Financialist Follies: Participating in Prosperity?

runaway horseNo matter if a person lives in downtown Manhattan (NY or KS)  or Antelope Fart Flats, Nevada… this  entry into the Financialist School of Mismanagement curriculum is a really bad idea:

“Ninety percent of companies now require employees to participate in variable pay plans, up from about 50 percent two decades ago, according to a survey of 1,100 U.S. companies by human resources consulting firm Aon Hewitt.  The dollars tied up in the plans, meanwhile, have quadrupled, from about 4 percent of payrolls in the early 1990s to about 12 percent of payrolls today, according to Aon Hewitt.” [HuffPo]

The result? Fewer companies are funding traditional pension plans and more are promoting self-funded, self directed 401(k) plans.   In short, the employee’s retirement funds are tied to the stock price of the corporation for which he or she works.  What could possibly go wrong?

Gee whiz, what could be a problem with allowing workers to participate in the prosperity of the company?   Here’s what:

(1)  Tying pension and any other form of compensation to stock prices skews the company’s priorities toward the financial markets.  Time was when a firm had three traditional priorities — the needs of the customers/clients, the employees, and the company’s profitability.  Take care of the customers, it was said, and everything else will eventually take care of itself.

Old school management sought to provide the best product on the market — the retail or wholesale market — at the most reasonable cost with the best service after the sale which could be practicably managed.  Employee retention was an important element in this system.  Experienced employees knew how to make the product or deliver the service, without inordinate training costs for new hires.  The “new school” pay for performance (stock market performance) plans distort the priorities until the needs of the customers and the employees are subordinated to the financial markets.

(2) The financial markets are fickle friends.  There are two basic pressures on stock prices — internal and external.  Internally, the price of a stock may depend on forces over which the employees have little or no control, but which can be controlled by management — to wit, the “targets” for a particular quarter.  Should a firm wish to reduce the payments to employees in a specific term all that is necessary is to increase the targets, thus adjusted the targets “cannot be met” and therefore a reduction in the “pay at risk” can be justified.

It doesn’t have to be this slick.  External forces can be at play.  If a civil war breaks out in western Goldistan, mining companies may delay orders for heavy equipment — if an outbreak of cholera decimates a portion of eastern Sweatshoppia subcontractors may not be able to supply components for  some manufactured products… In short there are very real risks associated with the production and distribution of goods and services.  In the stylish “pay based on performance” schemes an employee’s pension or compensation plan is tied to the risks formerly the province of management and the investors.  Not to put too fine a point to it, but the investors and management are seeking to shift these  risks from themselves onto their employees.

(3) The financial markets do not necessarily reflect commercial markets.  In some fictionalized narratives, the omniscient Financial Market, awash in analysts and algorithms, is capable of determining the real value of a corporation, as represented by its stock price.  If nothing else, the debacle of 2007-2008 should be an object lesson in just how far afield the value of a company can be from the reality of its commercial value.  Note how often a company was profitable, even in the face of very negative forces, but the “analysts” determined that the firm had “missed its targets,” and therefore the company is punished in the financial markets as investors move money into other equities.

The “thing” becomes a numbers game in which the company tries to determine its profits, gives “guidance” to Wall Street, the Wall Street wizards weigh in, and those targets become the end-all rather than general guidelines by which a company may be measured.  For all the gimcracks and gee-gaws, charts with bells and whistles, and fancy statistical gadgets — financial markets are run by and for human beings.  Human beings are herd animals.  If we were owls we’d be called a “parliament,” if we were characterized like our primate cousins we’d be called “troops.”   We get comfortable together, get elated together, and we have an unfortunate tendency to panic together.

We are the creatures on this planet who created both the washing machine and the Pet Rock.   The washing machine is still around, but powdered wigs, buggy whips, Pet Rocks, and muscle cars have come and gone.   In fine, there are still customers for washing machines.   The point of all this is that while some products and services may be fashionable or useful in the short term, long term corporate planning is not well served by focusing on short term results.  And yet, focusing on short term results is what Wall Street does best.  Thus we have the disquieting prospect that the long term viability of our manufacturing and commercial firms is to be measured in short bursts, from data conveniently inserted into algorithms, which in turn drive investors toward or away from a particular corporation.  The result is that we have a financial sector and its markets driven by short term vision applied to corporations which ought to be concentrating on long term viability.

Not only is there a problem with long and short term perspectives, there’s another complication.  That which makes a company profitable in the long run is not what might make it attractive in the short run.  How many times have we observed that a company which down-sizes its workforce is rewarded on Wall Street with increased share values?  If  the down-sizing is driven by a decrease in demand for the goods or services the reward is justified. However, if the down-sizing is the product of a hostile take-over, and bears little relationship to the actual operations of a company, then the reward is justifiable only in terms of the income generated by the take-over and not by any improvement in the real world commercial or retail markets which might be observable.

Consider for a moment the untenable position of an employee.  Should the person desire higher wages, the rejoinder from management would be “Why would you seek to increase labor costs, and thereby diminish the value of our stock in the financial markets?”   “You’d only be pulling money out of your own pocket?”  Damned if you do — and don’t.

(4) Financial markets are NOT self correcting.   If we learned nothing else from the Mortgage Meltdown and consequent recession after 2007-2008, someone somewhere should have gotten the message that the old canard Markets are Self Correcting is dubious and best and fantasy at worst.   Somehow “Manic Mr. Market” is transformed in financialist mythology as the creator of stable, efficient, and self correcting economies. [EconMonitor]  Really?  If markets create stable, efficient, and self correcting economies, then how do we explain:  (a) The Mississippi Bubble 1716-1720?  (b) The Florida real estate bubble 1925?  (c) The Stock Market Crash of 1929? (d) The Black Monday Crash of 1987?  (e) The Barings Bank Collapse of 1995? (f) The Dot Com Bubble? (g) The Housing Bubble?

If by “self correcting” one means the market for some goods or services collapse in a heap of decimated firms and scrambling investors, then so be it, however this is obviously not stable nor is it very efficient.

The Bottom Line

You’d be properly skeptical if I said I had a wonderful exercise opportunity for you — one that would increase your heart rate, promote deep breathing, and abet your muscle tone — all you have to do is paint my back fencing.  This is roughly analogous to what the financial sector is saying to American workers — put your money in 401(k) plans which we market to you, the plans will invest in whatever Manic Mr. Market loves today, and we will charge fees to your account for determining Manic Mr. Market’s mood swings.   In short, the financial sector makes money by handling your money, in an environment in which the financial sector creates volatility and bubbles, without all that much analysis into what would create a truly stable, efficient, and correcting marketplace in the real (commercial) economy.  [PBS]

If you believe in a financial market that is essentially stable, efficient, and self correcting — have I got a deal for you! And so do those corporate executives whose compensation is tied to stock performance — and want yours tied to that same horse too.

Additional resources: “Why the 410(k) is a failed experiment,” PBS.org, April 23, 2013.  “The 401(k) is a bad option for any worker,” EPI, April 8, 2013.   Hiltonsmith/Demos, “The Failure of the 401(k),”  November 9, 2010.  “How to save for retirement on a low income,” US News, April 11, 2011.   “90 Percent Of Employers Tie Workers’ Pay To Company Performance,” Reuters/HuffPo, September 1, 2013.  “Manic Depressive Mr. Market,” istockanalyst, September 19, 2010.

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