As of Friday, August 29, 2014 the S&P 500 stood at a healthy 2,003.37, increased by 6.63 from the day before. This figure is good news since the S&P was a pathetic 676.53 on March 9, 2009. [WSJ] S&P uses a weighted average market capitalization to calculate its index, so this must be the most accurate measure of the state of the economy? Maybe. Feeling all comfy right now? Maybe not. Not to be too much of a bear dancing through the bullishness of the stock market reports, but there’s something troubling about the numbers. Perhaps we should begin at the beginning.
The Truism of Yesterday Transformed into A Corporate Facade Today
In those days of yesteryear, before the late 1970s, corporations retained most of their earnings and invested them in new technologies, expanded facilities, more employees, or even – pay increases. [WP] Indeed, in those ancient times the argument worked: If corporations could hold on to more of their earnings then plants would expand, and more workers would be hired. What our numbers keep telling us now is that this old line is being applied to a new and quite different reality.
Not to put too fine a point to it, but it is as though the Captains of Corporate America are asking us to cling to the old reality while they saw the props out from under average Americans, creating a more profitable system for themselves. And they have been sawing away vigorously, fueled by the new corporate reality since 1980 which holds that the primary purpose of a corporation is to maximize shareholder value.
It is one thing to seek to enhance corporate profitability if the old line is true, and quite another when the goals have changed, and the new line is “Corporate profits are important because they make shareholders richer.” The pre-1980 truism is now a corporate facade covering a structure which places the demands of shareholders above customers, workers, and almost everyone else.
In some instances the facade is a very real false front inadequately covering the hollowing out of American industry. Remember Endicott, NY, the home of IBM? Some 10,000 employees of IBM worked there in the 1980s, by 2013 employment at IBM was down to 700, and the vacant storefronts in the community bore witness to the diminishment of the real American economy. [WP]
Since, Ferguson, MO has been in the news of late it’s appropriate to look at the moves made by Emerson Electric to enhance shareholder value by offshoring its operations – with its $44.68 billion market cap, and return on equity of 24.38% [YahFin] Emerson was praised in at least one financial journal for its long term strategy of “transferring costs to a basket of low-cost countries,” yielding the accolade: “Emerson is well known among its peers to have benefited considerably from being earlier and bolder in its pursuit of cost mitigation.”
That cost mitigation came with a price, but not for Emerson’s shareholders. On January 18, 2002 Emerson announced it was closing 50 of its plants and offices in the United States and moving the jobs to China, India, and the Philippines. No sooner was the announcement made than Emerson’s stock price increased by 3.4%. [SunSent] The Emerson plant in Kennett, MO closed in 2005. [DDD] Another plant, in Columbus, NE, closed in 2009. [WOWT] If it seems counter-intuitive to have share prices increase as people (consumers) are laid off that’s because most people have missed the point: It’s not how many people a corporation employs or how much their wages bring to our economy – it’s how costs can be “mitigated” so that shareholders get an increased portion of the pie being served.
Keeping the Shareholder Satisfied
If a decreasing number of people are enjoying an increasing share of the American economic pie, then why wouldn’t current stock market reports be indicating weakness in the economy?
Same answer. Shareholders are happy. One of the reasons for their happiness is that corporations are “mitigating costs” and propping up stock values. One way to prop up the old shareholder value is to engage in stock buybacks. Does Corporation X have lots of cash on hand? The best way to keep those shareholders happy is to use it in a stock buyback which results in a decrease in the number of outstanding shares and drives up the price of the ones which are on offer. [Forbes] Yes, that cash could have gone into research and development? Or, plant expansion? Or, even increased wages? However, those don’t make the shareholders happy, and since 1980 it’s been the primary job of corporations to make the shareholders happy, happier, and happiest.
And who else loves making shareholders happy? Bain Capital Management, which extolled the virtues of corporations which do the hard work of making shareholders, like Bain Capital, happy:
“In studying the offshoring practices of major industrial companies, we’ve found that Continental’s highly modular approach is shared by other supply-chain leaders like General Electric, Honeywell, Siemens International, and Emerson Electric. Rather than think in terms of entire factories when they make offshoring decisions, these companies focus on individual functions and products. They optimize, in a coordinated fashion, the location of every module of their supply chain, capitalizing on regional differences not only in costs but also in skills. As a result, they’ve been able to move quickly and with great agility, shifting activities among a wide array of regions and countries in a way that optimizes the cost and effectiveness of their entire operating system.” [BainInsights 2005]
It’s worth noting that when Bain speaks of “optimizing costs” it means reducing production and service costs, as in closing factories and offshoring jobs. Hence, the formula continues: Shareholder Happiness = Cost Mitigation + Propping Up the Stock Price.
The danger in not heeding this formula is the dreaded Takeover. Should some shareholders find their yields too low, the vultures begin swarming over the still warm victim.
There is a reminder of the perils of the dreaded takeover in north St. Louis. The old Rexall Drug Company plant stands at the corner of San Francisco St. and Kingshighway, now the site of an automobile auction company. The quick part of the demise began in 1977:
By 1977, Dart Industries had sold all of its Rexall business, including franchised drug stores. A group of investors, including Howard K. Vander Linden, president of Rexall at the time, formed the Rosshall Corporation and bought the manufacturing laboratories in St. Louis and other facilities. [NYT]
As part of the process the Rexall Drug Store franchises were spun off, a familiar drug story could retain the name but now had no affiliation with the parent company. It didn’t take long for the scheme to fall apart. The retailers were under pressure from chains like Eckerd, the manufacturing under pressure from various manufacturers, and the grand experiment failed. The St. Louis factory closed, and the Arlington neighborhood lost another industry. Rexall wasn’t the first, nor the last takeover victim, brands like Sunbeam and Singer also changed dramatically in the face of both friendly and hostile takeovers. The brand most closely associated with recent takeovers which have decimated a corporation remains Hostess, which was destroyed, not by its employees, but by the vulture capitalists who plucked it. [Salon]
True, there are unresponsive companies which fail because of a lack of vision, firms that falter because of poor management, and corporations which are takeover targets because there are some few valuable assets among a conglomeration of acquired flotsam and jetsam. However, the end game should be the improvement of a company such that it can be profitable, not merely the M&A gamesmanship which too often plays strip and run, leaving little but debris in its wake. However, those games will continue as long as there is a profit to be made by the investors – how much greater the danger to U.S. corporations in the prospect of upsetting those private investors than of disappointing the shareholders?
This isn’t our parents (or grandparents) economy. The days of cash allocation into research and development, plant expansion, higher wages, better facilities is as out of date as a Pontiac Firebird. These are the days of the F-150, and the maxim: “If the shareholders ain’t happy, ain’t nobody happy” – unless you’re a taxpayer, consumer, salaried or wage worker?