Podcasts26 Jan 2007 05:14 pm
This one’s all about the some causes, some effects and some possible solutions to the massive profit pressure on corporations. I’m no genius about these topics, and this is by no means a comprehensive discussion. Nevertheless, I think this is a topic worth discussing.
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January 27th, 2007 at 12:43 am
Couple of things…
Bicycle Mark’s comments on the word “liability” were poetic and all, but… “liability” in accounting terms its a neutral word. It just means “something you owe.” That’s it. Pensions are a liability because you owe them. Unused vacation time is too. So are the bills you haven’t paid yet.
It’s dangerous to apply standard meanings to words being used in a specialist context, because it sounds like the writer doesn’t know much about the topic at hand. I like Mark and his stuff but… this was silly.
I think you’re right that it would be healthy if things like stable cash flows, measured growth, treating employees right, and so on were reflected in stock market values. Well, actually, they are; but that’s hard to see when sudden high flying companies get rewarded with huge share prices.
But this points to the problem: where do market prices come from? The market. That is, the people who are buying and selling the stocks. There’s nobody decreeing that any one thing is valued more than others; the market reflects the collective choices that investors make about where to put their money.
I have a real concern about not having quarterly financial reports. Those reports represent the information that investors use to make decisions, and I’ve worked in companies where over the course of six months, things could change dramatically. If we went to annual reporting, then people would be making investment decisions based on what a company told the public about its operations eleven months ago- and they could be buying something very different than what they think they are. That’s why the general trend, with things like Sarbanes-Oxley, has been toward greater transparency, so companies can’t hide their problems so easily.
I think you give dividends an unfair knock. Frankly, if stocks were being bought because they throw off regular annual dividends, the market would be more stable. It used to be easy to value stocks; if they pay 10 cents a share every year, you calculate the present value of that cash flow, and that’s a reasonable share price. These days people expect to make money by changes in stock prices which often aren’t reflecting any financial fundamentals - the market has really transformed from something that provides a measure of a business’s actual performance to bets on its future potential. Both elements have always been there, but the balance has changed.
Which brings me to two final points:
First, you mentioned the small number of people who own stocks. While it’s true that direct ownership of stock is not something most of us have, you have to remember that everybody there are many indirect investors (though 401(k) plans and other vehicles). Stock ownership isn’t the game for the rich you make it sound like.
Second, it is reasonable for those who put their money into the market to expect a return; the market exists so businesses can raise capital to undertake activities they couldn’t otherwise. How much is “enough” profit? Well, if it’s your money being used, the question is a bit different.
Ultimately, I think that costs that are now externalized need to be internalized. You can’t increase your profit by overworking employees if there are strong labor laws. You can’t cut costs by dumping toxins in a river if there’s a well-enforced law against it and stiff fines for doing it. If we allow corporations to do things we don’t like because they increase profit, we shouldn’t be surprised when they do.
Think of the corporation as the puppy running around your house. He’ll chew up books and eat the remote control if they are there; it’s his nature. You can get mad at him for doing it. Or you can put these things out of his reach. The latter course is more practical, and unless we put abusive behavior out of the reach of corporations, they will do it, and we shouldn’t be surprised. When it’s more expensive to do the wrong thing, it won’t be done.
Finally, the pensions: again, transparency is better. It doesn’t make sense for a company to take pension contributions and put them in a savings acount when, if the company’s worth a damn, they can use the money better on business activities and get a better return (to provide the funds for paying those pensions). BUt the financial reporting has to be structured so that they cannot hide those liabilities; clearly, we haven’t done well in this area.
For cities, it’s a slightly different story. I’ve watched this play out in two different ways in two cities (Houston and DC). If your residents vote to cap taxes, or otherwise limit revenue, and you still have to provide basic services, and the cost of those services increases (as it always does), then you’re going to wind up with an unfunded liability. Houston is struggling with that now; revenue collection is up, and people say “Why do you need all those property taxes?” but we’ve still got all kinds of pensions to pay for police officers, firefighters, etc.
DC was interesting. Before the Home Rule act passed in the 70s, the federal government was responsible for pensions of city workers. When they gave the city limited home rule, they also gave it the entire pension liability - but no money to cover it, thereby guaranteeing that the city would be a financial basket case for years. (Then DC was criticized for not having its finances in order). Nice, huh…
January 27th, 2007 at 8:14 am
(There’s a stray “everybody” in the paragraph that starts, “First, you mentioned…” Brain fart. Ignore it, please…)
January 28th, 2007 at 10:49 pm
Interesting stuff. One of the big elements missing from the equation is that a lot of pension funds put their money into stocks!
Im not financial expert by any means, but Id say that the system is wobbly at best, and has been in a cannibalistic phase since at least the early 80’s. I think a big part of the problem is a far too narrow set of responsibilities for different people and entities within the system. Just as the idea of corporations has been criticised because they are bound to provide stockholder value above everything else, the pension fund manager at one firm’s duty is to try to get maximum return on that fund, even if it means investing in things that potentially harm the pension funds of workers at other companies.
I dont see this stuff fixing itself or getting better, not whilst the markets and growtch are considered the god of the current system. Only when it fails in a more spectacular way, will there be a real opportunity for people to demand something different. Ultimately that opportunity may lead to a fairer society and happier people, but I expect in real terms, we’ll all be much poorer.
If something like the oil supply peaking means it starts to become inevitable that the god of growtch must go, then we will start to see noises in the press about this stuff not being all its cracked up to be. Just the other day I saw an article here in the UK that said government is wondering why surveys show people are no happier than they were in the 1950’s, even though income has trebled. Are they starting to shuffle the props round ready for the next scene, or am I getting carried away with how quickly this might happen?
I wouldnt underestimate the impact that the baby boomers retiring will have, although the ’solution’ to that which has been chosen, is already showing signs of being an increasing relaxation of immigration rules. Ont his note sometimes I like to remove money altogether from the equation when thinking about economics, and look at it purely in terms of resources. If loss of people of working age due to old age, comes along at about the same time as a loss of ‘energy slaves’ (by this I mean fossil fuels), then the resource issues go well beyond the realm of people syphoning off the paper money from pension funds over decades, to more fundamental basics about how we support the elderly.
January 28th, 2007 at 10:59 pm
Oops sorry I typo’d growth in my above comments.
Was just thinking about what could be done to change the balance slightly within the current system and I remembered hearing something about Coprorate law in German,y that a representative of employee’s sits on the board.
If emphasis was moved from stockholder to all real stakeholders; employee’s, local community, customers, then this would be a better balanced system? Or has the term stakeholder already been spoilt beyond redemption by its use in corporate propaganda that claim they already care about all stakeholders?
January 28th, 2007 at 11:38 pm
I agree with a lot that John says, and he provides a useful metaphor with the puppy. But I think the nature of big business and investment today is far harsher than some benign “market”.
Instead, I believe that the underlying paradigm for big business has changed (Steve also touches on this). To be successful, businesses of all sorts must of course focus on maximising profit. Corporations have the added burden of maximising return to shareholders. These used to operate in tandem–a company would work to maximise profits and that would yield greater returns to investors. Sometimes the puppy would “chew up” things, but there was a disciplinarian nearby.
Nowadays, however, bald greed is the driving force. How many times has the news reported huge profitable companies announcing that their sizable profit would be somewhat lower than predicted? Shareholders dump the shares, the price drops, and the corporation responds by firing hundreds (or maybe thousands) of workers in an attempt to raise profits and so, the share price, all because that’s what the shareholders demand.
As John says, the balance between regular dividends and super-high returns has changed. What I see is that retirement and other funds aren’t innocent shareholders in this regard. Many pension fund managers, as Steve suggests, are ruthless shareholders, as demanding of super-high returns as any mega-rich individual. Investment bankers’ whole reason for existence is to maximise return on investment at any cost. None of these investors (unless they’re one of the “ethical investor” varieties) gives a toss about the effects of their demand for higher returns. They’ll just place their bets on another company.
Perhaps this is what makes the puppy go berserk–in the quest to maximise shareholder returns big companies do things that are improper, unethical, immoral or even illegal, betting that if they’re caught the cost will be lower than the “lost” returns if they hadn’t done the wrong thing. John’s right, puppies will be puppies, but these modern day robber-baron investors are encouraging the puppies to go mad.
Maybe what’s needed is a little of everything suggested–more transparency at all levels and more positive aspects of business were somehow measured in corporate performance. I also like Steve’s idea of mandating more stakeholder participation (in the real sense, not corporate hype) as a way to balance out “bad” shareholder influence.
I think I get where Jeffrey’s coming from about quarterly reports—all too often they’re just spin and hype. The stuff that investors need, like balance sheets and profit/loss analysis, for example, could be prepared quickly by any accountant, or even a competent bookkeeper, for that matter. But how do get corporations to drop the spin and hype?
The problem with the mega-corporations is that their power is immense, often enough to sway policies of governments around the world. The public has a right to expect greater transparency from such powerful entities. The media—mostly owned by these mega corporations—are unlikely to provide it. Regulators seem unwilling to take on the mega corporations, and the robber-baron investors are almost always beyond the reach of regulators.
In the end, I agree with Jeffrey on all the need for a new structure. I’d like to see a replacement for the current system, one that still rewards individual initiative without allowing the destructive behaviours we see all too often directed against workers, the environment or small shareholders. Personally, I’ve become totally pessimistic that this current puppy can ever be housebroken.
January 29th, 2007 at 7:58 pm
@All of you.
Damn good comments. Thanks heaps for taking the time, which I intend to honor by doing a Part II podcast about this sometime this week.
I was really afraid to put out an opinion about a subject that I know comparative little about, but it looks like the risk paid off. Stay tuned.
January 30th, 2007 at 7:08 pm
The quarterly spinning is indeed fantastic, I lived though it in my dot com days, as we tried to explain why burning a big pile of cash in three months was a fabulous thing. Perhaps we should just ban all forward-looking statements, instead of just putting disclaimers on them.
Shared getting dumped for less-than-predicted profits doesn’t surprise me. The share price is based on an expected value of the business, based on the expected profits, and if you guess wrong, then the share price will drop- as it should.
January 31st, 2007 at 3:42 am
Share prices are based on what people will pay for them, nothing more. Smart–I might even say real–investors will base their decision on the fundamentals of a company, but the speculators I’m talking about focus more on the bet.
The specific problem I was talking about was when shareholders dump shares because the return to shareholders was less than THEY expected, and that dumping of shares then depresses the share price. Share prices can rise or fall based on a company’s actual performance, but all too often it happens because of shareholders speculating–gambling, essentially. In such cases, whether the share prices “should” fall becomes a moral evaluation, not an economic one.
Commentators repeat endlessly the mantra that shareholding should be a long-term proposition, that over time such investments perform better than almost any other. But too many modern shareholders aren’t investing, they’re simply gambling, they’re after a killing, rather than a good return on investment over time. Personally, I wish they’d stick to poker or craps and leave companies and people’s livelihoods alone.