Friday, July 5, 2013

Andreas Schou on the dangers of a corporate short-term focus

All companies, but especially public companies, are measured on a quarterly basis. If a public company loses money in a particular quarter, its stock gets trashed. If a public company doesn't make as much money in a quarter as the analysts believe it will make, the stock gets trashed.

Performance is always based upon the reward structure. If I was paid based upon the number of proposals that I wrote, I'd be writing proposals day and night whether the customer bought anything or not. When executives at public companies are paid based upon quarterly results, their entire focus goes toward making the quarterly numbers as positive as possible.

How can they do that? Andreas Schou has described how one company did it:

(1) It shifted its pension fund into a higher risk category in exchange for higher returns. It funded its pensions accordingly. This freed up a bunch of cash. Then it paid out the cash it saved by risking the pension fund out in dividends.

(2) Around 1995, [the company] substantially cut its R&D costs. It then paid out the money it saved in dividends.

(3) The same year, it spun off [a subsidiary] as a hypothetically independent company....In reality, however, it only manufactured parts for [the company and its large competitors, who] used it as a place to stash their losses. Because of the exclusive relationship, the large...companies could simply demand particular prices and have those demands granted.

(4) Then, in order to raise the stock price -- the metric by which the CEO was compensated -- [the company] started issuing a large number of bonds, then conducted a series of share repurchases. Many of those bonds were purchased by the pension fund through an agreement between [the company and its union].

So, in the 1990s, the quarterly numbers of the company looked pretty good, but things were clearly not good a little over a decade later, when the company - General Motors - declared bankruptcy.

Read the whole story here.
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