I would like to discuss a topic today which has been on my mind for some time but, so far, writing about it had not gotten the upper hand over fighting the waves the markets have been throwing at us. My topic is our corporate model.
How will our companies – global, public companies – change over the coming years after the twin onslaught of the financial crisis and emerging countries (which seem to be really emerging this time round)?
One trend, already in place, is to see global companies seeking ever more intensely the markets of China and India, and to a lesser extent, Brazil and Russia. BRIC will grow in importance and will absorb more management attention and corporate resources as companies seek to take advantage of the material progress of huge populations.
What makes China and India special, of course, is that both are going for growth, many consider their chances of success to be above average, they are starting from a low base of material wealth and therefore have a long way to go on the upside, and they both have gargantuan populations. Brazil and Russia are smaller but still huge, and many believe both will continue to develop rapidly, perhaps the first with better prospects than the second.
Consider this: out of every ten people in the world, two are Chinese and two are Indians. India now has 1.1 billion people and is thought to soon surpass China, currently with a population of 1.3 billion. The USA and Canada have a population of 340 million, slightly more than Brazil (192 million) and Russia (141 million) together. The EU has a population of 500 million. The world is estimated at 6.7 billion.
As global companies seek growth in China and India, they will seek to curry favour – who can conceivably imagine doing business in a country unless welcome by that country’s government?
If China and India continue on their growth path, they will garner more influence and power. If they don’t like something, they will say so, and will work towards changing it. China and Russia have already expressed a preference for a global reserve regime which is not “unipolar”, that is, that does not depend on one national currency (read, of course, the preeminent US dollar).
As global companies move, so will the locus of the main securities exchanges: they need a hinterland, they need companies and organizations which seek to sell paper, and they attract investors who want liquidity.
One notes how we struggle with the fate of the Big Three while Tata Motors (TTM) in India unveils the Nano, a 67mpg car retailing at $2,000. China wants to be world leader in electric and hybrid cars (see link).
The worst we can is to shut our trade doors and play ostrich, heads in the sand. The best we could do is to promote trade, each country and region specializing in what it does best. How North American and EU countries react to BRIC is likely to be the most defining diplomacy this century and next.
The financial crisis may generate a second trend: a move towards more direct financial intermediation by global companies. Very few ever suspected that, in this age of globalization, the most basic of market functions, financial intermediation, would suffer such a seizure. Solid companies, triple-AAA rated groups, such as Buffett’s Berkshire Hathaway (BRK.A) have to pay more for money than banks running on negative capital. The financial crisis brought home the realization that financial intermediation cannot always be trusted to be there when needed.
We see how Germany came to the assistance of banks which are part of automobile manufacturers, such as BMW Bank. Insuring the deposits of such banks meant an indirect, and unavoidable, state guarantee of funds for these manufacturers. It may not be a bad idea for a global group to have a substantial bank in its stable. We look at GE now as being burdened by GE Finance – maybe, soon, we might look at GE Finance in a different light, especially as Main Street deteriorates, with the worsening recession.
A third trend is likely to be the growing discomfort with the agency problem. I, for one, think that executives should be well compensated if they perform. The better they perform, the more the personal risk they undertake, the higher the pay should be. Executives are shareholders’ agents and their compensation should be proportional to profit.
However, there is a growing feeling that the system has now been configured in such a way as to be unfair on shareholders and that agents have hijacked their principals’ assets. In addition to high compensation, there is a reasonable suspicion that billions of dollars have been paid in taxes on fictitious profits which helped boost executive compensation.
Credit agencies, for the umpteenth time, have acted too late, thus failing investors, if not actually misleading them – had their reputation not been so low, one would have suggested that they rate management on efficacy and cost so that investors would have some idea about what they are getting into. As things are, it would probably be a waste of resources.
Still, assessing the cost of management in public management would be beneficial. After all, we assess mutual funds both on performance and on TER, their Total Expense Ratios. This should now be extended to public company management.
The only (partial) remedy I can think of is that investors should insist on transparency and a cash yield; I have already written about this earlier, “Equity, The Blind Optimist” (see the post dated March 11, 2009), and I hope to examine the matter further in one of the forthcoming Perspectives.
The best tax amendment President Obama can push for is to remove the tax penalty on dividend distribution – distributing dividends should be tax neutral.
As the tax laws stand, companies distributing shareholders’ assets back to shareholders suffer a penalty with the result that the agency problem is abetted. The reason our mothers taught us to put any extra cash in the piggy bank is to avoid us having it in our pocket to spend – the managements of companies with high retained earnings and flush with cash soon find a use for it, often not the optimal one. We know the sorry record of many acquisitions.
A fourth trend is for there to be more government regulation of business. If banks, receptacles of deposits and fully supervised, cannot be trusted to stay solvent, who can?
Already, the Group of 20 have “called for stricter limits on hedge funds, executive pay, credit-rating companies and risk-taking by banks.”
The libertarian philosophy seems to have lost the moral high ground.
Capitalism (for its characteristics, see my post of March 20, 2009) emerged out of the libertarian philosophy. What makes capitalism preferable as a system to anything else is that, in its ideal form, people are free to transact or not to. A person will only enter into a transaction because it is for his or her own good. This would in turn ensure that no one can do unto others what he does not want others to do unto him. This leads to the greatest benefit to the greatest number, as witnessed by the burgeoning of wealth where capitalism’s basic conditions are approximated. Government action, on the other hand, usually involves a cost on one person and a benefit to another and no free will.
None of the four factors dealt with here is new, only more acute. The corporate model, therefore, while reflecting these pressures, is unlikely to change radically, as many are assuming.
It seems to me, however, that the cost of equity will increase, as will dividend yields. Maybe, too, the pressures would be strong enough to push dividend yields above bond yields (see my post “Equity, the Blind Optimist”, dated March 11, 2009).
This article was written by