal of Law and Economics which extolled corporate honchos who focused on 'maximizing shareholder value' — by which they meant using corporate resources to boost stock prices, however short the time-frame. In 1985 Jensen landed a higher profile pulpit at Harvard Business School. Soon, shareholder-value ideology became the mantra of thousands of MBA students who were unleashed in the corporate world.

Ignoring the Interests of Employees: Cost Cutting, Layoffs, Off-Shoring

Maximizing shareholder value only really seems to mean maximizing shareholder value in the short run, often by short-term cost-cutting that will reduce the ability to improve existing or develop new products and services. Hence, now(1)

When the shareholder-value mantra becomes the main focus, executives concentrate on avoiding taxes for the sake of higher profits, and they don’t think twice about permanently axing workers. They increase distributions of corporate cash to shareholders in the forms of dividends and, even more prominently, stock buybacks. When a corporation becomes financialized, the top executives no longer concern themselves with investing in the productive capabilities of employees, the foundation for rising living standards for all. They become focused instead on generating financial profits that can justify higher stock prices....

Furthermore,(1)

n the name of shareholder value, by the 1990s U.S. corporations seized on these changes in competition and technology to put an end to the norm of a career with one company, ridding themselves of more expensive older employees in the process. In the 2000s, American corporations found that low-wage nations like China and India possessed millions of qualified college graduates who were able and willing to do high-end work in place of U.S. workers. Offshoring put the nail in the coffin of employment security in corporate America.

Thus, "maximizing shareholder value" was the rationale for a variety of short-term cost-cutting approaches that turned employees (excepting, of course, the hired executives and their favorites) not merely into the makers of widgets, but into widgets themselves. By extension, this attitude that all employees (again, with the exception of top management and their cronies) are interchangeable applied even to highly skilled professional, technical and scientific employees, e.g., research scientists in a pharmaceutical company.

By further extension, as we have noted, health care organizations, including non-profit institutions like hospitals, insurance companies, and academic medical institutions, have been taken over by hired managers who are decreasingly health care professionals. Such hired generic managers have carried the latest fashionable management ideas into health care with them. Thus, in my experience, even experienced academic physicians began hearing that they had no individual value, were interchangeable and could easily be replaced starting in the 1990s.

For organizations that depend on highly trained, dedicated technical, scientific, and/or professional workers, devaluing and demoralizing such employees wold appear to be the height of foolishness.

As Lazonick pointed out in a later post(3), treating workers as interchangeable can be the death knell for innovation:

As is generally recognized by employers who declare that 'our most important assets are our human assets', the key to successful innovation is the extra time and effort, above and beyond the strict requirements of the job, that employees expend interacting with others to confront and solve problems in transforming technologies and accessing markets. Anyone who has spent time in a workplace knows the difference between workers who just punch the clock to collect their pay from day to day and workers who use their paid employment as a platform for the expenditure of creative and collective effort as part of a process of building their careers.

As members of the firm, these forward-looking workers bear the risk that their extra expenditures of time and effort will not yield the gains to innovative enterprise from which they can be rewarded. If, however, the innovation process does generate profits, workers, as risk-bearers, have a claim to a share in the forms of promotions, higher earnings and benefits. Instead, shareholder-value ideology is often used as a rationale for laying off workers whose hard and creative work has contributed to the company’s success. That’s grossly unfair.

A Fallacious Rationale: Only Stockholders at Risk

However, the reasoning, such as it was, behind the "maximizing shareholder value" mantra contained a rationale for so devaluing and demoralizing even the most dedicated and well-trained employees. As Prof Lazonick explained,(1)

Proponents of the Fama/Jenson view argue that for superior economic performance, corporate resources should be allocated to maximize returns to shareholders because they are the only economic actors who make investments without a guaranteed return. They say that shareholders are the only ones who bear risk in the corporate economy, and so they should also get the rewards.

He then went on to easily explain why this was complete rubbish(1):

But this argument could not be more false. In fact, lots of people bear risks of investing in the corporation without knowing if they will pay off for them. Governments in the U.S., funded by the body of taxpayers, are constantly making investments in physical infrastructures and human capabilities that provide benefits to businesses, but without a guaranteed return to taxpayers. An employer expects workers to give time and effort beyond that required by their current pay to make a better product and boost profits for the company in the future. Where’s the worker’s guaranteed return? In contrast, most public shareholders simply buy and sell shares of a corporation on the stock market, making no contribution whatsoever to investment in the company’s productive capabilities.

By Extension, In Health Care, Ignoring the Interests of Patients and the Values of Health Care Professionals

If one believes only stockholders are at risk and hence only stockholders deserve benefit from corporate activities, by extension this eliminates the interests of patients and the values of health care professionals from consideration by the leadership of health care corporations.

Of course, in health care, the patients may be the ones most at risk from corporate activities. For example, think of a patient who pays a large amount out of pocket for a drug that fails to benefit him or her. Worse, patients are not only at financial risk, but are at physical risk. For example, think of a patient who suffers an unusual, but severe adverse reaction to a drug.

In addition, in health care, health care professionals who do not work for a particular health care corporation may be at risk from its activities. For example, think of a physician who is fooled by a pharmaceutical company's manipulation of clinical research into believing a drug is effective and safe when it is actually useless and harmful. We have documented numerous instances of suppression of clinical research, manipulation of clinical research, ghost writing, deceptive stealth marketing, and other tactics used by pharmaceutical, biotechnology and device companies to deceive physicians about the effectiveness and safety of drugs and devices. Physicians who have been thus deceived are at risk of violating their fundamental responsibility to put individual patients' interests first.

Subverting the Mission of Non-Profit Health Care Organizations

As we mentioned earlier, there is ample evidence that non-profit organizations are now most often lead by hired managers who have brought the latest management with them, rather than health care professionals. It is therefore likely that the dominant notion of "maximizing shareholder value" has been operationalized even in non-profit organizations that do not have shareholders.

Most likely it has been transformed into simply maximizing short-term revenue. We have certainly seen many instances of leaders of such health care organizations who seem mainly preoccupied with short-term financial goals. Bad as this is for a public for-profit corporation, it is potentially disastrous for a non-profit organization which is supposed to put upholding its mission ahead of financial concerns (see examples of such mission-hostile management here).

Interests of Shareholders or Interests of Executives?

It is terribly ironic that in practice "maximizing shareholder value" turns out to mean maximizing executive compensation. In retrospect, this mantra looks entirely self-serving.  As Prof Lazonick noted in a second post, executive compensation has soared in recent years(2)

When all the data from corporate proxy statements are in within the next month or so, they will show that 2011 was another banner year for top executive pay. Over the previous three years the average annual compensation of the top 500 executives named on corporate proxy statements was 'only' $17.8 million, compared with an annual average of $27.3 million for 2005 through 2007. Yet even in these recent 'down' years, the compensation of these named top executives was more than double in real terms their counterparts’ pay in the years 1992 through 1994.

It might surprise you to learn that in the early 1990s, executive pay was already widely viewed as out of line with what average workers got paid. In 1991 Graef Crystal, a prominent executive pay consultant, published a best-selling book, In Search of Excess: The Overcompensation of American Executives, in which he calculated that over the course of the 1970s and ’80s, the real after-tax earnings of the average manufacturing worker had declined by about 13 percent. During the same period, that of the average CEO of a major US corporation had quadrupled!

We have documented seemingly endless examples of bloated executive compensation in health care.

In fact, as Prof Lazonick noted in his first post(1), by increasing stock prices short-term, executives of for-profit corporations can markedly boost their own compensation,

When a corporation becomes financialized, the top executives no longer concern themselves with investing in the productive capabilities of employees, the foundation for rising living standards for all. They become focused instead on generating financial profits that can justify higher stock prices – in large part because, through their stock-based compensation, high stock prices translate into megabucks for these corporate executives themselves.

The Conspiracy to Increase CEO Compensation

As CEO compensation climbed, they and their supporters have invoked a market-based rationale, as Prof Lazonick described in his third post,(3):

You often hear that stratospheric executive pay is the result of some inexorable law of supply and demand. If we don’t give top executives their multimillion dollar compensation, they won’t be willing to come to work and do their jobs. They are supposedly the bearers of 'scarce talent' that demands a high price in the market place. Even Robert Reich, Secretary of Labor in the Clinton administration and a critic of U.S. income inequality, has justified the explosion in executive pay, arguing that intense competition makes it much more difficult than it used to be to find the talent who can manage a large corporation (Supercapitalism, 2008, pp 105-114).

We have provided many examples of similar talking points used to support fat compensation for health care leaders (e.g., here. here, and here).
However, as we described here, the mechanism that executives have developed to set their own pay in line with the supposed market does nothing like that,(3)

That is not what determines executive pay. Here is how it works: Top executives select other top executives to sit on “their” boards of directors. These directors hire compensation consultants to recommend an executive pay package, which consists of salary, bonus, incentive pay, retirement benefits, and all manner of other perks. The consultants look at what top executives at other major corporations are getting, and say that, well, this executive should get more or less the same. Since the directors are mostly these very same “other executives”, they have no interest in objecting – and if any of them were to do so, they would find that they are no longer being invited to sit on corporate boards.

Meanwhile, given the preponderance of stock-based compensation (especially stock options) in executive pay, whenever there is speculative boom in the stock market, top executives of the companies with most rapidly rising stock prices make out like bandits. The higher compensation levels then create a 'new normal' for executive pay that, via the compensation consultants and compliant directors, ratchets up the pay of all the top dogs. And, when the stock market is less speculative, these corporate executives do massive stock buybacks to push stock prices up.

What we have here is not 'market forces' at work but an exclusive club that promotes the interests of the 0.1%. All too often executives allocate corporate resources to benefit themselves rather than to invest in innovation and job creation.

We have discussed similar mechanisms at work in health care, for example, here.

In other words,

almost unanimously, corporate executives proclaim that they run their companies for the sake of shareholders. In fact, their personal coffers pumped up with stock-based compensation, our business 'leaders' have increasingly run the corporations for themselves.

Were contemporary management of health care be only based on maximizing shareholder value or short-term revenue, that would be bad enough. However, it appears that it is really based simply on maximizing executive compensation. Health care, and our society as a whole has been turned into something like a feudal state, in which hired managers have become the new aristocracy.

The Rise of the Generic Manager

The likelihood that "maximizing [supposed] shareholder value" would lead to bad ends is increased by the decreasing likelihood that the managers who set out in this direction would know anything about the specific context in which they were working or other goals they ought to attempt. As Prof Lazonick pointed out, even before the rise of the "maximizing shareholder value" mantra,(1)

The beginnings of financialization date back to the 1960s when conglomerate titans built empires by gobbling up scores and even hundreds of companies. Business schools justified this concentration of corporate power by teaching that a good manager could manage any type of business — the bigger the better.

This was the notion of the generic manager. In health care, generic managers who have little specific health care knowledge or experience, and little understanding of or sympathy for the values of health care professionals might be particularly ruthless about putting short-term financial goals ahead of everything else.

Summary

On Health Care Renewal, we have focused on problems with health care leadership and governance. We have discussed the rise of generic managers, a focus on short-term revenue sometimes leading to mission-hostile management, the perverse incentives generated by executive compensation that is unrelated to achievement of the health care mission's goals, lack of executive accountability, and sometimes executives' complete impunity. It now appears that health care's leadership and governance problems simply reflect larger problems in the society as a whole.

Maybe it should be a relief that we in health care are not uniquely cursed. However, the immensity of the problems faced by our society as a whole will not make it easier to solve the problem of health care dysfunction.

I do feel better that our focus has been correct. Furthermore, I feel more confident asserting once again that true health care reform would put in place leadership that understands the health care context, upholds health care professionals' values, and puts patients' and the public's health ahead of extraneous, particularly short-term financial concerns. We need health care governance that holds health care leaders accountable, and ensures their transparency, integrity and honesty.

Maybe realizing that health care's problems are a part of society's problems will lead to more support for their solutions.

References
1.  Lazonick W. How American corporations transformed from producers to predators.  Naked Capitalism, April 2, 2012.  Link here.
2. Lazonick W. How high CEO pay hurts the 99 percent. Naked Capitalism, April 3, 2012. Link here.
3. Lazonick W. Three corporate myths that threaten the wealth of the nation. Naked Capitalism, April 6, 2012. Link here.
4. Parramore L. Capitalism's dirty secret: corporations don't create jobs, they destroy them.  Naked Capitalism, April 5, 2012.  Link here.

Semi-Retirement of a Salesman - Weldon to Retire as Johnson and Johnson CEO

The extremely well compensated CEO and Chairman of Johnson and Johnson, the huge and recently hugely troubled US based pharmaceutical and device company, is going to retire, at least as CEO.  Reporting on this event may shed a little more light on the sorts of leadership problems that now commonly afflict health care organizations.

The Credo

Johnson and Johnson was once one of the US' most respected companies.  Its credo, written in 1943 by Robert Wood Johnson, bravely begins:

We believe our first responsibility is to doctors, nurses and patients, to mothers and fathers, and all others who use our products and services. In meeting their needs, everything we do must be of high quality.

Dishonoring the Credo

Yet in the last few years the company has not honored this credo.

It seems to have lost the ability to manufacture high quality products. It has had to make 30 separate product recalls since 2009. The latest was Liquid Infant Tylenol. (The current WSJ Health Blog list of recalls can be found here.)

Johnson and Johnson also has an amazing recent record of ethical lapses and guilty pleas, including:
- Convictions in two different states in 2010 for misleading marketing of Risperdal
- A guilty plea for misbranding Topamax in 2010
- Guilty pleas to bribery in Europe in 2011 by J+J's DePuy subsidiary
- A guilty plea for marketing Risperdal for unapproved uses in 2011 (see this link for all of the above)
- Accusations that the company, which makes smoking cessation products, participated along with tobacco companies in efforts to lobby state legislators (see post here)
- A guilty plea to misbranding Natrecor by J+J subsidiary Scios (see post here)
-  Most recently, in 2012, testimony in a trial of allegations of unethical marketing of the drug Respirdal (risperidone) by the Janssen subsidiary revealed a systemic, deceptive stealth marketing campaign that fostered suppression of research whose results were unfavorable to the company, ghostwriting, the use of key opinion leaders as marketers in the guise of academics and professionals, and intimidation of whistleblowers.  After these revelations, the company abruptly settled the case (see post here).

Disconnect Between Leadership Performance and Rewards

Nonetheless, until very recently, the top leadership of the company continued to collect outrageous compensation, and to be regarded as a font of health care wisdom, even by the current US administration.

In 2010, the company gave CEO and Chairman William Weldon over $29 million in compensation, saying he "met expectations," (see this post).

In 2011, just days after the company pleaded guilty in the Risperdal marketing case (above), CEO and Chairman Weldon was invited to the White House to discuss health care (see this post.)

Just after his resignation was announced a few days ago, the Wall Street Journal reported that Weldon would get an increased bonus for 2011 ($3.1 million, up from $1.98 million in 2010), and an increased base salary ($1.97 million up from $1.92 million.)  His total compensation for 2011 was not yet revealed. 

Swapping One Salesman for Another

A single New York Times article suggested one reason why Weldon's reign was ultimately so unsuccessful, and perhaps why his successor may not do better.

Alex Gorsky, the newly named chief executive of Johnson & Johnson, shares a crucial biographical detail with William C. Weldon, the man he is succeeding. Both got their starts as pharmaceutical sales representatives, a notoriously grueling job that — because it demands stamina, charisma and a near devotion to making the sale — has become a crucible for future drug company executives in recent years.

Indeed, Mr Weldon's official biography indicates he "served in several sales, marketing and international management positions." The official biography of CEO-to-be, Alex Gorsky, stated he "began his Johnson & Johnson career as a sales representative with Janssen Pharmaceutica in 1988. Over the next 15 years, he advanced through positions of increasing responsibility in sales, marketing, and management." Previously, he earned "a Bachelor of Science degree from the U.S. Military Academy at West Point, N.Y., and spent six years in the U.S. Army, finishing his military career with the rank of Captain. Alex earned a Master of Business Administration degree from The Wharton School of the University of Pennsylvania in 1996."

Apparently neither current nor nominated CEO had any direct experience in patient care, nor in biomedical or clinical science, nor in chemistry, engineering or manufacturing. So both are generic managers, that is, health care leaders without any direct experience in health care, or in the science and technology underlying it.

"Making the Numbers" Versus the Credo

Moreover, they are both a particular type of generic manager, salespeople. As the Times reported:

Mr. Gorsky, who is 51, fits the mold of someone who once 'carried the bag' — industry slang for working as a sales representative. He is known as a polished speaker and an intense yet likable manager who is a quick study when it comes to learning new topics.

However, while sales people may be personable, they often have goals that have nothing to do with responsibilities "to doctors, nurses and patients, to mothers and fathers,...." As the Times article also noted,

But the ethos of the sales representative may not be what Johnson & Johnson needs right now, said Erik Gordon, who teaches business at the University of Michigan. 'That culture was very much the Weldon culture writ large — we will make our numbers for the analysts, period,' he said. 'And if that means we have to cut costs on things that affect quality, then by God, we’re going to make those numbers.'

So while Johnson and Johnson for years prided itself as a company that put the needs of patients and health professionals first, it hired leaders from the culture of sales where the impetus is to "make the numbers," to fulfill short term revenue goals, no matter what. This illustrates how generic management given perverse incentives in an era that honors greed and puts short-term economic goals ahead of all others had hollowed out health care.

We wish Mr Gorsky well, but worry that if he too focuses just on making the numbers, the result will be only mischief.

The Moral of the Story

Health care organizations need leaders that uphold the core values of health care, and focus on and are accountable for the mission, not on secondary responsibilities that conflict with these values and their mission, and not on self-enrichment. Leaders ought to be rewarded reasonably, but not lavishly, for doing what ultimately improves patient care, or when applicable, good education and good research. On the other hand, those who authorize, direct and implement bad behavior ought to suffer negative consequences sufficient to deter future bad behavior.


If we do not fix the severe problems affecting the leadership and governance of health care, and do not increase accountability, integrity and transparency of health care leadership and governance, we will be as much to blame as the leaders when the system collapses.

Just Business - Employee Control Fraud, Gresham's Dynamic, and the Race to the Bottom in Health Care

Since Enthoven called for the break up of the physicians' "guild," and handing over its supposed power to managers, (see post here) managers have taken over from physicians and other health care professionals as leaders of health care organizations.  Unfortunately, most of these managers are generic, often lacking knowledge and experience in health care, and understanding of its core values.  Instead, such generic managers may rely on the current management dogma.  The perils of doing so are illustrated by an analysis of the recent expose of conditions at Apple manufacturing plants in China.

The Apple Expose

The New York Times summarized in a landmark article how bad it is to work in factories building Apple products under contract in China.  Workers endure harsh conditions, toiling up to six days a week, 12 hours a day.  Meanwhile, banners remind them to "work hard on the job today or work hard to find a job tomorrow."  Workers may be exposed to hazardous, even poisonous materials (like n-hexane used to clean components).  Workers have died in explosions due to inadequate control of combustible dust. Over 18 workers at one factory attempted or committed suicide within two years.

The article suggested that while Apple managers may be well-intentioned, and "want to improve conditions in factories," the bottom line is more important:

that dedication falters when it conflicts with crucial supplier relationships or the fast delivery of new products.

In fact, because of its rigid insistence on cost control, its suppliers are sorely tempted to push their workers too hard:

Apple typically asks suppliers to specify how much every part costs, how many workers are needed and the size of their salaries. Executives want to know every financial detail. Afterward, Apple calculates how much it will pay for a part. Most suppliers are allowed only the slimmest of profits.

So suppliers often try to cut corners, replace expensive chemicals with less costly alternatives, or push their employees to work faster and longer, according to people at those companies.

'The only way you make money working for Apple is figuring out how to do things more efficiently or cheaper,' said an executive at one company that helped bring the iPad to market. 'And then they’ll come back the next year, and force a 10 percent price cut.'

So,

'You can set all the rules you want, but they’re meaningless if you don’t give suppliers enough profit to treat workers well,' said one former Apple executive with firsthand knowledge of the supplier responsibility group. 'If you squeeze margins, you’re forcing them to cut safety.'

William Black's Analysis: Employee Control Fraud and the Race to the Bottom

Writing in the Huffington Post, William K Black showed how Apple executives' relentless focus on cost could drive a race to the bottom. He began by analyzing Apple executives' explanation for out-sourcing their production:

'We shouldn't be criticized for using Chinese workers,' a current Apple executive said. 'The U.S. has stopped producing people with the skills we need.'

He noted that it is absurd to suggest that the US does not have workers with the technical skills necessary to build Apple products. He suggests, however, that these are not the skills that matter.

The suppliers want engineers and managers who will selectively apply their substantive skills. American engineers and managers cannot be counted on to provide the necessary selectivity. Apple's suppliers' often seek managers willing to order their workers to exceed the lawful workweek, to refuse to pay them for significant portions of the wages they have earned, to unlawfully employ child labor, and even to coerce abortions.

So, in the n-hexane example,

The engineer did not order the workers to use the nerve poison because he hated the workers. It was 'just business.' The nerve poison reduced cleaning time, so an engineer knowingly ordered the workers to use it and scores of other engineers did nothing to prevent the usage.

Note that Black calls this employee control fraud, deceiving the employee that he or she is working in a reasonably safe environment, and that employee health and safety is a concern, when in truth the only concern is the bottom line.

So what Apple executives, and by analogy, other multi-national corporate executives want are underlings, particularly middle and line managers who will do anything, anything to cut costs and improve the bottom line. This will produce the race to the bottom:

What we are observing is the essence of a Gresham's dynamic in which bad ethics drives good ethics out of the market.

Two aspects of this Gresham's dynamic are obscene, and both are produced by neoclassical economics dogma. Calling this process 'creative destruction' is baseless and dishonest. It is the fraudulent destruction of honest businesses, professions, and labor.

Black concluded:

firms that are anti-employee control frauds are likely to commit other forms of control fraud. Apple and its Western counterparts have driven the creation of an Asian network of fraudulent firms that has distorted international trade, hollowed out U.S. manufacturing, and created a bizarre hybrid: quasi-communist crony capitalism. It boggles the mind that theoclassical economists celebrate the corrupt result as the essence of creative destruction. The network is corrupt. It will not play by the rules. Firms like Apple help create the perverse incentives that encourage the network to cheat. Surviving U.S. manufacturing firms are whipsawed by the powerful Gresham's dynamic that the frauds produce. U.S. firms and workers are constantly pressured to reduce wages and workforce to try to compete with the foreign frauds. This is the 'Road to Bangladesh' strategy that has caused U.S. working class wages to stall for decades. Europe is retreating along this same road at an even more rapid rate. The Gresham's dynamic tilts the world in favor of fraudulent firms operating in fraud-friendly nations.

The Race to the Bottom in Health Care
Note that we have written about numerous examples of executives of US health care organizations putting revenue ahead of the health care mission, ahead of workers' morale, ahead of patients' and the public's health. Some of these examples involve executives of nominally non-profit organizations that are supposed to have charitable purposes. (Look under our heading of mission-hostile management.)

In fact, just yesterday, Dr Carl Elliott, writing for the Chronicle of Higher Education, summarized how pharmaceutical companies have out-sourced clinical research. The resulting commercial clinical research have generated conditions as bad for the research subjects as those endured by the Chinese electronics workers above:

If the past decade had an emblematic moment for clinical research, it was probably November 12, 2005, the day when Bloomberg Markets published its cover story, “Big Pharma’s Shameful Secret.” In that issue, Bloomberg reporters laid out the story of SFBC International, a contract research organization in Miami that was paying undocumented immigrants to test the safety of new drugs in a seedy motel. The SFBC owners had converted the lobby into a large waiting area with plastic chairs, and they were housing their research subjects six to a room. The medical director of the research site was unlicensed to practice medicine; the Institutional Review Board that approved many of the studies was owned by the wife of the company vice-president; and the converted motel, which had been cited for fire and safety violations, was eventually demolished. Nonetheless, SFBC had become an astonishingly successful enterprise. Just a few years before the Bloomberg Markets report, Forbes had named SFBC one of the most admired small businesses in America. Virtually every major pharmaceutical company had tested drugs with the company. In fact, with 675 beds, the converted motel was the largest research facility in North America.

Note: see our relevant posts here on SFBC International, and on contract research organizations.

Moreover, such out-sourcing has produced the sort of race to the bottom described by Black, but this time involving one of the US most important health care institutions, academic health care:

the more important reason is money. In medical schools, faculty members are often expected to generate their own salaries, either by seeing patients or getting grants and contracts. Likewise, academic departments are often expected to be financially self-sufficient, with as little support as possible from central administration. 'Eat what you kill' is the phrase used, without irony, by medical school deans and department heads. And if you are not killing it with NIH grants, you probably need to be killing it with AstraZeneca or Pfizer.

This system has not been good for human subjects, but it has not been good for academic physicians either. According to a recent study of over 5,000 faculty members at U.S. medical schools, 51 percent of respondents said that the administration is only interested in me for the revenue I generate.' Thirty-one percent said that their institution discourages altruism; 27 percent said that it does not reward clinical excellence; and over half said that it does not value teaching. Nearly half of respondents were considering leaving their current jobs; almost a third were considering leaving academic medicine altogether. Asked if their values lined up with the medical schools where they worked, over half said no. And just in case you are wondering why these physicians are not standing outside the building with picket signs, protesting the injustice of the system, the survey offers another clue. Thirty percent of respondents agreed with the statement, 'I am reluctant to express my opinion for fear of negative consequences.' [This was from an abstract by Pololi L et al.  See our relevant post here.]

Of course, this survey does does not exactly match up with the happy propaganda disseminated by the media-relations offices at most medical schools. Instead, it offers a picture of alienated, demoralized physicians, unhappy in their jobs, pressed to work according to values that repel them in order to prop up an institution that views them primarily as instruments to generate profit. In this environment, contract research makes perfect sense. It may not require much intellectual work, but it pays the bills and keeps the authorities happy. And if medical schools don’t really value intellectual work anyway, that may well be enough.

So the pressures on medical school faculty are little different from those on corporate middle management.  Their only role is to make money, mainly so that the top leaders can become multi-millionaires, and woe unto them if they object.
Summary

What is missing in all this is any organized opposition to the race to the bottom. As long as top executives can make nearly unlimited money, as long as they can do so by making their subordinates put revenue ahead of all else, as long as there are no countervailing forces, the race to the bottom will continue.

To stop it, we need some combination of efforts by honest government regulators, professional and trade organizations, civil society organizations including non-profit organizations and NGOs that really care about patients' and the public's health, and finally an activated, and properly outraged public.

As long as we think that a laissez faire policy allowing continual market dysfunction to continue, the good times for executives will keep rolling, over all of the rest of us.

"Conspiracy Theory" Proven - Taking UCSF Private

Students and faculty at the University of California have come up with a vivid, and prescient example of how the hired executives and bureaucrats have taken over higher and health care education. 

"Run in the Interests of the Administration"

Two weeks ago, the Orange County Register reported:

Over the past few months, the University of California has raised undergraduate tuition by 18 percent, awarded raises of as much as 23 percent to a dozen high-ranking administrators and announced a possible 81 percent tuition increase over the next three years.

Students haven't taken the news well.

At campus rallies across the state, thousands of students and their faculty supporters have decried the actions, staging raucous rallies and 'Occupy'-style sit-ins that in some cases have ended in clashes with law enforcement. They've also descended en masse on UC regents' meetings, disrupting proceedings and even forcing officials to retreat to a private room.

Behind the angry chanting and acts of civil disobedience is a growing sense that the 10-campus UC system is no longer a public institution accessible to the middle class, but rather a sprawling bureaucracy of hospitals and auxiliary research institutions buffeted by an ever-expanding roster of administrators.

The problem, as the student activists see it, is that none of these functions translates directly into expanded course offerings or improved student-to-faculty ratios, even as their tuition dollars help sustain the system.

'The university is now being run in the interest of the administration,' said UC Irvine student activist Anne Kelly, a Ph.D. candidate in earth system science. 'They're promoting their own internal growth, asking us to sacrifice with higher tuition – but administrators have had raises.'

In higher education, as well as in health care education and in health care in general, the pattern is the same: rising costs without any obvious increase in quality or quantity of services. As in health care, however, the pain never seems to extend to administrators/ managers/ bureaucrats/ executives. Worse, as their numbers grow, these insiders seem to run organizations more for their own benefit, and less for the mission.

One Manager Per Faculty Member

Furthermore, UC faculty have data:

The students' growing frustration is fueled by UC employment data that show that almost three-fourths of UC's 152,500 employees last year were designated 'non-academic personnel,' according to an annual UC employment report.

In the report, UC characterizes the growth in its non-academic staff as the inevitable byproduct of 'an increasingly complex university system that 'requires greater professionalization of its staff, who must meet higher technical and competency standards.' Non-academic personnel includes everyone from custodians and food-service workers to accountants and plant operators. [The question begged is whether it was the managers and executives that caused this complexity - Ed.]

UC Davis horticulture researcher Richard Evans, who has independently analyzed UC personnel data, offered a different take on the data, publishing a tongue-in-cheek piece for UC faculty in 2010 entitled 'Soon every faculty member will have a personal senior manager: Is this a good way to spend money?'

'Data available from the UC Office of the President shows that there were 2.5 faculty members for each senior manager in the UC system in 1993,' Evans wrote in his piece. 'Now there are as many senior managers as faculty. Just think: Each professor could have his or her personal senior manager.'

In his analysis, Evans compared the number of UC employees classified as either 'senior management' or 'managers and senior professionals' with the number of tenure-track UC faculty members.

As of spring 2011, UC employed 8,144 senior managers, managers and senior professionals, and 8,521 tenure-track faculty members, according to the latest available UC data.

This pattern is similar to that seen in some data we discussed a long time ago about the ever rising numbers of administrators/ managers/ bureaucrats/ executives in health care.  In 1988, Alain Enthoven advocated in Theory and Practice of Managed Competition in Health Care Finance, a book published in the Netherlands, that to decrease health care costs it would be necessary to break up the "physicians' guild" and replace leadership by clinicians with leadership by managers (see 2006 post here). Thus from 1983 to 2000, the number of managers working in the US health care system grew 726%, while the number of physicians grew 39%, so the manager/physician ratio went from roughly one to six to one to one (see 2005 post here). Health care went from being controlled by clinicians to controlled by a growing volume of managers.  Most of these managers were generic, in that they had little if any knowledge of, experience in, or sympathy to the values of health care. These generic managers have used the same techniques advocated for the management of supermarkets or automobile manufacturers to manage health care organizations, despite all the obvious differences in context, goals, values, and people involved.

A "Conspiracy Theory" About the Privatization of the University

At the University of California, the Register reported that there is a "conspiracy theory" about the next step to increase the domination of the managers:

The salaries and size of UC's administrative staff, in particular, have fueled conspiracy theories among students and faculty that the system has deliberately sought to 'privatize' itself – in other words, to compete with private universities on all fronts, from the scope of its non-instructional programs to executive compensation to the amount of tuition that students pay.

Three years ago, the head of a UC faculty group advanced the privatization theory in a multi-part series called 'They Pledged Your Tuition.'

Of course, the administrators denied, sort of, anything so far-fetched:

For its part, UC denies all such allegations, saying that while the university has arguably become privatized, outside influences beyond its control are entirely to blame.

"It is not something we advocate, not something we want,' Klein said. But, 'he added, 'times have changed; the economic model has changed.'

Not Just a "Conspiracy Theory" - UCSF Chancellor Advocates Privatization

It only took two weeks, however, for the notion of administrators taking the university private to go from "conspiracy theory" to official plan. Yesterday, the San Francisco Chronicle reported,

UCSF Chancellor Susan Desmond-Hellmann told the regents, delicately, that she wants out.

Under her proposal, UCSF's medical school, hospital, clinics and research facilities would remain a public university connected to UC, the chancellor assured the regents. But the tendrils connecting the two entities should be thinner than they are today.

Desmond-Hellmann said she envisions a relationship like those of UC Hastings College of the Law, Lawrence Livermore National Laboratory and Lawrence Berkeley National Laboratory, which contract with UC for health and pension services. While ultimately accountable to the regents, they are autonomous with their own boards of directors.

Referring to 'alternative governance models' and 'examining UCSF's financial relationship with UC,' the chancellor and campus executives talked of their ambition to become the world's leading innovator in the health field - a goal better achieved, they hinted, without the rest of the university weighing it down.

To Health Care Renewal readers, that UCSF would be proposed as the first part of the University of California to privatize should not come as a shock. After all, Chancellor Desmond Hellmann came not from academia, but from the world of for-profit biotechnology. She was a former president for drug development for Genentech.

Two and one half years ago I suggested that "hiring a lavishly compensated top executive from a biotech firm known for its high drug prices to run a public health sciences university does considerably blur the line between academic medicine and the health care industry." Furthermore, three months ago I noted that Dr Desmond Hellmann seemed be advocating that the university's focus turn to product development, so that it would start to emulate a contract research organization. Now it appears that Dr Desmond Hellmann wants to traverse the line between government and the private sector, so that the organization could "make a ton of money," and "focus on spinning innovations into business deals," according to the San Francisco Chronicle.

What any of this has to do with the university's fundamental mission to discover and disseminate knowledge, and with this health care university's mission to take the best possible care of its patients is not clear.

Summary

Turning UCSF into a private, quasi contract research organization might conceivably yield some good research and drug development. Why a formerly academic organization would be better at this than a purpose-built CRO is hardly proven. Whether UCSF recast as a CRO would yield better research, leading to better patient outcomes than would have resulted if it continued as a state government sponsored health care university is also hardly proven.

Turning UCSF into a quasi CRO, however, would likely be very much in the self-interest of its administrators/ managers/ bureaucrats/ executives who would be freed from any constraints on their incomes, and the disclosure of same that were previously obligated by the messy representative democracy to which they formerly had to answer.

On the other hand, it is hard to conceive of how such a privatization would be good for students or patients. In fact, it is not the least bit clear why a medical, nursing, or other health professional student would want to study within what would basically be a contract research organization. It is also unclear whether patients seeking care from such an organization could trust it to put their interests, rather than the organization's revenue and the self-interest of its administrators/ managers/ bureaucrats/ executives first.

We are now a good 30+ years into our ill-fated American experiment about the effects of turning medicine commercial and making health care a commodity. So far, it has yielded the highest costs in the world, but declining access, mediocre quality, and demoralized professionals. Turning one of our once proud and  prestigious state government sponsored academic medical institutions into a private contract research organization would be a powerful symbol of our final national health care decline.

Let us hope that the students and faculty whose "conspiracy theory" about privatization proved true will now mount a more effective protest before UCSF falls into the muck.

"Barbarians at the Gate" - Making Private Equity Less Private, and Understanding Its Effects on Health Care

One good byproduct of the tumultuous everlasting 2012 campaign for the US presidency has been to shed light on a number of political and economic issues that had previously been ignored, especially those relating to the global financial crisis or great recession.  In turn, many of these issues may be relevant to our understanding of our ongoing health care dysfunction. 

The latest issue to achieve prominence was the nature of private equity firms.  Current presidential contender Mitt Romney used to work for Bain Capital, a private equity group.  As we discussed here, Bain Capital owned a variety of companies, including some important health care corporations.  More importantly, attacks on Mr Romney's record at Bain by other candidates have lead to a broader discussion of the nature of private equity.  This discussion is very relevant to health care, since private equity firms have taken over a number of important health care corporations, and more recently, have begun to take over formerly non-profit health care organizations.

Therefore, we will summarize what has become known about private equity, and then consider its implications for health care.

Understanding Private Equity as Re-Branded Leveraged Buy-Out Firms

- Private Equity Firms are Just Re-Branded Leveraged Buyout Firms

The first good statement to this effect I found was by Merrill Goozner in the Fiscal Times(1):

Private equity is actually a misnomer, since the modus operandi of those investors is no different than the leveraged buyout firms that pioneered junk-bond financing in the 1980s.

As reported by the Los Angeles Times(2):

'Being known as a leveraged-buyout-deal shop wasn't the most attractive label out there,' said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth's Tuck School of Business. 'Private equity has a much nicer ring to it.'

In fact, according to Forbes columnist Robert Lenzer,(3) the famed investor Warren Buffet called this re-branding

'Orwellian': Buffett wrote that 'private equity' is a 'name that turns facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing.'

I must admit I always thought private equity firms simply collected large amounts of capital from investors, then used the pooled capital to buy out troubled firms. I assumed that because these investors therefore had a large personal stake in these firms, they would want to increase at least their financial value. I also thought that leveraged buy-out firms ceased to exist after all the bad press they got in the 1980s. It turns out I was wrong on all counts. Probably, a lot of other peoples' beliefs about private equity were similarly wrong.

Once the equation of private equity and leveraged buyout firms is made, understanding what they do and its implications are easier.

- Leveraging the Buy-Out

The modus operandi of leveraged buyout firms is to make their purchases of troubled corporations mainly with borrowed money. As Merrill Goozner put it(1),

Private equity firms generally finance anywhere from 60 to 90 percent of their purchases with borrowed cash.

Note that,

Interest payments on those debts are treated just like any other expense, and are therefore deductible from earnings.

- Then Leveraging the Acquired Company

If this leveraging were the only leveraging done in a leveraged buy-out, the implications might not be that big, except for the acquiring firm. After all, when the leveraged buy-out firm borrows the money, it then becomes obligated to pay it back. However, then comes the tricks.

One important trick was described in the following example by economist Dean Baker on the Beat the Press blog(4),

To take a simple example, suppose a public company (let's call it Gingrich Inc.), has $1 billion a year in profits. If Gingrich Inc. paid taxes at the full 35 percent rate (fat chance), it would have $650 million [thanks Robert] a year to either keep as retained earnings or to pay out as dividends to its shareholders.

Now suppose that a PE company (we'll call it Romney Capital) steps in. The current price to earnings ratio in the stock market is around 14, so Gingrich Inc. would have a pre-takeover market value of approximately $9.2 billion (14*$650 million). Romney Capital then arranges for Gingrich Inc. to borrow $6 billion which it pays out as a dividend to itself. This means that the Romney Capital has just gotten back almost two-thirds of its investment.

A somewhat less vivid description of the process appeared in a post by Robert K Lifton on the Huffington Post(5):

Most often, in order to increase the return on capital invested by the fund, the fund will borrow a significant portion of the purchase price of the business. And sometimes, if it can, the fund will take back as a distribution immediately upon closing the purchase of the business, a portion of its investment in the purchase price, reducing its own investment and enhancing its return on the investment left in the business. This distribution may come from the company's existing cashable assets or from money that the company is caused to borrow.

Thus, it appears that while the leveraged buy-out (or private equity) firm borrowed money to finance the purchase of a company, it can almost immediately get out of its obligation to pay off that loan, by making the acquired company its own loan, and using proceeds from that to end the LBO firm's debt. The leverage, and the obligation to pay back a debt has almost magically been transferred from the LBO or private equity firm to the acquired company. That has big implications, as Lifton wrote(5):

This additional leverage also creates additional risk; if things don't go right the business will not be able to pay the carrying costs of the debt, the lender will take over the business and the fund will lose its investment. Sometimes, that results in the acquired company placed in bankruptcy proceedings either to liquidate its assets to pay off the debt or to restructure, a process Bain also experienced.

- Selling Assets to Further Reduce the Private Equity Firm's Debt

LBO firms have another trick up their collective sleeves. As Dean Baker continued his example(4),

Now suppose that the Romney Capital arranges to sell off some of Gingrich Inc.'s assets, such as real estate or a highly profitable subsidiary, and then uses the proceeds to make a payment to the Romney Capital rather than leaving the money under the control of Gingrich Inc. Such sales may allow Romney Capital to recoup the rest of its investment and possibly more.

Of course, the result is

Gingrich Inc. is then left as a highly indebted company with few assets.

In this story, Romney Capital may have earned a substantial profit on a limited investment (it recouped most of its money almost immediately when it loaded Gingrich Inc. with debt), without doing anything to improve the operation of Gingrich Inc. If Gingrich Inc. manages to stay in business and generate profits, then this will increase the return. Romney Capital may be able to resell the company and treat the whole sale price as profit.

On the other hand, if Gingrich Inc. goes bankrupt, this will primarily be a problem for creditors, since Romney Capital has already gotten its investment back. In effect, Romney Capital might have secured large gains entirely by financial engineering, while creating no value whatsoever.

Let me underscore that. The LBO model (now also the private equity model) enables the acquiring LBO firm to avoid any losses, by shifting all the risk and obligations to the acquired firms. This puts these firms at considerable jeopardy.

- Tactics to Prepare Acquired Firms for Sale

Of course, LBO/ private equity firms want to do more than not lose money. To make real money, they must be able to sell off the firms they acquire. To do so, they must make these firms, or their components, seem attractive, at least in the short term. To do this, they employ a standard set of tactics out of the generic management playbook.

So, per the LA Times(2),

layoffs are part of the playbook that elite investment firms use to squeeze cash out of struggling companies.

Also, per Lifton(5),

To increase the profits of the acquired company, the fund may reduce the number of employees, reduce pay levels or curtail work time.

In addition, per Josh Barro writing for the Forbe blog(6), other tactics can include

downsizing, increased automation, offshoring, and the like.

- The Private Equity/ Leveraged Buy-Out Version of the Anechoic Effect

It is striking that while Mitt Romney worked at Bain Capital in the last century, and private equity has been around, if not growing, since then, the current presidential campaign seems to be the first occasion which prompted any real public discussion about the nature of private equity, and its significance for the larger political economy. Thus private equity/ LBO seem to have been anechoic for a very long time (like much about how our current health care system operates seems to be anechoic.)

This version of the anechoic effect seems to have been deliberately created by the private equity/ LBO firms.

A Washington Post commentary(7) quoted Mitt Romney,

You know I think it's fine to talk about those things in quiet rooms,...

As a New York Times story(8) put it, these firms are lead by

a group of Wall Street executives who prefer to operate out of the spotlight

A story in Politico(9) called private equity/ leveraged buy-out firms

one of the most secretive redoubts of the American economy

The article went on to suggest that these firms may well have something to hide:

Josh Kosman, author of 'The Buyout of America: How Private Equity Is Destroying Jobs and Killing the American Economy.' [said] 'Most private equity firms are because once you look behind the numbers, there is much they don’t want you to see.'

Furthermore,

Private equity companies often tend to have confidentiality agreements with their investors (Bain would not comment on what agreements it has). Several equity experts interviewed for this story thought any disclosures from Bain were likely to spook its investors.

The private equity business model is based on taking companies out of the public markets, where reporting requirements are strict and investors punishing, making changes that will hopefully make them more profitable and then selling them or taking them public through an IPO.

The part that happens behind the curtain is not always pretty, and private equity firms have learned over the years that it’s hard to tell a complicated story in the media. The goal of private equity is to keep things private.

'It’s had very little consciousness in the political realm until Romney came along because these guys are smart enough not to try to become Treasury secretaries,' said Bill Cohan, a former Wall Street banker-turned-investigative journalist who wrote 'Money and Power: How Goldman Sachs Came To Rule The World.'

In addition, Dean Baker suggested that the confidentiality is used to hide how private equity/ leveraged buy-out firms remove capital from acquired companies(4),

The sort of asset stripping described here, which harms creditors by taking away potential collateral for their loans, violates the law. However it is extremely difficult to prevent, especially with private equity companies that have to make few public disclosures.

Thus secrecy/ confidentiality/ deception should be regarded as one of the main tactics used by private equity/ leveraged buy-out firms.

Implications for Health Care

Mitt Romney's candidacy has generated a surprising amount of discussion about the effects of private equity/ leveraged buy-out firms on the political economy. Many are worried that despite his claims, such firms cause more job loss than job creation. In the Huffington Post(10), Robert Creamer wrote that private equity/ LBOs have contributed to the sense that ordinary people who play by the rules suffer while well-connected insiders prosper:

It just doesn't make sense to them that a relatively tiny number of people -- who don't build a product or create a service -- can make massive amounts of money, while ordinary people who work hard and play by the rules see their incomes flat-line.

Their view is simple. They create cars, or food, or houses or computers -- or they provide police protection, or care for sick people, or teach our kids. Why should they be asked to sacrifice when guys who basically gamble for a living -- as Wall Street speculators -- make incomprehensibly large sums of money?

There seems to be a good argument that the tactics used by private equity/ leveraged buy-out firms might be bad for the general political economy.

Moreover, these firms often take over health care corporations, drug and device companies, health care information technology companies, health insurance companies, for-profit hospital chains, etc. There is reason to think that their standard tactics used on such targets are likely to be particularly bad for health care.

Many health care corporations depend on a long-term view to be successes. To develop new products, drug, device, and health care IT companies must pursue research and development projects that take years. All health care companies depend on highly trained, specialized workers and professionals. To sustain these sorts of employees requires a long-term attention to their development. So private equity/ leveraged buy-out firms' short-term focus, transfer of debt and risk to the acquired companies, and emphasis on short-term generic management cutting costs techniques including lay-offs, outsourcing, etc clash with the sophisticated long-term focus these companies require.

These health care organizations often require the complex interplay of many components. Private equity/ leveraged buy-out firms' efforts to sequester and sell particular assets may disturb this complex system.

Health care quality, and successful research and development require transparency. Extreme emphasis on secrecy by private equity/ leveraged buy-out firms threatens such transparency.

Even more pointed concerns may arise when private equity/ leveraged buy-out firms endeavor to take over non-profit health care organizations. We plan to discuss these in a subsequent post.

The NY Times(g) noted that in the 1980s, leveraged buy-out firms

were branded as 'barbarians at the gate' - the title of a book [by Burrough and Helyar, link here] about the takeover of RJR Nabisco by Kohlberg Kravis Roberts.

Now 30 years later we are finally having a conversation about the role of these firms in the greater political economy. We in health care should be having a parallel discusion about their role in our sphere. I submit that their role was not likely productive. Since health care should not merely be looked upon as a means to make money, but as a public good, we ought to be talking about how to restrain private equity/ leveraged buy-out firms from doing it more damage.

References

1. Goozner M. Private equity's edge: buy now, deduct taxes later.  Fiscal Times, Jan 9, 2012.  Link here.
2, Hamilton W. Private equity industry: a bad rep, but is it deserved. Los Angeles Times, Jan 12, 2012. Link here.
3. Lenzer R. Why Warren Buffet disdains the private equity crowd. Forbes, Jan 14, 2012. Link here.
4. Baker D. NPR does fluff piece for private equity. Beat the Press, Jan 13, 2012. Link here.
5. Lifton RK. Mitt Romney and Bain Capital: understanding the reality. Huffington Post, Jan 13, 2012. Link here.
6. Barro J. The discussion we should be having about Bain. Forbes, Jan 12, 2012. Link here.
7, Robinson E. Reexamining the myth of no-fault capitalism. Washington Post, Jan 16, 2012. Link here.
8. Lattman P, Lowrey A. As Romney advances, private equity becomes part of the debate. New York Times, Jan 10, 2012. Link here.
9. Hagey K. Mitt Romney's Bain Capital days: a black box. Politico, Jan 11, 2012. Link here.
10 Creamer R. Why the Bain Capital controversy is so damaging to GOP chances this fall. Huffington Post, Jan 16, 2012. Link here.