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Monday, June 16, 2008

From Shareholders to Stakeholders

Unio I am an occasional reader of Megan McArdle over at Asymmetrical Information.  Take from this what you will, remembering that I also read the Huffington Post occasionally.  Ms. McArdle manages to attract quite a bit of ire.  I haven't quite developed the "universal theory of McArdle ire" yet, but I suspect the variables "political leaning," "logic quotient" and "vocal volume," are among the key variables in any formulation.  No surprise, then, that some of her readers might be annoyed should she have the temerity to suggest that unions might not contribute much to labor efficiency.  Ms. McArdle replies:

"But the idea that companies maximize short term profits at the expense of long-term returns is, to put it mildly, unproven."

Ah, but she fell for the reader's ruse.  Pity.

Throwing up the straw man of "the tyranny of the quarterlies" has nothing at all to do with the more central question the issue presents. The singular quandry when considering unions (or employees in general) is quite simple:  What is the function of the corporation?  The question of what public markets, and their rather obvious devotion to short term results, bring to the table is entirely divorced from the question of unions.  Moreover, the answer to short-termism is far simpler than resort to a survey of the academic literature on the presence (or absence) of short-term incentive effects of public markets.  This is because:

1.  To the extent there is a disutility to short-term focus of public markets, market actors have a fairly low-transaction cost recourse to recover any lost utility.  Namely, the "going private" transaction.  It should be obvious to anyone that where predicted loss due to costs of the public markets (like short-term focus and the deterrent for long term investment) exceeds going-private transaction costs, it is efficient to conduct a go-private buyout.  The imbalance is usually self correcting, provided the union doesn't resist the going-private transaction (ahem).  I might add that any study worth the paper its written on reports significant efficiency gains for properly executed going-private transactions (i.e. those where leverage doesn't get out of hand).  I suppose the argument here is that losses to the corporation are the increased cost of captial when stock price is depressed.  I'm not sure why unions would be upset by stock price except in captial intensive firms that are regular Wall Street customers owning to their constant (and frequent) resort to the capital markets to fuel growth.  In these cases, stock price could well cost employee jobs- but these are very forseeable effects.

2.  While variations in short term results may cause short term fluctuations in stock price, only management that has been poorly incentivized to focus on long term growth (through appropriate restricted share, option and other performance based compensation) will much care about "today's stock price" as opposed to, say, the 180 day moving average of same, or year on year change in stock price.  Then again, some stocks that don't look like they should be may well be very short term plays in capital markets.  Those equity investors looking primarily for, say, long term dividend yield, will, paradoxically, be rather sensitive to the very next dividend.  Drop one and these "long term investors" will exit immediately.  It doesn't, however, take much math to see that in capital intesive R&D stocks you don't need a lot of growth expectation factored into share price before long-term growth prospects are the main driver of share prices, not this quarters earnings.  (Pharma is a good example here).

3.  The presence or absence of a "short-termism efficiency drag" has nothing to do with the question of unions, essentially a labor issue that exists no matter if the company is private or public.  To present the alternative to unions as the "tyranny of the quarterlies" is absurd.  This suggests to me that Ms. McArdle's commentator was really beneath her notice.  But, that was already beyond obvious here:

"Any individual corporation would be best served by a return to servitude (company towns, anyone?). The system as a whole may well be better served by having a systematic counterweight to maximizing short-term profits."

And again here:

"As you think about that, remember that there are other values in this world than maximizing short-term productivity, like treating people with dignity."

I will set aside, for a moment, the results of "company town" experiments like Chicago's Pullman district (though I think history suggests a conclusion very much at odds with the reader's romantic notion of such arrangements).  More important is the question of what the "other values" that it is appropriate for a corporation to adopt are.  It will doubtless come as no surprise to regular Going Private readers that I am at odds with the reader over the central question, which he (she?) obscures with the tyranny of the quarterlies miasma.  There is a very dangerous modern trend to hold the corporation (usually by tasking the Board of Directors) accountable to the "stakeholders" (which is code for "shareholders plus."  Usually, this starts off as "shareholders plus employees" but often progresses to "shareholders plus employees plus community" and eventually to "shareholders plus employees plus general public."  This ignores two key issues.

First, corporations are simply no good at philanthropy.  Nor should we want them to be.  The central point of the separation of ownership and control is specialization.  Giving to charity (and having ones gifts actually generate utility) is hard, laborious work.  Do we want management spending the time to do this work?

Second, assigning any responsbility to the corporation other than to make a profit for the shareholders (be that short term or long term) is very dangerous.  By what standard do we measure this obligation?  Is the corporation beholden to the employees to provide employment?  To the community to provide tax revenue and gainful employment to its residents?  If so, shouldn't we take all modern tools away from the employees and instead provide them with a dull spoon for all tasks?  Oh, I'm sure you might think that inefficient, but there are other values than the efficient direction of labor for the benefit of the shareholders- my dear friend.  Afterall, in order to maintain the production schedule its clients demand, the corporation would quickly be the largest employer in the state.  Now that sort of good corporate citizenship is hard to shake a stick at!

Tuesday, June 17, 2008

Obfuscation By Any Other Name

Mudd Alarmed at the implications of directing corporations to ultimately serve only those who actually provide the capital to fund their business ventures, Labor and Capital vigorously agitates the water in a frantic effort to stir the silt and augment the general leftist miasma required to form a left-favorable argument about the nature of the bottom of the river.  I've watched Labor and Capital warily for awhile, as surely its mandate, "...getting the labour movement and the Left to understand the capital markets properly," is beyond hopeless and therefore the author either an idiot (which would seem contradicted by the prose) or possessed of a dangerous agenda and very cunning.  This is my favorite part of the recent post:

Hence leaving 'shareholders' in charge of companies must be the right thing to do because they have the self-interested drive to keep them on the right track. It's an elegantly simple idea, but rather messed up by the reality. Hence the identity of shareholders is usually left vague.

Really, I haven't run across a more shortcut laden yet convoluted and obtuse bit of prose since Pevear started translating Tolstoy.  I am all for creativity in the written word, but this tendency to obscure basic meaning and torture interpretation in the pursuit of social-political goals must end sometime.  The definition of "shareholder" is quite simple.  Do you hold a share?  You are a shareholder.  Don't hold a share?  Not a shareholder.  Absolutely fucking brilliant, no?

I'm not even going to touch the part where it is argued that because a pension fund holds shares and a pension fund is "the public" that "the public" is a "shareholder."  My aversion there is pure self-preservation.  I mean really, where in the world could I ever take that argument?

Saying that anyone who has a "direct stake in the success" of a corporation somehow the corporation must be beholden to is beyond dangerous.  The IRS (and by extension the treasury) has a direct stake in the success of a corporation.  Is the corporation required to maximize the taxes paid by virtue of this "direct stake?"  Why not?  Same argument.  Ah, perhaps the IRS is just slightly less sympathetic a victim than the local union worker.  Yes?  Well, that particular sympathy should certainly bolster the argument's actual merits, no?

Interestingly, there are a few academic studies on the effects on union cohesion (and power) where corporations are more generious with their equity.  Amazingly, "pro-labor" initiatives of the sort advanced by unions fall flat on their face as employees have larger portions of their total compensation linked to equity.  Guess it doesn't seem so cool to commit massive amounts of capital to expensive, even ruinous (ahem, Detroit) defined benefit pension plans and headcount commitments when your financial future is actually linked to productivity instead of paycheck extortion.  I know it is hard to believe, but somehow it appears that incentives work.  Also, I believe the planet already tried out that whole "workers unite" experiment a few times.

Want to use your financial assets in a "socially responsible way" (whatever that means)?  Sell your shares and give the funds to the "socially responsible" chairty of your choice.  But then stay out of the damn shareholder's meeting.

Wednesday, June 18, 2008

Apple Orchard

revenue The usually excellent Cluster Stock comments on the change in Apple's iPhone revenue model and a recent Morgan Stanley report: "At $200 a phone, that's $5 billion of revenue. Despite the recent price cuts, Morgan Stanley uses an average unit price of $550 per phone. This seems far too high to us, but 27 million units at this price would yield almost $15 billion of revenue."

Hmmm.  As a reader indicated in the comments section, the price cuts are due to AT&T subsidies, so the revenue to Apple is about the same.  It doesn't take much checking to see that subsidies of $200 - $300 are not at all unusual in the industry (see e.g., Treo, BlackBerry, etc.)  The offsetting issue is that AT&T is no longer giving the 30% of recurring contract service revenue to Apple.  One assumes these figures are about offsetting (though it is interesting to wonder if whoever decided they were balanced discounted the revenue against Apple's cost of capital and how far it was discounted and what the provisions for revenue sharing with contract renewals and the like were).

One wonders if Cluster Stock counted AT&T service revenue to Apple as "iPhone" revenue before when the percentage of total Apple revenue attributed to the iPhone was calculated?  What impact would this have on the calculations?  I suspect the figures are pretty offsetting, leaving any future gain in iPhone revenue as a percentage of total revenue really subject to iPhone sales growth v. other sales growth at Apple (i.e., the new application store- new iMacs, Macbook Air, etc) and not the new revenue model which is probably pretty neutral.

Given this, some other things are being, I think, overlooked.  Note what this does for Apple:

1.  Apple now has a consumer priced device to drive volume, having shifted a good bit of this burden to AT&T.  One expected this move since the original deal was cut before the success of the device was certain.  Apple has been quite expert at price discrimination.  Starting with $600 phones, slipping down to $500 and then $400 phones, and when they got a bit too aggressive rebating down customers who got caught just a month or two before the reduction.  Apple proved, again, that they can command larger margins than anyone else in hardware.  Once the early adopters were approaching saturation, they needed to shift down the curve and capture those customers.  Since Apple had resisted subsidies early on, they now had a ton of room ($200 - $300 per phone) to head down without sacrificing revenue any more.  It was AT&T's turn to pay.  And why not?  They had signed a ton of contracts from customers they did not have before the iPhone exclusive- and more importantly, taken many of those from their rivals.  Apple knows what they are doing when it comes to price discrimination.  (Consider how expensive their RAM upgrades are).  Apple holds all the cards.

2.  Apple's revenue is not tied directly to AT&T's service performance, or to AT&T's accounts payable lag or collections risk.

3.  Apple is much freer to defect from AT&T now without impacting revenue.  Note, the switch to "cash now" from "ongoing revenue" looks much better if Apple plans to bail on AT&T soon.  (Assuming $300 in subsidies, and a doubling of sales due to the price drop, Apple pockets an extra $400 (another phone sale) and loses Apple's 30% take per month on around $70 in AT&T revenue, (probably more like $100).  That looks to me like a breakeven for Apple after 18 months.  But if Apple was giving up 3-4 years of contract revenue, Apple is taking a loss.  What does this say about Apple's expectations for: A. Sales growth due to the subsidies.  B. Length of the AT&T relationship?

4.  Apple is pretty much locked into these lower magins now.  Traditionally, this means Apple has medium term plans for a significant hardware development to return to the right side of the price discrimination curve.  Subsidies can eventually lock a manufacturer into a network provider.  That's dangerous, and Apple is not acting like they plan an exclusive AT&T marriage forever.  I've speculated on the possibility of an Apple owned network provider in past.  Doesn't seem impossible, but who knows?

Thursday, June 19, 2008

A Brief Delay

Ican Unfortunately, there will be a brief delay in service while I dry off my undergarments and descend into the plateaued euphoria of the newly minted Icahn Report.

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